Discount and Online Brokers
Worry About Investor Suits
By REBECCA BUCKMAN
Staff Reporter of THE WALL STREET JOURNAL
Do online brokerage firms have a duty to stop their customers from trading themselves into financial ruin?
It might seem unlikely, since companies such as Charles Schwab, Ameritrade Holding and National Discount Brokers Group cater to do-it-yourself online investors who generally don't seek advice from an individual broker. But officials at some of those firms now worry they could get hit with a new wave of arbitration complaints from customers -- including newer, less experienced investors captivated by the online-trading trend -- who have racked up big losses.
At least one such complaint already has been filed, by a 27-year-old Indianapolis graduate student who says he lost more than $40,000 in savings for medical-school tuition by trading Internet stocks in a margin account this summer. And the more general issue came up this fall at two meetings of a new association of discount-brokerage firms, says Michael Anderson, an Ameritrade official who co-chairs the group.
The group, now a committee of the Securities Industry Association, wants securities regulators to clarify whether discount and online firms can be held liable in what are known as "suitability" complaints, normally brought against stockbrokers who allegedly recommend inappropriate investments.
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At discount firms, Ameritrade's Mr. Anderson says, "there is no broker assigned to the account. But once in a while, we'll be faced with an arbitration from somebody who says, 'Hey, you should have stopped me from selling myself into a hole.' " His response? "What do you mean, we should have stopped you? It was a self-managed account."
Ameritrade's non-Internet discount division hasn't lost such a case, he adds. But, he notes, "there's a concern of mine that we're going to continue to see more" complaints, particularly as Ameritrade's main Internet unit adds tens of thousands of new customers a quarter.
Last week, the Indianapolis graduate student, Lael Desmond, lodged such an arbitration complaint against Ameritrade, of Omaha, Neb. The student opened his brokerage account last year when he was working for his father's chemical business. He was preparing to take graduate biology courses at Indiana University at Indianapolis and says he wanted to make extra money for medical school.
Now, Mr. Desmond charges that Ameritrade didn't deal fairly with him and "breached its suitability obligation" by allowing him, as a novice investor, to keep buying risky Internet stocks in a margin account that quickly lost value in August's stock-market correction, according to his arbitration complaint, filed Friday with the National Association of Securities Dealers.
In margin accounts, investors borrow cash against the value of securities in their portfolio, usually to buy more stock. If the stock declines in value, losses can be magnified, requiring the investors to put up more cash in what's known as a margin call.
The crux of Mr. Desmond's complaint is that Ameritrade didn't give him enough time to put up cash to satisfy his margin calls before selling his stocks. He adds that he thought a margin loan "was much like a bank loan. ... I never dreamt I had any possibility of losing all my money."
Mr. Desmond's lawyer, Mark Maddox of Indianapolis, says Ameritrade should have warned Mr. Desmond as the value of his securities began to drop. Mr. Maddox also says he believes the firm should give all its customers more investment education.
Ameritrade Vice President Jim Ricketts responds that customers who open margin accounts sign special forms explaining how they work. Mr. Desmond acknowledges he didn't read the fine print on his. And all Ameritrade customers "assume their own liability" when they sign their basic account agreements, Mr. Ricketts says, adding that he hasn't yet seen Mr. Desmond's complaint.
Securities lawyers say suitability cases are tough to win against discount brokers, which serve mainly as order-takers for investors and don't generally give advice. Although two plaintiffs won high-profile cases against Schwab and Quick & Reilly Group, now a unit of Fleet Financial Group Inc., in the early 1990s, such complaints remain rare, notes Sam Scott Miller, a partner at the New York law firm Orrick, Herrington & Sutcliffe.
In the Schwab and Quick & Reilly cases, investors won awards after losing money trading complicated, risky stock options. Arbitration panels ruled that the firms shouldn't have allowed the investors to trade so recklessly and risk so much of their capital.
Orrick Herrington says in a Nov. 16 memorandum to clients that new types of services being offered by online firms -- including stock research reports with "buy" and "sell" recommendations and programs that alert investors to specific securities -- raise "questions about the extent to which online broker-dealers are responsible for the suitability of their customers' transactions."
David E. Robbins, a partner with the law firm of Kaufmann, Feiner, Yamin, Gildin & Robbins in New York, believes Internet firms are probably even less susceptible than traditional discounters to suitability complaints. That's because at a discount shop, there's at least a human order-taker to stand between the investor and his trade. Still, Mr. Robbins notes, even though computers execute trades at online firms, "there are people behind the computers watching what's going on."
Elisse Walter, chief operating officer for the NASD's regulatory arm, says the growth of Internet trading raises questions about online firms' duties to their customers, "since that opportunity for human intervention isn't there."
Online firms haven't yet approached her about clarifying or changing relevant NASD rules, she says, but "we would prefer for the firms to start taking care of this themselves, because they will be able to do it better than we would."
Indeed, some Internet-trading firms, such as Fleet's Suretrade unit, say they use computer programs to automatically monitor accounts for unusual trading activity. Most firms also make customers meet extra requirements if they want to trade stock options or buy securities on margin.
In general, though, online investors "want to be able to trade quickly and have control over their orders, and not have somebody coming in and second-guessing them," says Hardy Callcott, a Schwab vice president and deputy general counsel. Mr. Callcott says he isn't worried about suitability cases, since the NASD rule on the topic "specifically talks about recommendations," not do-it-yourself trading. The New York Stock Exchange, which also hears brokerage-arbitration cases, has a "know-your-customer" rule that deals with suitability.
However, Schwab Co-Chief Executive David Pottruck acknowledges that new advice-oriented services being offered online, such as research, may lead to more customer complaints. |
