It's 1999. The market looks great for investing. Dot-coms are springing up, tech markets are booming, and you* are ready to buy, buy, buy! You go to see a broker. Let's call him Jim. Jim is a great guy, and just as gung-ho as you are. You talk about your financial goals: let's say you're 45, with retirement far enough away that you feel like you can speculate a little. Your only son got a scholarship at the state school, so you're in good shape there. You're ready to hand over your cash: a cool million for investing. You know what you want to do. Tech! Energy! Communications! All the sexiest stocks. Jim's on board, so he buys big in Worldcom, Lucent, JDS Uniphase, Qualcomm, and Yahoo. He also gets a few PIMCO mutual funds--they've been turning out some really nice, high numbers. You nod, but really you're impatient at the idea of wasting your money in something so staid as a mutual fund.
Most of the time over the next couple months, you just hold onto your stocks, but you can't resist the occasional trade. You want to play around with options, but you lose a bundle when a naked put gets assigned, and you drop that like a hot poker.
Aside from your gaffes, you're watching your profits billow. You couldn't be happier. Jim starts making some noises about selling, but you're scornful about his caution.
In March 2000, your daily scan of the tickers gets frantic. You can't believe it. What's happening to Worldcom? Yahoo? They're sinking like stones. You call up Jim, hysterically order him to sell. Jim is adamant--you can't sell when they're down. It's a temporary wave, you have to hold on and don't lose confidence.
By April, you're despondent. More than two-thirds of your money is gone, and it doesn't look like it'll ever make it back up. But you're clinging to the idea of holding on, and your portfolio rallies a little over the summer. But in November, it dives again, and this time, Jim agrees to sell. Cut your losses, you think to yourself, and start again more carefully.
For several months you stew about the losses, until finally you go see a lawyer. Let's call him Sam. Sam grins like a shark when you tell him why you're there. He's more than happy to file a complaint on your behalf. After all, in 2002, there were over 4,000 formal investor complaints against a member of the NASD, and that number rose as more people got angry about their bubble bursting. He's about to make money hand over fist.
After you have a complaint number, Sam writes up a statement of claim. In the statement, you have magically become totally ignorant of investing--a complete naif. It was Jim and his firm that did all the trouble--failure to supervise, failure to diversify, making false and fraudulent representations, advising you, the Claimant, to pursue unsuitable investments, and causing you untold harm. When you finish reading the statement of claim, you're angrier than ever. How dare they take advantage of you like that! Never mind that most of it's just not true--you knew the risks.
The brokerage company gets the statement, and you're not sure what they do, but they come right back with an answer that calls you a big liar, and a slick profit and loss analysis of your account, complete with a row of neat little "U"s by the worst of the trades. You ask Sam what that means, and why he's covering his face with his hands like that, and he points to the footnote: "U=Unsolicited Trades." Oh. Those are the ones you initiated. That doesn't look good.
You and Sam continue undaunted, however. You schedule a mediation with the brokerage company, and it's scheduled for six months in the future, when the NASD finally has a free mediator. Meanwhile, you've stuck your money into a money-market account--what's left of it. The lawyer fees are starting to make a dent, and you're sweating a little. Doing some overtime, trying to get your wife to maybe think about working. She's pissed that you were so stupid about the stock market when you had a million bucks in the bank, and wants you to stop this idiotic lawsuit. But you persist.
When you get to the hotel that the mediation is scheduled at, you and Sam sit in one room while the mediator talks to you, then sit and wait while he runs to the room with the brokerage representative and lawyer. Huffing and puffing, he comes back with a settlement offer: 10% of your losses. Your lawyer laughs, and offers 75%. Eventually you're at an impasse--they won't come up, and you're too desperate to come down.
So Sam gets you in queue for an arbitration hearing. This is even harder to schedule, because three NASD arbiters will hear this case, and their time is as difficult to schedule as the mediator, multiplied by a factor of three. "Usually," Sam tells you, "Cases don't get this far. Brokerage companies generally have to pay out more, when the decision goes against them, but the awards can also be close to nil if the arbiters don't like you. It's like going to criminal trial, in a way. But you're a guy who likes risk, right?" You have a sudden qualm, but you can't stop now.
The intervening time is spent with the lawyer and the expert, trying to find some charts that look as terrible as possible, so the arbiters will take pity on your case. You have a sneaking suspicion the respondents, the brokerage firm, are spending time with their experts too--and the firm has a lot more money to spend on defending their case! They make Sam a few settlement offers, and you are really considering taking them, but he thinks you can get more, so you hold strong.
When the arbitration arrives, you realize that the respondents did, indeed, spend time and money prepping. Their expert, a chirpy young lady** in a very nice suit, lovingly describes every detail that could possibly prove ruinous for your case: your dealing in options, which shows expertise, and your enthusiasm for all those unsolicited trades. Your expert, a middle-aged man whose suit is rather rumpled, refutes, and your lawyers expostulate over the case.
The panel deliberates, and arrives at a figure. Less than $100,000. Once you subtract Sam's fee, you hang your head. He did better than you out of this. Was it worth it? Better than not having it, you explain to your wife that night. She rolls her eyes and ostentatiously hauls out the want ads.
*You in this case being a totally theoretical investor. This case is merely representative, and in no way is meant to portray any single individual.
**Chirpy young expert for the respondents? That would be me. Although truthfully it's very rare that we actually will testify in front of the panel. They'll fly us to Oklahoma or Minneapolis or Detroit, and we'll sit in a hotel room or lobby for hours, waiting to be called. Either that, or they'll schedule a time to call us over the phone--and then never end up needing us. (Our company's reports are very good. Usually, the claimant agrees to stipulate that our numbers are correct and we therefore aren't needed to testify about them.)