Data Race mentioned in Newsweek
newsweek.com
This brings me to Judy and Arnold Hyman of Boynton Beach, Fla., now retired. The Hymans used to own three dry-cleaning stores. For years they've kept their money in mutual funds.
But then their sons, Mark and Bill, decided to try day trading for a living. They hitched up with Cygnet Securities in Waldwick, N.J., and imagined they could do low-risk trading with high returns. Bill, 37, told his folks it would be a big help if they opened Cygnet accounts for him to trade. They did, in 1995. They didn't invest a penny of their retirement savings; they just signed the papers. "You'd do anything for your children," Judy Hyman says.
Fast forward to 1997. Cygnet failed. George Swan, Cygnet's owner, agreed to let the National Association of Securities Dealers bar him from the securities business for making unauthorized trades in customers' accounts.
W.S. Clearing, Inc., the firm that handled Cygnet's back-office business, failed too. In 1998 the owner of W.S. Clearing, William Saydein, settled with the Securities and Exchange Commission on a charge of misappropriating clients' money.
As usual, SIPC stepped in to clean up the failed firms, replacing cash or securities (up to $500,000) that the firms might have stolen or lost. SIPC also collects any money the firms are owed?including (without pity) customers' unpaid margin loans.
So it came to pass that in January 1998, SIPC sued the Hymans for more than $1 million in margin loans. "What loans?" the stunned Hymans cried. "Your loans," SIPC said?loans that turned up in their accounts. Similar suits were filed in nine other cases.
It wasn't son Bill's day trading that did the Hymans in. They discovered instead that George Swan had been buying huge amounts of a little-known stock called Data Race, for his clients and himself. It was done on borrowed money. At first Swan's purchases drove up the price. But eventually Data Race declined and Cygnet collapsed.
Here's where the real margin lesson starts. At a small brokerage firm you don't borrow from the firm itself. You borrow from the clearinghouse, in this case W.S. Clearing. SIPC says that W.S. wasn't to blame for the Data Race mess; it only lent money, which it should get back.
When you're on margin, you have a virtually ironclad contract to repay, says securities-law professor Steve Thel of Fordham University in New York. You can't default by saying you didn't understand the loan (you should stay home at night, reading the confirmation slips your broker sends). Nor does it matter if the broker borrowed more than the margin rules allow. You owe the money! Maybe you can charge your broker with fraud. Still, you owe the clearinghouse!
Ways out: There are only two possible ways out.
First, the margin loan might be erased if the trade was fraudulent and the clearinghouse was directly involved. This line of attack was taken by the Hymans' attorney, Thomas Harris of Irvine, Calif. He lost the case and has appealed.
You might also escape if you watch every single transaction that your broker makes and protest immediately, in writing, if you object (phoned objections don't count). The letter might get the trade reversed. If the broker ignores you, however, you'll still have to cover the loan. Hard to believe, but true. As for the Hymans, there's no way they could have tracked the blizzard of trades in their accounts.
Even writing a letter isn't as straightforward as it sounds. Cygnet client Howard Jahre of New York City sent Cygnet a written protest before it failed, saying he hadn't authorized the Data Race trades. In its lawsuit, however, SIPC brushed the letter off. Says SIPC: you have to write to the clearinghouse directly, not just to your broker. Who tells investors that? And the letter will work as a legal defense only if your margin contract allows it, says retired securities lawyer Charles Rechlin of Sullivan & Cromwell in Los Angeles.
The Hymans are frantic, needless to say. They don't blame Bill, who owed money, too, and declared bankruptcy. Mark quit the firm after two short stints, leaving behind what he says were two unused accounts (one for his wife). The accounts are now $568,000 in debt.
SIPC has no sympathy. "These people aren't victims," says SIPC general counsel Stephen Harbeck. "They made bad market decisions." Pure hardball. Now will you rethink your margin account? |
