The stupidity of free-market chic ... in the stock market.

• Author: Friday, Carolyn

The Stupidity of Free-Market Chic . . . . . . in the Stock Market

Julia and Eugene McMahon never saw it coming. They were in a dark restaurant one evening with their "financial adviser" from Shearson/American Express, when she handed them a piece of paper to sign. "It's just red tape to open a brokerage account," the adviser told them. Even in the light of day, the McMahons wouldn't have read through the tiny print and understood the clause that was to win them a place in judicial history. They didn't know a lot of things that day. They didn't even guess that this nice woman who had befriended them in church would betray their trust and invest their retirement savings in dicey options trading, or that she would reap $200,000 in commissions as they lost $500,000.

Nor did they know that the document they signed that day in New York robbed them of the right to take their adviser to court. The sneaky little phrase, "the parties are waiving their right to seek remedies in court, including the right to a jury trial," is buried in a finely printed litany of boiler-plate lingo. As the McMahon's lawyer, Theodore Eppenstein, noted dryly in a congressional hearing, when five congressmen could not find the clause in his clients' agreement, "I'll give you a hint. It's not on the first page."

Brokers prefer to gloss over the issue of disputes and forced arbitration when clients are preparing to trust them with their money. "We are told by investors that time and time again brokers advise them that the agreement does not have to be gone over with a fine-tooth comb, that it is just like opening a bank account," says Eppenstein. How many customers would balk if they fully understood when they signed such agreements that their only recourse to any broker shenanigans--including fraud--is an arbitration panel run by the broker's peers?

Of course, when there are disputes, arbitration can be a worthy alternative to a long, drawn-out court trial, but not the way it is currently practiced in the brokerage business. Moreover, the Supreme Court, hoping to unclog the courts, has barred investors from seeking justice there. Although the Securities and Exchange Commission (SEC), which oversees brokerage firms, has recently proposed a number of reforms for securities arbitrations, these reforms do not go far enough. The deck is still stacked. Arbitration decisions are still mysterious and final. And for all its bravado, the SEC does not have the power to ensure that arbitrators are even following the law, and if they aren't, to undo their decisions. So much for investor protection.

Unfortunately, fraud is not a rarity in securities cases. All too often, the files of customers wiped out through options trading or margin accounts contain falsified documents. Forged signatures on margin agreements and wildly inflated net worth and income figures let brokers "churn and burn" in investments that are crazy for widows, orphans, and many other small investors. Take the case of a young widow from rural Tennessee. She was 41 with a 14-year-old daughter when her husband died. His life insurance policy paid $50,000. She turned over that money and the $10,000 equity in her house to Chris Hodges, a young Paine Webber broker in Tampa, Florida. The widow, a secretary, was impressed with Hodges's M.B.A. and certified financial planner title. Besides, her sister knew him.

At first Hodges played it safe, investing her money in municipal bonds. Then he switched her account into over-the-counter stocks and finally to one stock, Syntech. His next move was to margin her investment to the hilt by borrowing against the stock she held to buy more. It doesn't take a rocket scientist to figure out that no one of her modest means and in her precarious circumstances should invest in only one stock and never, ever, with borrowed money.

When the October 1987 crash came, the inevitable happened: the widow from Tennessee was wiped out, her life savings and her daughter's college education both gone. According to Stuart Goldberg, a Danbury, Connecticut lawyer who argued her case before an arbitration panel last July, the signature on the margin account was forged and the customer profile "X'd" out. The broker, says Goldberg, had originally bought the stock for his own account, and when it started dropping in price dumped it into his clients' accounts rather than take the hit himself. To dispose of it all, he had to margin the accounts. His supervisors at Paine Webber never said a word. "They were too busy playing with their seeing-eye dogs," says Goldberg, a former assistant U.S. attorney, SEC enforcement attorney, and New York Stock Exchange (NYSE) assistant director, who has won two other cases against Paine Webber for Hodges's misdeeds. "But the real fraud is that Paine Webber made her go through two years of arbitration after admitting they owed her the money."

As things stand, arbitration is an investor's only avenue for redress. The U.S. Supreme Court has ruled that, whether or not customers read or understand what they sign when opening a brokerage account, it is a binding contract. Furthermore, the customer agreements stipulate that any disputes will be resolved by arbitrators who are members of the securities industry and chosen by the stock exchanges. Talk about getting snookered!

Anyone not willing to play by those rules gets shut out of the market. "You cannot open an account without agreeing to arbitrate," said David Robbins, an attorney, arbitrator, and former New York special deputy attorney general. Rep. Edward J...