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Investors Cry Foul As Money Vanishes


Investors cry foul as money vanishesYour money: Record wave of stock traders taking brokers to arbitrationDeborah Lohse – Knight Ridder Denise Day knew she needed help managing $1.4 million in cash and stock options she received in her divorce. So, like many investors, she turned to a broker for advice.

Just over a year later, she’s filed to take her broker to arbitration, alleging she lost almost everything when he handled her investments more aggressively than she wanted.

“I’m very frightened still,” said the 50-year-old former housewife, who moved late last year to Shell Beach, Calif., from San Jose.

Day is part of a record wave of investors crying foul over how brokers handled their money during the tech-stock boom. These investors claim that their brokers — blinded by the bull market and likely driven by a desire for commissions and fees — steered them into the danger zone of too-concentrated portfolios and heavy debt.

Like Day, many investors lost more than they thought possible, and some even wound up owing thousands to the tax man or to their brokerage firms.

The National Association of Securities Dealers reported record monthly levels from April through July of arbitration cases against its brokers. May’s 662 cases set an all-time monthly record for NASD.

“We used to see a few really good seven-figure cases a year; now we’re seeing several a month,” said Phil Aidikoff, a Los Angeles lawyer who represents investors. “People were just wiped out.”

Many on Wall Street say such claims are overblown, and investors need to look in the mirror when assigning blame for losses. “This is the kind of thing you see when markets go down,” said Dan Michaelis, a spokesman for the Securities Industry Association.

Michaelis noted that investor complaints have increased more slowly than trading volumes, and investors signed off on the trading strategies they are now decrying.

“You have to discuss the level of overexuberance, and there’s enough blame to go around in that area, both brokers and investors,” Michaelis said.

Common complaints are that brokers failed to advise customers — especially high-tech employees — to diversify their portfolios. Investors also complain that many brokers thought diversified portfolios meant buying a lot of different tech stocks.

But one of the fastest-growing areas of complaint, lawyers say, is margin loans.

Margin loans allow investors to use the value of their portfolio as collateral to borrow money to buy more stocks. In some cases, they can own twice as much stock as when they started, and get a limited tax deduction for the interest they pay.

In a rising market, buying stock on margin allows investors to multiply their profits without putting up any more money.

But investors can get burned by margin loans because in a falling market, losses get magnified.

If the stock declines a certain amount, brokers must make a “margin call” — a demand for more money from the investor or the sale of stock — to cover some or all of the losses. Many investors also do not realize their brokers can decide when and what to sell if the portfolio falls too much.

A staple for sophisticated investors, margin loans exploded during the past few years along with the bull market. Investors held $278 billion in such loans in March 2000, a peak month. And they helped make Wall Street firms rich: The industry earned a record $22.3 billion in interest from such loans in 2000, according to the Securities Industry Association.

Through July this year, 234 arbitration cases involved gripes about margin loans, compared with 284 for all of 2000.

Regulators agree that margin debt is about “as clear as mud” to most investors, according to Elisse Walter, chief operating officer at NASD’s regulatory arm.

NASD recently required all brokerage firms to send detailed explanations of the risks of margin to clients. The Securities and Exchange Commission is on the lookout for margin problems, after investor complaints spiked in that area. It recently added a margin-calculating tool to its Web site.

For Day, it all seemed simple at first. Around April 2000, after learning that her former husband was leaving Cisco, she had to come up with about $118,000 to exercise nearly 30,000 options. Otherwise the options — which gave her the right to buy Cisco at a cheap price — would expire. She also needed about $660,000 to pay taxes on the options.

She’d heard she might do both using borrowed money. A broker at Neuberger Berman readily agreed, according to her complaint.

But what wasn’t disclosed, she claims, was the risk to her entire portfolio — $500,000 in diversified investments as well as her Cisco stock. She says she didn’t realize how much she stood to lose if her stock declined and margin loans started to represent too much of her portfolio.

She claims her broker also used margin to pay another $200,000 or so of her expenses — including a home down payment — without telling her the money came from borrowing rather than selling stock.

Neither Neuberger Berman nor her primary broker, Robert Splan, would comment.

Day says she still owes $189,000 in taxes.

“I may have to sell my house, move and go back to work,” she said. “I’ll never use margin again in my life, if I ever come into money again.”

Investors’ lawyers say brokers had ample reason to push margin loans. It gave them more money to invest — which meant more commissions. In addition, some firms gave brokers a small cut of the margin interest they received.