Doctors are often sitting ducks when it comes to brokerage fraud. Here's how to protect your hard-earned cash.
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Doctors are often sitting ducks when it comes to brokerage fraud. Here's how to protect your hard-earned cash.
Cesar V. Maderazo still gets upset when he recalls how his broker took advantage of him.
The trouble started in 1997, after the Phoenix internist attended a seminar conducted by Piper Jaffray broker Vincent H. Rossi. Impressed by the dapper and smooth-talking Rossi, Maderazo decided to let him manage his $1 million-plus portfolio.
Almost immediately, Rossi persuaded Maderazo and his wife, Leonor, to liquidate their holdingsmostly no-load mutual funds, the rest blue-chip stocksand invest in what turned out to be essentially equivalent funds. Besides a 1 percent management fee, the transaction also netted Rossi and his firm more than $26,000 in "dealer concessions," which should have been credited to the Maderazos but weren't.
Less than nine months later, Rossi again persuaded Maderazo to flip his portfolio, this time from mutual funds to an assortment of individual stocks. The annual fee on the new account was 1.7 percent. And since the Maderazos had held the traded funds for less than a year, their account was assessed a $21,000 penalty, something Rossi and his firm had neglected to disclose ahead of time.
Concerned about the higher commission but still unaware of the penalty and other problems, Maderazo decided to transfer his account to Paine Webber, where his son-in-law worked. Before, he'd resisted family involvement in his finances, but by this point he was "desperate."
Maderazo's son-in-law became suspicious when he reviewed the documents from the old accounts. Prompted to retain a lawyer, Maderazo filed a claim with the National Association of Securities Dealers, which along with the New York Stock Exchange arbitrates nearly all security disputes. These days, brokerages almost universally require investors to sign an agreement binding them to resolve disputes through arbitration.
In late 2000, an NASD arbitration panel awarded the Maderazos more than $147,000 in compensatory damages, attorney's fees, and other costs. "It was a harrowing experience," Maderazo says. "But I wanted to make sure this broker didn't do the same thing to someone else."
Other investors have felt equally aggrieved of late. In 2001, mediation and arbitration case filings with NASD Dispute Resolution rose to 7,088a 24 percent jump from the previous year. Negligence, misrepresentation, and unsuitability were among the most common allegations. Of the 6,915 arbitration claims filed, 4,149 60 percent were settled prior to arbitration. Of the remaining 2,766 cases, claimants prevailed more than 50 percent of the time.
Of course, investors always get cranky when markets sputter, and discontent may be especially high these days because so many investors have never experienced a down market. But the influx of investors in the market's red-hot days has also had another effect: "There are more people in the market than ever, and consequently more people being abused than ever," says Tracy Pride Stoneman, a Colorado-based securities attorney and co-author of Brokerage Fraud: What Wall Street Doesn't Want You to Know. So what if your broker isn't on the up and up? We talked to Stoneman and others to find out how to make your case.
"It's not that brokers are crooks or evil people, but there are such huge conflicts in their business, it's sometimes easy for them to just cross the line," says Stoneman.
The conflicts are inherent in the dual roles brokers play. On the one hand, industry rules require them to put their clients' interests first. "There's a broad range of products available," says Margaret Draper, a spokesperson for the Securities Industry Association, a trade group representing nearly 700 securities firms. "The broker's job is to know his client, and then match that client with the right product."
But brokers are also salesmen looking out for their own interests. Indeed, unless you pay a fixed management fee, your broker receives a commission each time he executes a trade for you. The more trades, the bigger the commission. For some brokers, the temptation to boost their commissions by buying and selling a lot of stocksknown as "churning" an accountis simply too hard to resist. And because in some firms the riskier the investment, the bigger the commission, brokers sometimes end up taking their clients on a speculative spree ill-suited to their investment goals.
Why do investors go along for the ride? In some cases, because the broker has done a good job of selling himself as trustworthy and knowledgeable. As for doctors, "they may trust brokers more than other people do, because doctors see them as fellow licensed professionals," says Douglas J. Schulz, co-author of Brokerage Fraud and an expert witness in the Maderazos' case. "Physicians are used to people trusting them because of their license, and they feel they have the right to do the same." New York attorney G. Alexander Novak agrees: "Doctors project onto brokers their own obligation to diagnose and correct problems." What doctors often don't take into account, he says, is the "showmanship ability of brokers."
Even brokers handling asset-based or fixed-fee accounts can dupe the unsuspecting. "I've known clients who've come in with a million-dollar portfolio and are charged a fixed fee of 1 to 2 percent of the value of their investments," says Novak. "The first thing I see the broker doing is changing the account from all cash to a margin account." That permits customers to buy securities with money borrowed from the brokerage firm.
"The margin may be as high as half a million dollars," says Novak. "Why? Because the broker then gets his fixed fee based on $1.5 million gross value, not on the original $1 million." If the market tanks, the customer may lose his initial investment and be responsible for repaying any margin amount outstanding.
Discretionary accountswhich empower brokers to buy or sell without a customer's prior knowledge or consentmay also pose problems, especially when the stakes are high. "Often, a hotshot broker will violate the cardinal rule of prudent investingavoid putting all your eggs in one basketand concentrate in one sector, like high tech," Novak says. "I represented a client whose discretionary account was run down from $5 million to $1.8 million that way."
If you suspect your broker of wrongdoing, you have several options.
Your first step should be to contact the broker directly. "The problem may be an honest and easily rectified misunderstanding," says the SIA's Draper. If that doesn't work, write to the branch manager, keeping your letter short and to the point. "We caution people to be very careful about what they put in writing, because an imprecise letter can hurt them if they later go on to arbitration," says Tracy Stoneman. If your letter falls on deaf ears or the remedy proposed is unsatisfactory, take your complaint to the firm's compliance department, the unit responsible for monitoring compliance with regulatory rules and in-house policies and procedures.
If these internal mechanisms prove unsatisfactory, consider filing a claim with the NASD, the NYSE, or another self-regulating organization with jurisdiction over your broker. If you choose the NASD or the NYSE, you'll have the option of resolving your dispute through mediation or arbitration. All firms must belong to the NASD and may also belong to the NYSE or another exchange.
To mediate a dispute, both parties must agree to appear before an impartial negotiator whose job is to work out a mutually agreed-upon solution rather than impose a remedy.
Mediation is typically faster than arbitration, which can take up to a year or more. It's also far less expensive, especially if you represent yourself, and it can often work to the benefit of a claimant with a solid case, says Linda D. Fienberg, president of NASD Dispute Resolution. Some observers say mediation may be the only avenue for claims of less than $50,000, since busy securities lawyers often shy away from taking smaller claims through the time-consuming arbitration process.
Mediation has its downsides, however. For one thing, it doesn't formally include discoverya method for obtaining relevant materials from the other partyalthough parties may agree to exchange documents prior to or during mediation. Discovery may be unnecessary if you already have on hand the documents you need to make your case. If you don't, you could be stuck. In such cases, says Fienberg, claimants sometimes "file an arbitration claim first, get discovery, and then decide to use mediation."
Also, because it's voluntary, mediation may prove ineffective in highly contentious cases. "I won't agree to mediation unless the other side agrees to put at least half of what my client is seeking on the table going in," says Stoneman. "Otherwise, I don't think mediation will be successful."
In divisive cases with plenty at stake, arbitration may well be the only remedy that makes sense. If so, first find an attorney specializing in securities arbitration. The best way may be by contacting the Public Investors Arbitration Bar Association at www.piaba.org . According to PIABA rules, member attorneys must have experience in securities arbitration, may not be employees or principals of a securities firm or commodities brokerage firm, and must devote less than 20 percent of their practice to representing such firms.
During the initial consultation, be prepared to supply a written summary of your problem along with all relevant documentsthe new account form, monthly statements, confirmations, correspondence, and the like. Your attorney will use these materials to gauge the strength of your claim. Don't be surprised if the "slam-dunk" you see strikes your attorney as a long shot.
Indeed, busy securities lawyers often reject clients for reasons other than the value of their claim. "Some attorneys shy away from wealthy or sophisticated claimants, because arbitrators don't always find them sympathetic," says Stoneman. Doctors, she says, fall into this categoryand firms are sometimes successful in painting them as investors who knew, or should have known, what was happening. "My response is that my client may be sophisticated in the field of medicine, but that doesn't mean he knows beans about the investment market or how brokerage firms work."
To set arbitration in motion, your attorney will typically file a statement of claim with either the NASD or the NYSE. The broker and his firm usually have 45 days to respond, after which all parties attempt to agree on the composition of the arbitration panel, which typically has three members, but may have just one in small cases. As in jury selection in civil trials, this is frequently a tricky process, requiring a good deal of give and take.
Complicating matters is the fact that one member of the panel is an "industry" arbitratora person employed by a firm or otherwise connected to the brokerage industry. In their book, Stoneman and Schulz cite critics who say "the industry panelist often sways the other members of the panel to rule in favor of the brokerage firm." But supporters say this representative is a necessary presence, because of his basic knowledge of the industry.
Arbitration allows for only limited discovery. Each side may request that the other supply documents and information, but neither may conduct depositions, except under extraordinary circumstances. Outstanding discovery disputesas well as the arbitration-hearing scheduleare typically worked out during a prearbitration hearing.
Until recently, the arbitration process typically took eight months to a yearstill far quicker than the average civil suit. But with the ballooning number of new case filings, some observers fear that time frame could lengthen.
To prevent problems before they begin, consider these tips:
Check out your broker or adviser before handing over your money. Get started by going to the US Securities and Exchange Commission Web site, www.sec.gov .
Read your new account form carefully. If it isn't accurate, send it back with your corrections. If it still has errors the next time you see it, think about switching brokersand maybe brokerage houses.
Read your confirmations carefully. If you don't have a discretionary account, be especially alert for trades marked "unsolicited." That means the trade was your idea, not your broker's, and he's signaling his supervisors to that effect. Often, "solicited" tradesthose initiated at your broker's suggestioncarry no label. If the trade was your idea, you have nothing to worry about. But if you're sure it wasn't, immediately write a brief letter requesting an explanation. The letter will put your broker and his firm on notice.
Watch out for heavy trading.
Think twice before signing a margin agreement. Margin accounts increase your risk significantly and, in a sudden down market, could hurt you.
If you have a complaint, put it in writing. And always keep good records.
If your investment goal or lifestyle changes, be sure to update your investor profile. After all, it's one thing for your profile to read "aggressive growth" when you're 25 and have few responsibilities, but it's quite another when you're 55 with an unpaid mortgage and kids in college. Also, if you suspect your broker is selling you unsuitable securities, an out-of-date profile might well doom an otherwise strong case.
Most doctors, like most investors, don't expect investing to be risk-free. "But we are expecting honesty," says internist Cesar Maderazo.
To learn more about your rights as an investor, to file a complaint, or to initiate arbitration or mediation, contact the following agencies:
NASD Regulationwww.nasdr.comNASD Dispute Resolutionwww.nasdadr.comNew York Stock Exchangewww.nyse.comSecurities Industry Associationwww.sia.comUS Securities and Exchange Commissionwww.sec.govPublic Investors Arbitration Bar Associationwww.piaba.orgThe Investor's Clearinghousewww.investoreducation.orgAmerican Association of Individual Investorswww.aaii.comInvestor Protection Trustwww.investorprotection.org
Wayne Guglielmo. Bad brokers: Dr. Maderazo fought back. So can you.