Questions for the Defense

2004 has been a good year for investors thus far, but you'd hardly know it to look at the number of arbitration filings. Through the end of the first quarter, the NASD handled 2,059 new arbitration case filings. That's a 10 percent drop from the record number of filings during the same period in 2003, but it's still a very large number of complaints, historically speaking. Registered Rep. staff writer

2004 has been a good year for investors thus far, but you'd hardly know it to look at the number of arbitration filings. Through the end of the first quarter, the NASD handled 2,059 new arbitration case filings. That's a 10 percent drop from the record number of filings during the same period in 2003, but it's still a very large number of complaints, historically speaking.

Registered Rep. staff writer John Churchill spoke with securities attorney Aegis Frumento about the uptick in arbitrations and about the current regulatory environment. Frumento is a partner in the New York office of Duane Morris, a firm that employs more than 600 attorneys in 20 cities nationwide.

Registered Rep: Given the improvements in the markets thus far this year, it seems arbitrations aren't letting up much. What are you seeing?

Aegis Frumento: There are a lot of cases out there. Most pertain to more subtle issues. The boiler-room types and tech-wreck cases are slowing. There are lots of variable annuities cases, for instance, where the question is whether the investment portion was properly invested. Also, cases where brokers are accused of giving wrong advice, or not even investment advice specifically, but wrong tax advice for instance — these types of cases.

RR: How are most of the disputes being resolved?

AF: Most cases get settled — the vast majority, 80 percent to 90 percent. Most plaintiff attorneys work on contingency, so there's an incentive usually for both sides to settle. But most cases settle because most cases should settle — it's very rarely a black-and-white situation. More often than not, both parties are at fault to some extent, and there isn't a clearly foreseeable winner.

RR: What can brokers do to protect themselves now against future arbitration?

AF: The one piece of advice I would give to brokers is to document everything — document investment decisions, document recommendations, document conversations. It usually becomes a contest of credibility. Very often, you find cases that are relatively weak but end up getting resolved for substantial dollars. The paper trail is crucial. Suitability cases, and whether a broker recommended a security, are classic examples.

RR: Won't these stacks of forms and documents effectively overwhelm brokers [and investors]? Some SEC disclosure proposals have rankled advisors for this very reason.

AF: Yes, they probably will. That kind of documentation may be the best, but is it possible? Maybe not for brokers with hundreds — or a thousand — customers. But look, unless it's a trading account, it doesn't really take much to have a form letter on your computer, approved by the firm and ready to go out with the confirm. Also, each firm is different on this, but I'd like to see suitability forms signed by the customer — most of these forms don't even have a signature line right now — and confirmed letters, documenting what the customer told them about their investment objectives. The “confirm” document is supposed to do this, but it's really just a box for the customer to check off. It won't give you a lot of evidentiary ammunition if you get to a hearing.

RR: Moving away from arbitration, what trends are you seeing from regulators?

AF: There's a growing trend on the part of the regulators to hold individual brokers more personally accountable for what goes on in their practices. For example, in one of my cases involving a Smith Barney broker working in the office handling the WorldCom options, the NYSE deemed a broker liable because he sent out a misleading document. The exchange took this stance even though his boss gave him direct orders to send the document, and it was a reputable wirehouse, as opposed to some bucket shop. They concluded that every broker has an independent professional responsibility to make sure he doesn't send out misleading information. That was striking.

RR: What's your take on the actions of the SEC and the SROs, their attempts to “clean up” the industry?

AF: It's a bureaucratic reaction to things that have gone haywire. That case is a fine example. Five years ago there would have been a censure, a letter of caution, some remedial measure taken at the firm to make sure it didn't happen, but the individual broker wouldn't have been charged. The regulatory leadership has taken a stance that says the way to get people's attention is to hit them over the head with a two-by-four. We're in a “do something” era. It's almost an anti-intellectual streak, preferring action. My five-year-old is a person of action — it's hyperbolic, but it's the idea.

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