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Stop Loss Discipline Fails Stock Brokerage: Arbitration Panel Awards Two Merrill Lynch Clients

The Daily Journal

When the stock market tanked three years ago, a lot of investors lost their shirts.

Some brokerage houses blamed market forces for their customers’ shrunken portfolios.

Merrill Lynch took that position after two of its clients, brothers Aleks and Michel Horvat, lost more than $2 million over an eight-month period in 2000.

The brothers subsequently filed an arbitration claim alleging that broker Win Truong disregarded their risk tolerance and that his managers didn’t properly watch over him. They sued for breach of fiduciary duty, fraud and failure to supervise, among other things.

Last month, a three-member arbitration panel found in favor of the Horvats, awarding them $2.1 million. Horvat v. Merrill Lynch Pierce Fenner & Smith, 01-0257 (Los Angeles, National Association of Securities Dealers Dispute Resolution, settled Feb. 14, 2003).

The Horvats’ were represented by Robert A. Uhl and Ryan Bakhtiari. Mr. Uhl says the case sends a message that brokerage firms must accept responsibility for their mismanagement.

“As fiduciaries, the firm had the duty to guard against the well-known possibility that the market would go down thereby resulting in damages,” Uhl says.

Merrill Lynch’s attorney, Thomas L. Taylor III of Los Angeles’ Morgan, Lewis & Bockius, declined to comment.

Merrill Lynch spokesman Mark Herr says the company disagrees with the decision. He won’t discuss whether it’s considering an appeal.

Compared to the $320,000 deposited by Michel Horvat, his brother Aleks Horvat invested much more-about $5 million.

Much of the case focused on him.

“Aleks Horvat was an extremely aggressive technology investor who sought to capitalize on the technology boom,” Herr says. “When the market turned down, he-as most tech investors did-lost money.”

In 2000, Aleks Horvat, 42, wanted to invest in securities using the proceeds he recently had acquired from the sale of his publishing business. His wife’s business associate recommended Truong, who worked at a Merrill Lynch branch in Beverly Hills.

Aleks Horvat, Truong and one of his supervisors met in March 2000. According to Uhl, his client expressed a desire for taking only “moderate” risk with his trades. So they allegedly agreed to what’s known as a “stop loss discipline,” which meant that if the price of a security dropped by 10 percent to 15 percent it would be sold to avoid a possibly bigger loss in the future.

Everything seemed to be going well for Aleks Horvat in the first few months.

“Win told him, ‘We’re doing great,'” Uhl says.

In June 2000, Aleks Horvat suggested that his brother Michel Horvat, 39, have Truong invest on his behalf. Michel Horvat expressed the same risk tolerance as his brother, and the broker allegedly agreed to employ the same stop loss discipline.

But Uhl claims Truong failed to honor his agreements.

The broker held onto stocks after they had dropped below 10 percent to 15 percent. As long as he didn’t sell them, they remained an “unrealized” or paper loss Uhl says. At the same time, Truong sold securities that increased in value, which gave the Horvats the false impression that they were making profits, Uhl says. As a result, Truong reaped lucrative trading commissions, he says.

As a measure of how little Aleks Horvat was kept informed, Uhl points out that by May 2000, his client had lost $750,000. Nevertheless, Horvat sent Truong a $1,000 tip, Uhl says.

To make matters worse, management failed to carefully monitor Truong’s transactions, Uhl says.

“They said, ‘We’ll protect you,'” Uhl says. “They weren’t doing that at all. It was a failure to live up to the promise to protect the client on the downside.”

In arbitration papers, Merrill Lynch denied any wrongdoing.

It claims that the Horvats wanted to pursue an aggressive investment strategy that focused primarily on volatile technology stocks. In addition, the company claims that Aleks Horvat in particular closely monitored each transaction and never complained to management about Truong.

Uhl says he knows why.

“The broker didn’t keep him abreast of what was really happening,” he says.