Give Me Back My Money
When you've been done wrong, you can win the ARBITRATION game.

By Jeffrey R. Kosnett

Erwin Andersen, a self-employed construction engineer, runs his business from his cell phone. So when his handset chirped early on an October morning two years ago, as he worked at a Kmart building site in Chicago, he didn't expect it to be his broker, Jack Lantis of A.G. Edwards, talking options.

Andersen says that Lantis persuaded him he cou ld grab a quick $1,600 profit by selling some Dell Computer options he owned. But after the market closed that day, Lantis called back with a "problem." Dell shares had just plunged, and remaining in Andersen's account were other options that obliged him to buy Dell shares at a price above what they now traded for. (The options he sold in the morning had hedged his exposure to this risk.) The effect of the day's events: Andersen faced a margin call of $25,000.

The broker advised Andersen that he could satisfy the margin call by buying back the same Dell options he had sold that morning, plus other Dell options--but now it would cost him more than $27,000. To raise the money, Andersen sold options positions on other stocks that, as luck would have it, would have won big. When the dust settled, Andersen's account was wiped out and he owed A.G. Edwards $3,700.

Andersen later argued in an arbitration claim that the episode cost him $36,000 in actual losses on the Dell options and others he sold to cover shortages in his account, and $89,000 in profits he would have made had he not sold all his option positions because of the Dell disaster. A panel of three arbitrators awarded Andersen $64,000 plus interest and all his legal costs. Although lawyers for A.G. Edwards called Andersen a speculator who knew more about high-risk options trading than he let on, Andersen not only prevailed but won back more than he had lost. You can win, too--if you have a strong case, a good lawyer, complete records, and a strong stomach and patience.

Pressing an arbitration claim isn't cheap. A two-day hearing by a three-member panel of the National Association of Securities Dealers (NASD) cost Andersen $4,500. (If you win, the other side usually pays.) Legal fees and the cost of an expert witness can reach five figures. And even if you win, collecting the money you're awarded can be a problem, especially if your claim isn't against an established firm. Many losers of arbitration cases are missing, defunct or have filed for bankruptcy protection.

Investors recover something in three-fourths of the arbitration cases they file.

Learn the odds

Aggrieved investors can beef about the arbitration system, but they're stuck with it. Arbitration is used by the brokerage industry to avoid lawsuits. So in most instances, when you open a new brokerage account, you agree to take any "controversy" to arbitration. Arbitration allows no right of appeal. Punitive damages are rare, and there is no jury to impress. Cases are decided by a three-person panel, one of whose members is involved in the brokerage business. The other two panelists are "public" representatives, such as college professors or retired business people. To get even, you need to grab control of the process and stay on the offensive.

Roughly 6,000 arbitration claims are filed each year, a number that has held steady since 1995, after big increases earlier in the decade. The issues most commonly fought over involve investor claims of breach of fiduciary duty, misrepresentation, negligence, churning and unauthorized trading.

NASD data indicate that investors receive an award in 50% to 60% of the cases decided in arbitration. About 60% are settled before they reach a hearing, so investors recover something in about three-fourths of the arbitrations. But how much? There are no statistics on settled cases, but from 1992 to 1998 NASD arbitrators awarded about half of the amount claimed. Arbitrators rarely award lawyers' fees unless the investor asks. But if you do win and ask to be reimbursed for your legal fees, the odds favor you. In 1998 arbitrators awarded attorneys' fees to 68% of winners who asked for them.

For most investors, whether they are satisfied with the system depends on the outcome of their own case. Alex Philibert, 66, an engineer from Philadelphia, got an NASD panel to award him $43,000 (but not the legal fees he sought) for a back-office mess in which a stock certificate for 741 shares of AT&T belonging to his late father was mailed to the wrong address, lost and never replaced. Philibert says the three arbitrators were "savvy" and "very professional," but he had sought $300,000, including punitive damages, and thinks he could have done better in court. Philibert's attorney, Debra Speyer, says she believes the outcome was fair.

Rami Kichi, 34, a gem trader and importer from Miami, says he caught vibes during his hearing last summer that he might not win his six-figure churning case against a group of brokers from two firms. So he agreed to settle for about one-fourth of his claim. He says one of the brokers still owes him $65,000 of that settlement. His lawyer, Alexander Novak of New York City, says the settlement was reasonable.

There is one way to shorten the process. If your dispute involves no more than $25,000, you can file for "simplified arbitration," which costs less and is heard by one arbitrator. Such cases are usually handled entirely in writing. Because there does not have to be a hearing unless either party requests one, the case should move faster.

Find a good lawyer

The first task is to consult someone who can tell you if you have a realistic claim. Stick with a lawyer who specializes in securities arbitration. Some experienced investor lawyers, who generally work on contingency for 30% to 40% of the award, refuse cases involving less than $100,000.

While it may take three or four interviews, you should be able to find suitable counsel. One source of referrals is the Public Investors Arbitration Bar Association (see the box below), whose members may spend no more than 20% of their time (which also applies to their partners) defending brokers or securities firms.

You can fight a big case alone, but invariably your opponent will have a legal team that knows the process. One common tactic in cross-examination is to try to goad an investor into an embarrassing stream of contradictory statements under oath. Another is to paint the claimant as an educated and experienced investor who was greedy, failed to read account statements, never complained to supervisors, and should have known better. Investor lawyers coach claimants on how to beat back such counterattacks.

Build a winnable case

To prevail in an arbitration hearing, you can't just testify that you were bilked into buying illiquid penny stocks while the honest market soared. You must unleash the malodor of misconduct, or prove errors or incompetence.

Complete records will help you make your case. New York lawyer Jacob Zamansky looks for instances in which an investor was charged way too much by adding up commissions, margin interest and other costs. In some cases, Zamansky finds that the broker levied charges totaling 40% or 50% of the investor's account balance. "That means the investment would have had to make 51% for you to more than break even," he says. "No one in their right mind would assume that kind of risk." Zamansky likes those cases.

Another sign of a winnable case is when the broker says, in effect, double or nothing. "Let's say the guy has a half-million dollars and loses $200,000 of it," Zamansky says. The investor tries to close the account but the broker pleads that he can get the money back. "When you're down, a lot of people want to hear that. But the broker then engages in more highly speculative activity and loses the rest of the money. I've seen a lot of these two-step things."

Many investor lawyers insist that an expert witness--such as an authority on options, or a forensic stockbroker, who can uncover improper commissions and markups--makes the difference. John Lyman of Clearwater, Fla., a former broker who is now a professional witness, says claimants who don't have expert backups are "jumping into a shark tank." His job is to prove the extent of damages and testify about technical points that the opposition would rather ask the investor.

Andersen knew little about legal tactics. He just wanted to get his money back.

Savor the triumph

Andersen, the construction engineer who came to grief trading options, quit school after the eighth grade and knew little about legal tactics when he decided to arbitrate his case. He just wanted his money back. A few days after the margin calls, he faxed a complaint to Lantis's manager in Springfield, Mo. He thought the brokerage "might put me back the way it was." Instead, Andersen says, Edwards wrote him back offering to forgive his $3,700 debt if he would waive any claims against the firm or its employees. He refused.

Andersen, 55, who lives in Bradenton, Fla., found his lawyer, Drew Clayton, in Sarasota, Fla., through an acquaintance. Clayton showed Andersen's records to an options expert, who saw grounds for a case.

Andersen says he relied on Lantis, his broker for seven years, to be sure he was only in positions where he could lose no more than the price of the puts and calls, as options are known. Huge margin calls were not part of the script. So Lantis set up for Andersen what is known as a straddle: offsetting options on the same stock that limit potential profits but also prevent big losses. By selling some of the Dell options but keeping others that would have required him to buy Dell shares at an even higher price, Andersen had (in Wall Street parlance) "lifted one leg" of his straddle. Then Dell stock fell sharply that Tuesday, obligating Andersen to buy a huge number of Dell shares for far more than what they were worth--hence the margin call.

Although the sides disagreed on how well Andersen understood options, the case seemed to hinge on whether it was Andersen or Lantis who decided that Tuesday morning to sell the Dell options and thereby light the bonfire that melted Andersen's money. While Andersen pointed the finger at his broker, lawyers for A.G. Edwards argued that Andersen originated the dangerous trades.

Noting that Andersen had switched his investments from blue-chip stocks to options, that he listed his objective as "speculation," and that he had attended a seminar on aggressive options tactics, Edwards attorney Michael Naccarato called Andersen "a sophisticated and experienced investor." Andersen admitted that he had attended the seminar and hungered for quick profits. But he maintained that he never authorized Lantis to execute trades that would leave him exposed to margin calls.

NASD rules give both sides the chance to state their case, call witnesses and conduct cross-examination. At a hearing last July in a Tampa hotel, Lantis conceded to limited understanding of complex options strategies, according to Andersen's recollection. Andersen testified that he didn't realize his action on that Tuesday morning would expose him to a margin call.

To Andersen's surprise, the discussion at the hearing then moved away from who was to blame and toward options technicalities and his actual and potential losses. An expert witness handled most of the arbitrators' questions. "The first day," says Andersen, "we knew the thing was going to be won. The question was how much."

In a recent interview, Lantis, now retired, says that he talked Andersen out of many other options trades that would have turned out badly. He says he remembers little about the specific day's events that prompted Andersen to arbitrate except that this was the first and only options strategy of this exact sort that Lantis had ever handled among "thousands of trades" in his career.

As for losing, "when you have three arbitrators who are not sophisticated investors or familiar with the brokerage industry, this is what you get." Lantis also said that Andersen's attorney did a good job, and the consulting expert options witness was "able to sway some opinion."