It's hard to say when the targeting of financial advisors for litigation reached its peak — or whether it has even peaked yet. But the trend certainly passed a milestone in October when Money ran a cover story entitled, “Should You Sue Your Broker?” That article — in the nation's top-selling consumer finance publication — featured a systematic guide for investors interested in recovering financial losses by suing their advisor. It simultaneously commented upon and contributed to a legal feeding frenzy that continues to plague the brokerage industry.
To dismiss this phenomenon as a function of a nation in search of a scapegoat would be easy; certainly, the brokerage industry has weathered its share of I-didn't-know-burgers-made-me-fat sorts of lawsuits. But there's more to these new suits.
For starters, investors have watched a lot of their money disappear in the bear market, and the parade of financial scandals has convinced them that they are the victims not just of the market, but of tainted research and corporate fraud as well. They now say that their brokers could or should have protected them from these phenomena.
A second dynamic of the industry's current legal imbroglio is that lawyers smell blood; in fact, they are actively advertising for disgruntled retail investors. In most securities-related litigation attorneys work for a contingency fee paid as a percentage of any awarded financial settlement. The fee in securities-related cases often exceeds one third of the gross award. Thus, the undertaking of a lawsuit is relatively risk-free for investors.
Third, financial advisors are tempting targets. They are presumed to have ripe assets. Additionally, they are often licensed with a broker/dealer, an organization that frequently has Errors and Omissions Insurance (E&O), which deepens the well of available money.
In part because of these forces, complaints against financial advisors have skyrocketed. A June 2002 annual survey of financial professionals attending training sessions put on by Kansas City-based Higher Plateau showed a more than 100 percent rise in suits from the prior June. Further, the National Register shows that 28.9 percent of all pending class action suits are aimed at securities firms.
Even independents are targets. One Chicago-based RIA with 26 years in the industry experienced the phenomenon firsthand. “I was shocked,” said the advisor, who requested anonymity because he still is party to a $100,000 suit. “Clients whom I've known for decades were making threats and filing complaints for unrealized losses. Their heirs were also making legal threats, wondering what I did with Mom and Dad's money. As a fee-only planner, I thought I was somewhat immune to these type of attacks.”
Disturbingly, the outcome of such litigation often is dictated by economics rather than by guilt or innocence. According to NASD statistics, the average securities-related settlement is $20,000. Meanwhile financial advisors typically pay $28,000 to defend against suits (according to data gathered by Financial Advisors Legal Association) — and that figure does not include the costs associated with arbitration. Simply put, it's relatively easy to get an expeditious economic settlement from a financial advisor or his E&O carrier or broker/dealer, because the cost of defense usually outweighs the cost of settlement.
The Chicago-based advisor thought his E&O would cover him in a legal crisis. “Think again,” he said. “What I needed was a lawyer who could help me evaluate the pros and cons of various legal alternatives. Instead my E&O carrier simply wanted to settle the claim.”
So how to protect yourself? Documentation is indispensable. Use record-keeping software that allows for quick retrieval and long-term storage. At the same time, educate your clients: Make sure they truly understand their investments, their risk exposure and their financial direction. Keep in touch with them regularly to reestablish their goals and to gauge their emotional states of mind. If possible, get to know your client's children and heirs. This comprehensive approach not only will generate more clients; it will go a long way to preventing you from becoming target practice for your clients.
Jerry L. Reiter is CEO and chairman of Las Vegas-based Financial Advisors Legal Association, an organization specializing in legal defense for financial professionals. www.falegal.com