The Law Planet Blog

There has been a huge shift in the United States from defined benefit retirement plans, where an employee is guaranteed a fixed payment upon retirement, to defined contribution plans, where the employee makes the contribution and maybe the employer makes a matching payment. Defined contribution plans are considered cheaper for the employer.

The best known defined contribution plan is the 401(k). In a 401(k), the employee contributes to the plan and chooses the investment strategy. A plan administrator offers a variety of investment vehicles, usually associated with mutual fund-type investments, and the employer may offer to match a percentage of the employee's contribution. The employer is called the plan sponsor.

There was some discussion in legal circles as to whether or not an employee, the "plan participant," could bring an action against the plan administrator regarding administration of the plan. ERISA lawyers, who are apparently immune to boredom, batted this around at some length for a while. The Supreme Court brought an end to this discussion and made a logical decision in my view.

In Larue v. DeWolff, the Supreme Court held that an administrator can be held liable to an individual participant, not just the plan, if the administrator screws up. Now how hard was that? Logic would tell you that if it's the participant's money, and the administrator is responsible for dealing directly with the participant, then the administrator has a problem if they/he/she don't listen to the participant's instructions, which was the case in LaRue.

This is what's wrong with the law. Logic gets suspended while egghead lawyers sit around and argue about the placement of a comma in a sentence or the meaning or a single word in a paragraph. Why couldn't someone just say "duh" (not "doh!")? I, for one, am glad to see that our Supreme Court got it right this time. Now, if we could only get Congress to worry about something other than flawed arbitration studies....

That's the view from The Law Planet - Jupiter, Florida.

Posted by Dobin & Jenks | Permalink | Email This Post

Posted In: Investments

Bookmark:

It has been 20 years since the stock market crash of 1987. Many were predicting that this was the end of the world as we know it (Insert REM music here). Others saw the crash as a buying opportunity. It turns out that the buyers were probably right.

If we look at a chart of the major market indices such as the Dow Jones Industrial Average, the Standard and Poors 500 and the Russell 1000 have done quite nicely over the last 20 years. In fact, the "crash" shows barely a blip on a historical chart.

The 1987 crash brought an onslaught of arbitration claims. It wiped out billions of dollars of net worth and pointed out weaknesses in various systems. Daily trading volume on the NYSE was over 600 million shares during the crash period -- and the system was strained. Now, daily trading volume regularly tops 1 billion shares without a hitch.

This year marks the 215th anniversary of the execution of the Buttonwood Agreement, which marked the formation of the NYSE. Much has changed, including the fact that the exchange is now publicly held instead of owned just by its members. But the basics remain the same. Buy good stocks and remember the reason they were purchased during market downturns.

That's the view from The Law Planet - Jupiter, Florida.

Posted by Dobin & Jenks | Permalink | Email This Post

Posted In: Investments , Securities Industry

Bookmark:

Senator Russell Feingold (D-Wis.) has sponsored a bill in the Senate to eliminate consumer arbitration, including securities arbitration. This knee-jerk reaction to some "Chicken Littles" claiming that big chunks of sky have landed on their heads is misguided. Consumer arbitration, including securities arbitration, has deep roots in American commerce. I am disappointed that, once again, our government is sticking its nose where it need not do so.

Here is why arbitration is good. It is fast. It is less expensive (not cheap, by any means). And a resolution is generally final. The persons hearing the case want to be there and are generally somewhat familiar with the issues presented. They may not be geniuses, but they have some knowledge, at a minimum. In securities arbitration, there is at least one member of a three member panel who is classified as being a "non-public" arbitrator because of securities industry ties. I am classified as a "non-public" arbitrator because my firm represents brokerage firms like A.G. Edwards & Sons, Stifel, Nicolaus & Co. and Legend Equities Corporation for more than 20% of its revenues.

Here is why arbitration is bad. The panel's knowledge and prejudices are the luck of the draw. Sometimes you get a well-educated panel with no biases. Other times, you get a panel that "hates" whichever side you happen to be representing that day. And it's very difficult to overcome the biases. Further, the rights of appeal are very limited. This is usually a good thing, but sometimes an arbitration panel just blows it. They focus on the wrong points, misinterpret some facts, and come up with the wrong result. It happens. And when it does, the appeal rights are virtually non-existent.

In court there are depositions. These cost, just for the court reporter, over $1,000 per day. In court, the days tend to be shorter so less is done. There is motion practice, which means more attorneys running to court to cool their heels to argue some esoteric point of law that is part of the judicial procedural jousting. There is jury selection. And then there are the appeals. They cost money, delay the result and possibly change the result. And the expenses attendant to keeping the matter open, through appeal, would be astonishing.

Here's an example of a case we have in our office. Our client has sued a Registered Investment Advisor. The lawsuit was filed in February of this year -- almost 6 months ago. We have now been through two motions to dismiss and have served our second amended complaint. We haven't even seen an Answer from the defendant yet.

In arbitration, we would already have a hearing date and discovery would be underway. Our client is elderly and we tried to get her trial expedited. The court denied the motion. Is this the result that Senator Feingold wants? Doubtful. Be careful what you wish for, folks.

That's the view from The Law Planet - Jupiter, Florida.

Posted by Dobin & Jenks | Permalink | Email This Post

Posted In: Investments , Securities Arbitration , Securities Industry

Bookmark:

A recent article in the Sarasota Herald-Tribune described a FINRA (formerly NASD) arbitration award to a retiree in Venice, Florida. I'm not particularly upset about the award, I don't know enough of the facts based upon the article.

From what I can tell, there were at least two registered representatives and one unregistered person who were somehow involved in the sale of an unapproved product to the retiree. This is a violation of FINRA rules and I am certain that it violated Sterne Agee's internal procedures. Frankly, if this occurred as described, the brokers should have known better.

What troubled me most was the mention of the "hedge fund" promoter at the end of the article. Guy Della Penna is a former stockbroker who was found by an arbitration panel to have violated State and Federal Securities laws in 2002. He fought the award and, ultimately, the Fifth District Court of Appeals confirmed it. I have not kept up on the case, but last I heard the award was still outstanding. With this information, who in their right mind would give this guy parking meter change let alone over $100,000?

This information was, and is, publicly available and should have been disclosed by either the selling brokers, registered or not, and Della Penna himself. I don't know if this was done. This is the problem with the world of unregistered investment vehicles. The disclosures are weak, if any. The oversight is lax and the only time an investor finds out something is wrong is when the investment vehicle itself is pushing up daisies. It wouldn't have been easy, but the successful arbitration litigant in this case should have been able to find out about Mr. Della Penna and taken his money elsewhere.

Remember, your mother was right. If it sounds too good to be true, it is. And there is no such thing as a secure investment that pays higher than CD returns but is as safe as a CD. IT DOES NOT EXIST! If it did, would I be writing this blog?

That's the view from The Law Planet - Jupiter, Florida.

Posted by Dobin & Jenks | Permalink | Email This Post

Posted In: Investments , Securities Industry

Bookmark:

OK, I try to limit the posts to once a week, so I can actually do some billable work, but I read an article about this video on YouTube and I couldn't resist.

Enjoy.

That's the twisted view from The Law Planet - Jupiter, Florida

Posted by Dobin & Jenks | Permalink | Email This Post

Posted In: Investments , Securities Industry

Bookmark:

Bear Stearns announced bankruptcy petitions for two of its hedge funds. The term "hedge fund" has been used to describe a variety of investment vehicles. Generally, these funds are designed for high net worth investors with significant investable assets. The investors in these funds have virtually no say in how the funds are invested and, generally, they pay significant management fees to the fund manager. They are usually organized as partnerships.

According to this article in Forbes magazine, these funds invested heavily in subprime mortgage instruments. This is the domestic equivalent of Third World debt. These are instruments backed by loans made to borrowers with low quality credit.

To make matters worse, at least one of these funds appears to have been using leverage to purchase these instruments. Leverage is a buzzword for borrowing money. So the leveraged fund is borrowing money to buy investments that loaned money to people with bad credit. When it is explained this way, instead of buried in some dense disclosure document, would anyone place any significant amount of money in this investment?

Subprime lending survived because of the real estate boom in most parts of the country. Now that the gloss is off of the real estate market, the subprime market has come crashing down, taking those that were profiting from the higher interest rates of subprime loans with it. Bear Stearns, as manager of the funds, had no monetary risk unless it had some of its own money in the funds, which I doubt.

The hedge fund "industry" is an area that desperately needs regulation. I'm guessing that some of the "high net worth" investors in these funds are going to be people who had no business being in the investment. Only time will tell -- and the sob stories on 60 Minutes

That's the view from The Law Planet, Jupiter, Florida.

Posted by Dobin & Jenks | Permalink | Email This Post

Posted In: Investments , Securities Industry

Bookmark:

The NASD has levied fines against four brokerage firms for mutual fund violations related to B shares. See the NASD press release here. There is a certain amount of hypocrisy involved in these fines.

I remember when B shares were first released. They were marketed as a means to eliminate the broker's self-interest in the mutual fund transaction. This was done with the full knowledge of the SEC and NASD. A broker is supposed to "know the customer." A broker violates that rule when a recommendation is made because a broker would receive a higher or lower commission depending upon the selection of mutual fund family.

B shares, which charge a declining redemption fee based upon years held, charged no upfront fee. A customer was encouraged to buy B shares because "all your money goes to work immediately." That was the sales pitch. In exchange, the brokerage firm received a commission which was financed by the mutual fund sponsor and amortized over the redemption period. This was viewed as a good thing.

But then, one day, someone woke up and said "we're paying these higher fees over the life of the investment, not just during the redemption period." This resulted in a change where B share purchases became A shares, which were eligible for lower ongoing expenses and whose purchasers paid a sales charge upon initial investment. In my experience, the crossover period, where it is a better investment to be an A share purchaser instead of a B share purchaser, is about 7 years.

The regulators have been examining this situation for a number of years. One thing they are looking for is large purchases in a fund family (a group of mutual funds administered by the same company) that would be eligible for a breakpoint (a commission discount). Some funds have breakpoints as low as $100,000. Most funds allow an investment without commission at $1,000,000.

If you are an investor in mutual funds, ask your broker for the most cost-effective way to buy the funds, including using purchases among your household accounts. If you are a broker, it is your job to get the client the best deal.

That's the view from The Law Planet, Jupiter, Florida.

Posted by Dobin & Jenks | Permalink | Email This Post

Posted In: Investments , Securities Industry

Bookmark:

Wachovia Securities, which recently announced its merger with one of our clients, A.G. Edwards & Sons, agreed to pay a $3 million fine for allowing buy-and-hold customers to sit in wrap fee accounts. A wrap fee account is one where the client pays a flat fee for either no commissions or reduced commissions. Some brokers throw in extra services in exchange for the wrap fee.

Wrap fees have been around for a long time. In the "old days" (i.e. when I first started defending brokerage firms), a broker accused of churning would throw up his/her hands and say "That's it, I'm going to managed money" meaning a wrap fee account. The broker saw this as a way of not being accused of churning the client's account. Of course, a wrap fee is not a cure for all ills.

Wachovia, like other firms before it like Raymond James and UBS, was accused of letting its wrap fee clients just sit there racking up fees but getting nothing for the fee. Further, it appears that "A" share mutual funds, for which a client already paid a sales load (commission), were also being used in a wrap fee account, a definite no-no.

This tension between commission business and wrap fee business creates the issue of "which is cheaper." Sometimes a broker won't know how much activity the client is going to do, so a wrap fee would be inappropriate. Other instances may call for a wrap fee, such as a client investing significant new money, but the long term costs can be high if the strategy is to buy and hold.

Ultimately, the decision comes down to the basic premise of what is best for the customer. That is and has always been the mantra of securities business. Sometimes, for a myriad of reasons both honest and not-so-honest, the securities industry loses sight of the goal - the best interest of the client. In this case, the wrap fee was seen as placing the client and the broker on the same side of the table, with no transaction-based incentive. Most brokers that I know feel this way. Unfortunately, the decision to recommend a wrap as opposed to a transaction-based account is not a simple one. And the regulators don't provide any real guidance on the front end but are more than willing to extract a fine or two when the plan doesn't work out.

That's the view from the The Law Planet, Jupiter, Florida.

Posted by Dobin & Jenks | Permalink | Email This Post

Posted In: Investments

Bookmark:

The National Association of Securities Dealers ("NASD") has issued warnings to investors regarding the sales of Equity Index Annuities. NASD Investor Information This is interesting because an Equity Index Annuity is treated as a fixed insurance product in Florida and not subject to securities regulation. This allows the unscrupulous insurance salesperson plenty of room for abuse.

Here's the problem with one of the most popular brands of Equity Index Annuities - the annuity values on the account statements are misleading. The only way to get the statement value out of the annuity is to annuitize it over ten years. I have a client who thinks that when she dies, her beneficiaries are going to get the "value" listed on her account statement. In fact, they will only get the value if they take 10 equal payments over 10 years. Hence, the Roach Motel analogy. Your money checks in but doesn't check out.

An Equity Index Annuity is a securities-based product that only requires an insurance license to sell. The performance of the annuity is tied to a market index or blend of market indices. Usually, the annuity's link to the index is capped and/or participates in only a percentage of the index's performance. Further, if the market declines, there usually is no limit on the decline. But there will be a limit if the performance rebounds.

I can barely understand this and I do this for a living. I can only imagine what the inexperienced investor must think. Actually, I know because we have spoken with people who have purchased these hybrid products. They didn't understand them when they purchased the annuity and they could not explain them to me when I asked for a description.

The unfortunate part is that the senior citizens who purchase these products can least afford having their money tied up in this manner. Worse yet, from my view, is that the aggrieved purchaser may have to go to court rather than go to arbitration. And since they are not securities, the attorneys' fee provision of the Florida Blue Sky Law would not apply.

Our advice - if you don't understand it, don't buy it. If you think you've been wronged, do something about it. Don't suffer in silence.

That's the view from The Law Planet, Jupiter, Florida.

Posted by Dobin & Jenks | Permalink | Email This Post

Posted In: Investments

Bookmark: