Market Drop Sparks Run on Arbitration Claims

The recent stock market slide that pushed the Dow Jones industrial average down roughly 300 points is beginning to spur a number of securities arbitration cases in which investors claim that their brokers lied, cheated, stole or otherwise misled them into taking bigger risks than they otherwise would have.

Some securities arbitration firms say they have been deluged with phone inquiries. The National Assn. of Securities Dealers--which handles roughly 80% of all securities arbitration cases--has also detected an uptick in the number of individuals requesting arbitration information packets.

Previous market slides have caused dramatic increases in the number of broker disputes brought to arbitration. The October, 1987, market crash, for example, helped boost NASD arbitration filings that year by 82%. The following year, arbitration cases rose another 38.2%. (Filings often lag a market correction by as long as nine months.) The number of cases received in 1989 and 1990 fell.


“We always see an increase in a down market, but it usually takes several months before a severe market drop will filter into lawyers’ hands and arbitration filings,” says Ted Eppenstein of Eppenstein & Eppenstein, a New York-based securities law firm.

New complaints are mainly falling into a handful of categories that appear to reflect securities industry trends, adds Michael Paule, president of Investors Arbitration Services in Woodland Hills. For example, woes from financial derivatives--which have been blamed for rocky earnings reports at several companies and mutual funds--have also hit individuals, he says.

Recently, an Eastern Airlines pilot hired IAS to represent him in a case against a Florida stockbroker who sold the pilot the interest-only piece of a collateralized mortgage obligation, Paule notes. The CMOs were supposed to meet the pilot’s conservative investment objectives, but the security lost a substantial portion of its value when interest rates rose in February.

Numerous investors call him after investing in bank-sold mutual funds, says IAS Chief Executive William Levine. Many of them say they were misled into believing they were buying the equivalent of a certificate of deposit when they invested in bond funds.

It is important to note that broker wrongdoing--the basis of a securities arbitration case--does not increase when the market dives. People are just more likely to notice and object to it when they are losing money than when their accounts are profitable, says Deborah Masucci, vice president and director of arbitration at the NASD in New York.

“People start taking greater risks as the market goes up, but they don’t recognize the risks until the market comes down and they start to lose money,” she says.

But experts stress that a market loss does not necessarily translate into an arbitration case. Indeed, arbitration firms generally reject anywhere from 10 to 50 cases for every case they take.

That’s sometimes because the cases are too small for an attorney to litigate. Sometimes it’s because the statute of limitations has expired. But often it is because there was no sign of illegal or improper activity, regardless of the loss, says Levine.

“Probably one out of every 12 or 15 people who come to us have a bona fide case, not a frivolous action,” he says. “There are some people who suffer market losses because of risks they knew they were taking.”

Those who lost money on “appropriate” investments and who were not misled about the risks have no cause to litigate unless the broker stole from them or participated in illegal or unauthorized trading, experts say.

But those who were misled or pushed into inappropriate investments--and who have been unable to persuade the broker or brokerage firm to unwind the transaction--should take their case to arbitration.

Individuals win their arbitration hearings more than half the time, according to NASD statistics. And roughly 55% of the cases filed are settled out of court, often in the investor’s favor, Masucci says.

“The critical issue is to fight back,” says Paul N. Young, chief executive of Securities Arbitration Group in Los Angeles. “If you don’t fight back, you are guaranteed to lose twice.”

When do you arbitrate? When you have a loss due to wrongdoing on the part of a broker or brokerage firm and the firm refuses to reimburse you. Broker wrongs generally fall into one of five categories:

* Unsuitable recommendations. A broker urges you to buy an investment that doesn’t suit your objectives, level of experience or is otherwise inappropriate for you. The nature of an inappropriate investment depends on who you are. Commodities would be inappropriate for an unsophisticated investor or for someone who couldn’t handle a loss. However, it would be a suitable investment for a well-heeled speculator.

* Unauthorized trading. The broker buys or sells securities without your permission and without authorization to trade in your account on a discretionary basis.

* Misrepresentation. The broker lies or purposefully misleads you about what the investment is, what it does, what the risks are or what it costs in commissions and fees.

* Omission. You’re not told something pivotal about the investment, such as that the company you’re investing in is in bankruptcy, or that while the investment appears to be a bank deposit, it is not FDIC-insured.

* Theft. The broker steals money from your account.