Spell out what your broker needs to know

February 18, 2005

To protect yourself in case of a dispute, make sure you spell out this information—in writing.

Next time you open an account with a brokerage, keep in mind that the information the firm gathers regarding your family situation, income, net worth, and investment goals may prove decisive if you later have a dispute.

Suppose a doctor-client has indicated on the form her broker had her fill out that she's retired, with modest assets, a fixed income, and a very conservative goal-to guard principal. "If a broker brings such a doctor into speculative areas, that would be exposure to inappropriate risk-and if losses occur, that doctor probably has a valid claim against the firm," says Connecticut arbitration consultant Jerome Olitt.

So, to help your broker make the right decisions-and to protect yourself if he doesn't-be as accurate as you can in describing your finances and investment objectives.

And beware brokers' games. "Plenty of tricks are played with profiles," says securities attorney Steven L. Miller of Encino, CA. "Often, brokers fill out the form for you. Some will encourage you to exaggerate your financial strength and risk tolerance, so the firm's computers will permit the broker to sell you more speculative investments or perhaps allow you to invest more than you should on margin. But if your account runs into trouble, those inaccuracies or exaggerations protect the broker and the firm."

If the questions about your investment experience and objectives seem sketchy, consider writing a letter to fill in some details. Also write a letter any time your broker increases your risk more than you want, or doesn't contact you promptly when things change. Letters can be a big aid in presenting a winning case. You want a record of your investment goals, and of how carefully the broker is heeding them.

Securities attorney Mark E. Maddox, past president of the Public Investors Arbitration Bar Association, agrees. "If you're not interested in speculation or aggressive growth, say so explicitly in the letter," he advises.

Speaking of letters, advises Olitt, "many firms will send an 'activity letter' saying they hope you're pleased with them, and they hope broker John Doe is working with you well. They often ask you to sign and return it." That's not courtesy; it's very specific strategy. The firm sends out such letters when it detects possible problem areas, like "churning" (excessive trading). So it's creating a paper trail showing that you were satisfied with the way your account was being run.

"I advise you never to sign one of these," says Olitt. "It might cost you money someday."