By John D. Tuerck
An arbitration panel has ordered a brokerage firm to pay about $3 million to a Falls Church man who lost more than $1 million in high-risk investments in the stock market.
The case is the latest in a number of lawsuits filed nationwide against stockbrokers arising from questionable investment strategies made at a time of economic downturn.
Nearing retirement, the man intended to insulate $300,000 to $400,000 against inflation in low-risk investments. Without his knowledge, however, the broker sank the money in high-risk technology stocks in a margin account.
In arbitration before a three-person panel of the National Association of Securities Dealers, the brokerage contended that losses in the declining stock market were widespread and that the man consented to the investments.
"This was not the little old man who gave a pile of money to a broker and found out a year later it was gone," said the brokerage's lawyer, John M. Myers of Philadelphia.
The panel, however, ordered the brokerage to pay the man $1 million in compensatory damages, $1.3 million in punitive damages and $775,000 in attorneys' fees. The parties later settled for an undisclosed amount.
"The key in this area of the law is to have informed consent," said the man's lawyer, W. Scott Greco of McLean. "Someone who's retired should not be in the stock market to the degree my client was."
The case is McLeod v. Josephthal & Co. Inc. et al. A Verdict & Settlement report appears on page 8.
On the margin
The claimant, 65, is a retired U.S. Army historian with severe health problems. In November 1998, he put about $100,000 in a cash-brokerage account with the respondent. He wanted his money invested in growth and income funds.
"His goal, in essence, was to stay ahead of inflation," Greco said. "Another of his objectives was preservation of capital."
Not long after, the claimant and his wife sold some property and increased the amount of money in the account by $200,000 to $300,000.
In August 2000, the broker switched the claimant's funds to a margin account and invested the money in high-tech stocks. The account, according to Greco, had no diversification, where different types of funds are invested to spread risk. "These were, for the most part, stocks that no one had heard of," he said.
Greco explained that a margin account allows an investor to borrow additional money from the brokerage to fund investments. If the investment falls short, however, the brokerage can issue a "margin call" to have the investor cover the amount borrowed.
"It greatly increases the risk, as well as the potential to make money," Greco said.
With the stock market poised to enter its current downturn, however, high-tech stocks proved to be a bad bet.
"It was not the time to be putting more money in the stock market," Greco noted. "And [the broker] began to really ramp up the trading at that point."
The claimant called the broker, concerned about the mounting losses.
The broker "told him not to worry" and urged him to increase his investment, Greco said. "The broker told him, 'This is the way to fix this.'"
Myers disagreed, contending that the claimant's conduct indicated he that he was aware of the new investment strategy.
"At that time, he knew he had a margin account, and he didn't close it," said Myers. "What's important here is that at that time, he continued to invest additional funds."
Ultimately, the claimant lost more than $1 million, or half of his net worth. Of that amount, said Greco, the broker received $218,120 in commissions.
The claimant's contract with the respondent required any dispute to be heard by the National Association of Securities Dealers, which, according to a spokesman, hears about 90 percent of all such disputes in the country.
During a four-day hearing in January 2003, Greco contended that the respondent and the broker failed to make a "suitability determination." In such a determination, the broker considers a number of factors — including the investor's age, sophistication, objectives and risk tolerance, among others — in tailoring an appropriate investment portfolio.
"The significant fact was whether [the claimant] had ever agreed to this being a margin account," said Greco.
"He certainly acted as a savvy investor," said Myers. "He was a savvy investor because there were literally hundreds of pages of his own documentation."
However, said Greco, the respondent could produce no documentation showing that the claimant had agreed to switching the funds to a margin account.
In addition, Greco learned during discovery that after the claimant had lost about $300,000, the broker had filed an "internal activity account."
"His figures were completely wrong; they showed virtually no losses on the account," he said. "Their documents showed a lot of inconsistencies."
In addition, Greco contended that the broker had engaged in "churning," the practice of exercising control over excessive investments for the sake of earning commissions instead of acting in the investor's best interests.
"You could see this was how this guy was making a living," Greco said.
The question was put to Greco: How is his client's experience any different from those of countless investors who took a beating in the market?
"One of the overriding issues in the case was credibility," he said. "As a professional in the business, the broker's the one with all the facts and all the knowledge. The broker can't assume the customer's going to understand the risks of every investment he makes."
"The decision here reflects, in my judgment, a very inexperienced panel with virtually no securities-arbitration experience," Myers remarked. "If you're going to treat these brokerage firms as insurers against market loss, then you've really created a hopeless situation."
Greco, who handles securities matters with his father, Frederick, said that news about bad investments likely had little impact on the sophisticated NASD panel.
As a general matter, however, "I certainly think the atmosphere of credibility is good for investors," he said. "We certainly get calls from people because of what they see in the papers."
June 9, 2003
