The Claim Game
So you think you got burned by your broker. Is there anything you can do to get your money back? A look at legal options for the aggrieved investor.

Linda Stern

Ernie Petko was trying to stretch his 88-year-old mother's money. She had suffered a stroke and he wanted to make sure she could continue to afford a private nurse in her own home. So when her CDs came due, he asked his bank for advice. The broker in the bank's new investment department steered him to four different tech-heavy mutual funds, and last November, Petko, who says he had never invested before, handed over $158,000--all of her savings. Four months later the portfolio was down to $118,000 and Petko was looking for a lawyer so he could sue the broker. He's got lots of company.

The bear market for stocks has produced a bull market in complaints against brokers. Aggrieved investors are filing cases at a rate of one every 20 minutes at the National Association of Securities Dealers dispute-resolution office, where most securities claims are arbitrated. (You can't actually sue a broker; instead you must submit to binding arbitration run by the securities industry. More about that in a minute.) That's 15 percent higher than last year, and would result in 6,382 cases this year, the most in NASD history. "We have the heaviest caseload we've ever had in the history of our firm and we're turning away four or five cases for every one we're taking," says New York attorney Steven Caruso, who specializes in representing unhappy investors.

Most of the new crop of complaints sound a lot like Petko's. Conservative investors claim their brokers overdid tech, misrepresented the risks and stuffed their portfolios with unsuitable stocks and funds. Brokers are legally required to know their customers and recommend investments that fit their circumstances, but in the feverish day-trading days of 2000, many brokers got carried away, too. There's also been a rash of what the pros call "margin blowout" cases by investors who may have been unused to the sophisticated investing tools they were handed, says Debra Speyer, a Philadelphia lawyer. In these cases, investors borrowed against their portfolios to buy tech stocks, unaware that if the price of the stocks fell, the broker was free to sell any and all securities in the portfolio without notifying the investor to meet margin calls for additional cash.

The case of Petko's ailing mother is typical. He had power of attorney to manage her money, and says he told the broker he had never invested before. He claims his broker painted a rosy picture with charts showing how money invested back in the 1920s would be worth millions today. The four funds the broker recommended had more than 30 percent of their assets in high-tech companies at the time, according to an analysis by Morningstar, the Chicago-based investment-research firm, which said the funds were down an average of 31 percent in the first four months that Petko's mother held them. He got more heartsick with every monthly statement. "To my horror it was lower and lower and lower," but he says the broker encouraged him to hang on. The brokerage firm, Conseco Inc., disputes his version, saying that Petko signed a document when he opened the account agreeing to take higher risks for higher returns. It claimed in a letter to Petko that he was adequately warned of risks before he agreed to the investments. "He's trying to make this like a shirt he wants to return because it didn't fit," said Patricia Milner, the firm's spokesperson.

Not every loss is a legitimate case. It takes at least $50,000 in losses to get the contingency-charging lawyers interested, and even then they want a client who presents a strong case. Sophisticated investors who should have known better don't make good cases. Good claims against bad companies aren't worth their while, either: those firms might not stay in business long enough to pay awards.

Certain moves by brokers, however, make lawyers salivate. They relish brokers who encouraged investors to sell long-held conservative positions to buy pricey tech stocks, who churned accounts by trading furiously to compile commissions or who redirected clients' retirement funds to much more aggressive holdings.

Even a good case is no guarantee of a good outcome, because of the way arbitration works. Brokerage customers sign agreements that prohibit them from using the court system to sue their brokers, and more than 90 percent of the forced arbitration cases go to the NASD, which is an industry-sponsored organization. Only slightly more than half of last year's cases resulted in awards for investors. "It's a total monopoly," says Seth Lipner, a Garden City, N.Y., attorney and president of the Public Investors Arbitration Bar Association. Under NASD rules, one of the three arbitrators on a panel must be in the securities industry; frequently the remaining two panelists also have industry backgrounds, though they technically will have been out of the business at least three years. "Arbitrators are necessarily unsympathetic to the investing public and notoriously stingy," he says.

"I don't agree with that," says Linda Feinberg, head of the NASD's dispute-resolution program, noting that investors' attorneys help select the arbitrators that will hear their cases and that the NASD system is regulated by the Securities and Exchange Commission. NASD defenders say the system was understaffed and overtaxed even before the current spate of cases. Feinberg concedes, "We are always looking forarbitrators."

To speed and simplify the process, the NASD started a nonbinding mediation process and single-arbitrator decisions to put smaller cases on a faster and cheaper track. It has automated the way in which it selects arbitrators to make the pool more diverse. And even if case backlogs and arbitrator shortages start to stretch beyond the 17 weeks it now takes for a case to be heard, it will still be a quicker resolution for most investors than they would have if they were allowed to go to court, where a four-year wait is not unusual.

Even wronged investors who win claims shouldn't assume they'll get their money back. Almost half of all awards have gone unpaid because the losing companies file for bankruptcy or just disappear into the night, according to a General Accounting Office study completed last year. The GAO found that investors were able to collect only 20 cents on the dollar awarded to them by the arbitration panels, and those awards were already substantially lower--about 30 percent--than the amounts investors requested in their claims.

Investors might do well to protect themselves from the next fire, which will surely come once everyone has forgotten this dot-com debacle and invented some new paradigm. The best way to avoid legal squabbling is to follow time-tested investment precepts: don't invest in anything you don't understand, don't give brokers the right to trade without your approval and always review your statements. Investors who stay diversified, avoid margin investments and ignore hyperbolic brokers will probably be able to avoid lawyers, too, and killer statements like the ones causing all those tears and tribunals now.

Newsweek U.S. Edition