Lawyers describe five stumbling blocks that trip up brokers and make defending claims difficult.
Sometimes you can avoid legal pitfalls, and sometimes you can only de- fend yourself. Here are the most common shortcomings securities lawyers see with brokers that get the reps into trouble or make defending a case tough.
Securities attorneys agree new account forms are critical.
"One of the most common yet avoidable pitfalls a broker falls into is inconsistent or missing information on the opening account documents," says Tracy Pride Stoneman, a Colorado Springs, Colo., securities attorney.
Stoneman challenges brokers to ensure these forms are complete and consistent. The information must be updated as clients' income and net worth grow, they become more sophisticated, and their investment objectives change.
Beware of anything that goes counter to clients' objectives. "Say you have a client who wants to take a flyer on a new dot-com stock," says Amy Miele, a partner at Kutak Rock in Atlanta. "Write a letter and put it in the client's file." Note that you talked and agreed to place a trade that was unsolicited and inconsistent with stated objectives.
Have customers sign the new account form, as well as an updated form once a year, even if your firm doesn't require this. Defense attorneys have long criticized the industry for not always requiring a customer sign-off.
"It can short circuit the customer's claim if their signature is on the new account form," says Alan Foxman, a securities attorney in Boca Raton, Fla.
Take some care in maintaining account information. New account forms can "end up as a critical piece of evidence," says John Shaw, a partner at Berkowitz Feldmiller Stanton Brandt Williams & Stueve based in Kansas City, Mo. "You see it filled out with two or three different types of handwriting. Different people are involved - the sales assistant fills out part, the broker fills out part. It all may be accurate, but think about how that looks."
Inaccurate information is a killer. "If you get the account holder's or spouse's occupation wrong, it undercuts your credibility," Shaw says. At the very least, inaccuracies can make you look sloppy.
If a legal problem arises, documentation is key to a broker's case. Why? "Five years later in an arbitration proceeding, no one remembers the words that were spoken," Miele says.
This doesn't mean writing down your every sentence, but at least document important conversations such as when a client refuses to follow your advice. Documentation should be proportional to risk, says Vincent DiCarlo, a Sacramento, Calif., sole practitioner. The more something troubles you, appears out of character for a client or involves risky products, the more you should document what happened.
After all, clients do. "You can count on being surprised by the notes customers come up with about conversations that supposedly occurred," Shaw says.
"In the absence of notes, everything becomes the broker's idea," says David Bartholomew, an attorney and shareholder at Keesal Young & Logan in Long Beach, Calif.
When a problem arises, sometimes a broker wants to avoid it. But festering problems can turn into legal cases.
Investors often complain that when things started going badly, the broker wouldn't return their calls, says Christopher Vernon, a securities attorney at Treiser Kobza & Lieberfarb in Naples, Fla. "Communicate with your clients," he advises. "When a problem comes up, get on the phone. If you get yelled at, it's still better than a lawsuit."
Even if you can't resolve the issue that day, call the client with an update, Miele recommends.
With any type of possible compliance problem, "communicate clearly and quickly with compliance people regarding a difficult client or situation," Shaw says. "Rather than being an ostrich, enlist the manager's guidance or supervisor's guidance on how to handle it." Be willing to answer questions and dig through documents to reconstruct what happened.
Suitability is a complex and thorny issue. "The largest number of customer complaints are suitability-type complaints," Foxman says.
One of two things happens. "The broker is explaining things to the customer, and the customer doesn't want to admit ignorance," Foxman says. Or the customer understands what he's getting into but he really shouldn't be in certain securities.
What can you do? First, understand past investment history - in detail. If a client says she's been investing for 12 years, find out if the experience was limited to, say, picking funds in a 401(k). Second, follow up with the customer to make sure her situation hasn't changed. "If the broker assumes nothing's changed, he can get in trouble," Foxman says.
Of all the problems brokers face, suitability is the most complicated, Bartholomew says. "It's a vague concept. Is a security registered? It's cut and dry. Unauthorized? You did or didn't. You get to suitability, and it's more difficult."
The totality of a client's situation determines suitability. Factors include risk tolerance, age, goals, experience with various accounts (both full-service and discount), income, net worth and more.
Along with suitability, misrepresentation and omission are big issues for brokers, says Frank Razzano, a partner with Dickstein Shapiro Morin & Oshinsky in Washington, D.C. "The analyst says it's a good stock, and the broker gets on the phone and recommends it. But is it good for this customer? Is it good for this type of account?"
For protection, err on the side of conservatism, especially in this day of unrealistic expectations. Try to calm people down and bring expectations into line. Avoid product pitching and sell by explaining risks. Document your client profiling process. Diversify portfolios - overconcentration is a common theme in many lawsuits, attorneys say, and not suitable for most investors.
Even then, you can never fully protect yourself from a suitability claim, Razzano says. "It's a litigious society we live in."
A firm is pursuing you. They make an offer you can't refuse. Sign on the dotted line? No problem. Problem.
Consult an attorney before you sign. Brian Carlis, a partner with Stark & Stark in Princeton, N.J., says, "An attorney spending a couple of hours tops to review the contract is money well spent."
Negotiating less stringent noncompete contracts can save you thousands should you ever have to leave the firm. "Defeating a well-drawn contract is difficult," Carlis says.
You may also want to get in writing what the new firm promised you, such as the corner office and a sales assistant. You have the negotiating power during the courtship stage.
But typically, brokers call lawyers after the fact, says Mitchell Ostwald, a securities attorney in Sacramento, Calif. "You get a call from a broker leaving PaineWebber going to Prudential. There are two years left on the contract, and [the broker has] a laundry list of problems."
Just like before you sign, consult an attorney well before you change firms to minimize your exposure from any lawsuits after you leave.
You can't count on your firm to protect you from a customer claim. Here's how to find legal counsel.
If a customer files a claim against you, most likely your brokerage firm will be named, too, and will hire an attorney to represent you and the firm.
But can you trust that lawyer to represent your best interests?
Christopher Vernon, an attorney at Treiser Kobza & Lieberfarb in Naples, Fla., doesn't think so. He represented a broker named in an arbitration case who subsequently left the firm. "They kept him in the loop for awhile, but then he couldn't get in-house counsel to return his calls," Vernon says. Meanwhile, the firm decided to pay off the investor and charged the broker for it because the broker's contract stated he had to reimburse the firm for settlements.
How do you find an attorney? "Don't just hire a lawyer who has an account with you," says Matt Bartle a partner with Berkowitz Feldmiller Stanton Brandt Williams & Stueve in Kansas City, Mo. "If I were a broker, I would want someone who has handled a lot of sales practice arbitrations."
Attorneys agree that word-of-mouth is the best way to find qualified representation. Short of a referral, check industry magazines for legal ads, and the Public Investors Arbitration Bar Association (www.piaba.org), a plaintiff lawyers' group with some members who represent brokers in claims against their employers.
Boca Raton, Fla., securities attorney Alan Foxman does legal work for the National Association of Investment Professionals. He says the NAIP (www.naip.com) has an attorney referral service for members.
In addition, check with your local state and county bar associations. "They may have a classification for securities attorneys," Foxman says.
Another resource is the Financial Advisors Legal Association (www.falegal.com), says Walter Baumgardner of Musilli Baumgardner Wagner & Parnell in St. Clair Shores, Mich. Baumgardner serves on the group's advisory board. Reps pay $730 a year and get legal representation with maximum out-of-pocket costs capped at $1,500 for a case.
You can also search for a securities attorney on the Martindale-Hubbell Lawyer Locator at www.martindalehubbell.com.
The cost for an attorney depends on the area of the country, size of the firm, nature of the case and the experience of the attorney, Foxman says. In a typical defense for a customer dispute, "you're looking at $175 to $300 or more an hour," he says. A senior partner at a hotshot, big-city firm costs even more.
If it gets to arbitration, the typical three-day hearing for a customer case is $10,000 to $15,000, Baumgardner says.
In some states, you may be entitled to employer-funded individual representation. "In California, employers have an obligation to indemnify and defend," says David Bartholomew, an attorney and shareholder at Keesal Young & Logan in Long Beach, Calif. "It's not the case that the firm will always pay for defense, but it could be. It's worth checking into."
Bartle's pet peeve is a lack of prevention. "People think about bringing in a lawyer when it's already a big problem," he says. "Sometimes you can call a lawyer for 45 minutes and avoid arbitration. Have an ongoing relationship with an attorney."
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