Advisor Insight

Wronged investors win cases over brokers but never collect

Andrew Osterland, special to

How do you get deadbeat brokers and the firms that employ them to pay what they owe to investors?

The Financial Industry Regulatory Authority is open to suggestions.

Finra, the regulator of the brokerage industry, recently released some troubling data on arbitration awards and the proportion of them that go unpaid. "Previously unpublished data" from Finra that appeared in The Wall Street Journal showed that 15 percent of awards granted to investors by FINRA arbitration panels in 2014 — roughly $34 million — remain unpaid by the brokers and their firms. That's slightly higher than the 13 percent average over the five years through 2014, according to FINRA's data.

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"The reality is that problems with collection of judgments exist across all courts, arbitration forums and government agency settlements," according to a FINRA statement emailed by public spokeswoman Michelle Ong. The self-regulatory organization said it "continues to be concerned" about unpaid awards, but a task force recently examining FINRA's arbitration process — mandatory for all clients of Finra-registered brokers — did not agree on a solution and offered no advice to help investors collect on awards against bad brokers.

"Finra continues to explore a number of solutions and welcomes input from interested parties," per the statement.

Not nearly good enough, said Hugh Berkson, president of the Public Investors Arbitration Bar Association and a securities lawyer with McCarthy Lebit, Crystal & Liffman. The problem of investors being stiffed by investment brokers found liable in arbitration disputes is not new.

The Government Accountability Office has raised the issue twice in the last 15 years. Berkson said the numbers released by FINRA understate the problem, and he revealed that one out of three arbitration awards and $1 out of every $4 awarded goes unpaid.

Advisors can harm clients by trying to 'do it all' themselves

"It's time to do something about this," said Berkson, who represents investors in disputes with brokers and their firms. "There should be money available to investors who are found to have been wronged [by brokers]."

PIABA's suggestion is the creation of a national recovery pool that would cover unpaid awards. A $100 assessment on the roughly 650,000 registered reps in the industry would have covered the $62 million of unpaid awards to investors in 2013, per PIABA research. Finra has considered other solutions, such as requiring firms to have insurance that would cover losses in arbitration disputes, but decided it would be too expensive for many firms. Ditto for the idea of raising net capital requirements that can be as low as $5,000 for small brokerage firms.

"A pool of assets financed by the industry makes the most sense," said Andrew Stoltmann, a Chicago-based securities lawyer. "Let brokers who are responsible for the problem pay for it."

The focus should be on preventing fraud and wrongdoing in the first place. Look for advisors you know with deep roots in the community. It's up to individuals to get engaged and to develop financial wherewithal.
Brian Hamburger
founder, president and CEO of MarketCounsel

A recovery pool would of course benefit lawyers such as Stoltmann and Berkson, who get stiffed along with clients when brokers don't pay arbitration awards. The idea, however, is not likely to fly in an industry that feels it already faces excessive regulation.

"Good" brokers — those who pay arbitration awards against them — would have to help finance the "bad" brokers who don't. "The industry would fight it tooth and nail," Stoltmann said.

So what can investors, who've been burned, do when they can't collect on arbitration awards? Unfortunately, not much other than paying more lawyers to pursue the broker and/or brokerage in court.

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FINRA members who don't pay awards against them are barred from the industry until they do. Small firms, however, often face multiple claims from clients when some private placement investment or other typically high-commission product blows up.

Many can't pay the awards, so they leave the industry, declare bankruptcy and hire lawyers to help shield their personal assets. Investors rarely win those legal battles.

"You can go to court and use other resources to try to get paid, but it doesn't substantially increase the likelihood that you will get paid," said lawyer Brian Hamburger, founder, president and CEO of consulting firm MarketCounsel.

Hamburger thinks a national recovery pool would create perverse incentives in the industry, encouraging brokers with arbitration awards against them to leave the business because they know their clients will be made whole.

"The focus should be on preventing fraud and wrongdoing in the first place," said Hamburger, who suggested investors be more diligent in picking their financial advisors and understanding their investment advice.

"Look for advisors you know with deep roots in the community," he added. "It's up to individuals to get engaged and to develop financial wherewithal."

Make sure the advisor you select is the right fit

That's cold comfort for people who may have lost their life savings to brokers who've sold them unsuitable investments.

Stoltmann suggested that people are better off dealing with bigger firms that are more likely to honor arbitration awards against their brokers because they want to stay in business. "If something goes wrong — and things go wrong a lot — at least you have a firm you can collect from," he said.

For investors with smaller brokers that run into major problems, the chances of collecting on arbitration awards get progressively worse. Without FINRA stepping up with a solution, it remains a "buyer beware" environment in the brokerage industry.

"There's literally a playbook that owners of brokerage firms follow to shield their assets when things go wrong," Stoltmann said. "Once you're in that boat, you have real problems."

— By Andrew Osterland, special to CNBC,com