Op-ed column: Investors have little protection from fraud by stock brokers

If you think there is nothing more to worry about than 401(K) losses and the looting of the national

If you think there is nothing more to worry about than 401(K) losses and the looting of the national treasury by insolvent financial institutions, you are wrong. Even those stocks you hold with your brokers could be ripe for ravage. What is grimmer, under the laws, there is little you can do about improper trading.

When one opens a brokerage account, one must sign an agreement that any improper trading by the broker must be settled by mediation or arbitration. This indemnifies the brokerage firm from lawsuits for damages. Doctors would love such an arrangement — even if an operation went wrong, all they would lose is the original fee.

Of the two options, mediation is the cheaper. You and your broker meet and talk it over. The mediator has no input. Hopefully, the two parties will agree on something. But this is like John Dillinger meeting with the banker he robbed. More than likely, Dillinger would deny the whole thing. Mediation closed.

Arbitration is more formal. An agreed-upon arbitrator from the financial community hears both arguments and makes a judgment. The victim can have a lawyer present but must pay him.

Don’t think the Securities and Exchange Commission will help in these small disputes. It will send pamphlets and wish you luck. Nor does it list available lawyers who specialize in such activity. You will not find them in the Yellow Pages, either.

No effective law

Thus, in this one area of capitalism there really is no effective law. If you are raped, robbed, or run down by a car, you can report the crime to the police and the wheels of justice begin turning. Not so with stockbroker crime. True, there are laws which brokers should not break. The problem is, the laws are not enforced.

Had I not, as the executor of a will, endured this oversight, I might have blissfully believed in justice for all. The lesson has been expensive for the heirs, not to mention the IRS and any charities the money could have supported. One defective cog can corrupt the entire machine.

This laissez-faire arbitration solution to brokerage crime goes back to a law produced during Calvin Coolidge’s reign in 1925. The law was successfully challenged in the 1953 Wilco v. Swan case before the Supreme Court, when the public was granted momentary relief. The court argued that mandatory arbitration could be ignored and the disputes sent to civil court. The court saw that the chummy relationship between brokers and arbitrators left the complaining investor vulnerable.

Nevertheless, the Reagan court of 1987 overruled Wilco in Shearson v. McMahon. Justice Sandra Day O’Connor led the majority, stating, “The court effectively overrules Wilko by accepting the Securities and Exchange newly adopted position that arbitration procedures in the securities industry and the commission’s oversight of the self-regulatory organization (SRO) have improved greatly since Wilko was decided.”

Why that department would tell such a base lie and the court of our brightest legal minds would accept it is beyond comprehension. All both are doing is legitimizing the feudal system of pre-revolutionary France (see de Tocqueville). Self-regulation by thieves is an oxymoron.

Relevant to many

This arcane subject is not quite as remote as it appears. America has never had so many people investing in the stock market. And, with negligible returns on bank savings programs, more will eventually take the plunge. But if the public is not properly protected, it will be ripe for future harvest.

What appears to be needed is a formal investor court — one similar to that of bankruptcy, with vetted judges. If the possible judgments rise over a certain limit, the cases can then be transferred to a higher court with a jury.

With all of this in mind, it would be wise for one never to agree to the arbitration-only contract. That’s why Internet accounts might be an improvement. There, at least, no broker can give you bad quotes or sell without your permission.

The apparent collapse of our investment system probably surprises no one who has seen depredations in the billions by the pirates of Wall Street. But what lack of honesty leaves in its wake is a lack of trust in the entire social fabric. Barbaric behavior can only breed barbarism. Good, effectively operated laws are our best defense against anarchy.

Yet, when one man (Madoff) can run a Ponzi scheme for decades that bilks $50 billion from citizens, it appears laws protecting investors are not suitably enforced.

Beyond the SEC

But the Obama administration may hold out hope for improvement. According to the July 10 Wall Street Journal, Obama plans to “move some consumer-protection powers outside of the SEC . . . to give a single federal agency authority to police mortgages and other consumer-oriented products, such as mutual funds.”

SEC Chairwoman Mary Schapiro responded, “I will question pretty profoundly any model that would try to move investor-protection functions out of the Securities and Exchange Commission.”

While the initial proposal does not touch on the above problem, it is a move in the right direction. The SEC was incorporated as the FBI of national finance. It has failed in its mission, perhaps because of past political and court decisions.

David Childs lives in Johnstown.

Categories: Opinion

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