When Attempting to Persuade Arbitrators,
a Dozen Victims are Better Than One.

“So okay,” you say. “Group cases sound like they’re better than class actions.  But what if I had a really big loss and have the money to afford litigation costs. Wouldn’t I be better off suing on my own than being part of a group?” Not necessarily.

It’s true that when a lawyer is yours alone, he or she will advance your interests alone.  It’s also true that a group representation presents a few potential conflict situations for your lawyer.

For instance, if a Respondent has very few assets or is facing insolvency, numerous Claimants may be competing for access to limited funds. An attorney representing you alone will have no impediment to rushing ahead and seeking to recover as much as he can for you, without regard to whether anything is left for other victims. But a lawyer undertaking a Multi-Client Representation can’t grab funds for you while cutting out his other clients.

It’s also conceivable that at some point in a Group Matter, you or another member of the client group might wish to follow a course of action different from that which the attorney and the remaining clients wish to pursue. This can be resolved in various ways, whether by compromise on the part of the dissenting client or by counsel’s taking of steps to accomplish the dissenting client’s individual goal or, if those measures are impracticable, protecting the client’s interests while assisting him or her in obtaining new counsel. But if the conflict can’t be resolved in a manner satisfactory to all clients, the attorney might have to completely withdraw from the Multi-Claimant Representation.

Thus, group representation is not perfect and carries with it at least a potential for conflicts to arise. Nevertheless, multi-claimant arbitrations provide at least four significant advantages over single-claimant proceedings.

Multi-Claimant Arbitration

First, there are economies of scale in that each group member saves money by sharing the same expert witness and obtaining and copying core documents one time instead of a dozen.  Second, when multiple claimants pursue recovery against the same broker, their collective memories and combined records result in their lawyers having an early and fairly complete picture of what led to the claimants’ losses. Third, claimants who join in a group matter usually have had similar experiences with the broker and will corroborate each other’s testimony, making arbitrators far more likely to find their testimony credible and to award adequate compensation. Finally, brokerage firms are particularly motivated to settle a group case because a confidential group settlement can both simultaneously eliminate numerous complaints and reduce the risk of adverse publicity for the firm.

These advantages of group arbitration over individual proceedings are fairly powerful inducements for even the wealthiest claimants and those with the biggest losses to join with other victims. In particular, the corroborative effect of multiple victims testifying before a single panel of arbitrators makes recovery a good deal more certain than if one pursued recovery in a separate proceeding.

We should say in conclusion that group cases don’t come along every day. They usually occur only when a single financial professional or firm has sold the same bad investments to many customers. Even then, group cases don’t happen unless lots of people learn through word of mouth or media coverage that other aggrieved investors like themselves exist, have come forward, and are willing to fight. But when all of the necessary elements align, group arbitration enables victims to recover far more money than they typically could recover in either a class action or a stand-alone proceeding.

Our investment litigation team has the extensive experience and deep knowledge needed to guide large numbers of unrelated victims through the group arbitration process. If you’ve suffered investment losses and know of other victims, please contact us to discuss the potential of a putting together a group case. If you’ve lost money and believe the same broker has victimized others in the same way, we may be able to put you into an existing group or to find other victims with whom you can join. Contact Hugh Berkson or Tony Hartman at (216) 781-5515 or toll free at (800) 789-2389, or reach us through the consultation form on the right of this page. We’ve helped hundreds of aggrieved investors. Talk to us about how we can help you.

Part 1: Group Arbitrations

Part 2: Securities Class Actions

Dispute Resolution Smackdown: Group Arbitrations vs. Securities Class Actions vs. Individual Arbitration – Part 3

While Class Members Surrender All Control to the Lawyers and Court, Group Arbitrations Keep Clients Involved and In Charge.

As we noted in part 1, securities class actions tend to produce paltry returns for victims, while group arbitrations generally result in significant individual recoveries. There are many reasons for the disappointing results in class actions, but in our opinion, the main problem is the inherent conflict of interest between class action attorneys and their clients. Though class counsel technically have a strict duty to always put class interests ahead of their own, it rarely works out that way because class actions fracture the traditional relationship between attorneys and their clients.

The Downside of Securities Class Actions

In the traditional attorney-client relationship, the client hires and interacts with his or her lawyer and can control the major decisions that lawyer will make. In a class action, the court appoints the lead attorneys, and since most classes are enormous, the class lawyers don’t have to interact face to face with individuals who populate the class. Consequently, class counsel have a greater tendency to be guided by their own interests, one of which is to avoid going to trial and potentially losing out on the huge court-ordered attorneys fee that generally will accompany a settlement. The result of this disconnect between lawyer and clients is twofold: class counsel almost always will settle, even if they have a really strong case, and class counsel will settle the case more cheaply than the clients would permit if the clients had full knowledge of and control over the case.

The Difference Between Us and Them

Unlike class action lawyers, when we at HC&S handle groups of claimants, we retain a one-on-one relationship with each client in the group. The individual nature of each client’s claim is preserved and no client’s interest can take precedence over another’s. Group size is always kept small enough to ensure frequent direct communications between each group member and the lawyers. Also, we never make a material decision such as whether to discuss settlement of the case without first consulting with and obtaining the approval of each client. Thus, in contrast with the conflicted relationship between class action lawyers and class members, our actions in a group case are governed by the requirements of the traditional attorney-client relationship.

This difference leads to vastly better results for our group members than the 2% to 3% average recoveries achieved by class members in securities class actions. The group cases we’ve handled have consistently resulted in settlement amounts ranging from 55% to 80% of losses. And with sufficiently egregious conduct, even a future settlement of 100% of losses would not surprise us. (We refer to settlements rather than awards because thus far, every brokerage firm with which we’ve had a group case has chosen to settle rather than risk an adverse arbitration award.)

 Continue to Part 3 – Individual Arbitration

Dispute Resolution Smackdown: Group Arbitrations vs. Securities Class Actions vs. Individual Proceedings – Part 2

Modest Losses?

In Group Arbitrations, a Lot of Little Can Be Really Big

We’ve said it before, we are not a fan of class actions. In fact, except for the lawyers who handle them, no one is a fan of class actions. Class actions definitely play at least a small role in deterring bad corporate behavior, but as a remedy for victims seeking compensation, it grades out at a D-minus. Yes, you can opt out of a class actions and sue on your own. But what happens if you’re in litigation limbo, with losses big enough to really hurt but not big enough to justify pursuing a claim on your own?

Medical Capital Fraud

A few years ago, we were contacted by a couple we’ll call Tom and Sally Garnett. Those aren’t their real names, but they are real people. Tom and Sally had been persuaded by their stockbroker to invest $50,000 of their precious retirement money in a promissory note issued by a California corporation called Medical Capital. The broker told them the note was a safe, conservative investment and would produce an excellent return. But he failed to mention that Medical Capital’s CEO had a well-documented history of shady business practices, legal problems, and corporate bankruptcy. Nor did he disclose that independent due diligence experts examining Medical Capital had expressed concerns about the integrity of the company’s unaudited financial records.

Medical Capital turned out to be riddled with fraud, and its collapse caused thousands of investors across the country to collectively lose nearly $1 billion. While some victims suffered losses ranging from hundreds of thousands to millions of dollars, many others like the Garnetts lost only the minimum investment of $50,000 – a significant blow, but not large enough to justify the expense of pursuing an individual claim. The Garnetts seemed destined to be stuck in a class action along with thousands of other similarly situated victims, each of whom likely would recover no more than pennies on the dollar.

Group Arbitration

Fortunately, the Garnetts happened to hear about another option.  Under the rules of FINRA — the brokerage industry’s self-regulatory organization — multiple parties can join in a single arbitration proceeding if their claims have questions of law or fact in common and arise from the same series of transactions. Our securities litigation team was preparing several group cases, each one advancing the claims of a dozen or more separate households who had purchased Medical Capital notes from the same broker. While the Garnetts’ loss was too small by itself to justify a stand-alone arbitration proceeding, we were able to include them in one of the groups we had assembled.

Though the Garnetts’ losses may have been at the low end of the continuum, a $50,000 loss is a meaningful loss. For anyone who suffers a meaningful loss, which we define as one that constitutes more than a mere inconvenience, group arbitration is vastly superior in almost every way to being stuck in a class action. Class actions are only a good remedy when large numbers of people have suffered minuscule individual losses for which no one would ever sue on their own. But class actions make very little sense for injured investors who have meaningful losses. According to one fairly recent study of securities class actions, settlements typically return in the range of just 2-3%. In other words, the median recovery by a class member in a securities fraud class action is two or three pennies for each dollar of loss.

All things being equal, an investor is likely to recover vastly more money by actively pursuing individual claims in a group format than by passively participating as a class member.

Part 2: Securities Class Actions

Part 3: Individual Arbitration

Dispute Resolution Smackdown: Group Arbitrations vs. Securities Class Actions vs. Individual Proceedings – Part 1

The Cleveland Plain Dealer’s award-winning business reporter and columnist, Teresa Dixon Murray, has written a timely article prominently featuring extensive comments from one of our team members, the inimitable Hugh Berkson. The article, which links to our Stockmarketloss.com website, reminds investors to be particularly watchful for fraud and scam investments when the financial markets and many brokerage accounts are on the rise. Hugh gives some valuable tips to help you avoid becoming a victim.

You can find the article here:  With the stock market doing so well, now is the time to watch out for fraud and scam investments

It may seem counter-intuitive to say that good times call for extra vigilance and skepticism. But in a rising market, improper or fraudulent investment opportunities can perform impressively and thus be hard to spot. The analogy we sometimes use is that a shoreline often will look pristine and beautiful when the tide is in and the water is high, but submerged junk will show itself when the tide goes out again.  Read this article and you’ll see what we mean.

Hermann, Cahn & Schneider’s Investor Advocates In The News

Yesterday, we discussed an anti-investor ruling that permits Charles Schwab & Company to force its customers to waive their right to participate in class actions against Schwab. That ruling potentially could lead to such a restriction becoming an industry-wide practice. We mentioned that FINRA might choose to appeal the ruling. The word “might” no longer applies. FINRA has announced that is in the process of filing an appeal.

FINRA Will Appeal Schwab Ruling

In October 2011, Charles Schwab & Company informed its customers that it had amended its account agreement to prohibit customers from either bringing a class action suit against Schwab or participating as a class member in such an action. The amendments also purported to force the customer to agree that arbitrators would be precluded from consolidating the claims of multiple customers in a single arbitration proceeding.

Schwab’s amendments were designed to significantly reduce its potential liability to customers for fraud and other forms of misconduct. The restrictions meant that a victimized Schwab customer would be left with a single remedy: a one-on-one FINRA arbitration between that customer and Schwab. Customers could no longer participate as class members in a class action, nor could they join with other similarly situated Schwab customers in group arbitration.

The only problem with this scheme was that it blatantly violated rules of the Financial Industry Regulatory Authority (FINRA), the brokerage industry’s self-regulatory organization. Though Charles Schwab & Company is a FINRA member, Schwab obviously decided that the risk of thumbing its corporate nose at FINRA was vastly outweighed by the rewards that would accrue to Schwab if the amendments were allowed to stand.

FINRA could not abide Schwab’s new restrictions because FINRA rules permit customers of member firms such as Schwab to participate in class actions and group arbitrations. In fact, FINRA conduct rules expressly forbid the use  of a pre-dispute arbitration agreement that “limits or contradicts the rules of any self-regulatory organization.” Consequently, FINRA brought disciplinary proceedings against Schwab. On February 21, 2013, the Hearing Panel issued a decision that has potentially far-reaching consequences for all brokerage firm customers.

The Panel concluded that that Schwab had violated FINRA rules by attempting to preclude arbitrators from consolidating claimants in group arbitrations. A $500,000 fine was assessed for this violation.

The Panel also found Schwab’s attempt to preclude customers from participating in class actions to be a violation of the same rule. But surprisingly, the Panel concluded that FINRA didn’t have the power to enforce its rule in this context because the rule conflicted with the Federal Arbitration Act. Specifically, the Panel cited Supreme Court rulings  that the Federal Arbitration Act requires a party to an arbitration agreement to go to arbitration unless Congress – and Congress alone – has created an applicable exception. Schwab’s arbitration agreement thus prevailed over the FINRA rule because only Congress could create an exception to the enforcement of that agreement.

FINRA’s enforcement division now has the option of appealing the hearing panel’s decision, or the appeals board itself can call for a review. But if the ruling stands, other brokerage firms almost certainly will put the same class action prohibition in their  account agreements. This is bad news because if investors are unable to pursue any sort of class action recovery, brokerage firms will be able to safely engage in abuses that harm multitudes of customers but cause relatively small individual damages. For instance, a brokerage firm that charged excessive commissions to all of its customers would never have to answer to most of those customers because it would be impracticable for the victims to pursue such smaller claims in individual arbitrations.  Class action relief is tailor-made for that type of situation, and a prohibition on class participation will leave many people without a remedy.

Frankly, we at Stock Market Loss don’t like class actions in securities disputes and we usually recommend that most investors steer clear of them. In the interest of full disclosure, I should note that we make our living handling FINRA arbitrations for injured investors, so class actions negatively affect our business. But the reality is that class actions usually net an investor only a few cents for every dollar of loss, whereas most investors will recover far more in individual or group arbitrations. In fact, in contrast with the 2%-3% median recoveries reported for securities class actions, our group arbitrations have all returned between 55% and 85% of losses to our clients. Moreover, even claimants with relatively small losses can afford to be part of a group case.

Despite our antipathy for class actions, we think it is bad public policy to permit broker-dealers to bar their customers from participating in them. There is a need for class actions under appropriate circumstances and we hope FINRA’s fight against the Schwab amendments ultimately is successful.

Newly Released Disciplinary Ruling Whittles Away Investor Protections

Interest rates are near all-time lows. Consequently, whenever rates finally start moving again, we all know they’ll be going up. No one knows for sure when rates will begin to rise, but the Financial Industry Regulatory Authority must be worrying that the day isn’t far off. It’s just released an Investor Alert entitled “Duration – What an Interest Rate Hike Could Do to Your Bond Portfolio.” You can read the entire alert here.

When interest rates rise, bond prices fall. This phenomenon is known as interest rate risk. But FINRA points out that it’s not enough for bond investors to understand interest rate risk. They should also be wary of “duration risk” – i.e., the risk associated with the sensitivity of a bond’s price to a one-percent change in interest rates.  (Bond fund investors can find measures of duration in the fund’s fact sheet, while holders of individual bonds can check with their brokers or the bond’s issuer, or search the web for an online calculator to get the figure.)

The higher a bond’s duration, the more dramatically the bond’s price will be affected by rate changes. To illustrate, FINRA compares two medium investment grade corporate bonds, one with a duration of 8.4 (10-year maturity, 3.5% coupon) and the other with a duration of 14.5 (30-year maturity, 4.5% coupon.) With a 2% rise in interest rates, the first bond could drop 15% in value while the second could drop 26% due to its greater duration. FINRA notes that the same effect occurs with bond funds, meaning that a fund with a duration of 10 would lose 10% of its value for each 1% increase in interest rates.

We don’t give investment advice. If you want on-line prognostication, you can Google “bond bubble” and see plenty of opinions. But we feel pretty safe in suggesting that interest rates won’t stay this low forever. If you have big positions in bonds, particularly bonds with high durations, your broker probably should already have at least discussed with you the concept of limiting your exposure. If your broker hasn’t mentioned anything, you might want to think about asking.

FINRA Warns That Rising Interest Rates Would Hurt Some Bond Owners Worse Than Others.

Words like “new and different” or “new and improved” might pique your interest when it comes to computers or cleaning products. But if your broker offers you a newfangled investment product, especially one that seems really complicated, watch out. The overriding purpose of Wall Street’s inventiveness is first, last, and always to generate fees and commissions and to create an environment in which investment banks win in the end, even if investors lose.

If a new or revamped product is really complicated, your chances of getting burned go way up. Complexity and opacity ensure that you – and most likely your broker – won’t understand how things could go terribly wrong until they’ve gone terribly wrong. We’re not exaggerating when we say that innovative and complex investment products offered by Wall Street are almost always really good for broker-dealers and really bad for investors.

The Reverse Convertible Note

One case in point is a recent investment innovation widely referred to as a “reverse convertible note.” Reverse convertibles are debt obligations of the issuer that are tied to the performance of an unrelated security or basket of securities. Although often described as bonds, they’re far more complex than a traditional bond and involve elements of options trading.

One reverse convertible that recently made the rounds and now is making news is a so-called note tied to the performance of Apple stock. Various broker-dealers issued these things under a variety of names, but to be clear, Apple Inc. had no connection whatever to these investments. The use of Apple’s share performance as a benchmark was just an element in a scheme by investment banks to parlay the public’s excitement over Apple into a huge payday for the banks.

As is usually the case with tricky products, stockbrokers either didn’t fully understand the investments themselves or misrepresented them to customers. The broker typically would describe one of these things as a bond or say it was “like a bond,” a very safe short-term debt instrument but with fabulous monthly interest payments. The product generally would mature one year from issuance. If Apple stock went up in price during that year or even if it dropped somewhat, a note holder would get those great interest payments each month and would have his or her entire principal investment returned at maturity. In the unlikely event Apple stock sharply declined during the term of the note (by perhaps 15% to 20% or so) and hit a preset threshold called the “knock-in price,” the brokerage firm would keep the note holder’s principal at maturity but would instead give the note holder Apple stock.

If you’re one of the thousands of investors who bought these Apple-linked products, the recent big downturn in the price of Apple has or is about to deliver a very unpleasant surprise. Why? Because when your note matures, you’ll own Apple shares that are likely to be worth far less than the amount you invested in the note. In fact, you may lose 25% or more on these “safe” and allegedly bond-like investments.

For example, suppose you bought a reverse convertible note for $700, roughly the same value as one share of Apple at that time. As various analysts and journalists have noted, you would be in the same position as someone who sells a cash-secured “naked” put option. (If you’re interested, read our section on Options.) You would essentially have assumed the risk that if the price of Apple falls far enough, your original investment of $700 would be treated as the purchase price for Apple stock, even though the shares you receive might now be trading at well below that price. In other words, if Apple shares are only worth $500 when your note matures, you’ll have paid $700 for a share worth $500, and you’ll have lost nearly 30%.

Negatives of Reverse Convertibles

These reverse convertibles frequently were sold to people who had no business buying them – i.e., people seeking safe, income-producing investments. Why would they buy them? Brokers happily talked about the great interest payments but typically failed to mention the not-so-great features of these investments, including:

• Reverse convertibles expose you not only to risks traditionally associated with bonds and other fixed income products—such as the risk of issuer default and inflation risk — but also to the additional risks of the stock to which the reverse convertible is tied, in this case Apple.

• When investing in a reverse convertible, you effectively buy a note from the issuer and sell a put option to the issuer simultaneously, so if you don’t have the risk tolerance for selling put options generally, you might not want to invest in a security that contains the equivalent of one.

• The broker-dealer was charging you an up-front embedded fee (2% or much more) for assembling and packaging the reverse convertible’s individual components, but if you wanted to know the true size of this embedded fee, you’d find it virtually impossible to calculate.

• Because secondary trading for the reverse convertible would be limited or non-existent, the investment would be highly illiquid.

• A reverse convertible is an unsecured senior debt obligation of the issuer, meaning that the promise of interest payments and return of principal is only as good as that issuer’s ability to meet its obligations when due. Defaults are rare but do happen, a prime example being the $8 billion of Lehman Brothers 100% Principal Protected Notes outstanding at the time of that firm’s collapse.

Of course, as is usually the case with complex structured products, this may have been a rotten deal for you, the customer, but it was a terrific deal for your brokerage firm. How so? To begin with, the firm would get that whopping fee for selling the note.  Next, the firm would get the benefit of owning Apple stock purchased with your money. The firm would get to keep the dividends paid (now running at around 2.3%).  And, if the Apple stock went up in value, the firm would keep that increase. If, on the other hand, there is a significant drop in the Apple stock price and it breached the knock-in point, it would be you who took the risk, not the firm.  The firm would simply keep your invested principal while it unloaded the devalued shares on you. These benefits to the firm more than make up for the interest it would pay you for the use of your money for the year. And to add insult to injury, if you decided to sell the devalued Apple stock, you’d likely do it through the firm and would have to pay the firm a commission for the privilege.

The Financial Industry Regulatory Authority warned broker-dealers back in 2010 that reverse convertibles aren’t suitable for most individuals, and that brokers should only offer these investments to a very select group of investors and only in conjunction with full and fair disclosure. If you get burned by one of these Apple-linked structured products or by reverse convertibles linked to other companies and benchmarks, don’t be a passive victim. Call us. Contact Hugh Berkson or Tony Hartman at (216) 781-5515 or toll free at (800) 789-2389, or reach us through the consultation form on the right of this page. We’ve helped hundreds of aggrieved investors. Talk to us about how we can help you.

Apple-Linked Reverse Convertibles: Rotten To The Core

Over the past several years, we’ve handled many customer cases against investment firm Sanders Morris Harris, Inc. arising from sales activities at its Solon/Beachwood branch office in suburban Cleveland, OH. Last month, FINRA announced sanctions against SMH and two of the registered principals at that office, based upon both their failure to properly supervise a broker who was the subject of many customer complaints and their failure to have qualified personnel supervising options trading.  In a Letter of Acceptance, Waiver, and Consent (“AWC”), the sanctioned parties consented to various findings of wrongdoing, including the following.

The AWC indicates that during the period November 2007 through February 2009, Sanders Morris Harris, Inc., acting through its branch manager, failed to reasonably supervise the broker in question. The branch manager failed to adequately implement a heightened supervision plan that had been ordered with respect to that broker. More specifically, the manager had failed to pre-approve a number of low priced equity transactions executed by the broker and failed to document that he had contacted the broker’s customers on a quarterly basis as required by the heightened supervision plan.

Further indicting the entire options trading business at the branch office, the AWC states that during the period July 2006 through February 2009, SMH failed to establish and maintain a reasonable system to supervise options trading at the branch. Specifically, SMH allowed brokers at the branch office to transact options business, even though the principal supervisor of the branch office was not qualified as either a Registered Options Principal or a Limited Principal-General Securities Sales Supervisor.

All of these described acts, practices, and conduct constituted violations of NASD Rules. Sanders Morris Harris Inc. was censured and fined $150,000, and the former branch manager in question was fined and briefly suspended from association with any FINRA member in any principal capacity.

Cleveland-Area SMH Branch Office and Personnel Sanctioned by FINRA

When you lose a lot of money in an investment account, you may wonder whether your financial advisor was to blame. A definitive answer usually requires a careful review of account records by someone who knows what to look for. But it’s not difficult to figure out whether the circumstances of your loss warrant suspicion and mandate further investigation. Just ask yourself a simple question. Did something happen that you didn’t expect or that your advisor told you wouldn’t occur? It’s as basic as that.

Say you lost more money than you thought you could lose or more money than the advisor said you could lose. You should be very suspicious about whether the advisor misled you or sold you a product that was unsuitable. For example, advisors often tell customers that an investment is safe and investment principal will be protected, or they’ll claim the investment is comparable to a Certificate of Deposit but with a better return. If you bought such an investment and then incurred a big loss, you’d be wise to suspect your advisor. The same would be true if, for example, you lost 40%-50% or more of your invested funds even though you originally told your broker you were a “conservative” or “moderate” investor.

Surprise that should arouse suspicion may not be limited to the unexpected size of your loss. Maybe the stated value of your investments fluctuated wildly, even though your broker said the products would provide protection from volatility. Maybe your advisor told you the invested funds would always be readily accessible, but when you tried to cash in, you found out there would be a prepayment penalty or there was no market on which to sell it.

Consequently, it’s the occurrence of surprise, the experience of unforeseen consequences, the contradiction between what happened and what you were told or led to believe would happen, that constitutes the key indicator of wrongdoing by a financial advisor. The recognition that you’ve experienced this sort of disconnect is your cue to contact an experienced investment lawyer.

We humbly recommend that you contact us — the investment lawyers of Hermann, Cahn & Schneider LLP. We’ll do an entire preliminary workup of your case, free of charge and without any obligation on your part to retain us. If your case isn’t legally, factually, or financially justified, we’ll carefully explain why. If we think you should pursue compensation, we’ll tell you the strengths and weaknesses of your case, how the arbitration or litigation process works, how much it might cost, how long it likely will take to complete, and how our fee (if any) will be determined. Then, and only then, will you need to decide whether to hire us.

Please contact us through our online form or e-mail us at hberkson@hcsattys.com, or call us at 216-781-5515 or toll free at (800) 789-2389.

How Can You Tell Whether Your Broker or Advisor Caused Your Losses?