Which Assets Are Seeing the Biggest Rise in Complaints? (On the Street)

Nov 19

Which Assets Are Seeing the Biggest Rise in Complaints? (On the Street)

With the Dow still 19% lower than it was at this point in 2007, perhaps it’s not surprising that the yearly volume of arbitration cases filed to the Financial Industry Regulatory Authority have risen over the past two years.

As investors continue to lick their wounds (and, in many cases, discover new ones), complaints over several particular kinds of assets are on the rise.

The greatest increase came in claims over preferred stock, a category that, although meager compared to mutual funds or common stock, rose a whopping 235% over 2008 by September.

Preferred Stock Claims
2005: 41
2006: 35
2007: 26
2008: 115
Through Sept. 2009: 386

“Consider Citigroup, and a lot of deals where the government took over and the preferreds got wiped out,” says Jack Ablin, chief investment officer at Harris Private Bank. “The thing to remember is they are not like a bond, the issuer is not obliged to pay interest once they eliminate the dividend on their common.”

Of course, those claims represent a relatively small portion of the overall complaints. As of September, the most common claims this year have been about mutual funds and common stock.

2005
Mutual Funds 888
Common Stock 1,348

2006

Mutual Funds 679
Common Stock 1,257

2007

Mutual Funds 395
Common Stock 790

2008

Mutual Funds 930
Common Stock 672

Through Sept. 2009

Mutual Funds 1,272
Common Stock 1,053

Still, the jump suggests that investors are losing patience with financial professionals who steered them toward preferred stock.

The assets that saw next biggest increases in complaints were corporate bonds and variable annuities, which drew just 208 and 93 claims, respectively, but represented increases of 101% and 98%.

“We’ve had an enormous rebound in bonds, but prior to that happening, priced plunged toward the end of last year,” says Ablin. “It’s all probably a matter of market vs. expectations. Most individual investors try to approach these things with their eyes open, but when you buy a bond you don’t expect to have it plunge in value. Some high profile companies had lousy bonds last year.”

Variable annuities are known for high fees, but some investors feel like they have assurances that they’ll always get income out of them, says Paul Nolte, managing director at Dearborn Partners. “So there was some concern that when those things blow up you’ll never wind up with anything. Nobody cares about fee structure when you’re going up 15% to 20% a year.”

But when markets go down, investors start to care about a lot of things that might not have bothered them before. Overall, new cases increased 46% between 2007 and 2008 and increased 60% through September over 2008.

That’s because a wave or claims tend to follow severe downturns in the market, says Brendan Intindola, FINRA spokesperson.

FINRA is a private corporation that acts as a self-regulatory organization. It provides the binding arbitration service that investors agree to rather than being able to bring their claims against Wall Street firms and brokers into the federal court system.

Complaints over certain kinds of industry malfeasance also saw big year-over-year jumps, including fiduciary duty, misrepresentation and negligence. The category that saw the greatest increase, failure to supervise, was up 94% by September over 2008. Claims designated negligence were up 65%, and unsuitability were up 61%. The categories aren’t mutually exclusive, and each claim can be classified as up to four category types.

Broadly, arbitration cases are well above where they were last year, but well off their high for the decade. Arbitration claims peaked in 2003, when there were 8,945, and had fallen 58% to 3,238 by 2007. They are up 71% from there at 5,545.

New Arbitration Claims Filed
1999: 5,608
2000: 5,558
2001: 6,915
2002: 7,704
2003: 8,945
2004: 8,201
2005: 6,074
2006: 4,614
2007: 3,238
2008: 4,982
Through Sept. 2009: 5,545

“When you get that quarterly statement and you’re examining it and say ‘this can’t be right’ it gives [investors] extra pause to consider perhaps filing an arbitration claim,” says Intindola.

Nolte says some claims are born out of an emotional reaction. “It’s investor disgust with returns on their portfolios,” he says.

The window to file a claim is six years, but it’s not clear if people are looking back and filing more claims from years past during a down economy, nor what the typical lag time is. But “typically there is some sort of conduct that a person believes is actionable in terms of a new claim,” Intindola says.

“I can only imagine it’s a direct result of how the market behaved,” says Ablin. “Generally people don’t file claims if they make a profit, whether the security was suitable for the client or not. So you’ll look at periods where there’s a particular weakness and that’s where they will come from — no one expects to lose money.”

FINRA has stepped up its efforts to handle the larger case load. The number of arbitration cases closed was up 18% in 2009, and the turnaround time fell 12%.

“We’re able to meet the sharp increase this year,” Intindola says. “It’s not the first time we’ve had market turmoil. After a few months lag time you see the increase in claims. We’ve travelled this road before we [had] adequate staff and systems to facilitate quicker turn around.”

Roughly the same percentage of claims are being decided by arbitrators this year are were decided by them last year — either through hearings or document review — according to FINRA. The percentage of cases resolved through direct settlement with the parties remained unchanged, while those settled through mediation fell by 4 percentage points. Withdrawn cases increased by 4 percentage points.

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