stock brokers

Remembering the “customer’s man”

Capital Markets, Investors , ,

customer's man

The 1970’s

Several weeks back I had lunch with a colleague who, like me, had started in the brokerage business in the 1970s. At one point he referred to himself as a “customer’s man”. It was a term used to describe a registered representative that I had not heard in years. It evoked a way of doing business that has largely been lost.

At that time, commissions and costs were fixed across the industry. Today, we see these costs as an impediment to our ability to maximize investment returns. We have lost sight of the value that a good customer’s man brought to the process.

A good customer’s man got to know you.

The brokerage firms encouraged every customer’s man to get to know every one of his customers and to get to know them well. You would meet in person to share lunch, drinks, dinner or to play squash, tennis or golf. Over time and many conversations you would get to know quite a bit about each others’ lives and families. Your customer’s man would become one of your trusted advisers.

A good customer’s man was a good stock picker.

Customers’ men were always on the look-out for the next stock that was about to make a move. They were selling their ability to pick stocks and to buy them for you at the right price.

Your customer’s man would always tell you which stocks he was following and why he was following them. He would call to tell you when the price had dipped and to recommend that you give him an order to buy a few hundred shares for you. You would not hesitate.

A good customer’s man made money for you.

Customer’s men were judged by how much the stocks that they recommended went up. It was a simple metric that everyone understood. Very few built their book of customers by advertising or seminars. The best built their books by word of mouth. They asked existing customers for referrals. Customers who made money following their broker’s recommendations gave the best referrals.

From the 1970s forward if the firms wanted more customers, it meant having more brokers with bigger and bigger books of customer accounts. The big action was moving established producers around from firm to firm. Front-end bonuses for really big producers became really big. Just about every broker wanted to be a bigger producer.

That attitude was good for the firms and they encouraged it. Brokers became almost exclusively focused on bringing in more customers. No longer were they judged for the stocks that they picked or how much money their customers made. Producers were now judged on how many “assets under management” they have.

The actual management and investing of the customers’ funds was increasingly handled elsewhere. Enticing new customers meant selling the investing and management skills of others.

The 1987 Crash

This was logical as so many of the customers’ men had not seen the 1987 crash coming. If they had, logic suggested that they would have pulled their customers out before it happened.

customer's man

It was time to let the experts manage your investments. Customers were sold many different kinds of managed funds, annuities and other “packaged” financial products. All of these products were expensive from the customers’ standpoint. The firms had built in significant underwriting costs and management fees.

Many of these fund managers drank from the Kool-aid that said that price/earnings ratios of 50 or more were sustainable and likely to go higher. Individual brokers who questioned the wisdom of the high paid fund managers and research analysts were brought into line or shown the door.

When the tech market inevitably crashed, many in the industry argued that “no one had seen it coming.” They said the same when the market crashed again in 2008. It was a phrase that was repeated so often that people started to believe it.

It re-enforced the idea that the average financial adviser can do no better than average. Everyone just started buying the index, certain that no human being who actually works in the markets every day could actually have awareness of what was going on or to help customers profit from it.

The index was much cheaper than a human adviser in any event. Lower costs were more efficient and would increase returns, provided, of course, the market goes up.

A good customer’s man always put the interests of his customers first. It was an era when almost every business adhered to the idea that “the customer was always right.” When is the last time that you heard that phrase or saw it posted in a business or an office?

Today, the industry staunchly opposes any regulation that would require individual brokers to put their customers’ interests first. That should tell you everything that you need to know about the financial services industry today.

The individual registered representative, the back-bone and the public face of the brokerage industry will likely not survive another generation. Their jobs are already foolishly being replaced by computer driven robo-advisers.

The industry will survive and prosper without the customer’s men. It is already oblivious to what it has lost.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

Suing Your Broker After the Crash

Capital Markets, Investors, Law , , , , , ,

When the stock market corrects again it will be the seventh or eighth time that it has since I began working on Wall Street in the mid-1970s. Corrections are always studied and talked about after they occur.  Corrections really need to be identified before they occur because they  always result in losses in accounts of smaller, retail investors. And they always result in a spike in litigation by those customers who wish to blame their brokers for their losses.

One of the reasons that the number of customer claims will go up is that in a rising market customers have fewer losses. That does not mean that the broker’s conduct was correct, just that it did not cost the customers money or that they could not see the losses or bad conduct until the market went down.

In the normal course, customers that have disputes with their stockbroker do not end up in court. Almost all of the cases are resolved by a panel of arbitrators at FINRA. It is a lot quicker and cheaper and in the vast majority of the cases, the customer walks away with a check for at least a portion of the amount lost.

Securities arbitration was the one consistent part of my professional practice. I worked on my first claim while still in law school. I represented mostly the brokerage industry for the first 15 years that I was in practice and mostly customers for the last 25 years. In all I represented a party or served as an arbitrator in almost 1500 cases. Some were unique and interesting; most were fairly mundane.

There are a few hundred lawyers around the country who specialize in securities arbitration representing customers.  Arbitration is intended to be simple enough that any customer can file and prosecute a claim themselves. But in every case the brokerage firm is going to be represented by a good lawyer and put on a competent defense. Even if you have the most mundane claim you need proper representation.

I have worked closely with about 2 dozen customer representatives over the years and like any other profession, some were better than others.  The best have all spent some time working in house for large brokerage firms.  They understand how the firms operate, what records the firms need to keep, how brokers are actually supervised and what defenses the firms are likely to have.

Do not be afraid to hire a representative that is not an attorney.  My fellow lawyers refuse to acknowledge that a retired branch office manager can often question the conduct of a broker better than anyone else.  For most of the claims that I handled I worked with a team that included both a lawyer and a non-lawyer who had worked in the industry for many years.  The latter was invaluable to every successful outcome.

Many lawyers think that securities arbitration is about the law, which it is not, nor has it ever been.  Arbitrators are not judges. They are not required to know the law, follow the law or to read legal briefs. Arbitrators are fact finders. They want to know who did what and why.  Too many lawyers approach securities arbitration as if they are presenting the case in court. It is the single biggest mistake and the single biggest reason why customers lose these claims.

Beginning in the late 1980s there began to be a lot of product related claims where the investment was itself defective.  Prudential Securities for example put out several billion dollars worth of public and private limited partnerships. Some were defective because the disclosures were not accurate or the due diligence was shoddy; others because the advertising and representations minimized the risks or projected returns that were unsupportable.

Over the years I have seen real estate funds where one appraisal of the property was sent to the bank and a second, higher appraisal went to the investors. I have seen “North American” bond funds full of bonds issued by South American companies and funds and ETFs full of derivatives that no investor could understand. Those claims are relatively easy to win. But it does help if you have a clear understanding of what the proper disclosures should have been.

There are always claims that stem from an individual broker’s bad conduct. Sometimes a broker will place an order without calling the customer for permission first. That is clearly against the rules and a customer is entitled to be compensated for any loss that occurs. If it happens it is easy to prove as the telephone records and the order are both time-stamped. Either the phone call preceded the order or it did not.

Sometimes a broker will help a customer trade an account or recommend a lot of buys and sells in a short period of time. Trading is not the same thing as investing.  Most traders, because they are making a lot of trades are concerned about how much commission they are paying on each one. That is why most traders gravitate to one of the low commission discount firms.  When you see a trader paying high commissions per trade and making a lot of trades it is usually a problem.

When the market comes down again, some of the losses will be the result of bad products and bad brokers.  However, most of the losses that the customers will suffer will be the result of staying in the market too long.  They will not be the victims of fraud but of simple negligence, as the claims will be based upon violations of the brokerage industry’s suitability rule.

The suitability rule is something that stockbrokers and their supervisors deal with every day. Notwithstanding, lawyers representing customers seem to have a hard time explaining it and how it is violated to arbitration panels.

Simply stated the suitability rule requires that a broker have a reasonable basis every time they make a recommendation to a customer to either, buy, sell or hold onto a security.   As it is written the rule sets forth a course of conduct for stockbrokers and requires them to get pertinent information about the client’s financial situation and tolerance for risk.

The typical defense is that the customer checked the box on the new account form that said he was willing to accept some risk or was willing to accept something other than conservative, income producing investments. This customer-centric view gives defense lawyers a lot of latitude to confuse arbitrators and will befuddle a lot of claimants when they file claims after the next crash. The proper way to view the suitability rule is to focus on the investment and the recommendation, not the customer.

In the normal course the only reason for a broker to recommend that a customer purchase any security is because the broker believes that the price of that security will appreciate in value. When they think the price will appreciate no further, they should recommend that the customer sell the position and move on to something else. The broker does not have to be correct, but he must have a reasonable basis for his belief.

Brokers and investors all over the world have for decades used the same methods to determine which securities will appreciate and which will not. It is called fundamental securities analysis and it is taught in every major business school.  Most of the large firms have cadres of analysts who write research reports based upon this type of analysis. Most of those reports set forth the analysts’ opinion of a target price for the security they are reviewing.

Deviating from that analysis will always get the brokerage firms in trouble.

That is what happened in the aftermath of the crash in 2000-2001.  Many of the claims from that era were the result of conflicted research reports. The firms were competing to fund tech companies and were funding companies that had few assets other than intellectual property and fewer customers if any.

I had several prominent research analysts on the witness stand who basically explained to arbitrators that they had to make up new ways of analysis because the internet was so new. That was BS, of course, and those “new” formulas were never disclosed to the investors or for that matter, never the subject of an article in any peer-reviewed journal.

Markets never go straight up for as long as this one has without a correction. I think that a lot of people seriously believe that a market correction or a crash is coming sooner rather than later. It may happen next week, next month or next year but it will happen.  I can say that because there is a lot of empirical data to support that position.

For example: 1) price/earnings ratios of many large cap stocks are at the high end of their ranges and when that happens prices come down until they are closer to the middle of the range; 2) employment is very high meaning wages should go up impacting the profits of many companies; 3) interest rates are rising which will cause people to take the profits that they have made in stocks over the last few years and convert them to safer, interest paying instruments; 4) rising interest rates also curtail borrowing, spending and growth; 5) an international tariff/trade war came on the markets suddenly and its impact has yet to be shown; 6) the global economy is not that good which should decrease consumption and prices; 7) oil prices keep rising and gas prices along with it because of international political uncertainty which adds to the cost of everything that moves by truck, which is virtually everything; 8) there is a lot of bad debt in the marketplace (again) including student debt, sub-prime auto loans and no-income verification HELOCs; 9) real estate prices are very high in a lot of markets and in many markets the “time on the market” for home sales is getting longer; and, 10) the increased volatility of late is itself never a good sign for the market because investors like certainty and stability.

None of this means that the market will necessarily go down but all of it needs to be considered. And that is really the point.  Many so-called market professionals urge people to just stay in the market no matter what. They claim that they cannot be expected to call the top of the market. They argue that the market will always come back, so what does it matter if you take some losses now.

Any investor who has made money during this long bull market should want to protect those gains. Any broker who is smart enough to advise clients when to buy a security, should be smart enough to tell them when to sell it.  Any advisor who keeps their clients fully invested when there are indications that a correction may be imminent is going to get sued and frankly deserves it.

The brokerage industry has always had a prejudice that suggests that customer should always be fully invested.  Brokers who work on a commission basis are always instructed that any customer with cash to invest should invest. Likewise, as the industry has morphed away from commissioned brokers to fee-based investment advisors, those advisors want to justify those fees by having a portfolio to manage not just an account holding a lot of cash.

Registered investment advisors are likely to be especially targeted by customers seeking to recover losses they suffer for a number of reasons. Many are small shops that do not employ a large stable of research analysts.  Many advisors just buy funds and ETFs and allocate them in a haphazard way because they really do not understand how asset allocation actually works. This is especially true of robo-advisors that are not programmed to do any analysis at all or to ever hold a significant amount of cash in their customers’ accounts.

All investment advisors including robo-advisors are held to the highest standard of care, that of a fiduciary. Any fiduciary’s first duty is to protect the assets that have been entrusted to their care. Any customer of a stockbroker or investment advisor should have a reasonable expectation that the profits they have earned will be protected.

I am posting this article on the evening before the US mid-term elections and on the day that the US re-imposed economic sanctions on Iran. Both may have significant effects on what will happen in the stock market in the next few months and beyond. Analysts may differ on what they believe those effects will be. But that is not an excuse to do no analysis at all.

The markets are driven by numbers and any broker or advisor who believes that they can offer advice without looking at those numbers has no business calling themselves a professional.  To the contrary, any advisor who tells you to stay in the market because no one can know when it will stop going up or that it will come back if it goes down is just playing you for a fool.

 

 

Expungement- FINRA’s dirty little secret

Investors, Law , , ,

Both FINRA and the SEC encourage investors to investigate the record of a financial professional before hiring them. It would certainly be valuable for any customer to know if the stockbroker to whom they are considering turning over their life savings had previous problems with other customers.

For more than 20 years FINRA has provided a free online tool called BrokerCheck. It provides potential customers with a history of where the broker has worked and in which states the broker is licensed to do business.

A BrokerCheck report is supposed to provide accurate information about regulatory problems that the broker may have had and basic information about complaints and arbitration claims that other customers may have asserted against the broker. Unfortunately arbitration claims, even those with serious allegations of misconduct are frequently not reported to the public.

From the outset brokers have strongly opposed this disclosure. They believe that many arbitration claims filed by their customers are frivolous, false or factually incorrect. There have never been any facts or data to support that assertion.

FINRA has always had a rule in place that permitted arbitrators to expunge the claim from the broker’s BrokerCheck record after the hearing or if the claim settled. The rule and the procedures have been tightened up over the years, but the fact remains that BrokerCheck’s record of a broker who has been the subject of multiple customer complaints and arbitration claims may reflect none of them.

There are actually reports of brokers who have been the subject of more than 20 customer complaints or arbitrations having some or all of these complaints expunged. In other words the worst offenders may get the most benefit from expungement. Brokers who have had the most serious problems may have those problems affirmatively concealed from investors.

Over the years there have been multiple studies, law review articles and comments regarding the pros and cons of permitting the expungement of customer claims against stockbrokers. The issue is lot easier to understand if you put it into some context.

If your neighbor slips and falls in front of your home on a snowy morning before you have had a chance to shovel the sidewalk and sues you for medical bills and lost wages, the lawsuit is matter of public record and will be a matter of public record forever. If you fail to pay your student loans or are late with a mortgage payment it will be noted on your credit report for many years.

FINRA arbitrations are private matters. If they are not reported on a BrokerCheck report they are unlikely to show up anywhere else that a prospective customer might access.

Some commentators have suggested an arbitration claim is similar to a bad review on Yelp or similar website. But they are not. A FINRA arbitration claim often means that a customer has lost money that they did not expect to lose. This usually means that the broker did not make a full disclosure of the risks involved.

As an attorney who has represented a great many customers in FINRA arbitrations I always understood that my job was to recover as much of my client’s losses as I could. No claim is perfect and every claim has its strengths and weaknesses. It is for this reason that the vast majority of arbitration claims that are filed with FINRA end up settling.

The question of expunging the broker’s record comes up in settlement discussions almost every time. Most of the defense lawyers with whom I have dealt over the years have been ethical and rarely made expungement a condition of the settlement which is not permitted.

More often, I would offer not to oppose the broker’s request for expungement if they made one to the arbitrators because the client rarely cared about anything more than getting the best monetary settlement they could. That is not the same as suggesting that I believed or in any way acquiesced to the idea that the claim was frivolous, false or factually incorrect in the first place.

Any attorney will tell you that clients do not always walk in the door with all of the paperwork that you would like to see or a firm recollection of all of the relevant facts. It was always my practice therefore to send a draft of the claim, with the client’s approval, to the brokerage firms’ compliance department before I filed the claim with FINRA. I would ask them to tell me if I had the facts correct and would solicit their interest in an early disposition of the matter.

Occasionally, they would respond that the broker named in the claim was actually out of the office when the offending transaction occurred and that a different broker had actually spoken with the client and was the official broker of record. Better to deal with these factual glitches up front than to fight over expungement later.

Understand that both FINRA and the SEC consider information about customer complaints to be information that any customer would consider to be important before they began doing business with a stockbroker.

In the context of an offering of securities the SEC routinely sanctions issuers who omit material facts. In the context of a BrokerCheck report, the Commission has sanctioned the omission of facts that everyone agrees are material.

Every year there are articles in industry publications bemoaning the public’s lack of confidence in the industry. Wouldn’t full disclosure of prior complaints instead of burying them help to restore the public’s confidence?

I have every reason to expect that this controversy will continue, in part because many people in the industry will never get over the arrogance of a customer who dares to file an arbitration claim. Even those with the most to gain, the honest brokers who work for years without a single customer complaint are silent.

For this reason FINRA is unlikely to acquiesce to allowing BrokerCheck to report any and all claims made against a broker without providing some type of escape mechanism. In the meantime, it is impossible for a customer to know if the BrokerCheck report that FINRA urges them to read is accurate. As a practical matter a BrokerCheck report is worthless.

Allow me to offer a practical solution.

If you are considering hiring a new broker and find that BrokerCheck reports no complaints or arbitration claims, send the broker the following e-mail:

Dear Mr. Smith: We have done some research and were very pleased to learn that throughout your many years in the brokerage business you have never had a complaint or arbitration with a customer. Please confirm that this is true and that none have been removed from your record.

That should protect any customer and level the playing field. It is one thing for a broker to have arbitration claims expunged from their record and quite another to lie about it.