Broker Poker

By Julie Rawe

No one complained about making too much money. Loading up on tech stocks seemed like a no-brainer when the bubble was inflating. Who knew we should have been blaming our brokers all along? Lawyers working on contingency fees, that's who, and they are eager to help recoup the $3 trillion that investors have lost since the NASDAQ tanked last spring. For retirees who fried their nest eggs or boomers who blew their kids' college tuition on margin, the road to restitution could be as easy as dialing 877-CAN-I-SUE (where you'll reach some New York City lawyers).

Most brokerage account agreements require disputes to be settled through arbitration, and lots of distressed investors are doing so. The National Association of Securities Dealers (NASD), which handles 90% of arbitration cases, is hiring more staff to help sift through all the Internet rubble. During the past five months, new claims were up 27% over the same period last year. Securities attorney Jim Shapiro has landed 70 "slam-dunk" cases since running newspaper ads in March that asked, "Have you lost more than $100,000 in NASDAQ stocks?" His argument is simple: even if customers clamored for more tech, their brokers had a responsibility to apply the brakes.

"Brokers forgot the rules," says lawyer Darren Blum, who won a $98,000 award last year after arguing that a broker failed to make suitable recommendations based on his client's assets and investment experience. The client, a 73-year-old bookkeeper in Hollywood, Fla., agreed to put nearly $200,000--or roughly 80% of his liquid net worth--into a stock he'd never heard of, Sigma Design. "I was buying like crazy on margin," says the bamboozled bookkeeper. "And I got wiped out."

Of course, investors forgot the rules too. (Diversification, remember?) So don't count on being bailed out by NASD arbitrators, who ruled against 47% of investors last year. "You never know what's going to happen in arbitration," says Deborah Bortner, Washington State's chief securities regulator. "It's a total crapshoot." Claims involving more than $25,000 are decided by three-member panels that can be swayed by the expert testimony of compliance officers or "forensic" stockbrokers.

While failure to diversify left many Americans with too much tech exposure, brokers often gave them fair warning. If you listed your initial investment objectives as "speculative" or received a call or letter from the brokerage firm stating that your portfolio had entered Riskville, "then you're S.O.L.," says Bortner, president of the North American Securities Administrators Association (NASAA). "People need to take responsibility for their actions."

But that sentiment goes against our inalienable rights to life, liberty and the pursuit of litigation. Even the talking heads on CNBC are being dragged into the fray. A pediatrician in New York City recently filed an arbitration claim against celebrity analyst Henry Blodget, accusing him of keeping a "buy" rating on a downhill dotcom because his employer, Merrill Lynch, was underwriting a merger pegged to the company's share value. Merrill Lynch insists Blodget did not know about the impending merger.

Analysts as a group, however, are being outed as cheerleaders. Comments made on CNBC have been shown to boost stock prices almost immediately, an effect referred to as "Blodgetting." And "sell" ratings are still issued about as often as famine warnings. Out of some 7,500 current recommendations on S&P 500 stocks, only 1% are "sells," according to Zacks Investment Research. "Analysts are the most relentlessly optimistic people in the world," says NASAA executive director Marc Beauchamp. "They make Pollyanna seem like Hamlet." Some regulators are calling for industry guidelines to expand analysts' conflict-of-interest disclosures.

Meanwhile, NASD is cranking out new rules to protect investors from themselves as well as from overzealous stock pickers. From now until November, and once a year after that, brokers must send a letter to each margin customer spelling out the risks associated with such accounts. This fall NASD and the New York Stock Exchange will raise the daily cash requirement for day traders from $2,000 to $25,000 and reduce the time they have to meet margin calls from seven days to five. NASD has also decreed that online recommendations must be tailored to a customer's investment goals and assets. But this long-awaited cybersuitability rule doesn't mean that do-it-yourself investors who sign up for a stock picker's e-mail alerts can start blaming the messenger. "The customer is setting the parameters, not us," says Schwab spokesman Glen Mathison.

Arbitration can cost a bundle in nonrefundable fees and takes an average of 12 1/2 months from beginning to end. And victory can be Pyrrhic. According to a government study, only a fifth of the $161 million awarded to customers was paid out in 1998, in part because investors were stuck dealing with paperwork while their dishonest brokers skipped town or filed for bankruptcy. Although NASD is doing a better job of tracking award payments, the agency can't force defunct brokers to cough up anything. Starting this month, however, investors in such cases will be allowed to bypass the mandatory arbitration process and ask a judge to start freezing assets before the deadbeats make themselves scarce.

NASD has also started posting arbitration awards online, armchair reading likely to delight and discourage in equal measure. Most lawyers won't even start sniffing if you've lost less than $50,000, which means your time may be better spent finding a new broker to rebalance your portfolio. The SEC urges investors to check a broker's history before opening an account. But its Central Registration Depository won't mention any complaints that were erased as part of settlement agreements, which took care of 41% of last year's arbitration claims. NASD has been dragging its feet in drafting a proposal to prevent expungement in most cases. "Brokers shouldn't be able to buy a clean record," says Charles Austin Jr. of the Public Investors Arbitration Bar Association. If brokers remain branded by complaints of churning and misrepresentation, fewer investors--or at least the ones who do their homework--may get burned next time.