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Investors Seeking Justice Gain Little In New NASD Rules

Dow Jones Newswires

It isn’t easy for a naive investor to conquer a street-smart brokerage firm, but Cara Marks succeeded three years ago when she won $137,000 in an arbitration case against Lew Lieberbaum & Co.

Then the 45-year-old Beverly Hills resident found out that winning isn’t everything on Wall Street, at least not in the industry’s investor grievance system known as arbitration. Just months after a panel decided in her favor, Lew Lieberbaum shut its doors, never to pay Marks’ award. While it was mandatory for Marks to go through arbitration with her claim that a broker made unsuitable and unauthorized trades in her account, it wasn’t mandatory that the firm actually hand over the money.

“It’s losing twice, is what it’s all about,” said Marks, a former greeting card designer who said she knew nothing about investing when the Lew Lieberbaum broker first called her.

Now, the self-regulatory organization charged with dispensing justice to investors is trying to address complaints like Marks’. The National Association of Securities Dealers is proposing changes to tweak the arbitration system and, in some cases, allow customers to bypass it altogether and go directly to court.

There’s just one problem, say critics. Investors still aren’t going to collect the money they are owed from firms that close down.

Zero Plus Zero

“In theory, it sounds like they are trying to help investors. In reality, it does absolutely nothing,” said Jacob H. Zamansky of Zamansky & Assoc. a New York City firm that represents investors in arbitration claims.

The changes being considered are the result of a U.S. General Accounting Office study last year which showed only 49% of investors who win arbitration cases against their brokers actually get paid, with another 12% receiving partial payment. One factor contributing to the high delinquency rate: NASD didn’t have any procedure for tracking award payment at its member firms.

The GAO report last June spurred a flurry of NASD proposals. In September, firms were required to certify award payment within 30 days, or risk suspension. A second proposal filed with the Securities and Exchange Commission last month would allow investors to bypass mandatory arbitration and go to court if their brokerage had lost its NASD membership. A third draft proposal expected this spring would streamline arbitration proceedings when brokers go out of business and skip hearings.

From the NASD’s perspective, the second proposal in particular is a handy tool for investors, who theoretically could get a court order to freeze the assets at a dying firm before they disappear. But even SEC attorneys have had difficulty obtaining such orders from judges. And if private clients can convince a judge to do so, they must then post a bond to cover the amount frozen – an expense that some investors can’t handle.

Brian Carlis, a partner at Stark & Stark in Lawrenceville, N.J., said he isn’t sure that he would have gone to court if he had had the opportunity in a recent case. That case involved a Florida widow who claimed a Hamilton-Shea Group Inc. broker convinced her to liquidate exchange-listed stocks she owned and invest the money in Pro-Tech Communications Inc. (PCTU), of Fort Pierce, Fla., which is thinly traded on the over-the-counter bulletin board.

An arbitration panel awarded her $254,000 in November, but by then, Hamilton- Shea was defunct. So far, she has received nothing. Carlis said the slim likelihood of obtaining an asset freeze, combined with the cost of a bond, might not have made court an attractive option.

“There’s no guarantee you’d get it and it’s not inexpensive,” Carlis said.

The NASD said it isn’t selling its rule changes as a complete fix for what ails the unpaid investors, but they could be helpful in some cases.

“This isn’t going to solve everything. If a firm is out of business and has no assets…well, zero plus zero is still zero,” said Linda Fienberg, president of NASD dispute resolution, which oversees the arbitration system. “But we think these will help give a partial remedy.”

Changing The SIPC

Plaintiff attorneys say there are better options that regulators should pursue. Allan Fedor, of Fedor & Fedor in Largo, Fla., said an industry-sponsored restitution fund would have helped a client who won an almost $1 million judgment in November against a former Hackensack, N.J., firm known as Investors Associates Inc.

Investors Associates shut down in 1997, after state regulators charged it with selling unregistered stock and defrauding small investors. Several of its executives have pleaded guilty to federal charges related to stock price manipulation, and their state securities licenses are revoked. Meanwhile, Fedor’s client is still waiting for a check.

“I think it’s too little, too late,” said Fedor of NASD’s proposals.

Fedor and other plaintiff attorneys say a restitution fund would provide investors with the same type of protection bank customers receive from the Federal Deposit Insurance Corp., which makes good on every account of $100,000 or less when it takes over a failing bank. One proposal by the Public Investors Arbitration Bar Association would involve the Securities Investor Protection Corp., which currently doesn’t provide protection from losses caused by fraud at a failed brokerage firm.

The General Accounting Office is studying SIPC’s role in investor protection at the behest of Rep John D. Dingell (D-Mich.), and a report is due out next month. But opening up the SIPC coffers to defrauded investors is an unpopular notion at SIPC itself, and isn’t likely to gain support from the securities firms which fund it. NASD’s Fienberg said it wouldn’t be fair for firms that make good on arbitration claims – such as Merrill Lynch & Co. (MER) or Morgan Stanley Dean Witter & Co. (MWD) – to pay for the misdeeds of small shops like Lew Lieberbaum, who create the majority of the delinquent awards.

“Inevitably, it would mean good firms will be paying for bad firms,” she said.

That’s the most common argument against a restitution fund within the brokerage industry, but there’s no basis for thinking that such a system would be set up. After all, that isn’t the way it works at the FDIC: riskier banks are required to pay more to that insurance pool. A bank with millions of accounts but little risk of collapse – such as Citigroup Inc. (C) – doesn’t pay a cent in FDIC insurance. A smaller bank that is considered less safe can pay as much as 23 cents for every dollar it holds to the FDIC. In addition, the FDIC conducts extensive examinations of its member banks to monitor their risk.

SIPC charges all its members, large and small, an annual fee of $150, and it carries out no regulatory function similar to the FDIC’s examinations. Its president, Michael Don, said his staff of 29 has been carrying out Congress’ intent since the 1970s, and it will take an act of Congress to broaden its mission further. He questioned the push for increased use of SIPC funds, coming from plaintiff attorneys who stand to profit from such a move, and said investors would end up footing the bill.

“If the industry is assessed to pay for it, those assessments will be passed down to the customers,” Don said.