In Statements We Trust

The little 554-point thing that we’re not calling a crash and the volatility in the markets since then may not mean the end of the roaring ‘90s as we know them.

But it probably is the end of Easy Street for some stockbrokers who have been less than honest with their clients. Even the guy who thinks “circuit breaker” has something to do with the electrical system is going to dust off those unopened, unread account statements after a one-day 7.2% decline in the Dow Jones industrial average.

And if his stockbroker is unethical, our once-happy-go-lucky customer might find, among other things, unauthorized trades funded by unauthorized margin loans.

Bull markets such as the one we’ve been in for most of the 1990s make it easier for stockbrokers inclined to mischief to get away with it. Plenty of customers will, if they think they’re making good money, probably not ask too many probing questions. After a day like Oct. 27, though, “people will start paying more attention,” says Jonathan Kord Lagemann, a New York lawyer who represents investors in lawsuits against brokers.

Linda Feinberg, executive vice president of adjudication at the regulatory arm of the National Assn. of Securities Dealers, which acts as the brokerage industry’s self-regulatory organization and runs the Nasdaq Stock Market, agrees. “I do think the increased volatility we’ve seen over the last month or so will result in an increase in claims,” she says.

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How big an increase? It’s too soon to say.

But Morgan Bentley, an investors attorney who was in-house counsel at now-defunct Thomson McKinnon Securities when the stock market crashed in 1987, says his former employer’s arbitration docket doubled after the Dow made its famous 508-point one-day drop--although that day’s was a much bigger percentage decline. The customer complaints began arriving about a month or so afterward.

Actually, crash and correction-related complaints can stretch over a long period. The plunge of last October may have planted the seeds of cases that won’t sprout for years, says Tom Grady, a Naples, Fla., lawyer.

“Some people in the 1987 crash had brokers who kept saying, ‘We will work this out; it’s a temporary thing,’ ” Grady says. “There are investors who go on for years believing that” before concluding their brokers have sold them a bill of goods and those investors decide to sue.

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Allan Fedor, a Largo, Fla., investors lawyer, says he had a post-’87 crash case in which the customer had no idea that one of his accounts had been put on margin--that is, the investor didn’t know his broker had him borrowing money, and paying interest, to buy new investments. “The broker borrowed against the guy’s Treasuries [i.e., Treasury securities] account and used the money to buy stocks in the growth-stock account,” Fedor says. “Some of these [investors] get whacked because they may see something about margin or interest in their monthly statement, but they’re clueless as to what it means.”

Of course, in any market, lawyers will be filing cases against brokers for “churning”--that is, executing trades simply to drum up commissions. And those cases are likely to increase in a market correction or crash too.

“Customers are getting statements that say they’re up 12% to 15%, which historically is a good return, but the market in the same period was up 35%,” said Grady. The question is, what accounts for the difference? It could simply be a poor choice of investments. Or there could be a more sinister reason.

Another situation that those who’ve been careless are more likely to notice when the market goes south: the investment in mutual funds that they thought was “safe,” that was used in place of a certificate of deposit.

Fedor recalled a case in which a 91-year-old client had been persuaded to abandon her CDs for funds, who thought she would be getting the same income with the same guarantee that her principal would be safe. She found out the hard way that the monthly checks she arranged to get weren’t just income: She’d eaten into her principal at an alarming rate because the fund wasn’t performing well enough to provide her usual monthly income otherwise.

Lagemann, the New York lawyer, says to expect more accusations of unauthorized trades as well--something brokers may get away with when times are good and they can persuade customers to stick with a “mistake” because, after all, the broker has made them money. “In good markets,” he said, “brokers talk you into it, saying, ‘You are up anyway, so do me a favor and keep the stock.’ ”

Unauthorized trade cases can get tricky, says Howard Elisofon, a New York lawyer who represents brokers and brokerage firms. The most common unauthorized trade complaint revolves around a customer’s giving “limited discretion” to a broker. Such a murky designation leads to difficult squabbles in which the investor might not deny that he expressed interest in a particular stock but there will be a dispute over whether he wanted to buy 5,000 shares or the 50,000 the broker bought on his behalf.

“There are a lot of new brokers out there,” Bentley says by way of predicting two new types of cases--against discount brokers and stockbrokers who sell their wares at banks, where customers may not have been aware that the FDIC insurance that protects their bank accounts does not apply to any mutual funds they may have bought there.

So are you one of those lackadaisical folks? The sort who let the envelopes from the financial firms pile up untouched on the desk? Open them right now and give them a thorough going-over. Let’s hope you don’t see anything untoward.

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Susan Antilla writes for Bloomberg News. She can be reached at santilla@bny15.bloomberg.com