Lingering Scars – Auction-rate blowup

Lingering Scars – Advisers’ job records and client relationships may long be tarred by the auction-rate blowup


November 30, 2008
By Daisy Maxey

More and more investors are being freed from their auction-rate securities as banks step in to buy securities for which the resale market disappeared. But the after-effects of the seizing up of the auction-rate market may last much longer for some financial advisers who sold these failed instruments.

Auction-rate securities are debt instruments with interest rates that are meant to be reset periodically at auction. Financial advisers promoted the securities to clients for years as safe, liquid instruments, but the $330 billion market seized up in February due to turmoil in the credit markets.

Shocked investors were left stranded with holdings they couldn’t unload, and complaints flooded in to the firms that sold the instruments as well as to regulators.

There’s no way to tell how many brokers have had or will have their records tarnished as a result of customer complaints or arbitration claims related to the sale of auction-rate securities. Certainly, with regulators stepping in to encourage banks and others to offer buyouts and many banks doing so, there are likely to be far fewer complaints against advisers than had originally been feared.

But those brokers who do have their records tarred with a sales-practice violation may find that it’s effectively a modern-day scarlet letter — which makes it difficult to retain old clients, attract new ones or move from one firm to another. The rules on brokers’ sales practices require, for instance, that they disclose the risks of securities and that they make recommendations appropriate for a client’s risk profile.

Brokers’ careers have suffered due to the auction-rate crisis in other ways as well. Some have alleged that their firms retaliated against them for cooperating with regulators investigating the auction-rate mess. In less-extreme cases, brokers may be left facing strained relationships with their superiors or with remaining clients. Others are losing accounts as angry clients, some who have had their money locked up in auction-rate securities for months, end relationships that may have taken years to establish.

The auction-rate mess has angered a group of very conservative investors with a lot of money, says David Robbins, a partner with New York-based law firm Kaufmann, Feiner, Yamin, Gildin & Robbins LLP, who has handled about 20 arbitration claims related to auction-rate securities. “They’re all very intelligent, educated people who are angry,” he says.

Complaints Filed

The Financial Industry Regulatory Authority, or Finra, which oversees 677,500 registered securities representatives, hasn’t yet broken out how many auction-rate complaints it has received. But it will investigate each one, says Brendan Intindola, a spokesman for the authority.

Mr. Intindola says more than 260 auction-rate arbitration claims have been filed with the authority so far, but he declines to say how many of those claims name individual brokers.

Attorneys say many arbitration claims haven’t yet made it to an initial hearing. So it’s far too early to tell how many of the complaints and claims will result in marks on brokers’ records — permanent or otherwise. Some clients who were bought out of their holdings may withdraw their claims, while others may continue to seek reimbursement of legal expenses or the costs of borrowing money when they couldn’t liquidate their auction-rate holdings.

A complaint or violation can mar a broker’s record for years. Currently, if a client makes a written complaint to his brokerage firm alleging a sales-practice violation by a broker registered with Finra and claiming damages of $5,000 or more, the firm must amend the broker’s record and file it in the Central Registration Depository. The public can view the broker’s record through Finra’s BrokerCheck system, which is publicly available at

That mark, reflecting that a broker has been named in an investment-related complaint from a customer, remains publicly viewable on his or her record for two years. If the matter is settled for $10,000 or more, it will remain on his or her record — and be publicly viewable — permanently.

But any mark — even one removed after two years — remains archived on the broker’s record. While it won’t be available to the public, it may be seen by potential employers and regulators.

With arbitration claims, those that allege a sales-practice violation and claim damages of $5,000 or more will be reported on the broker’s record if the customer names the individual broker as a respondent. If so, it remains on the record until there is a decision on the claim. If the claim is settled for $10,000 or more or if there is an award to the customer of any amount, the matter remains on the broker’s record permanently. Otherwise, it’s removed.

Who’s to Blame?

Many clients who found themselves trapped in auction-rate securities viewed their individual brokers merely as foot soldiers who did what their firms told them and who were likely unaware of the investments’ inherent dangers.

As a result, many clients didn’t name their individual brokers when making complaints to firms or when filing arbitration claims. Instead, they named the firm that sold the instruments, say attorneys who handled some of the claims.

Indeed, there are few good reasons to name an individual adviser, these attorneys say. “It’s a toxic product. The broker didn’t know,” says Mr. Robbins. “Why mark up a broker’s permanent record if he or she didn’t himself know the risk of the product he was selling because the firms were pushing it?”

Michael Deutsch, a partner and co-founder of Singer Deutsch LLP, a New York and Los Angeles-based law firm, says firms will always fight a claim vigorously. But he adds that they will be more likely to take it to a hearing if a broker is named because his or her record will be tarnished — potentially hurting his or her ability to generate revenue for the firm and increasing the likelihood of scrutiny from regulators.

“A firm may choose to go to a hearing if they’re confident they’ll win to make sure the broker’s record looks better,” says Mr. Deutsch, who has handled multiple arbitration claims related to auction-rate securities. The firm “may be more inclined to settle the case if the broker is not named.”

Some clients, however, felt that it was a broker’s duty to understand the risks of auction-rate securities. Steven Toskes, a partner at the law firm Klayman & Toskes P.A. in Boca Raton, Fla., says he has handled one or two claims in which an individual broker was named. He currently has 10 auction-rate arbitration claims pending on behalf of investors.

“Most of the time it’s just the firm [that’s named], with the firm being the deep pockets,” Mr. Toskes says. But brokers were named in some cases where the client’s gripe was “more personal” or the broker vastly misrepresented the securities, he adds.

Several firms that sold auction-rate securities decline to say how many of their brokers have had their records tarnished as a result of the sales.

It remains to be seen how heavily auction-related complaints will weigh on brokers when they look to change firms.

A blemish on one’s record is “a serious problem” for a broker, says Jason Archinaco, a partner at Pittsburgh law firm Pribanic & Pribanic LLC. “Whenever you have a mark, the next person that goes to hire you reviews your regulatory record, and it could adversely affect your ability to move to a competitor or another company in the industry,” he says.

But some recruiters say that prospective employers are likely to overlook auction-rate-related violations on a broker’s record unless there are several such violations. Bill Willis, chief executive of Willis Consulting Inc. in Palos Verdes Estates, Calif., says he’s hearing that firms are “not tremendously concerned” about auction-rate problems unless there are an excessive number of them. “Everyone knows it was a strange industry problem,” he says.

Mr. Willis says such violations are likely to be viewed somewhat like those related to limited partnerships, many of which collapsed in the 1980s. Back then, “it became rather understood, unless it was an extreme case, that brokers were more the victim of a product problem rather than a selling-practice problem,” he says. “I think it will be even more understood here. Most firms are refunding money [to investors in auction-rate securities]. They’re not blaming the broker, but, in fact, taking blame themselves for selling the product.”

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