Opinion

John Wasik

Hollywood’s Hagman un-fleeces Wall Street

October 15, 2010

MONACO/

It would be great if investors who got fleeced by a bad broker got most of their money back like Larry “JR Ewing” Hagman.

The actor who played the rapacious Texas oil baron got more than $11 million in damages and legal fees from Citigroup’s Smith Barney brokerage (now run by Morgan Stanley) unit in a securities arbitration award. Despite his instructions to the contrary, his broker had shifted most of Hagman’s portfolio into stocks, which got burned in the 2008 meltdown. Citi denies any wrongdoing.

Yet Hollywood is not Main Street. Not by a Texas mile. Most investors aren’t made whole when burned by brokers, nor do they reap punitive damages. Most are offered — and agree to — settlements from the brokers.

“In the hundreds of cases I read (in 2008), what appeared to be punitive damages were awarded in less than 5% of the cases,” said Louis Straney, a securities arbitration consultant based in Santa Fe, New Mexico. “Even attorney’s fees and costs are rare, awarded less than 15% of the time.”

The brave minority that chooses to fight the system faces long odds in arbitration hearings. The securities arbitration forum is run by FINRA, a unique industry-run organization that somehow is allowed to police itself, license brokers and protect Wall Street’s interests.

When investors agree to settle, we have little idea how much they receive (or how much they were fleeced) since the industry makes them sign confidentiality agreements when they get their settlements — most likely for a fraction of what they lost. Only settlements of a certain size are required to be reported in the FINRA system.

Brokers have never liked the idea of you suing them. When you sign any standard brokerage agreement, you are locked into their mandatory binding arbitration. While this may be more efficient and less costly than litigation, it can severely limit your ability to recoup your money.

What happens if you go through arbitration and don’t recover any funds or don’t agree with the three-arbitrator panel’s (there is no jury of your peers) decision? You generally can’t appeal it all the way to the Supreme Court. Only in the cases of outright fraud is a decision challenged.

Should you wrestle your way through an arbitration hearing — some 80% of investors don’t make it this far — unlike a court decision, arbitrators don’t have to explain their findings. Since at least one of the arbitrators represents the industry at each hearing (except in new pilot programs), that adds to the perception that brokers have the upper hand.

So there’s a good reason that investors feel they’re not going to get a fair shake when they’ve been wronged by brokers. A University of Cincinnati Law School study found that many survey participants who went through arbitration “with recent comparable experience in a civil court case perceived (securities) arbitration as unfair by comparison.”

Perhaps responding to years of criticism from the plaintiff’s bar and state securities regulators, FINRA recently announced a proposal to allow investors to opt for an all-public arbitration hearing. That means an industry representative wouldn’t be directly involved in a dispute decision.

In a FINRA pilot program that gave investors this new option, some 60 percent chose this route. Reflecting what usually happens when people challenge their brokers, most settled and only 23 of the 560 cases thus far resulted in an award for investors. Still, investors won in 71% of the cases arbitrated with the “all-public” panel versus 50% for a panel with at least one industry arbitrator.

Even with the improved prospect of getting an award, unless the Securities and Exchange Commission decides to remove mandatory arbitration from brokerage agreements — it’s studying that option now — wronged investors may still be stuck in a troubled system run by the brokerage industry.

They certainly won’t be as fortunate as the man who played oilman JR Ewing. Most often they’ll come up disappointed and broke.

John F. Wasik is author of “The Cul-de-Sac Syndrome: Turning Around the Unsustainable American Dream.


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