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Ignorance Defense Works on Wall Street

By Larry Doyle on November 15, 2009 at 6:45 PM in Economy, Sense on Cents (Larry Doyle blog)

* Bumped Up *

Ignorance of the law is never an acceptable defense on Main Street; regrettably, the same does not seem to hold true on Wall Street. How so?

A recent auction-rate securities arbitration case involving an investor who purchased ARS from a Raymond James financial representative acknowledges the ignorance of the sales rep, but effectively absolves the firm in the process. The implications of this decision should not be underestimated. The Wall Street Journal sheds further light on this case in a recent review, GETTING PERSONAL: Investor Loses Out In Auction-Rate Case:

A complaint brought by an auction-rate securities investor offers insight into the plight of those stranded in the instruments as well as the arbitration process some investors dread.

Like many investors, Gene McCutchin, a real-estate entrepreneur, was holding auction-rate securities when the $330 billion market froze up in early 2008. He filed a complaint against his broker, Raymond James Financial Services Inc., in September 2008 asserting negligence, fraud and breach of fiduciary duty, among other things. He said the brokerage failed to warn him about the risks before his purchase, and he asked for compensation and punitive damages.

A Financial Industry Regulatory Authority arbitration panel, in an Oct. 26 resolution, didn’t award damages or order that the share sale be rescinded. It supported some of McCutchin’s assertions, finding that a Raymond James broker, Rick Woolfolk, “was poorly trained with respect to the ARS product,” and it did order the brokerage to pay forum costs.

But the panel also said that McCutchin identified himself as “a sophisticated investor.” While McCutchin wasn’t informed about the extent of risk before the transaction, it was clear that his personal adviser, Dan Chilton, understood that he was buying ARS bonds, and that the higher returns they offered came with higher risk, the panel’s resolution said.

Let’s zero in on the phrase, “wasn’t informed about the extent of the risk before the transaction.” The fact that the FINRA arbitration panel is absolving Raymond James in this transaction, despite the fact that the customer was not informed of all the risks, should send chills down the spine of every investor in our public markets. With that statement, the arbitration panel is sending a message, loud and clear: “Buyer Beware!!” You are on your own.

To mitigate the enormous risk of purchasing an investment that a sales representative may not understand, I would strongly encourage individual investors to do the following:

1. Make sure your conversations with your sales reps are on taped lines.

2. Ask the sales rep if he fully understands ALL of the risks in the dog meat, I mean the investment, he is trying to sell you.

3. Ask the sales rep to put his understanding of the risks in writing and have him sign it. Have his sales manager sign it as well.

4. To the sales reps in the audience, compel your product and sales managers to provide a fully written explanation of ALL the risks which you can share with your customers. While individually sales reps may think that may be a tough request, if the entire salesforce makes the request, management will have to listen.

If the financial industry is going to send incompetent and uninformed sales reps out to lay garbage investments on the American public, and FINRA is not going to hold the firms and individuals accountable, then American investors only have one choice: play offense.

I strongly encourage each and every investor to put the burden back on Wall Street and utilize the above approach. If the firms, reps, and managers are not willing to accomodate you, then take your business elsewhere.

Caveat Emptor . . . Buyer Beware?? No, I don’t think so.

Caveat Venditor . . . Seller Beware!!

Comments, color, constructive criticisms always appreciated.

LD

  • Ellen D

    1. Make sure your conversations with your sales reps are on taped lines.

    Please be aware that in many states it is illegal to tape someone unless you tell them they are being taped.

    So, start off every taped conversation by telling them they are being taped, to make sure there is no misunderstanding. If they object, that should send a red flag up right there.

    I also object to the government settling any cases with Wall Street firms that don’t involve them admitting their wrongdoing. That is the whole point of suing them. The money means nothing to them.

    • Larry Doyle

      Ellen,

      My point in regard to the taped lines is that you as the investor want your conversations with your brokers on a taped line. The taped line would not be on your end but on their end. Obviously the broker would need to inform you that the line is taped. Moreover I would recommedn that the investor request a taped line so nothing the broker tells you is lost or open to misinterpretation.

      • Ellen D

        But Larry, if they are responsible for the tape couldn’t it get “lost”? I guess I have Rosemary Woods syndrome. If I’m the one that wants the record, I’d be happier if the record were in my hands, not there’s.

        • Ellen D

          oops “theirs”.

  • mountainaires

    Thanks LD, What about municipalities or pension funds that get sucked into these “investments?” Can they bring action as an entity, and perhaps gain more “standing”?

    It’s always the same. The game is rigged. They’re all trading on inside information, that investors aren’t privy to, and even when they’re brought to trial over it, they can’t be held accountable. I am not in the “market” anymore, and have given up on the illusion of “investing” as a financial strategy.

    Why is this man still here? ;-)

    http://www.businessinsider.com/aig-ceo-robert-benmosche-must-be-fired-immediately-2009-11

  • Ellen D

    I am not trained as a financial person so I’d like to ask you, who are, to please educate me.

    As I understand it, the U.S. government doesn’t have a National Bank. The Fed is a conglomeration of large banks, is that right?

    Do most Western countries have National Banks that are government controlled? Bank of England? Bank of Canada?

    If the answer is yes, why doesn’t the U.S. have one?

    Thanks, guys.

    • Unabashed Galt

      If the answer is yes, why doesn’t the U.S. have one?

      My guess is, based on the ineptness of our government, we are better off nor having one? :)

      • Ellen D

        Point taken, but don’t we then have the big banks creating Government policy? Is the choice between possible ineptitude and possible conflict of interest?

        • Ladydawnelle

          ahh there is the rub ;-)

  • FrenchNail

    Larry.

    Spamy ate my comment again. It is getting impossible for me to post at NQ.

    • Ladydawnelle

      LOL, French your name always reminds me of how BADLY I need a manicure!!

  • elaine

    I doubt the investor “identified himself as a sophisticated investor”, what happened more than likely is the broker, upon knowing the investor had a large sum to invest prompted him to “talk up” his real estate acumen & got him to say on tape he had a million+bucks, these clowns will even try to count your home toward that magic number of $1,000,000, the total is really all it takes for FINRA to bless you being thrown to the wolves. You could be totally sophisticated if you don’t have at least a million bucks FINRA doesn’t approve of you being put in super risky investments. Guess they figure if you managed to get your hands on a million you can afford the haircut. What kind of reasoning is that? FINRA is a joke. However to be fair, how could the broker have known the markets would melt down in 08? One of the morals of the story is never invest more than you can afford to loose.

  • elaine

    Never invest in something you do not understand

  • Doc99

    Ignorance works on Wall Street? Heck it worked for “Turbo Tax” Geithner.