The annals of stockbroker skullduggery are extensive indeed, and getting lengthier by the day. There are the brokers who abscond with funds, or confidentially convince clients to invest in scams outside the purview of their brokerage, or "churn" accounts (engage in excessive buying and selling), claiming that was what the client wanted.
One scam prevalent these days involves brokers coaxing clients to take out home-equity loans, or credit-card debt, to play the market. Clients are then urged to trade on "margin," leveraging their accounts by borrowing from the brokerage. Such actions, while possibly unethical, are not illegal.
But then the broker crosses the line by urging the customer to leverage the account in excess of the legal limit. With that over-leveraged account, the broker proceeds to trade heavily, or "churn." That churning generates big transaction fees for the client and big commissions for the broker.
"I had a client who, on the advice of his broker, went out and borrowed more than $100,000 on his house and credit cards," said Steve Buchwalter, an Encino-based lawyer who often represents clients in cases against stock brokerages. "Then the broker heavily traded the account. The turnover rate was 17 for a nine-month period." (That means if there was $100,000 in the account, the broker bought and sold $1.7 million worth of investments.)
Further, the broker "margined" the client at 50 percent effectively doubling the client's investable funds. (The term "margined at 50 percent" means leveraging the account by 100 percent. For each $1 of investable funds, $1 is borrowed, resulting in an account that is 50 percent margined.)
Doubling investable funds also doubles the broker's potential commissions. Those commissions, when combined with interest payments on the margined funds, all but guarantee that the client will lose money, even in a bull market, said Buchwalter, who has filed for arbitration in the matter and can't reveal further details.
The client was caught in a vicious cycle once he was lured in by hints of lucrative returns, he realized he had interest payments to make, and so felt compelled to undertake even higher-risk strategies to make the plan profitable.
"The 'borrow money on credit cards' advice is something we are seeing more of right now," he said.
The travails of Buchwalter's clients are not unusual. The files of NASD Regulation, the arm of the National Association of Securities Dealers charged with enforcing disciplinary actions, are filled with actions taken against brokers for allegedly doing wrong to their clients.
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