Arbitration decision raises value of broker-client communication
If anyone needed a reminder of what ``buyer beware'' means, the United States Supreme Court has given them one. The court's 5-4 decision this month giving brokerages the power to block customers from suing them in federal court could - for a while, at least - make it harder for investors to win awards from brokers who mess up their accounts.
The justices said that when a Yonkers, N.Y., couple signed a standard broker-client contract they agreed that all disputes would be settled by arbitration. That contract holds, even though the couple say their broker cost them more than $350,000 by ``churning'' their account, buying and selling securities simply to generate commissions.
In most cases, arbitration clauses are used when the customer has a margin account where part of the money used to buy stocks is borrowed from the broker, or where there's a ``discretionary'' account permitting the broker to buy and sell securities without calling the customer beforehand.
But you don't have to sign the agreement, securities experts and attorneys say. Or you may be able to alter the contract. Or you may find another broker.
``If there's an arbitration clause, make sure you understand it,'' says Earl K. Cantwell, a partner at Jaeckle, Fleischmann & Mugel, a Buffalo, N.Y., law firm. Mr. Cantwell has written on consumer rights in the Journal of the American Association of Individual Investors. ``You're always free to negotiate many of the terms in the contract.''
If brokerages use the Supreme Court ruling to take a tough line on this issue and not permit changes in the contract, Cantwell predicts, ``people will vote with their feet'' and find a more accommodating broker. ``If a significant number of customers refuse to go along with the arbitration clause, that will have an effect,'' he says.
``Customers always have the right not to sign something,'' says William Tyson, assistant professor of legal studies of the Wharton School at the University of Pennsylvania.
While the Supreme Court's decision may make it harder to cross out that clause altogether, Cantwell says, you may be able to specify ahead of time where the arbitration panel comes from. Traditionally, this panel includes one or two members from the brokerage business or lawyers who also have brokers as clients. Brokers contend this ensures that at least one member of the panel knows the securities business well enough to make a fully informed decision. But consumer groups argue that this process tilts the decision in favor of the broker.
If you want a totally impartial panel, see if the arbitration clause can be changed to use a panel put together by the American Arbitration Association or the Better Business Bureau, rather than the New York Stock Exchange or one of the other exchanges.
An arbitration clause is, of course, based on the premise that there might be a misunderstanding between the broker and the customer, a mistake, or even outright fraud. Avoiding misunderstandings and selecting an honest, competent broker are the first steps toward making such a clause unnecessary.
``The best protection is to do business with a broker you know to be of the highest integrity,'' says Perrin Long at Lipper Analytical Services. ``If the firm makes a mistake, they almost always make amends right off the bat. But they don't always know what their brokers are doing.''
The second protection, Mr. Long says, is to ``keep all transactions as simple as possible. The more complex you make each transaction, the more chances there are for misunderstanding.''
A third way to protect yourself, he says, is to avoid discretionary accounts. ``A customer probably should not give carte blanche authority to a broker to trade in and out of a customer's account at will,'' he recommends. Some brokerages, in fact, don't allow their brokers to handle discretionary accounts.
If you want, you can add your own protection. Most discount brokerages and mutual funds tape record all transactions to avoid future misunderstandings. Even if your full-commission broker doesn't do this, you can, with a tape recorder and a small suction cup device near the top of the telephone receiver. As long as both parties know the conversation is being recorded, it's perfectly legal.
For the future, any problems that have been created by the Supreme Court decision may be short-lived. The Securities and Exchange Commission (SEC) is reviewing the arbiration procedure to see if it is fair. If the commission thinks changes are needed, recommendations will probably be made later this year.
Rep. John Dingell (D) of Michigan, chairman of the House oversight and investigations subcommittee, plans to review the SEC recommendations and the Supreme Court ruling before holding hearings on the subject, which could lead to legislation. His efforts will have support from at least one member of the Supreme Court. In his dissent, Justice Harry Blackmun wrote: ``There is hope that Congress will give investors the relief that the Court denies them today.''
``I think Congress could perhaps propose legislation to direct the SEC to promulgate rules that would make arbitration fair,'' Professor Tyson at Wharton says. ``The arbitrators should have no connection to the securities industry.''