When Oscar Bugarini was downsized into early retirement from Boeing Co.’s Long Beach aircraft plant in 1999, he turned his $240,000 in retirement savings over to brokerage Salomon Smith Barney, asking in writing for a conservative portfolio balanced among “value” stocks, bonds and cash.
Instead, Bugarini says, he wound up with technology stocks and Salomon-managed growth-stock mutual funds that shot up briefly, then fell into a long decline. All the while, Bugarini says, he was demanding that his Salomon brokers sell the volatile holdings.
“They kept saying, ‘Don’t worry; it’s under control. The worst thing to do is get out when the market is down,’ ” recalls Bugarini, now 64. By the time the brokers finally cashed him out in 2001, Bugarini figures he had lost $109,000.
Believing they had been wronged, and wanting to get at least some of their money back, Bugarini and his wife, Mercedes, filed an arbitration complaint against Salomon last summer.
And that’s when things really got complicated.
Using arbitration to settle a dispute is supposed to be a quick, affordable alternative to a courtroom trial. Instead, the Yorba Linda couple discovered that the brokerage industry wouldn’t appoint arbitrators to hear their case unless they first waived rights granted by a new California ethics law.
The Bugarinis had landed in the middle of a major legal dust-up pitting the brokerage industry — backed by the U.S. Securities and Exchange Commission — against the California Judicial Council, the state attorney general and hundreds of investors like themselves.
The battle was sparked after the Legislature in 2001 passed an ethics law that requires arbitrators in California to follow much broader disclosure rules than those required of arbitrators by the New York Stock Exchange and the NASD (formerly the National Assn. of Securities Dealers), the brokerage industry’s self-regulatory organizations.
The California law requires that arbitrators divulge a checklist of all business, personal and professional ties that could represent conflicts of interest.
Investors could use such disclosed material to challenge and disqualify proposed arbitrators. The state wants these rules to apply in all arbitration cases, including disputes involving medical claims, employment, insurance — and brokerages.
The NASD and the NYSE asked a federal judge in San Francisco last fall to decree that California has no authority to issue arbitration rules that conflict with the industry’s standards. The suit was thrown out on technical
grounds, but the industry is appealing.
In a separate case on the subject, U.S. District Judge Jeremy Fogel in San Jose on Monday heard arguments on the central point of the dispute: Whose rules — the securities industry’s or the state of California’s — should govern arbitration cases brought by residents of the Golden State?
That’s bad news for the hundreds of Californians who, like the Bugarinis, have paid $1,000 or more in fees in the last seven months to the NYSE or to NASD Dispute Resolution, in hopes of having their complaints heard by an arbitration panel.
With their cases now held up, the aggrieved investors face difficult choices. Should they waive their rights under state law? Take their complaints to another state, such as Nevada, where they can be heard by arbitrators under securities industry rules? Wait for the courts to resolve the state-versus-federal dispute?
Or should they abandon the arbitration process altogether and try to take their complaints to state court?
For investors, deciding what to do while the conflict is sorted out is a “tough question,” acknowledges SEC Commissioner Cynthia A. Glassman.
For those who won’t waive their rights under the new state law, “there would really appear to be from a legal perspective only two options, which are to go out of state, for those who can, or to wait,” she says.
But other investors, including Bugarini, are taking option No. 4. They’re asking state court judges across California to accept complaints that, according to brokerage contracts signed by all customers when they open accounts, are supposed to be heard only by arbitrators provided by the industry.
“I’m not going to waive my rights,” Bugarini says.
He and his wife sued in September to recover losses from Salomon Smith Barney. Orange County Superior Court Judge Thomas Thrasher Sr. last month rejected the brokerage’s efforts to force the Bugarinis into industry-sponsored arbitration, saying that part of their contract with Salomon was unenforceable because of NASD’s boycott of arbitration proceedings under California law.
For its part, Salomon says it “continues to believe that this matter is properly referable to arbitration, where we will defend it vigorously.”
In the meantime, the Bugarinis’ lawyer, Douglas Ames of Huntington Beach, has gone outside the arbitration process and filed two other broker-complaint cases in state court on behalf of Southland retirees.
Besides avoiding the legal logjam over arbitration in California, Ames says taking his cases to state court will enable him to use discovery, which generally isn’t allowed in arbitrations, to pursue allegations that securities firms encouraged their brokers to make overly risky investments.
He also is convinced that juries would be more likely to side with his clients than would arbitrators, who are supplied by the brokerage industry.
One of Ames’ suits, filed on behalf of former airline pilot Patrick “P.J.” Schachle of Cypress, has withstood efforts by Merrill Lynch & Co.’s lawyers to force the matter into arbitration. In a ruling, Orange County Superior Court Judge Thierry Colaw said he has “considerable doubt” about the effectiveness of arbitration, given the industry’s stance on the California ethics rules.
Schachle, who lost more than $1 million of his retirement savings, contends that his broker put him 99% in technology investments despite his stated desire to take only average risks. He says the broker wouldn’t listen when Schachle wanted to get out of tech stocks in October 2000.
Salomon and Merrill Lynch characterize the suits as part of a wave of complaints by investors who got caught up in the stock-market boom and now are trying to find someone to blame for the consequences of the gambles they freely took.
Schachle’s suit, says Merrill Lynch spokesman Mark Herr, “is a garden-variety case.”
“Like many people, he lost money during the 30 months of a bear market, and he now claims somehow he was mistreated,” Herr says. “The only thing that makes this stand out is the attempt by his attorney to transform this to a test case about California’s approach to arbitration.”
The NASD and the NYSE, which figured last September that 500 Californians had been affected by the dispute, won’t provide an updated estimate. But hundreds of additional investors’ cases have since been put on hold. The number is expected to climb as disgruntled investors, their ranks swollen by the three-year bear market, look for someone to sue.
Critics of the securities industry, meanwhile, maintain that the real agenda of the NASD and NYSE is to pressure state legislators to exempt brokerage firms from the new ethics law. Senate President Pro Tem John Burton (D-San Francisco), and Sen. Martha Escutia (D-Montebello), the co-authors of the statute, say the industry’s aim is “holding these cases hostage.”
It’s an argument that resonates with Bugarini: “The industry has some real deep pockets. And we don’t.”