Having practiced investment law for more than 20 years, Tom Walton knows that as market losses mount, so does the number of claims filed by investors who believe their broker's advice wreaked havoc on their portfolios.

"It will go in cycles like the stock market," said Walton, an attorney with Nyemaster, Goode, West, Hansell & O'Brien P.C. in Des Moines. "We saw an uptick in claims after the tech bubble business, and we're seeing an increase now."

At a time when the majority of investors with exposure to the stock market have lost anywhere from 25 to 50 percent of their portfolio values, proving that a broker's advice made those losses worse is a daunting task. Last year, only 42 percent of cases decided by arbitrators resulted in damage awards to the plaintiffs, according to industry statistics.

"There has to be a lot more involved in the case than just that someone lost money on the investment," said Walton, who has represented both investors and brokerage firms. Generally, the investor must prove that his or her adviser failed to act in the investor's best interests, and that the actions taken were contrary to the client's investment objectives, he said.

Brokerage houses and investment advisers are governed by the Financial Industry Regulatory Authority (FINRA), which requires advisers to enter into an arbitration agreement with each client when opening a new account. Under those agreements, the advisers and clients agree to be bound by the decisions of FINRA-appointed abitrators rather than taking any disputes to court.

Last year, investors filed nearly 5,000 arbitration requests with FINRA nationwide, up from about 3,200 in 2007. The previous peak was in 2003, when nearly 9,000 cases were filed by investors in the aftermath of the technology stock bubble bursting.

This year, 525 new cases were filed in January, double the number of cases filed in January 2008, "and they're predicting a considerably higher number in 2009," Walton said.

Settlement outside the arbitration process is another option, however. Between 50 and 60 percent of FINRA cases typically conclude with a settlement, compared with about 25 percent going to an arbitration hearing, he said. In 2008, however, less than 10 percent of cases were decided by arbitrators. The arbitration process averages about 14 months from start to finish.



New rules

Under new FINRA rules that go into effect March 30, investors can choose to have one arbitrator, rather than a panel of three, hear their case if it involves a claim under $100,000. Previously, any claim over $50,000 had to be heard by a three-person panel. That change, along with the fact that FINRA arbitrations are now held in Des Moines, should make the process less burdensome for Iowa investors with legitimate claims, said Gail Boliver, a Marshalltown attorney who specializes in securities law.

"I think some folks are convinced their loss is related to the market, when perhaps they shouldn't have been in the market," Boliver said. In one instance, he represented a client who was about 80 years old and yet had the majority of his investments in stocks on his broker's advice, rather than being largely in more conservative investments such as bonds.

Boliver, who also handles cases from his Omaha office, has represented plaintiffs in more than 40 arbitration cases since 1991. The trend nationally has shifted from about 60 percent of FINRA rulings in favor of investors to about 40 percent currently, he said. FINRA requires one of the three arbitrators to be from within the brokerage industry, which has been criticized as weighting the decisions in favor of the industry. FINRA has instituted a pilot program to use panels with no industry members, but only a small number of brokerage firms are participating.

Also, "since the core panel members are generally the same, I think what happens is people start comparing one case with another," Boliver said. "So I'm a little concerned about frequency of people sitting on a case, plus the effect of having industry people on the panel." Currently, Iowa only has about a dozen trained FINRA arbitrators, meaning the Des Moines panels often include arbitrators from outside the state, he said.



Communication key

Michael Sherzan, president and CEO of Broker Dealer Financial Services Corp. (BDFS), said his private brokerage firm has rarely been involved in arbitration cases over the past two decades, and that he's not seeing evidence of clients filing formal complaints now, despite the market turmoil. The Johnston-based brokerage employs 323 registered investment advisers and serves approximately 17,000 clients throughout the country.

"We have a very vibrant compliance area and we try to make sure our representatives comply with not only what the regulations state, but also what the ethics require, which is basically you have your client's interests first and that you discuss objectives and the needs of that client prior to providing any advice," he said.

"That said, market fluctuations can sometimes wreak havoc to a person's portfolio value and sometimes you have to reassess where you're at. But from a long-term perspective, as long as you continue to communicate with clients, at least you understand what they're dealing with and can inform them of any market action that's going to affect their long-term goals."

Part of the process BDFS and other brokerages must follow is to review new accounts and transactions to ensure the suitability of the investments to the clients' goals, Sherzan said.

"If there are any verbal or written complaints, we have to resolve those and deal with those directly," he said. "Ultimately, the difficulty comes in when there's a loss in value due to market volatility. That's a tough one from an investor's perspective, because the (regulations) really don't require any perfection in forecasting. It's hard to collect on an arbitration simply due to a loss in value on a portfolio, if both the ethical and regulatory rules were followed. To be an investor, by definition, you're going to incur some risk."

Investment firms can best protect themselves against formal complaints by keeping complete and accurate records of their discussions with clients regarding financial objectives and recommendations for investments, Walton said.

"They should tend to rely only on information from companies whose products they're selling," he said, "and not be making representations not supported by the companies they're selling."

In most cases, the customer's account agreement with the broker dealer will identify what his or her objectives were, Walton said. However, "in some cases what's checked there is not what the person really wanted. So (investors) need to think about what they talked with their registered representatives about. Many times after a loss, I'll hear a client say, 'I was looking to preserve my capital. Why was I in the market?'"

Liquidity problems

Over the past year, a large number of FINRA claims nationally have been tied to specific types of securities, such as auction-rate securities and mortgage-backed securities, Walton said. With the collapse of the auction-rate securities market, for instance, 160 FINRA claims were filed between March and May of 2008. Those long-term notes, issued by cities, student-loan lenders and mutual funds with variable interest rates set periodically by auctions, were sold as liquid alternatives to cash. The largest portion of new claims filed between January and September last year, 493, were related to investments in mortgage-backed securities, with most plaintiffs claiming they didn't understand the risks, Walton said.

Money-market mutual funds were another source of liquidity problems for many investors "because everyone was trying to get their money out at once," Sherzan said. "Fortunately, we didn't have (that investment type)," he added, noting that his firm has been fortunate not to have dealt in any of those categories of problem securities.

"We are not high-risk, high-flying people here relative to our advice to our clients," he said. "I personally believe that protection of principal is extremely important. It's a lot easier to protect your principal than to make it back in the marketplace after you've lost it."

Typically, Walton said, those who file claims tend to be high-wealth investors who have accumulated sizable retirement portfolios. However, those same investors are often presumed by arbitrators to know what they're doing.

"If they are very sophisticated or knowledgeable about investing, it is less likely they will be found in favor of because there's kind of a presumption that sophisticated investors understand the risks and don't rely as much on the advice of their representatives," he said.

In 2008, there was no place to hide in the market. Sherzan said.

"Really, the advice we provide and the philosophy we have as a firm hasn't changed a bit, as far as providing people with sound advice based on what we know to be the facts at the time we're making the decision," he said. "That's the best we can do. It's the equivalent of any other professional trying to help their clients achieve their goals."