Frustrated Fund Investors Seek Arbitration - TheStreet

Many investors have lost loads of money in mutual funds over the last few years. But some people are doing more than sitting around and complaining about their funds over dinner. More investors are going after their brokers for putting them in truly awful funds. But a payday could be tough to come by.

Last year mutual funds were involved 543 arbitration cases filed with NASD Dispute Resolution, an arm of the National Association of Securities Dealers that runs the largest forum for securities arbitration. That's up from 82 in 1998. During the first quarter of this year, that number has already hit 295, higher than all the cases involving funds filed in 2000.

Of course, these numbers need a little perspective. Yes, the overall number of securities arbitration cases is going up, due in large part to the enormous losses investors have suffered in the market. For the first three months of the year, the total number of new cases filed was up 17% from the same period last year. So it's natural that the number of claims involving funds is also on the rise.

However, mutual fund-related claims as a percentage of all arbitration cases are also heading higher. In 1998, they represented 1.7% of all arbitrations filed. For 2001, that percentage up was up 7.9%. For the first quarter of 2002, that number was up to 16.2%. (It's worth noting that each arbitration case can involve several types of securities, including mutual funds.)

It Ain't Easy

But winning an arbitration case isn't going to be as easy as filing one. Mutual funds, for one, are sold differently than stocks. When one's sold, it comes with a prospectus filled with CYA language, which is meant to disclose every possible risk a fund might take. Also, mutual funds, by their very nature, are diversified investments, while a single stock is not, and diversification is supposed to translate into less risk.

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In the securities industry, customer complaints are typically heard in arbitration (a private legal proceeding that's legally binding on both parties), rather than in a court. When you open a brokerage account, you must agree to settle disputes through arbitration.

Only about a third of all securities arbitration cases ever reach the actual hearing. Most are settled or dropped before they reach that stage. And of those cases that do result in hearings, investors win about half the time.

Now, you can't just file an arbitration claim if you bought some horrible fund on your own and then lost money in it. In that case, you have nobody to blame but yourself. But if a broker sold you a fund that was a completely inappropriate investment, then you might have a case.

In a case involving a fund, you may need to show that the fund sold to you was unsuitable for your risk tolerance and investor profile. That might mean all your money was concentrated in one or two risky sectors of the market. Mitchell Perlstein, an attorney at the Investors' Law Center in Boca Raton, Fla., said he's currently handling a case where in an elderly woman's money was put in some risky mutual funds. And the 80-year-old woman had never even invested before. "The broker talked her into buying a group of very speculative funds that were no different than a few very speculative stocks," he said.

Indeed, many mutual fund companies rolled out concentrated, aggressive funds in the late 1990s. And investors only found out how treacherous they were when the bull market bubble burst.

Collapses Open the Door

Given the collapse of some of these funds, some attorneys think investors have a better shot at winning in arbitration.

"I can tell you that, prior to the last couple of years, we almost never took cases where mutual funds were the primary subject of the claim," said attorney Mark Maddox, a former securities commissioner in Indiana. "Why? Generally, there weren't any claims we thought we could win."

And so-called "suitability" cases are just one type of claim people are pursuing.

"We're also very interested in cases where brokers forgot to recommend the fixed-income side of diversification and put 100% of a person's money in stocks," said Maddox. "You'd be amazed at the number of brokers who forgot that bonds existed in the late '90s."

If you can prove that a fund's risk was misrepresented to you, then you might also have a case.

Attorney Perlstein said he's preparing to file a case on behalf of a man in his late 70s who wound up in

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Merrill Lynch's Focus Twenty fund. That fund was launched with great expectations after Merrill lured manager Jim McCall from PBHG. But its prospects quickly dimmed. Concentrated in tech stocks, it fell 70% last year, making it one of the worst large-cap growth funds in the country. McCall left the firm in November of last year. A Merrill Lynch spokeswoman declined to comment.

Perlstein claims the fund was misrepresented to his client and sold to him as an investment that was much less risky.

Obviously, other investors out there feel the same way about funds they bought and then saw collapse. But whether their complaints will help them get their money back remains to be seen.

In keeping with TSC's editorial policy, Dagen McDowell doesn't own or short individual stocks, nor does she invest in hedge funds or other private investment partnerships. Dagen welcomes your questions and comments, and invites you to send them to

Dagen McDowell.