In a lousy market, it's all the more important to be wary of broker abuses that could cost you money. There have been more new arbitration cases filed this year with the National Association of Securities Dealers involving securities disputes than there were in all of 2000 (3,358 through June 2001 vs. 2,712 all last year).


Tracy Pride Stoneman
Securities lawyer and arbitrator

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To find out how investors can protect themselves, we talked to Tracy Pride Stoneman, a securities lawyer and arbitrator for the NASD and

NYSE

, who's co-authored an upcoming book on the subject,

Brokerage Fraud: What Wall Street Doesn't Want You to Know

. Besides describing conflicts of interest in the brokerage industry, she explains how firms try to cover themselves in the wake of complaints -- and why wronged investors shouldn't be too quick to drop their cases when brokerage firms try to dodge responsibility.

TSC: What are some of the most common complaints about brokers?

Pride Stoneman:

Suitability is the biggest complaint against brokerage firms. And of course the term suitability is such a broad term. If a stockbroker churns an account, that's unsuitable. But the typical suitability case is one in which a broker recommends an investment to an investor that is much more risky than the broker leads the investor to believe. That ... is the No. 1 problem that occurs.

TSC: You've pointed out that stockbrokers are required by the NASD to ask investors certain questions before they're allowed to make stock recommendations. That's something a lot of people may not know.

Pride Stoneman:

There are many brokers who never ask the required questions, which is a big problem. The NASD rule book requires that brokers ask about their customers' financial status ... how much they make, what their net worth is, their tax status, when they'll retire.

But most important is the customer's investment objective. And that particular question is also fraught with debate in every securities arbitration case. Most investors don't understand the term, so they don't know how to respond to the question.

I've had many a client who's said, "

My investment objective is to make money." They don't mean they want to risk their money. To them, that means, "I want it to grow, but don't want to risk the principal." But to a broker, that means, "Oh, a speculator! Willing to take some risk, are you?" So there's a lot of miscommunication between the broker and client, which is purely the broker's responsibility to clarify.

Another problem in this area is that so many brokers put down on the new-account form an investment objective of speculation or aggressive growth, or something riskier than the investor wants. The broker is motivated to put down speculation or aggressive growth because he knows the riskier investments that match that objective pay him more. Brokerage firms may pay higher commissions to a broker on these riskier investments because the stocks are in inventory and they want to move them, just like a store stocked with goods, or because the firm had a business relationship with the company. And many firms don't send the completed account form to the investor, so the investor never sees how the account is tagged in terms of investor objectives.

The other thing that causes investors harm is active trading of the account. In its most elementary form, a broker makes no money unless he trades the account. Brokers never set out to lose their customers' money, but when a broker recommends, let's say, a risky investment and it goes down, the broker in some ways is glad. He may get to say to the client, "We need to get out. Let's sell and get something else." That's a perpetual pattern in a lot of brokerage cases -- the broker justifying the sale of something he recommended maybe just a couple of weeks ago and buying something else. From the broker's perspective that's great, because he gets a commission on every single trade.

TSC: How do brokerages typically defend themselves when investors complain about problems like these?

Pride Stoneman:

The No. 1 defense is the just-say-no denial letter, and it's employed in virtually every case of wrongdoing. The firm will respond with a letter that attempts to point the finger of blame back at the investor. The thing that's amazing is even in cases where the facts are egregious and where wrongdoing is clear, and in cases where the firm

ultimately settles for millions of dollars, it started out with a response letter from the brokerage firm saying, "We deny your claim." It doesn't matter how strong your case is; you're going to get that letter. The brokerage firms are in it for one reason -- to make money -- and they know that for every just-say-no letter they send out, a very significant percentage of people who will read it will go away.

Another defense that's very, very common is the rich-man defense. Firms will pull sometimes inflated information from the new-account form to conclude in the response letter, "Our records reflect that you have a net worth in excess of $1 million and you're making $200,000 a year. Clearly, you have the financial wherewithal to sustain this loss." That's often a problem that stems from the broker who views a wealthy client as a license to aggressively trade the account.

Another defense I see routinely is the sophisticated-investor defense, where the firm again relies on information from the new-account form related to the number of years of experience trading stocks or options or commodities that an investor has. Oftentimes these numbers are inflated by a broker who wants to make the client appear more sophisticated and aggressive than he is. Regardless of the numbers, I have seen just about every type of individual that you can think of being called a "sophisticated investor" -- an elevator operator, a janitor, a college student and a housewife.

TSC: So what do you think investors can do to protect themselves?

Pride Stoneman:

I would highly recommend that every single investor obtain a copy of their new-account form and ensure that everything on it is correct.

If an investor sees a lot of incorrect information on the form, it might be high time to question whether or not their broker has their interests at heart. I think it's fair for me to say that every case I see has misinformation on the new-account form. Or oftentimes, we see blanks, where a broker simply doesn't fill in areas that are critical.

Also, I'd say investors need to carefully review their

trading confirmations and look for the word "unsolicited." If they find confirmations that say "unsolicited," that means the broker is saying to his firm, "This investment was not my idea. It was unsolicited by me, the broker." Brokers often mismark these confirmations because they want to make the investor appear like he's calling the shots. It's often a he-said/she-said situation, but the firm has some written records that show an investment was the investor's idea.

Mismarking confirmations as unsolicited is a serious violation of the securities rules, and the investor should immediately document it by writing a letter to the broker's manager. That letter has to go in the broker's files, and it may inhibit the broker from committing this violation against future investors. It may also protect your account from further abuse if you choose to stay with the broker.

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