Like many doctors, you probably haven't read through the boilerplate. Much of it isn't as dense as it looks--and some of it can be dangerous.
Like many doctors, you probably haven't read through the boilerplate. Much of it isn't as dense as it looksand some of it can be dangerous.
Chances are, when you set up a brokerage account, you signed a form but barely glanced at the agreement or other paperwork that went with it. Who wants to plod through a lot of undersized print and oversized sentences?
But you should. If you do, you'll see some very ominous-sounding stuff. Some is mostly bark, but some can truly bite you. So you need to know where the hazards areand aren't.
Consider these examples:
If either example seems surprising, it's time to dig out your brokerage papers, brew some coffee, and maybe find yourself a magnifying glass. But first, read the rest of this article, so when you see all that fine print, you'll understand what it really means.
Then you can take steps to protect yourself. You may become more careful about your relationship with your broker, and review more fully any communications you receive. You may start creating a better "paper trail" of your own, too. That way, you'll be on safer ground should a dispute arise.
I acknowledge that I have read, understood, and agree to be bound to the terms and conditions set forth in the Customer Agreement as are currently in effect, and as may be amended from time to time.
Instead of asking you to sign a long contract, a brokerage house typically asks you to sign a nice, short form, usually called an "account application." That's less scarybut guess what? Somewhere near the bottom, the form usually has a clause like the preceding one from Fidelity. It means you're signing a much longer agreement, indirectly.
Sometimes, the agreement is attached. But it may be completely separateeven provided in a way that makes it seem peripheral. Charles Schwab & Co. prints it in a separate brochure. And one Fidelity account bundles the text with other material, in a pamphlet entitled "supplemental information." Since the pamphlet includes the heart of the agreement, that's a bit like calling a car's accelerator and brake "supplemental controls."
This one-two combination is really a way to ease you into signing: You don't skip the main agreement, you simply sidestep it. Nevertheless, your John Hancock says you've read and understood that contract. So be sure you really do.
Reports of the execution of orders (confirmations) and statements of account(s) . . . shall be conclusive if not objected to by written notice delivered . . . within ten (10) business days after delivery of or communication of the reports or statement. . . .
Clauses like this are common. Their message: If you don't protest within the time limit, you're out of luck. But in reality? "That 10-day ruleand it's often three days, especially for confirmation slipsfrequently means nothing," says Indianapolis attorney Mark E. Maddox, the immediate past president of the Public Investors Arbitration Bar Association. "Securities disputes are generally decided by looking at the facts of the case, not at an agreement's rigid provisions." That's because the disputes are usually arbitrated, which can work for you, because arbitration permits flexible decisions.
So your real deadline will depend on the facts. Indeed, it might be measured not in days, but in months. For instance, if you failed to review your statements for several months because you put in long hours at your practice and were busy with family and community activities, in a dispute you might be awarded much or all of your loss, says Maddox.
New York securities arbitration attorney Theodore G. Eppenstein provides another example: "Suppose you don't discover you were trading options until your accountant reviews your statements at year-end," he says. "If you understood little or nothing of the trading, the 10-day rule might not matter."
But don't get too relaxed. The underlying principledo what's reasonabledoes matter. If you're simply sloppy when it comes to reviewing communications about your investments, you may indeed lose in a dispute, even against the big, bad brokerage.
Whether delivered to you by mail, e-mail, or other electronic means, all confirmations, statements, notices and other communications . . . shall be binding upon you, if you do not object, either in writing or via electronic mail, within forty-eight hours after any such document is sent to you. . . .
Datek Online Brokerage Services
Welcome to e-tradingfast, efficient, and able to zap you with even shorter protest deadlines. But if 10 days is too short, then 48 hours is absurd, right?
Again, that depends. To some experts, such a brief period seems inherently unfair. "I've never heard of a period that short," says Maddox, who doubts that it would be regarded as valid.
However, New York securities attorney David E. Robbins points out that since Datek Online isas its name indicatesstrictly for online trading, this deadline normally applies to records of trades investors are carrying out themselves. "In some circumstances, then, that short period might seem reasonable," he says. "It's not as though you're trying to make sense out of what some broker did." The SEC, in fact, is currently taking a close look at this issue, recognizing that because online trading is different from traditional forms in many ways, the rules involved may have to differ, too.
Communications may be sent to the Client at the Client's address or at such other address as the Client gives. . . . All communications so sent . . . will be considered to have been given to the Client personally, upon such sending, whether or not the client actually received them.
Notices and other communications may also be provided to you [orally], . . . left for you on your answering machine, or otherwise, [and] shall be deemed to have been delivered to you whether actually received or not.
Datek Online Brokerage Services
Suppose your broker sends off some incorrect confirmations and statements. They don't reach you, so you can't protest promptly. Later, when you do argue, the broker claims that sending equals receiving. Is that valid?
As you might expect, he's on shaky ground. "Things simply don't work that way in arbitration-land," says broker-arbitration expert Howard Silverman of Bridgewater, CT. True, there may be a legal presumption that messages get to their destinations, but in a brokerage dispute, the facts are examined. So such a clause probably can't be used to prevent you from discussing what actually happened. Nevertheless, brokerage agreements often include such assumptions of receipt.
But when it's you who does the sending, the agreements don't let you make such assumptions. For example, orders to the online service of Morgan Stanley Dean Witter aren't considered received until the brokerage house "has acknowledged that the order has been received." And your notices to A.G. Edwards & Sons concerning discrepancies on statements or confirmations must be made via both telephone and letter.
Why do agreements even include such lopsided provisions? "Because lawyers write these things," says Robbins. In other words: Hey, it can't hurtthrow it in. Such clauses probably keep some customers from making a claim, or even a fuss. But don't let them fool you.
The firm shall have the right . . . to require additional collateral or the liquidation of any account of the Client . . . without demand for additional margin, [or] other notice of sale or purchase. . . .
If your margined stock heads south, says this clause, the brokerage can sell itor any of your other holdingsto come up with what you owe. Moreover, it can do so without notifying you.
That may sound too harsh to be enforceable, but it's one reason why buying on margin is probably an investor's biggest danger zone. Though tough provisions elsewhere may be mostly posturing, this one is for real, and you'll probably never see an agreement without it. When you invest on margin, you borrow from the brokerage, which means you're partly playing with the brokerage's money. This changes everythingfor the broker, too. "If many clients are heavily margined, a firm's own back can be to the wall," notes Robbins. "So when margin's involved, brokerages will be absolutely ruthless, if need be." And because arbitrators understand why such actions happen, they generally decide in favor of firms that take these steps.
Moreover, if you are notified of a margin call, you may have to come up with the cash within hours. Not surprisingly, many experts tell horror tales on the topic, like this one from Maddox concerning a case that's still under arbitration: "The brokerage house sold out my client's account after leaving a message on an answering machinenot the investor's machine, but his brother's." What made this especially infuriating, Maddox says, was that the investor was out trying to wire money to the brokerage house, to cover that margin position. That's why he wasn't home to answer his phone.
So when you're on margin, you may be on thin ice. And watch out if your broker tries to sweet-talk you into feeling safer. Schwab even warns you not to trust any such assurance: "Notwithstanding any oral communications between you and us, we reserve the right to liquidate at any time if the equity in your account falls below Schwab's minimum requirements." Here, "talk is cheap" means talk might cost you plenty.
You agree that neither Schwab [nor the companies supplying it with financial data] shall have any liability, contingent or otherwise, for the accuracy, completeness, timeliness or correct sequencing of the Information. . . . In no event will Schwab [or the information providers] be liable to [anyone] for any . . . damages (. . . including lost profits . . .) that result from . . . delay or loss of the use of the [online services]. . . .
Charles Schwab & Co., online agreement
[Prudential] shall not be liable in connection with the execution, handling, selling, purchasing, exercising or endorsing of puts or calls for my account except for gross negligence or willful misconduct [by Prudential].
Prudential Securities, option agreement
In online trading and in options, things can move fast. Special agreements that cover such situations often include clauses like these, insisting that the firm is flat-out not responsible for certain matters. Their audacity can go far: Fidelity has language like the Prudential clause, but it doesn't even include exceptions for gross negligence and misconduct. "Such clauses actually state that they're not responsible for the proper operation of the basic services they provide," says arbitration expert Silverman. "But that's not reasonable."
So such disavowals often don't hold up when disputes develop. As Robbins notes, "These are similar to what your parking-lot claim ticket probably says, in trying to avoid damage responsibility for crushed fenders." But legally, responsibility typically goes with the territory, he notes. "A broker offers financial services, and you're entitled to expect that it's making reasonable efforts to ensure that the service is not full of errors."
So the not-my-fault clauses won't be taken literally, though they may have some effect, notes New York arbitration consultant Jerome Olitt. "Such clauses may shift the burden of proof to the investor," he says. "But the facts still will be examined, and arbitrators, more than judges, can ignore technicalities and focus on what's fair and reasonable." Or, as securities attorney Steven L. Miller of Woodland Hills, CA, puts it, "such disclaimers are often absurd. A firm can't hide behind them."
Sometimes brokers' agreements do accept some responsibility. Schwab's, for example, also says, "If we don't complete a transaction to or from your account on time or in the correct amount according to our agreement with you, we may be liable for your losses or damages."
As we've seen, you won't generally be bound by the letter of most brokerage agreements, with the notable exception of clauses about margin. But as the financial expert Bob Dylan once said, "to live outside the law, you must be honest." That applies here: Arbitrators may disregard the specifics of written clauses, but also may not favor you unless you've behaved reasonably. Maybe you can't always check paperwork within hours or even days, but do your best. Make sure your financial profile is accurate and complete (see below). And pay attention: If your broker's actions increase your risk, then objectin writing.
Beyond that, make sure you're comfortable with your broker. "Most of all, you simply want a good relationship with him," says David Robbins. "That will avoid more disputes than any piece of paper. For instance, a brokerage can often grant extra time to meet a margin call; you want to deal with someone who'll do that for you, when possible. That's what to look for."
One element that can be decisive in a dispute isn't even part of the brokerage agreement: It's the information the firm gathers regarding your family situation, income, net worth, and investment goals.
Some firms go way beyond what the SEC requires in this regard. A.G. Edwards' margin agreement, for example, says the firm may obtain an investigative report on you, which, besides credit information, may deal with your "character, general reputation, personal characteristics or mode of living." (The firm says that it will ask your permission before seeking such a report.) Most firms, though, simply supply a few spaces to check off or fill inrange of income and net worth, for instance. And though you'll typically be asked to sign off on the information's accuracy, it may seem a very informal part of setting up your account.
But don't take this lightly. The brokerage is required to gather this information and to heed it in dealing with you. So this has legal consequences, as New York arbitration consultant Jerome Olitt explains: "The broker is obliged to know the customer's overall financial situation and investment goals and to make sure the trading is appropriate." Suppose a doctor-client indicates she's retired, with modest assets, a fixed income, and a very conservative goalto guard principal. "If a broker brings such a doctor into speculative areas, that would be exposure to inappropriate riskand if losses occur, that doctor probably has a valid claim against the firm."
Moreover, Olitt adds, both finances and goals must definitely be considered. "A wealthy doctor who could afford very aggressive investments could still have a valid claim if he specified that he wanted only conservative investments," he says. That's important to knowand it's also important to make sure you don't lose that protection. Be as accurate as you can in describing your finances and investment objectives; you don't want to wake up deep in pork-belly futures, unless you know what you're doing.
And beware brokers' games. "I've been a broker myself, and I know plenty of tricks are played with profiles," says securities attorney Steven L. Miller of Woodland Hills, CA. "Often, brokers fill out the form for you. And some will encourage you to exaggerate your financial strength, so the firm's computers will permit the broker to sell you more exciting investments or allow you to invest more on margin if you're short on cash. But if your account runs into trouble, all 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 anytime your broker seems to be increasing your risk more than you want, or not contacting you promptly when things change. You needn't be belligerentjust definite and firm, notes arbitration expert Howard Silverman of Bridgewater, CT. "In a dispute, arbitrators have to work with what's brought to them," Silverman says. "The he-said-I-said kind of testimony may not help much, but 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," he adds. "That's what you'd need to show an arbitrator why you should recover your losses."
Securities attorney Mark Maddox agrees. "If you're not interested in speculation or aggressive growth, then say so explicitly in the letter," he advises. "That can protect you a lot."
Silverman's firm, Brokerarb, has a Web site (www.brokerarb.com) with samples of such letters, like the one below. They're designed to be sent when you find your portfolio is heading into riskier territory than you've specified. The letter adopts the honey-beats-vinegar approach, but it shows firmly what the investor intends and how he wants his account handled.
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, to assure them of that." That's not courtesy; it's very specific strategy. The firm sends out such letters when its monitoring procedures detect possible problem areas, like "churning" (excessive trading). So it's checking on its brokersand, at the same time, 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. I had a client who signed one because his broker said, 'If you don't sign, I won't be able to keep trading your account.' Later, that paper almost lost my client's arbitration case. What saved him was that the panel believed his explanation that he was, in effect, coerced into signing it."
When a dispute occurs, most brokerages invoke a contract clause requiring that you arbitrate instead of going to court. Is that reason to worry? It might be.
Arbitration involves both pluses and minuses, notes arbitration expert Jerome Olitt of Stamford, CT. "There are certainly limitations," he says. "You can't compel discovery as strongly as you can in a lawsuit, so you may not get all the material needed to make your case. Also, arbitrators aren't always expert in all the technical issues of trading, especially specialized areas like option trading."
On the positive side, Olitt adds, the process is informal, typically much faster and cheaper than a lawsuit, and decisions can sidestep legalistic nitpicking. "Also, in some states, you can be awarded attorneys' fees and punitive damages, just as in a lawsuit," he notes.
But what about the larger issue: Arbitrators are often drawn from within the industryso do they favor the firms? Many experts, even those who typically represent investors, say this is not usually the case. Attorney Theodore G. Eppenstein of New York, for instance, argued for the investor in the 1987 Supreme Court case that decided brokerages could make arbitration mandatory for dispute resolution. Today, even Eppenstein says, "Formerly, the industry-run forums often were perceived as being biased, but you don't hear that sort of comment very often anymore."
However, others, such as New York securities attorney John Lawrence Allen, argue that arbitrators frequently do favor the brokersespecially when it comes to deciding whether to grant an award to an investor. "It's inevitable, given two facts," says Allen. "First, attorneys who request arbitration procedures have a lot of say in choosing who the arbitrators will be. Second, the records of an arbitrator's earlier decisions are readily available, including the size and frequency of awards granted. So arbitrators who often give out big awards know that they may not get as much work."
Unfortunately, you can't delete the arbitration clause from your contract. So keep it in mind, as a spur to create and maintain a strong paper trail concerning your brokerage relationships. That way, in case of a dispute, you'll be able to support your position from your own records.
. Your brokerage agreement: Watch out for that fine print!.