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NASD’s Bumpy Road to Justice

Los Angeles Times

Convinced that she had been defrauded by her stockbroker, Cara Marks fought back.

She took her claim to the arbitration program of the National Assn. of Securities Dealers, the nation’s dominant forum for resolving legal disputes between investors and brokers.

For Marks, who said the broker sent falsified financial statements to keep her in the dark about her losses, there eventually was some good news: an arbitration panel awarded her $137,000.

But it was a hollow victory. More than a year after winning the arbitration, the 43-year-old Beverly Hills resident hasn’t received a dime and doesn’t know if she ever will.

For a growing number of investors, claimants’ lawyers say, the NASD’s arbitration program is a flop. Sometimes, as in Marks’ case, investors don’t recover any money because brokers duck their financial obligations by quitting the securities business or filing for bankruptcy.

In smaller disputes, investors frequently encounter tough obstacles just trying to put together an arbitration case. Attorneys versed in securities law say the high costs and time required by arbitration mean that they ordinarily can’t afford to take cases involving claims of less than $25,000 or $30,000.

Although investors in smaller disputes can represent themselves, they often are thwarted by the complexity of the litigation.

As with any system for resolving financial disputes, the arbitration program run by the NASD–an industry organization with quasi-governmental regulatory powers–has supporters as well as detractors.

In addition, securities lawyers acknowledge that since the NASD launched an overhaul of its regulatory and investor-protection operations more than three years ago, the arbitration program generally has gotten better. They cite improved methods for training and selecting arbitrators, along with streamlined procedures for resolving cases.

Still, arbitration is widely thought to remain one of the major problem areas at the NASD. The NASD parent organization, acknowledging that further changes are needed, is planning a reorganization next year that will put its arbitration and recently expanding mediation services into a stand-alone division.

What makes the NASD’s arbitration program important is that there are so few other legal options for investors with grievances against their brokers. The securities industry, ever since winning a favorable U.S. Supreme Court ruling in 1987, generally has required new customers to sign away the right to sue their brokers in court over investment disputes.

So, if filing a complaint with the brokerage firm itself doesn’t resolve the dispute, arbitration is normally the only avenue to pursue.
Although there are other arbitration forums, including one at the New York Stock Exchange, the NASD system handles roughly 90% of the claims brought by investors across the country.

The latest NASD statistics show that investors win 62% of all arbitration decisions, reflecting a steady rise from 47% in 1994. Fredda Plesser, a lawyer for the Securities Industry Assn. trade group, said the increase demonstrates that “the forum is neutral and the system works well.”

According to the Securities Arbitration Commentator newsletter in Maplewood, N.J., over a five-year period ended in June 1998, the average award in NASD cases won by customers was $86,172.
At the same time, more brokers are failing to pay when they lose arbitration. While the big-name Wall Street concerns almost always pay up to safeguard their reputations, problems commonly come up with small, little-known brokerage firms.

The result is that “we’re not taking cases we should because of fear of not collecting,” said Jacob H. Zamansky, a New York securities lawyer.
Zamansky said the problem is aggravated by the slowness of the NASD system, which takes 15 months to bring the average case from filing to decision.

“It’s no problem if you’re suing Merrill Lynch, but what about if you’re suing one of these small firms that are dropping like flies?” said Zamansky. He added that when the firm involved is a New York Stock Exchange member, he prefers to file arbitrations with that exchange.

Mark E. Maddox, an ex-securities commissioner of Indiana and now president of a claimants lawyer group called the Public Investors Arbitration Bar Assn., estimates that unpaid awards totaled roughly in the range of $30 million to $50 million a year in both 1997 and 1998. That, he said, is up from $10 million to $15 million a year in the mid-1990s.

A business as prosperous as the securities industry, Maddox said, should be able to cover investors against damages in such cases. He has urged the industry to set up a special insurance fund to cover unpaid arbitration awards.

Another option, he said, would be to provide that sort of insurance by expanding the Securities Investor Protection Corp., or SIPC, a nonprofit fund that already covers customers against losses stemming from financial failures by securities firms.

NASD and industry officials, however, call Maddox’s proposal unrealistic. They say it could create an expensive bureaucracy, punish aboveboard brokerage firms for the misdeeds of others and discourage investors from seeking other legal means to collect their awards.

Failure to pay already carries severe consequences for brokers. It normally is grounds for tossing them out of the securities industry. Last year the number of brokers suspended for failure to pay arbitration awards jumped to 170, up from 69 in 1997.

That, in fact, is what happened to Marks’ broker. “So, at least something good came out of this,” grumbled Marks, a greeting card illustrator who has two teenage sons.

Today, Marks faults herself “for not taking responsibility for money I worked hard to earn.” Marks, who was put in touch with her broker through a business acquaintance, dealt with the broker exclusively over the phone or through the mail.

From now on, she said, “I’ll rely on meeting someone. I want to see what they’re like. I want to see their staff. They need to work for my trust now.”

Another stubborn problem is the complexity of the arbitration process. Lawyers representing investors and brokers alike agree that it has become more like a regular court process, complete with high-priced expert witnesses.

Linda D. Fienberg, an executive vice president of the NASD Regulation unit and head of arbitration and mediation, said one of her main goals is “to streamline the process even more. We’d like to make it easier, less litigious and less like court.”

The NASD offers so-called simplified arbitration for cases of up to $25,000, partly as a way to help investors who can’t afford a lawyer. But that process still can be far too complicated for investors–or even for lawyers who don’t specialize in the securities field.

That’s what Salim N. Turk, a Los Angeles insurance lawyer, found when he helped his father bring a simplified arbitration claim this year. “There’s nothing simplified about it,” Turk said.

Even in modest-size securities arbitration cases, he discovered, “you’re trying to put together a picture of what the offending brokers may have done, and the only way to do that is to essentially analyze the paper trail, which is labor intensive.”

Turk apparently learned his securities law lessons well: He won $10,000 for his father.

Still, given the cost of handling the arbitration, Turk said, “If it hadn’t been my father’s case, it wouldn’t have been worth it.”