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Disputes With Online Brokers Could be Frustrating to Resolve

Wall Street Journal

Complaints against online brokerage firms are surging in tandem with Internet trading, but many investors who feel they have been harmed by their broker can’t file a lawsuit to recover any damages.

Most brokerage agreements require disputes between a firm and its clients to be settled through industry-sponsored arbitration — fine print that many investors probably never pause to read when they open an account.

Arbitration has long been a very contentious issue. Lawyers for investors claim it is stacked in favor of securities firms. But the firms insist the system is fairer and quicker than going to court to settle a dispute.

Nevertheless, securities lawyers say a number of high-profile system failures at online brokerage firms recently have inspired a wave of arbitration cases despite concerns about fairness.

But Phil Aidikoff, a Beverly Hills, California, securities lawyer who has fought against brokerage firms, cautioned investors against incorrectly believing arbitration is like small claims court.

“They think they walk in and Judge Judy will give them justice. But it’s a very complex process, and the other side is very, very good at it,” says Mr. Aidikoff.

The rush of claims by investors come as securities regulators examine problems at major online firms. Among their concerns is whether the firms are living up to their pledges of reliable service.

The U.S. Securities and Exchange Commission says the number of complaints involving online brokers has risen dramatically. The agency says complaints rose 330% last year to 1,114 from 259 and continue to surge.

The SEC says the top three complaints it receives against online brokers are difficulties in accessing accounts, failures or delays in executing orders and errors in processing orders.

Several firms, including Charles Schwab Corp. and online pioneer E*Trade Group Inc., the two biggest Internet brokers, have experienced computer problems recently that have prevented investors from trading.

“Investors don’t know what they’re getting into when they sign up with online brokers, and they definitely don’t know what to do when they run into a problem,” says Denise Voigt Crawford, the Texas securities commissioner.

While arbitration is the main forum for settling disputes, most online investors probably know just enough about the arbitration process that they never want to go through it. The process can be intimidating for a novice.

What’s more, regulators say investors may avoid bringing cases because they often chalk losses up to their own inexperience, rather than a problem with their online brokers.

Nevertheless, some investors have started to file claims arguing online firms should have stopped them from making risky trades — despite the do-it-yourself nature of online investing

Arbitration became widely embraced after a 1987 Supreme Court ruling affirmed its use for settling securities matters. The forum is far more informal than court proceedings.

Proponents point out that arbitration is faster and cheaper than a traditional court case. Most cases are resolved in 10 to 12 months, compared with court cases that can span years.

The National Association of Securities Dealers, an industry self regulator that handles the bulk of arbitration claims, says about 63% of all such cases end with investors receiving some money.

Lawyers for investors say that number is low and shows a bias for firms. But securities firms say it proves that hearing panels are more sympathetic to investors who have lost money, even if it was their own fault.

They say investors are often upset that they made a bad trade, and want the firms to bail them out. “There are many people who go into the market, and you have to believe they’re fully cognizant of the risks, but when they lose a lot of money they figure they can cut their losses by initiating a claim,” says John Peloso, a securities attorney with Morgan Lewis & Bockius in New York and a former arbitrator. “But many times, these cases are very unclear, and there is fault on both sides.”

Still, lawyers say, the arbitration process isn’t easy for an individual investor. “You walk in with your complaint form, and there’s an attorney from the firm with 175 indexed document exhibits. These guys know what they’re doing,” says Mr. Aidikoff, the Florida attorney.

Arbitrators are selected from a pool of candidates who are screened by the NASD. Cases involving more than $50,000 are argued before a three-member panel. The others are decided by one arbitrator.

Ms. Crawford, the Texas securities regulator, says many investors can resolve their problems just by contacting the firm’s compliance officer rather than taking a case to arbitration.

She says documentation is important, and that means printing out screen shots and saving trading confirmations. “You’ve got to have a paper trail. Without it, you’re not going to get anywhere,” she said.

Still, regulators and attorneys agree that investors ultimately have to be responsible for making unwise investment decisions.

“There comes a point in time where we have to accept the fact that people have to have some responsibility for getting themselves into trouble,” says Bill Singer, an attorney with Singer Frumento in New York. “When you walk into a casino and put your life savings on the craps table, you don’t get it back just because you claim that the casino shouldn’t have let you place the bet.”