Thousands of angry investors, many of whom saw their life savings disappear when the financial markets plunged on Oct. 19, appear headed for a massive confrontation with the nation's securities firms over whether brokers properly advised customers and protected them from risky investments.
The confrontation will take place during the coming months in hundreds of closed-door arbitration sessions that are the securities industry's traditional -- but often controversial -- method for settling disputes between customers and brokers.
A deluge of cases generated by the market's collapse is expected to severely strain the industry's arbitration facilities, which already were under pressure because of a recent Supreme Court decision requiring customer-broker disputes to be settled by arbitration rather than in court.
In one measure of consumer complaints emerging from the market collapse, a Washington "hot line" operated by state securities regulators drew 8,500 calls in a month. Many of the calls came from investors who blamed their brokers for improperly investing their money or for failing to explain the risks involved.
Callers to the office of the North American Securities Administrators Association (NASAA) reported losses as small as $100 and as large as $1.2 million.
The complaint sheets are laced with charges that brokers were not available, traded accounts without authorization, pressured investors into opening margin accounts or put customers into investments such as options and futures that may have been unsuitable.
Margin accounts allow investors to buy stocks and pay only 50 percent of the cost, borrowing the other 50 percent from the brokerage firm. However, if the value of the shares drops, the investor has to ante up more money to maintain the 50 percent level. When an investor cannot respond to a margin call, his shares can be sold.
A selection of notes taken by NASAA personnel answering hot line phone calls offers these glimpses of the complaints:
Little Rock, Ark. -- An investor said she lost $7,000, her life savings, and still owes $1,000 after her account was liquidated to meet a margin call. She said she did not authorize trading on margin.
Plainview, N.Y. -- An investor said he lost $60,000. He couldn't make his margin call, he said, and had to liquidate so much stock that he can't recover losses. The investor said he "didn't realize he was so heavily margined," the notes said.
Temple City, Calif. -- A 74-year-old man who invested in a gold-oriented mutual fund said he lost $3,000 and that his broker had not discussed the risk involved in the investment.
Fort Lauderdale, Fla. -- An investor said he put $50,000 in an options trust fund and was "guaranteed" it would not drop by more than 5 percent. But it dropped 22 to 25 percent.
Laguna Beach, Calif. -- An investor said he held options on the Standard & Poor's 100 index in a margin account and was subject to a margin call of $1.2 million. The notes did not reveal whether he had been able to meet the margin call.
Kokomo, Ind. -- An investor said she could not make a margin call of $27,000, so her broker liquidated her account. She said she lost $55,000 -- "all she had," according to the hot line notes.
El Cajon, Calif. -- A 70-year-old investor said he lost $60,000 in S&P 100 options. Two sons lost $60,000 each, he said.
One of the officials answering phones at NASAA headquarters was Robb Levin, 29, an investigator for the Bureau of Securities in New Jersey. He had taken as many as 200 phone calls in a day, listening to unending tales of woe.
"People lost their shirts in the market," he said.
Levin recalled one man who said, "I make $25,000 a year. Was I in a position to be put on a margin call for $35,000?"
Levin steered many of the callers to state securities officials and sent them information on how to begin arbitration proceedings.
Until the Supreme Court decision on arbitration, some disputes between customers and brokers went to arbitration, others were tried in court.
The choice was curtailed when the high court ruled that customers had to abide by the agreement they sign when they open new accounts. In those agreements, customers promise to submit any disputes with their brokers to arbitration.
The Supreme Court ruling in the case of Shearson/American Express Inc. vs. McMahon was considered a major victory for the securities industry because it allows the disputes to be held before panels on which the industry is represented.
However, the court decision has put pressure on the industry to revamp its arbitration procedures to cope with its new and more complicated caseload.
Shortly after the decision, the Securities and Exchange Commission weighed in with a 13-page letter asking for a series of changes and emphasizing the need to reduce the number of arbitrators with industry contacts and to increase the number of public arbitrators.
Officials at the New York Stock Exchange, the National Association of Securities Dealers (NASD) and other exchanges have responded with measures intended to enhance the arbitration system, even while they are being hit with a wave of new cases related to the market's collapse.
Deborah Masucci, NASD's director of arbitration, said that her office has been receiving 40 arbitration filings a day, about 75 percent more than normal, and about 100 calls a day for information.
She expects the number of arbitration cases filed with the NASD to soar from 1,587 in 1986 to 2,600 in 1987 and then to 4,000 in 1988, as the market collapse cases hit.
"I hope I'm exaggerating, but I don't think I am," she said.
Edward W. Morris Jr., arbitration director at the New York Stock Exchange, said he guessed his cases would rise 50 percent because of the market downturn on top of a 25 percent to 30 percent boost because of the Supreme Court decision. He said he expected many of the cases coming in to be more complex and more time-consuming than those seen earlier, when such cases ended up in the courts.
Generally, the changes being made in arbitration procedures include:
A clarification of who can be a public arbitrator, with limitations on individuals who have left the industry.
Expanded disclosure of an arbitrator's background and experience so the parties know who is hearing their case.
A process of expanded arbitrator education.
Provisions for either a tape recording or stenographic record of the hearing.
A move to broader "discovery" (pretrial) proceedings, including prehearing conferences in complex cases.
The industry, which now uses panels with one, three or five arbitrators, will move to a two-panel system.
One public arbitrator will preside over cases involving $10,000 and less. Two public and one industry arbitrator will hear cases above $10,000.
The changes are being made, Masucci said, to cure "a perception of unfairness among the public and the plaintiff's counsel" who have complained that the current system favors the industry.
The subject of arbitration, however, remains as controversial as many of the cases it is intended to solve.
Advocates say it is an efficient and relatively inexpensive way to deal with complaints from customers, especially where relatively small sums are involved. Arbitration proceedings tend to be informal and help customers avoid months or years of litigation and large legal fees.
Critics say while arbitration has advantages for small claims, it is not a sensible procedure for cases involving large sums -- the kinds of cases that usually went to court prior to the Supreme Court decision.
Arbitrators, the critics say, are not as tightly bound to rules of law as are judges, and a plaintiff could wind up with a significantly lower award than he might get in court.
"The ultimate problem is the nature of the arbitration process," said Russell B. Stevenson Jr., a securities lawyer at Hale and Dorr in Washington. "Arbitration is Solomonic in the sense that the baby often gets cut in half."
In the classic tale, King Solomon offers to settle a dispute between two women arguing over possession of a baby by announcing he will cut the baby in half. Solomon's decision brings an anguished cry from the true mother, who would rather give up her child than see it harmed.
Stevenson, a former deputy general counsel at the Securities and Exchange Commission, noted that while arbitrators often appear inclined to come up with decisions that "make everybody a little happy and a little unhappy," this approach also can work in the customer's favor.
"For example," Stevenson said, "a brokerage firm may mismanage a customer's account in such a way that does not violate the law. A sympathetic tribunal might be willing to give the customer some relief, when a court, bound to follow the law strictly, would not do so."
Stevenson said, unlike court decisions, arbitration decisions are not subject to appeal unless the participant can show "manifest disregard" for the legal rules, which is difficult to do.
How Investors Can Take Cases To Arbitration
An investor who is unable to resolve a dispute with a brokerage firm may take the matter to arbitration.
A customer can pursue his claim in any market where his brokerage is a member -- such as the New York Stock Exchange, the National Association of Securities Dealers and the American Stock Exchange.
The investor should first contact one of the markets to obtain information on how arbitration works and to get the needed forms.
Generally, an investor will be asked to file a claim letter and sign a submission agreement, in which he or she agrees to arbitrate the case and to abide by the award.
There is a fee for arbitration, ranging from $15 to $100 for investor claims of $5,000 or less.
For additional information, contact the director of arbitration at one of the following:
The New York Stock Exchange, 11 Wall St., New York, N.Y. 10005. The American Stock Exchange, 86 Trinity Place, New York, N.Y. 10006. The National Association of Securities Dealers, Two World Trade Center, 98th Floor, New York, N.Y. 10048.