NEW YORK TIMES -- February 9, 2003
An Iceberg of Irate Investors
By Gretchen Morgenson
Francies Edward Wolfe, a close-cropped, soft-spoken family man who hoped to travel the country with his wife in a motor home when he retired, hardly seems intimidating. But this 58-year-old former truck driver from Fredericksburg, Ohio, and other investors like him, have become one big nightmare for Wall Street. Mr. Wolfe sued Merrill Lynch last year over $172,000 in stock market losses in his 401(k) plan, and last month, arbitrators awarded him $310,000, including legal expenses.
What happened to Mr. Wolfe may be particularly egregious — it involves an investment in an Internet fund that his broker bought at the top of the market that also enriched the daughter of a supervisor. But across the country, there are hundreds of thousands, perhaps even millions, of people like Mr. Wolfe. They, too, pinned their hopes on the stock market in the 1990's boom and then lost out as the brutal bear market ravaged their investments. Many are making claims against their brokers. And there are growing signs that arbitrators judging these cases are showing more sympathy to investors than the firms had expected.
The trend, if it holds, is yet another sign that the worst is not over for Wall Street, which breathed a big sigh of relief in December when its top firms agreed to pay almost $1 billion to settle accusations that much of their research has been tainted. Other bills from the 1990's market mania, like these covering customer complaints, continue to come in for payment. "The Wolfe decision sends a message that big Wall Street firms, and their brokers, will be held accountable for destroying the retirement savings of unsuspecting customers by recommending risky high-tech stocks and funds," thundered Jacob Zamansky, a lawyer at Zamansky & Associates in New York who represents Mr. Wolfe.
It is impossible, of course, to know how much brokerage firms will wind up paying customers who are suing them. Investor complaints can take years to make their way through arbitration, and investors who claim to have been hurt by corrupt Wall Street research may be waiting to file their cases until securities regulators release documents related to investigations into the practices of brokerage firms. But some securities lawyers and experts in arbitration cases say the flood of newcomers to the stock market in the late 1990's may be prompting arbitrators to take the side of investors more often. Unsophisticated and inexperienced investors who took enormous losses in speculative stocks peddled by brokers appear to be arguing with more success that the recommendations were unsuitable. "When you get newcomers to the stock market, this adds a factor favoring the customer which may not have been as prevalent as before," said Lewis D. Lowenfels, an expert in securities law at Tolins & Lowenfels in New York. "The element of a newcomer's inexperience in investing builds on other factors which are weighed in determining suitability." Regulators require brokers to suggest only those investments that are appropriate or well suited to their clients' needs and circumstances.
Accusations by customers that brokerage firms recommended unsuitable investments rocketed last year. According to NASD, which oversees the nation's largest securities arbitration forum, 2,644 cases in 2002 claimed unsuitability, 73 percent more than in the previous year. NASD statistics also show that customers are winning a greater percentage of cases than in previous years. Of the roughly 1,500 cases that were decided last year, 55 percent involved customer awards. In both 2000 and 2001, 53 percent of cases generated awards. Not surprisingly, given the losses incurred in the bear market, arbitration awards were also higher in 2002. Customers received $139 million in awards, up 43 percent from 2001 and almost double the level of 2000.
There is more. The NASD's figures do not include class-action cases brought in state or federal courts; those cases are hard to track. They also do not include arbitrations going before the New York Stock Exchange or other arbitration forums. According to the Big Board, customer complaints almost doubled last year from 2001, rising to 1,009 cases.
Richard Ryder, editor of the Securities Arbitration Commentator, an industry publication in Maplewood, N.J., agreed that the higher customer awards indicated a shift in sentiment of arbitration panelists. But he cautioned that the greater numbers of cases in arbitration and the higher awards might also be a result of brokerage firms' inability to settle cases before arbitration. Lawyers for the brokerage houses are overwhelmed by the flood of cases, he said, and have less leeway to offer settlements because their firms, also hit hard by the bear market, have much less cash to throw around. "There is always a greater risk to the firm in going to the fact-finder for determination than in settling the case," Mr. Ryder said.
Consider the arbitration decided a few weeks ago in favor of Mr. Wolfe. He sued Merrill a year ago, and the New York Stock Exchange arbitration panel that heard his case awarded him $235,000 in compensatory damages and $75,000 to cover lawyers' fees. Arbitration awards are binding and are rarely overturned. Although every customer's case is different, Mr. Wolfe's situation mirrors that of many neophyte investors across America who were convinced by overly optimistic stockbrokers that the only risk associated with the stock market was not being in it. Mr. Wolfe's case is very close to that of dozens of other Merrill Lynch customers who invested with Joel Cessna, a stockbroker at the firm's office in nearby Wooster, Ohio.
Mr. Wolfe was one of almost 200 people who in January 2000 took early retirement deals from Rubbermaid. At least 50 of them went with their payouts to Merrill Lynch, where Mr. Cessna and a colleague advised them to buy Internet and technology stocks, said Mr. Zamansky, who also represents some of Mr. Wolfe's former colleagues who have filed claims against Merrill, which are pending. "Hard-working Rubbermaid retirees like Ed trusted Merrill Lynch to invest their retirement savings responsibly," Mr. Zamansky said. "Instead, the firm betrayed that trust and wiped out their savings in about a year."
Mark Herr, a Merrill spokesman, said: "It would be a mistake to assume that because the number of claims has gone up, that industrywide the amount of wrongdoing has gone up. What plainly is at work here is a prolonged bear market. And you also see a number of investors who were heretofore not experienced in the market and are experiencing their first downturn and casting about for a cause."
For more than 32 years, Mr. Wolfe worked for Rubbermaid, doing everything from driving a truck and working on the company's assembly line to mowing its yard. But in early 2000, when the company offered retirement packages to him and other workers, Mr. Wolfe signed up. In each of his years at Rubbermaid, Mr. Wolfe had never made more than $50,000, but with company contributions he had managed to amass a 401(k) worth $325,000. In his final days at Rubbermaid, Mr. Wolfe said, he had heard other workers talking about a seminar they had attended for new retirees that was sponsored by Merrill Lynch. Mr. Wolfe and his wife made an appointment to talk about their finances with a Merrill representative at the firm's office in a strip mall in town. After an hour with Mr. Cessna, the branch manager at the two-man Wooster office, they decided to switch their account from Fidelity, where it had been placed in a conservative bond fund. "He convinced us that we could have a pretty safe investment with an 8 percent return on our money," Mr. Wolfe recalled. "We wanted no risk. I told him, `No gambling with my money.' "
Despite that instruction, he said, Mr. Cessna immediately put him into technology stocks and three tech-stock mutual funds, two of which were concentrated in Internet stocks. One fund that Mr. Cessna recommended, Merrill Lynch Internet Strategies, was the firm's ill-timed attempt to participate in the boom for Internet stocks.
Merrill brokers were pushed hard by their superiors to sell the fund. In March 2000, the very month the stock market reached its pinnacle, the fund took in about $1 billion. The sales push included a half-day series of presentations in San Francisco that were beamed to the computer screens of Merrill's 14,000 brokers across the nation. Among the presenters were Henry Blodget, Merrill's celebrity Internet analyst, and top executives from two technology companies. The firm also flew in Michael Lewis, author of "The New New Thing: A Silicon Valley Story," a book celebrating the new economy, from Paris for the event. In just a few weeks, however, investors who had bought the fund when it was offered were down 25 percent on their money. Soon the fund became known as the Internet Tragedy fund; Merrill closed it less than two years later, after it lost almost all its value.
Testifying before the arbitration panel in the Wolfe case, Mr. Cessna explained that he had more than 1,400 clients and that he had routinely recommended the Internet Strategies fund to many of them. Mr. Cessna counted many retirees from local companies among his clients; he had sponsored a series of seminars in town offering retirement guidance to those attending. In his testimony, Mr. Cessna cited two other Merrill employees. One was David Ruckman, Merrill's district director for the Ohio region.
The other Merrill employee was Mr. Ruckman's daughter, Nicole Elizabeth Dobbins. She worked for the fund management group that sponsored the Internet Strategies fund and was responsible for having brokers in Ohio sign up their customers for it. Her compensation was based at least in part on how many brokers in the region did so. Mr. Herr of Merrill said: "We deny that there was any conflict of interest." Merrill maintains that Mr. Wolfe's success in arbitration will not be repeated by other former clients of Mr. Cessna in similar circumstances. "We win the preponderance of our arbitrations," Mr. Herr added.
Bonnie Burns, 56, was another Rubbermaid retiree who invested with Mr. Cessna. When she accepted the company's early-retirement offer in April 2000, she was a machine operator earning $32,000 a year. She had worked for Rubbermaid for almost 34 years. Ms. Burns attended one of Mr. Cessna's seminars along with roughly 30 other Rubbermaid workers. When she met with Mr. Cessna, he discussed the ins and outs of I.R.A.'s but never said what he would invest in. "There was no mention of stocks or how he was going to invest it," Ms. Burns recalled. "He said, `You worked for that money; now your money is going to work for you.' "
She deposited $357,421 with Merrill in mid-April 2000. When her first brokerage statement came, she saw that Mr. Cessna had bought technology stocks and stock funds, including the Internet Strategies fund. "I didn't question it," she said. But with each new statement, Ms. Burns saw that she was losing money. In October, she called Mr. Cessna to ask what was going on. "He would say, `I know we're in trouble, but don't you worry, the market's going to come back,' " Ms. Burns said.
It did not, of course. She lost $250,000 in stocks like Cisco Systems, JDS Uniphase, Xilinx and Oracle. The final blow came last year when Exodus Communications, a company whose stock she held, filed for bankruptcy. Ms. Burns's case against Merrill Lynch is pending. She has gone back to work as a teacher's aid in the Wooster school system. "I know about 40 people in this circumstance, and there's more to come," she said. "We're all so embarrassed because we were so stupid to let this happen. Every one of us are back to work; some of us are making $6 an hour because the economy's not good around here. One guy has to work till he's 67 now because he lost everything."
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