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Paul Bedoe awoke at 3 a.m. on Apr. 6 and drove three hours in the predawn darkness from his home in Big Bear Lake, Calif., to a TD Waterhouse branch office in Rancho Cucamonga, near Los Angeles. The 42-year-old owner of a security alarm business made that trek to cover a margin call on his account and to show his discount brokerage that he was no shirker.
But the effort did him little good 11 days later, when without warning Waterhouse sold 5,000 shares of Pacific Gateway Exchange, a risky Nasdaq stock that Bedoe held in his margin account. Bedoe claims he waited on hold for two hours before he could get a Waterhouse rep to explain to him what was happening. But what bothered Bedoe more than the financial loss was what he felt was roughshod treatment. "They told me on several occasions they would never, ever sell my stock without giving me notice," says Bedoe. Waterhouse declined to comment "on any individual accounts."
Over the course of a wild spring for the markets, stories like Paul Bedoe's have become increasingly common. They send a message that the rapidly growing online-brokerage industry best heed. The industry needs to rethink how it informs and serves its customers. Meanwhile, the Securities & Exchange Commission should step up oversight, particularly on sales pitches to new customers. The SEC should insist on fuller, upfront disclosures of the risks involved in margin trading.
Otherwise, online brokers could find themselves facing major upticks in lawsuits and arbitration cases. "We have to increase the education process so that they know what they are buying. You need regulation more when industry practices are changing at such a rapid pace," says Muriel Siebert, CEO of discount brokerage Muriel Siebert & Co.
Angry investors like Bedoe underscore a growing problem for online brokers. On the one side, market volatility is straining customer support systems and computers. On the other side, shareholders are demanding stepped-up growth in the number of accounts and earnings, leading to questionable issuance of margin debt. The combination has led to a breakdown of broker protocol. "You went from 50 firms to almost 200 in a period of a couple of years," says Siebert. "And the most important thing was the ones that knew the technology weren't market people. They didn't come from the brokerage industry."
FLOOD OF COMPLAINTS.
Stockbrokers have never been an especially friendly lot, especially in times of market turmoil. But beginning in March and with a crescendo in April, complaints about strong-arm margin-call tactics have flooded investing bulletin boards on Yahoo! and Raging Bull. Many investors have made claims similar to Bedoe's -- that broker reps unloaded their holdings after telling them no stock would ever be sold out of their account without their being given notice. Furthermore, investors complained of interminable waits on phone lines, sketchy computer access, and rude treatment at the hands of customer-service reps.
No one knows how many people got their accounts sold out from under them, but some industry insiders estimate roughly 100,000. (Bedoe says a customer rep told him more than 25,000 customers had margin calls at Waterhouse alone. Waterhouse says it was a far smaller number.) Many of these investors were relative novices who should never have been allowed to access wild margin plays, say securities lawyers. "We used to discourage margin trading for first-time investors. Most of the time if they came in they would bring all the investment capital they had. We thought margin trading in that situation was imprudent," says Joseph Meyer, who worked as a broker in the 1970s and now runs an investment firm in Ormond Beach, Fla.
Sure enough, some angry investors appear to be reaching for the legal stick. Attorney Steven B. Caruso, a securities attorney and member of the Public Investors Arbitration Bar Assn. in New York, says complaints continue to flood in. While no significant spikes in arbitration cases are yet apparent, industry insiders expect a bump as the disputes work their way through the system later this year. In any case, disputes are expensive propositions. Legal fees and possibly damages add up, while customer goodwill evaporates.
True, legally savvy brokers rarely lose these cases in court, and the grievances of some investors will likely prove baseless. After all, Bedoe and others did sign agreements indicating they understood the risks they were facing -- even if the full explanation was written in legalese. And brokers have been quick to finger the stupid margin tricks of investors. Says Waterhouse spokeperson Melissa Gitter: "We acted prudently, and we believe in the best interests of these customers and the firm. Our actions were in accordance with the policies laid out in the firm's margin agreement. Everything we are talking about was in response to [New York Stock Exchange] requirements"
CHANGING RULES.
Brokers insist their service reps walk the straight and narrow. But Caruso argues that online brokerages are changing the rules of the game so quickly -- sometimes hourly -- that the investors have little chance to keep up. Simply too many tales are circulating of broker account reps saying one thing and asking customers to sign an agreement that says something else.
Fact is, with an eye trained on their own share values, brokers have little short-term incentive to discourage risky trading. Proceeds from interest on margin loans represent about 20% of gross earnings for Waterhouse and other brokerages last quarter. That compares to 12% for old stalwart Merrill Lynch. Since many online brokerages are actually losing money on each stock trade, relying on margin loans for revenue growth is tempting.
While some online brokerages claim they're tightening margin requirements, Siebert and others say this isn't the case with all. And the long-suffering SEC, pinned between dot-com accounting shennanigans and scores of other Internet-related investigations, isn't pushing for any big changes in this area.
Too bad. Because if changes don't come from the brokerages themselves or from the SEC, the industry will eventually suffer. Bedoe has shut down his Waterhouse account. He says he has also forsworn margin trading and will never do business again with any entity associated with Waterhouse. Add up thousands of Paul Bedoes, and online brokers could have a big problem.
Salkever covered the recent margin-call panic from New York EDITED BY DOUGLAS HARBRECHT
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