You can take steps to avoid being sued by your customers.

By Mark J. Astarita, Esq.


Introduction

Since the United States Supreme Court Decision in MacMahon v. Shearson American Express, arbitration has been the preferred method of resolving customer disputes. In fact, today nearly every brokerage firm in the country includes what is known as a pre-dispute arbitration clause, which forces the firm, the broker, and the customer, to arbitrate all disputes arising out of the account.

The relative benefits and risks of arbitrations are discussed in another documents, but generally speaking, arbitrations have been demonstrated to be an efficient method of dealing with customer disputes, and are widely used for that purpose.

Types of Claims Against Brokers

For a full discussion of the types of claims that are typically asserted against stock brokers, see Typical Customer Dispute Issues. For purposes of this article, the typical disputes involve churning, unauthorized trading, unsuitability, misrepresentation, breach of fiduciary duty and breach of contract.

Documentation

Brokers, and customers, often fail to realize the importance that documentation plays in arbitrating customer disputes. It cannot be stressed often enough, that documents are the most important piece of evidence in a brokerage dispute. This is because most of the disputes related to what someone SAID…either what the broker said about a particular investment, or a customer about his objectives or financial health, or any of the thousands of other conversations that occur between brokers and their clients every day, across the country.

While the author is not suggesting that every word spoken between a customer and his broker be recorded and documented, a few simple procedures can bolster a broker’s defense against an unwarranted customer claim. None of these suggestions are time consuming, and all can go a long way toward resolving a dispute.

Account Documentation

First, the Account Documentation. Every brokerage firm requires certain documentation from a new client, and should be requiring continuous updates as the relationship progresses. Many market participants fail to realize that 1) these documents are, for the most part, required by the various securities regulations, and 2) the information contained in these documents are strong evidence at a hearing, regardless of what a party says at that hearing regarding changes to the information contained in those documents. Remember my favorite tenants of cross examination -” I hear what you say now, show me what you wrote then.”

New Account documentation typically includes a new account form, a customer agreement, a margin agreement, and an option agreement, typically with some type of option information form. Many of these forms are often combined together in one or two documents, depending on the firm or the clearing firm, but each are required by applicable rules and regulations, or in order for a firm to demonstrate compliance with the rules and regulations.

The first form, and the one that every account must have, is the New Account Form. One would be amazed at the lack of attention paid to the New Account Form by many brokers and customers. The lack of attention is mind boggling when one realizes that the New Account Form is probably one of the most critical documents in a wide variety of customer disputes.

Therefore, complete the new account form properly., and review it annually with the customer. While most firms do not have the customer sign the new account form, a written verification of the form will go a long way towards resolving disputes over this information. I have estimated that in well over 75% of customer arbitrations, the customer alleges that the information on the new account form is materially inaccurate in one way or another. This indicates that either customers are not careful in what information they provide to the broker when they open their account, or brokers are not carefully ascertaining essential information regarding their customers, In either event, and regardless of who is at fault, a signed or verified new account form will focus the customer, and the broker, on the information contained therein, and insure that the broker is acting on accurate information.

Customers and brokers are familiar with the form. It contains the relevant information about the customer name and address, the type of account, contact telephone numbers. However, it also contains critical information regarding the financial and investment background of the customer. Keep in mind that the information on the form is requested for a very specific reason, and not because the broker or his firm get thrills from asking personal questions. The information on the form is the basis for the broker’s recommendations to the client, and for the firm’s compliance reviews. Brokerage firms often have nothing but the new account form by which to review a customer’s account for suitability issues. If that form is not accurate, problems can be overlooked by even the most exhaustive compliance review.

I have always advocated having customers sign their new account forms, fully completed, with no blanks. Unfortunately, the industry has been slow to incorporate a signature line into the new account forms, although this has been changing in recent years. Brokers should, if permitted by their firms, have BLANK new account forms sent to the customer, by the operations department, for the CUSTOMER to complete, in his own handwriting, with instructions underscoring the importance of the information, and its accuracy.

Realizing that the nature of the retail business operations do not always allow the luxury of this, brokers should carefully review ALL of the information on the form with a new customer, and complete EVERY item on the form, even using “N/A” for items that are not applicable. Then, even if the form does not require a customer’s signature, send the form to the customer, with a covering letter, stating something to the effect of, “here is a copy of the form I completed, based on our conversation. Please review it carefully, and let me know immediately if anything is incorrect.” Keep that letter with the form. If the customer makes a correction, send the corrected form, with another letter, and keep that letter. This is the time to start keeping small manila file folders for each customer.

This form MUST be kept up to date. Failing to record, on the new account form, or by completing an amended new account form, changes in the customer’s investment objectives, or financial status, is a recurring problem in the broker-customer relationship, and I believe this problem relates to a failure to understand the importance of that simple form. Very often, where there is a long term relationship between the broker and the customer, the customer’s objectives will change over time, and his financial status may change, for better or worse. Brokers and customers would serve themselves well to be sure that the account documentation reflects these changes, to avoid problems and misunderstandings later.

For example, a customer who begins his relationship with a broker when the customer is 35 years old undoubtedly has very different assets and investment objectives when he reaches 40 and his children start to grow. Annual reviews of account information, which can be easily incorporated into the annual review of the account, will avoid the problem of having a mismatched investment objective and trading activity.

From the customer’s side, your broker should be aware of any changes in your financial status, so that he can adequately guide your investments. If you were earning $100,000 a year, but then decide to change careers and earn substantially less, or if a spouse stops working, be sure to advise your broker, as he will be making investment recommendations based on the information you previously gave him, in good faith, which may be totally unsuitable for you at the present time.

Following up the oral advice to the broker will insure that your financial status and goals are understood, not only by the broker, but by his firm, and will resolve any factual disputes in later years.

Many brokers and customers complain that the data on the new account form is sensitive. While clients view it as confidential and are reluctant to disclose it, brokers have to ask the difficult questions. The broker-client relationship is grounded in mutual trust. If there is a problem in disclosing personal information, or in asking for such information, the entire relationship may not work. If a customer refuses to provide certain information, the broker should indicate the refusal on the form. The broker should not guess or estimate, as he may very well be wrong, which will be a costly mistake in a subsequent arbitration.

Communications

The vast majority of communications between brokers and their clients are oral. Brokers should strive to be clear in their communications with their customers, and to confirm any material conversations in writing. It is amazing how many times critical conversations are recalled differently by the parties to the conversation, in court, years after the conversation. We all have good memories, but those memories tend to become jaded years after the fact, in a middle of a dispute. Written confirmation of important conversations remove this problem.

For example, when a customer departs from a broker’s recommendation in a way that substantially increases his or her potential risk of loss, the broker should make a note of it and confirm the conversation in writing. So too when the customer insists upon purchasing a security that the broker is not familiar with.

And on the topic of communications, brokers should always, every time, no matter how busy they are during the day, repeat customer instructions. A simple statement, such at “Let me just confirm that we are selling 200 shares of ABC at the market, and this order is good until you cancel it” can head off a misunderstanding, and should be part of every brokers normal conversation with his customer.

The same is true for the customer. Confirm important conversations, particularly any complaint or concern that you have. As stated above, if you cannot prove that you complained earlier, an arbitrator or judge is not going to believe that you did, and is going to view any complaint that you claim years after the fact with great suspicion. Your letter does not have to be fancy, or even typed, but make sure it is in writing.

An important sidenote on communications – tape recordings. Today, it is extremely easy for anyone to tape record their own conversations, and many people do so. While a tape recording often provides indisputable evidence of what was said during a particular conversation, there are a few important considerations before you start recording your conversations.

First, and foremost, it may very well be illegal. In some states, a conversation cannot be recorded, by anyone, unless every party to the conversation consents to the recording. This prevents the surreptitious recording of conversations.

Second, for brokers, your firm may have internal rules or policies regarding recording, and you should check with your firm before recording any conversation with any customer.

And third, keep in mind that surreptitious recordings are viewed by many people, including arbitrators, as unethical, improper, or simply unseemly. If you are going to record your conversations, your best procedure is to inform the other party that you are recording the conversation.

If you do record conversations, be sure that you carefully keep and store every single tape of every single conversation. There is nothing worse than a witness who testifies that he recorded all of his conversations, but he has lost the tape of some crucial conversation.

Personal Notes

Brokers should strive to keep a “paper trail” of their activities. Brokers should maintain calendars, day timers or some other record of appointments and conversations with clients. Regardless of where you make those notes, make them. Contemporaneous notes of conversations or meetings are very effective in resolving complaints that often arise years after the fact. No one could possibly remember a conversation that occurred three years ago. However, a note on a diary, made at or about the time of the conversation will not only jog one’s memory, it will provide additional evidence that the conversation in fact occurred.

Many of my broker clients use composition books, or some other type of hard bound notebook, keeping notes of conversations with customers, compliance and branch managers in the notebook. The book is simply a running diary of the broker’s activity, day by day, and provides a chronology of events in the broker’s work day, and can be extremely useful years later when attempting to reconstruct a particular conversation or series of events.

Using a notebook is at first a daunting task, because the most effective notebook is one that is always with the broker, and used all the time. It takes a fair amount of self-discipline to get into the habit of using one book to record all notes, rather than a scrap of paper, but the benefits to such efforts are enormous.

Telephone Records

Keep telephone bills as evidence of calls placed from the office. This one applies to both customers and brokers. While customers can simply retain their telephone bills, brokers may need the assistance of their firms in keeping these records. Most brokerage firms have an internal computer system which records all telephone numbers dialed, the time and date of the call, and the length of the call. Brokers should ask their operations manager for copies of the reports that are generated by such a system, for the broker’s lines, and his assistant’s line. The reports can be filed away on a monthly basis in the broker’s files.

While this may seem to be another painstaking task, there are a large number of disputes where brokers, or customers, claim that they did not speak before a particular transaction. Phone records, showing a call, are compelling evidence that the conversation occurred, and are often invaluable.

Similarly, the absence of a call from the broker, or client’s usual telephone, does not mean that the call did not occur, it is often enough to persuade the arbitrator or court that the call did not occur. Many brokers believe that they can obtain these records if needed, years later, from the telephone company or their firm. Do not rely upon this belief, for it is not true. Most of the telephone companies periodically purge their database of calls, some as frequently as every 90 days. Firms too purge their internal databases, as the cost of maintaining in-house records of every call made may very well require a warehouse simply for those records!

On a similar note, keeping telephone message pads with carbonless copies to maintain records of all calls received, will also help establish the dates of telephone calls in later disputes.

Other Pre-Dispute Procedures

While documentation is often the key to resolving disputes, everyone’s goal should be to attempt, where possible, to prevent a dispute from occurring.

Brokers, or their sales assistants, should call the customer when initial monthly statements arrive to verify that the customer received them and that he or she understands them. While this may appear to be a daunting task, a registered sales assistant can handle most of the calls, in a few minutes. This procedure has the added benefit of providing a contact with the customer who the broker may not speak to every month, to keep the communication lines open between the broker and the customer.

For the customer, if an account statement is not received, you should immediately call your broker and advise him that you did not receive it. Brokers will, correctly, assume that you are receiving your statements and confirmations, and reading them. If he doesn’t know that you are not getting them, he cannot take steps to insure that they are being properly sent out.

Confirmation slips are another overlooked, yet crucial, documents, for they are exactly what their name implies – a document which confirms the execution of an order that the customer placed in his account. They should not, under any circumstances, be ignored. Many states, including New York, have laws which make confirmation slips BINDING CONTRACTS, if not objected to on a timely basis. Depending on the particular arbitration panel, customers may be held to those trades, despite a claim of fraud or unauthorized trading, if there was no objection to the information on the confirmation slip, including the mere existence of the trade.

Giving bad news. Brokers, like the rest of humanity, do not like to be the bearer of bad news, but that is part of the job. You MUST inform your customers of a downturn in your favorite security, or an unexpected news report regarding his investments.

While it is tough to own up to a mistake in judgment, or advice that turned out, after the fact, not to be profitable, failing to tell your client the bad news will often turn a simple bad call into a complaint. Time and time again, I have seen simple market losses turn to suspicion, and turn again into a customer complaint, simply because the customer became angry, and then suspicion, and then convinced that the was defrauded, simply because the broker did not return his calls.

Conclusion

A simple document like this cannot prevent disputes between customers and their brokers, and those who manage to follow every suggestion made here may still find themselves embroiled in a dispute that they did their best to prevent. However, following the suggestions here will hopefully make the prosecution or defense, of the claim easier for you and your lawyer, and may even enable the dispute to be resolved without a full hearing, and the costs and time involved in such hearings.

If you have any questions, or comments on the suggestions contained in this article, or if you have your own suggestion that has been successful, I would like to hear from you, and will incorporate appropriate suggestions and comments into later revisions of this article. I can be reached by email at astarita@seclaw.com.


Copyright 1995 by Mark J. Astarita, Esq. All rights reserved.