Brokers and Brokerage Firms

What stock brokers can and can't do with your money.

In most cases, if you want to buy stocks, bonds, or other securities, you'll need a stockbroker to handle the transaction on your behalf. (There are some stocks you can buy without a broker's help, as we'll see later.)

Brokerage firms generally fall into one of two categories. A full-service brokerage sells a full range of financial products, maintains a large research staff to track the stocks that are hot and the ones that are falling in value, and provide advice to investors about where they should invest their money. To pay for all this service, investors pay high commissions on each transaction, and may even be charged a fee if they don't use their accounts to trade securities on a regular basis.

A discount brokerage doesn't provide any advice about how you should invest your money, but merely buys and sells securities according to your instructions. Since the discount brokerage doesn't have to pay the salaries of economists and other research personnel, it charges a substantially lower commission than the full-service brokerage. Depending on which discount brokerage firm you use and the size and type of transaction involved, you can save more than half of what a full-service brokerage would charge.

No matter which kind of brokerage firm you use, make sure that you're the one who does the picking and not the other way around. Some brokers looking for business will "cold call" names they obtain from a mailing list company. If you've ever owned an insurance policy or responded to a sales pitch for an investment letter, chances are you are on one of these lists. You want to select your own broker, and to do so you will need to do some research.

In most cases, experts suggest that you use brokers who work for firms that belong to the New York Stock Exchange. The broker himself should have at least several years of experience, and he should be willing to give you the names of several clients who have been satisfied with his work during that time.

You should also check with your state's office of securities regulation to find out if any of the broker's customers have filed complaints about the way he handled their accounts, as well as how those complaints were resolved. Thanks to an arrangement with the National Association of Securities Dealers, your state's securities regulators can provide you with a ten year history of the broker's employment record, including previous firms for which he worked, and tell you if the broker has ever been charged with fraud, claimed bankruptcy, or had court judgments assessed against him. You don't have to pay anything to take advantage of this service, and it could help you avoid a broker with a checkered past. And you can find out about the history of the brokerage firm for which he works at the same time.

If you decide to use a full-service brokerage, remember that your broker is essentially a salesperson whose livelihood depends on the commissions he generates. To improve his own financial status, he has to convince you to buy securities (on which he will collect a commission) or sell securities (on which he also gets a commission). In some cases, his brokerage firm may give him special incentives, like cars, golf clubs, or even vacation trips in order to convince you to buy certain stocks or other investments that bring additional profits to the brokerage. In fact, some brokerages penalize brokers who don't steer you into certain investments.

For example, suppose you want to buy shares in the LMN mutual fund. Your brokerage administers a similar fund, the NOP fund. If the broker convinces you to buy NOP instead of LMN, he may get a bonus, since the brokerage firm will collect the administrative fees for handling your account. If he can't convince you to buy NOP, he could find himself losing clerical and secrettohama support, and a number of such failures could even cost him his job.

Additionally, brokers earn the highest commissions when they sell you high risk investments. If you are a conservative investor interested in preserving your assets, you don't want to put your money into options trading or new mutual funds that have no established history. But those are exactly the kinds of investments that earn brokers the highest commissions.

By law, brokers are supposed to explain the risks involved in making a particular investment, and they are only supposed to recommend investments that meet your own goals for your money. If your broker doesn't provide this information, or makes promises that the investment doesn't deliver on, you may be able to recover some of your losses through arbitration. In order to minimize the number of lawsuits filed against brokers for bad advice, most brokerage agreements now require you to submit any claim you have to arbitration. Depending on your agreement, the arbitration may be conducted by an independent organization such as the American Arbitration Association, or it may be run by the New York or American Stock Exchange, or the National Association of Securities Dealers.

At an arbitration hearing, you can represent yourself. If your case is clearly documented with notes you made during conversations with your broker and any correspondence, sales materials or other documents the broker provided to you, you may not need a lawyer to represent you. In fact, if the amount you're trying to recover is relatively small, you may not be able to find a lawyer to represent you even if you do want one. However, you can probably get at least an initial meeting with a lawyer who will give you some idea of just how strong your case is, and he may be able to provide you with some worthwhile advice about how to present your case in advance of the arbitration hearing.

Although procedures may vary in some small details, arbitration hearings are typically conducted by a panel of three arbitrators that you and the brokerage firm agree on before the hearing. Both sides present whatever evidence they have to support their arguments. In most cases, the full hearing is conducted in one day, but in some cases it may take longer.

After the arbitrators hear the evidence and examine the documentation each side provides, it usually takes from four to six weeks or so before you receive notification of their decision. You generally won't receive any information about how the arbitrators arrived at their decision. In most cases, neither side can appeal an arbitration panel's decision, unless you can show that the arbitrators' failed to follow their own rules in conducting the hearing or examining evidence. But unless your evidence that the arbitrators acted improperly is strong, the cost of filing an appeal will usually make doing so a waste of time.