Want To Take On Your Broker?

Investors' odds have shrunk in recent years. Even if you win, don't expect a windfall.

Perhaps the thought ran through your mind as you watched the stock market plummet and the value of your portfolio melt in the summer heat. "My broker is going to pay for this!" Alas, brokers rarely do--and when there's an exception, they usually don't pay much.

As a rule, you cannot sue your broker. You waived that right when you signed up for a brokerage account, which included agreeing to take any disputes to arbitration. It has always been tough for investors to prevail in these proceedings, and a recent report suggests it's getting even tougher. According to a study of 14,000 arbitration cases from 1995 to 2004, in the late 1990s plaintiffs won 59% of their cases and recovered 38 cents for every dollar in damages they claimed. By 2004 only 44% of plaintiffs prevailed, and they collected 22 cents on the dollar. (You can view the study, Mandatory Arbitration of Securities Disputes: A Statistical Analysis of How Claimants Fare, at slcg.com, the Web site of the Securities Litigation & Consultation Group.)

Plaintiffs' attorneys such as Daniel Solin, the study's co-author, say the data show that the arbitration system is flawed. Linda Fienberg, who heads the dispute- resolution unit at the Financial Industry Regulatory Authority (FINRA), has a different take. She says the win rate was higher in the 1990s because regulators were aggressively pursuing "bucket shops," and investors were able to take advantage of that. Now, she adds, "there have been fewer rogue brokers, and large firms have been settling a larger percentage of cases."

Either way, you need to think hard before going to arbitration. Unlike a civil suit, where justice is served by a jury of your peers, in arbitration it's dispensed, in part, by members of the securities industry. On a panel of three arbitrators, one is an "industry" arbitrator--generally a current or former brokerage-firm employee. The other two are "public" arbitrators, i.e., professionals who arbitrate for a living.

Before a hearing, both sides get a list of eight arbitrators for each position and get to knock off four from each list. Plaintiffs' attorneys say brokerage-firm lawyers tend to bump those who have awarded big payouts in the past. By the same token, says George Friedman, executive vice-president of FINRA, investor attorneys can veto arbitrators who have awarded too little.

Brokers settle about 70% of claims before they reach arbitration. Settlement data are confidential, but arbitration attorneys say payouts are likely to be small. Still, plaintiffs' lawyer Solin always recommends that his clients take a settlement if offered. "If you go to arbitration, there's a risk you get zero," he says.

Just because you lost money doesn't mean the broker erred. Successful cases often revolve around investment suitability. "If I tell my broker I'm a conservative investor, and he puts me in volatile tech stocks, that's a good case," says arbitration lawyer Jacob Zamansky of Zamansky & Associates in New York. Your sophistication as an investor is also crucial, since the opposition can argue that you should have known better. "If the client is a novice who didn't really understand what the broker was saying, that bodes well for his chances," he says. Older and less affluent investors often fare better, too. "It's one thing if you're 30 and you can earn the money back," Zamansky adds. "It's another if you're retired."

Even if you have a good case, pursuing it is expensive. Lawyers often charge a contingency fee of 33% of winnings. Then there are filing fees, charges for each day of arbitration, pay for expert witnesses, document recovery and stenographer costs, travel, and loss of wages.


Gayle Kennedy of Center Point, Tex., says her family spent some $600,000 pursuing a $10 million claim against Salomon Smith Barney and its star telco analyst, Jack Grubman. They also spent innumerable hours reviewing 20,000 documents. "We had to go through years of account statements," she says. To have any chance of winning, good records are a must. Any e-mails your broker sent hyping a stock, any conversations you had where you took notes, your risk-profile questionnaire, evidence of your investing style and sophistication are invaluable.

Still, Kennedy's case failed, as have 70% of the cases against Grubman and Salomon, even though the firm paid $400 million in fines in 2004, and Grubman was barred from the securities industry. "The analyst is not the broker providing advice," says Marc Lackritz, CEO of the Securities & Financial Markets Assn. "These cases are harder to win."

Arbitration also carries psychological costs. One of Solin's clients, Mary Jane Schwartz, a retired emergency-room nurse whose broker lost two-thirds of her $2 million nest egg, felt opposing lawyers were particularly invasive. "What happened to my account should've been the only thing they talked about," she says. "But they put me on trial, talking about my divorce, my parents dying. They called me an opportunist. I've never done anything bad in my life." The arbitrators awarded Schwartz $5,000--and charged her $6,825 in "forum fees."

Smaller cases are almost always better. Investors can file a simplified arbitration claim for damages of less than $25,000, with the forms available at finra.org. Instead of a hearing, one public arbitrator rules on your case. The win rate is about the same as with larger cases, but the payout is often higher, averaging 33 cents on dollars claimed. Lawyers generally won't take a case worth under $100,000, though, so you'll probably be on your own.

For some plaintiffs, pursuit of a claim may be worth any cost. "I knew in the middle of the process that no matter what I did, I couldn't win," says Schwartz. "But I had to go through with it. I said: 'Mary Jane, you'll never forgive yourself if you let them get away with it.'"

By Lewis Braham

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