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Feeling Their Pain

The conflict of interst scandal's forgotten victims: wirehouse brokers.

The excessive touting of tech stocks by a relatively small number of analysts in the late 1990s ranks among the greatest financial frauds in history. The investment banking arms of major securities firms created a wave of public offerings that generated enormous fees for the firms.

None of this would have been possible without the public cheerleading of analysts, resulting in eight-figure compensation packages for certain stars. The investigation by the New York State Attorney General, among others, has revealed the interconnection between supposedly independent analysts and the investment bankers.

While the firms and the analysts got rich, investors lost billions of dollars by placing their trust in the prognostications of people who were untrustworthy. Some of the biggest losers were those investors who also happen to be brokers.

Many of you put your own money where your firm's mouth was and invested in these tech boondoggles along with your cus tomers. A surprising number of you blew the upfront money you received for switching firms on tech bubble stocks.

Analyst fraud has made for strange bedfellows. Normally, customers and brokers have nothing in common when it comes to investment losses. When it comes to tech, however, you and your customers rode the stocks down together as your firm's analysts kept shouting, “Strong Buy.”

Your customers lost money. You lost money, and customers. You feel like the TV anchorman in the movie Network, ready to shout, “I'm mad as hell and not going to take it anymore!” But of course, reality is otherwise. You should be suing your own firms, but you won't. You will take it some more.

Just wait. It's going to get worse. Some lawyers are applying the mass tort model to analyst fraud, preparing to bury firms in thousands of customer claims. It remains to be seen whether this will be an effective strategy for investors.

Regardless of whether the mass tort model puts money in the pockets of individual retail investors, there will be repercussions for the securities industry. It was the prospect of tens of thousands of individual claims that forced asbestos and pharmaceutical manufacturers (and many companies that merely handled the products) into bankruptcy.

The avalanche of investor claims is just starting to roll down the mountain. As a financial advisor, you're standing in the valley. To those of you who have been in the business for over 20 years, it all sounds familiar. The firms push a product, and you and your customers pay the price. Can you say “limited partnerships” and “tax shelters?”

It is unclear how much this avalanche will affect your CRD record. If your firm is sued because your client's account was unsuitably concentrated in tech, the claim is reportable on your U-4 because your conduct is at issue. If the claim does not allege unsuitability, but only fraud by the firm analyst as to the stock in question, then your U-4 shouldn't take a hit because you are not alleged to have done anything wrong.

If history is any guide, however, the firms will be selective in reporting analyst claims on individual brokers' U-4s. Favored brokers will get the benefit of the doubt from management, while unfavored brokers will have every claim reported regardless of whether the broker's conduct is at issue.

Unfortunately, there is not a lot that you can do about this situation. If claims are made by your customers, make sure you consult your own attorney. The firm's attorney has no interest in protecting you. To the contrary, it would not be surprising if the firm pointed the finger at you, the broker, asserting that you were in the best position to understand the customer's needs and objectives.

Perhaps the best advice is for the future. Do not fall into the trap of pushing the stock of the day, or the product of the hour. Presently, many firms are encouraging brokers to sell high cost annuities, even in retirement accounts, as a way of generating commissions in this down market. As hard as it might be to resist this pressure, it is in your best long-term interest to build your book based upon what is best for your customers, not what is best for your firm.

Writer's BIO:
William Jacobson
is an attorney in Providence, R.I. who represents securities industry employees in employment disputes.

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