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Ameritrade Case Shines Light On Online 'Suitability' Claims

Wall Street Journal

Indianapolis attorney Mark Maddox says his phone has been ringing incessantly since word got out about what he calls his “unique victory” last week against online broker Ameritrade Holding.

Mr. Maddox represented Lael Desmond, an Ameritrade client who lost money when the firm sold stocks from his account to cover a margin loan. Mr. Desmond claimed, among other things, that the online brokerage firm violated suitability rules by allowing him to establish a margin account — something his attorney argued wasn’t appropriate for a novice investor. A National Association of Securities Dealers arbitration panel awarded Mr. Desmond about $40,000 in the case.

Whether Mr. Desmond, 28 years old, actually won a suitability claim against an online broker is a matter of some debate. Arbitration proceedings are secret and the public ruling doesn’t make exactly clear of which Mr. Desmond’s claims (which also included general negligence) the arbitration panel agreed. Mr. Maddox maintains the case was “at its heart” about suitability; Ameritrade says suitability had nothing to do with it.

Regardless, the case puts a renewed focus on an issue that has become a growing concern: Do online brokerage firms have an obligation — as traditional brokers do — to monitor their customers’ trades to assure that they aren’t getting in over their heads? The U.S. Securities and Exchange Commission has studied the matter, but hasn’t given brokers clear guidance.

“I think we are all pretty shocked by the decision and not sure where we are going to go from here because the decision doesn’t give a good explanation of what happened,” says Henry Carter, chief compliance officer for E*Trade, the No. 2 online brokerage firm. “In a worst-case scenario, suitability becomes an issue very quickly in our industry, and in a best-case scenario this has nothing to do with suitability and is about a [margin call] gone wrong, which everyone can deal with,” he says.

Kim Shepherd, an Ameritrade spokeswoman, declines to answer questions about the case. In a prepared statement, the company said: “We believe that the Desmond NASD arbitration has been mischaracterized as a suitability case. The Desmond matter was essentially a margin sellout case. The arbitration panel made no findings as to suitability and this matter has no wide-ranging industry implications.”

In late 1998, Mr. Desmond began trading stocks in an effort to earn money to pay for medical school. He bought five hot technology stocks on margin — his broker loaned him some of the money to buy the shares. In August 1998, the value of some the stocks tumbled, and Ameritrade issued a “margin call,” an order to put up more collateral to cover the loan. Mr. Desmond maintains that Ameritrade didn’t give him enough time to cover the loan, and instead immediately sold the stocks in his portfolio. Because there wasn’t enough equity in his account to cover, Mr. Desmond says he had to borrow $12,000 on credit cards to pay back the debt.

Mr. Maddox acknowledges that his client was presented by Ameritrade with a disclaimer that explained the risks of margin trading, but he says that’s beside the point. “Yes, he agreed to it. But they shouldn’t have let him,” he says. Mr. Maddox says if Ameritrade had asked a few questions, the firm would have realized that Mr. Desmond was a novice investor who was about to enter medical school full-time. “They weren’t interested in any of that. They’ll give a margin account to any adult with a pulse and $2,000,” Mr. Maddox says.

Ms. Shepherd, the Ameritrade spokeswoman, declines to say what the broker’s requirements are for establishing a margin account.

The award is one of the first involving a suitability claim against an online broker, and, according to NASD records, is the largest arbitration award against Ameritrade. Mr. Desmond had originally sought $225,000 in his complaint, which includes the gains he could have realized on the stocks if Ameritrade hadn’t sold them to cover the loan.

Arbitration cases aren’t the same as legal proceedings in a court, and the notion of precedent is a bit murky. So even if all of the facts of Mr. Desmond’s case became public, there’s no guarantee that a similar case would have the same result in front of a different arbitration panel. Still, the case has energized securities attorneys who say brokers should take a greater role in making sure customers don’t get in over their heads.

“There’s absolutely no question in my mind that suitability is an issue that has to be dealt with by the online firms, and this case only reaffirms that,” says Phil Aidikoff, a Beverly Hills, Calif., attorney who has represented investors in arbitration claims against brokers. “The online firms will let people do anything they want, and they shouldn’t. The broker has a duty to make sure that the right kind of trading is going on for each particular investor, because a lot of these people don’t have any idea what they’re doing.”

Still, some attorneys say the case points up what they see as a growing trend among online investors to avoid responsibility.

“This is one of those cases, which I characterize as a ‘Someone should have protected me from myself,’ ” says Bill Singer, a lawyer with Singer Frumento, a New York firm that has represented brokerage firms. “The whole point of online trading is that it’s supposed to be for individuals who have some sense of maturity, and people who want to make their own decisions. You shouldn’t be agreeing to contracts that you don’t understand, or aren’t willing to follow.”