How to Avoid, Resolve Disputes With Broker

Stock market investors, take at least a little bit of heart. New rules approved this week should make arbitrating disputes with brokers more fair and open. But these rules are no substitute for taking more care to avoid misunderstandings in the first place.

Arbitration cases between investors and brokers mushroomed in the 1982-1987 bull market and continued to grow following the crash. Investors complained of everything from mishandling of orders, to misrepresentation of investment risk, to unauthorized trading.

Investors have been required to resolve their beefs through arbitration instead of the courts because the industry contends that it is less costly and time consuming. But investors complain that arbitration panels operated by the New York and American stock exchanges and the National Assn. of Securities Dealers (NASD) are biased toward the industry.

The process hasn’t allowed investors to obtain enough information, and the results of proceedings were often kept under a shroud of secrecy, investor advocates have complained.


These and other concerns prompted the Securities and Exchange Commission this week to unanimously approve new rules, effective in September, covering arbitration systems run by the exchanges and the NASD. One of the most important rule changes requires brokerages to clearly highlight and explain pre-dispute agreements that bind investors to use arbitration instead of lawsuits.

New rules also require arbitrators to disclose their employment history over the previous 10 years and take other steps to disclose possible conflicts or pro-industry bias. Brokers will be required to produce more documents, and investors may be allowed pre-hearing conferences or preliminary hearings in large or complex cases. Results of arbitration proceedings will be made public.

The rules are an important step forward, but many investor attorneys and lawmakers say they don’t go far enough.

“They aren’t a panacea for arbitration,” says Theodore G. Eppenstein, a New York attorney who represents investors in arbitration cases. He and others want a ban on pre-dispute arbitration agreements, among other things.


But that may be pie in the sky, at least for now. Given what you have to work with, here are some tips on how to better police your broker and take advantage of the new arbitration rules:

- Shop carefully for a broker. Get referrals from friends or colleagues. Interview several brokers. Visit their offices. Ask for references of clients. Ask clients if the broker had ever executed unauthorized trades.

Be sure a prospective broker tries to understand your investment preferences and goals. “If he or she immediately tries to sell you something before even finding out who you are, that means they are a product pusher,” says Michael E. Friedman, a Pasadena attorney who represents investors in arbitrations. Avoid such brokers, he urges.

- Don’t assume you must sign the arbitration clause. Many brokerages don’t require you to sign an arbitration clause if you are just trading on a cash basis (that is, you are not trading on margin using borrowed funds, or you are not trading stock options).

See if you can cross off the arbitration clause while agreeing to the rest of the brokerage agreement, Friedman suggests. Or write in a clause that permits you the option of also using the American Arbitration Assn., a more expensive but less industry-biased arbitration service. However, if you do this, be sure to keep a copy of the form.

- Don’t allow your broker discretionary power over your account. A broker can make trades without your consent only if you grant power of attorney. In almost all cases, don’t do this, Eppenstein advises. That is an invitation for an unscrupulous broker to churn your account.

If you plan to be out of town but want your broker to keep an eye on your account, ask him or her to check with a family member before trading, Eppenstein suggests.

- Take and keep detailed notes and records. Keep copies of all mailings from your broker. And keep a log of all orders you place, with the date and time, price and type of order. Compare that with your trade confirmations and account statements. If there is a discrepancy, write immediately to your broker and branch manager.


“Don’t rely on your broker’s word that he will fix it,” Eppenstein says. If you don’t respond promptly, the brokerage will assume the statement is correct.

You might also consider tape recording conversations with your broker. But make sure the broker knows you are doing this. Under most circumstances, it is illegal in California and many other states to record phone conversations without the other party’s consent.

- Conduct important business in writing. If you are making a complex or expensive transaction, don’t just have your broker repeat back to you the terms. Send a letter confirming what you ordered, Friedman suggests.

- Keep track of commissions. These usually are reported on your confirmation slips. But ask your broker periodically for a cumulative accounting of total commissions you are paying.

- Ask to be kept up to date. Ask your broker to contact you if the value of your account falls 10% or 15%. “Don’t wait for your monthly statement in order to find out if you’re in trouble,” Eppenstein says. “Put the onus on your broker to let you know what’s going on.”

- Be wary of aggressive sales pitches. If your broker tries to sell you something you don’t understand or that is inappropriate for you, beware. That type of broker may succumb to unauthorized trading or other misdeeds.

If questionable trades occur more than once, get a new broker. Request in writing that the offending broker halt trading immediately, Friedman says.

If your brokerage is unable to resolve your dispute and you have to go to arbitration, consider these steps:


- Seek counsel if appropriate. For small cases you probably won’t need an attorney. Cases of under $5,000 ($10,000 starting in September) can use small claims arbitration, a quicker and less costly route. But a key drawback is that there are no oral hearings. Each side simply presents its written case.

For almost all cases involving losses of $50,000 or more, you will want to seek counsel. Try to get one that specializes in securities litigation.

- Be prepared. Collect and organize documents. Find witnesses. Work to be credible.

- Check the backgrounds of arbitrators. Ask attorneys or others who have had cases heard by your arbitrators. Check their backgrounds to make sure their law firms aren’t representing the brokerage firm you are against. In proceedings before the exchanges and the NASD, you have the right to preempt one arbitrator, Friedman says.

- Consider alternatives. Arbitrators working for the American Arbitration Assn. are less likely to have served the securities industry.

However, the AAA won’t be better in all circumstances. AAA’s fees can cost as much as three times more than those charged by the exchanges or the NASD, Friedman notes. In cases of clear-cut and serious securities law violations, exchange or NASD arbitrators will be more familiar with the rules, he suggests.

Bill Sing welcomes readers’ comments and suggestions for columns but regrets that he cannot respond individually to letters. Write to Bill Sing, Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.