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In the News

Fewer Arbitrations -- Much Higher Fines
By Halah Touryalai
Wealth Management Letter
December 28, 2005

The good news: there were fewer arbitrations against registered reps in 2005. The bad news: fines were up, setting a new record. That is the take-away from NASD's year-end review, released yesterday. Celebrate the New Year knowing that the chance of getting hauled before arbitration proceedings is dropping, but be very leery of any violations, even small technicalities, which will now cost dearly.

Total filings dropped by more than 25 percent to 6,000 cases this year, according to the NASD, from 8,201 in 2004 -- the lowest level since 2000, when just 5,558 were filed. At the same time, fines collected by the NASD soared over 20 percent to an all-time high of $125.4 million, up from $103.9 in 2004. Although the figures are preliminary, according to the NASD, the final numbers are not expected to change materially.

What's behind the drop in arbitrations? One reason is the heightened vigilance of firms and management -- all that Big Brother stuff does have a benefit. Meanwhile, investors have chilled (and the markets have been if not hot, warmer, which helps). "The decline reflects that the cases involved in the collapse of high-tech and Internet bubbles have filtered through the system," says Jacob Zamansky, principle at Zamansky & Associates in New York who specializes in securities fraud and arbitration. "As we get into 2006, you'll be seeing the last of the tech bubble cases, which generally started to occur in 2000."

That bodes well for 2006, when the statute of limitation starts to run out on the tech wreck of 2000-2001. Under NASD rules, no dispute, claim or controversy is eligible for submission after six years, notes Peter J. Pfeffer, partner at Walsh, Pfeffer & Co in Mundelein, IL, and a former stockbroker.

The rising costs of even technical infractions is another factor in slowing arbitration. "What we're seeing is fine inflation," says Michael Wolk, a partner and securities attorney at law firm Foley & Lardner in Washington, D.C. "The fines for even the smallest infractions have gone up."

Wolk notes that while the NASD reported an all-time high in the number of enforcement actions it is consistent with the trend toward beefed up enforcement efforts that emerged after a prolonged bear market and pervasive trading scandal. More brokers are getting caught by the in-house cops -- before a client can be harmed and seek arbitration. "Surveillance tools are so much better than they were in the past," he notes.

Rick Ryder, owner of Securities Arbitration Commentator Inc., a research company in Maplewood N.J., says arbitration cases dealing with intentional misconduct like churning and unauthorized trading are on the wane. "It's the result of far more self regulatory activity and in-house compliance programs. Firms have been giving those [programs] more authority and bigger budgets, and they're using better technology to detect misconduct."

Ted Eppenstein, senior partner at Eppenstein & Eppenstein in New York, says that the NASD got a wake up call when Eliot Spitzer extracted huge fines from the largest firms in the research and trading scandals. The NASD had to catch up and show that it was capable of doing the same thing as an SRO, says Epperstein: "Regulators have been criticized for not doing sufficient job policing the industry. The best way to avoid those criticisms is to increase fines."

The NASD also worked on the investor side of the equation, mandating new tools for clients so that they could better understand products such as 529 college savings plans, mutual funds and variable annuities. Among them a new and improved Mutual Fund Expense Analyzer that delivers fee and expense information to investors for virtually all of the more than 18,000 mutual funds.

As for what the future holds, Wolk expects the pace of enforcement actions to remain consistent due to the positive effect it has yielded for the industry and for investors. So while advisors can breathe easier due to the drop in arbitration cases, they better build up cash reserves if they think they might run afoul of the NASD.

Zamansky thinks the low arbitration numbers will continue for several years. He and Pfeffer see new trends replacing tech boom losses as reason to go to arbitration. Chief among them are variable annuities. Their complex structures and fees will pit buyer against seller.

"It's an area where you'll see much increased arbitration when people see what they really bought," says Pfeffer. Currently, annuities rank third behind stocks and mutual funds as the reason for bringing arbitration cases.

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