FINRA Flooded With Arbitration Claims
The Financial Industry Regulatory Authority (FINRA) is seeing a sharp rise in the number of arbitration claims filed by irate investors seeking compensation from the securities industry for steep losses during the market downturn.

FINRA, the non-governmental regulator of the U.S. brokerage industry, says the number of new arbitration case filings jumped to 1,065 during the first two months of 2009 versus 561 in the year-earlier period--a 90% increase. That surge continues the upward trend that began last year following a three-year stretch of declining arbitration case filings from 2004 through 2007. There were 4,982 cases filed in 2008, a 54% jump over the prior year.

The agency says the main types of arbitration cases filed in 2008 involved mutual funds, common stocks, annuities, corporate bonds, options, limited partnerships and certificates of deposit. In addition, there were a sizable number of cases dealing with auction-rate securities, along with collateralized debt and mortgage obligations. The most common complaints against securities firms in these cases included breach of fiduciary duty, misrepresentation, breach of contract, negligence, omission of facts, unsuitability and failure to supervise.

Increased arbitration hearings are a byproduct of down markets--the last great surge in cases occurred in 2003 and 2004 after the tech bubble burst. "When markets go down, it's sort of like people go through the three phases of grieving," says Marc Dobin, director of the financial services department at LaBovick & LaBovick in Palm Beach Gardens, Fla. "The first phase is disbelief, followed by mourning and then analysis, or blame-placing."

Dobin says the growing arbitration workload also stems from three other factors: There are more lawyers doing securities-related work, they advertise more aggressively and consumers are better educated about their rights. People realize that investments can lose money, he says, but now they can also question whether they should have been in an investment in the first place.

"It's the financial advisor's responsibility to match the investment with the investor," says Dobin, who represents both investors and broker-dealers in arbitration cases. "They have to make recommendations that are suitable to a client's investment objectives and financial situation."

Typically, arbitration cases involve a three-member panel consisting of one person from the securities industry and two non-industry members. But an independent study published last year found there was a presumption of industry bias on the panels because the one industry member could influence the other two panelists in favor of the broker.

In response, FINRA late last year launched a two-year pilot program that lets investors choose three "public" panelists rather than the traditional panel with the one industry member. Eleven broker-dealer firms have elected to participate in the program, and they run the gamut of industry giants including Citigroup, Morgan Stanley, LPL Financial and Fidelity Brokerage.

These firms have agreed to participate in a set number of cases to be overseen by the all-public panels during the next two years. The number ranges from 40 cases each year for Citigroup to 10 cases each year for Fidelity.

Some people feel the pilot program is unnecessary, if not a detriment to the arbitration process. "There have been thousands of awards, and there hasn't been found any significant rate of dissent by industry arbitrators," says S. Lawrence Polk, a partner at the Atlanta office of Sutherland Asbill & Brennan, who represents broker-dealers in securities arbitration cases.

Dobin, who represents both sides, says he believes industry panel members are helpful because they know the industry and understand its nuances. And he doesn't believe industry panelists prejudice cases toward brokerage defendants. "Oftentimes, it's the opposite because industry arbitrators see it as a chance to help clean up the industry," he says.

According to FINRA, arbitration resulted in awards in 24% of cases last year. That's up from 21% in 2007, but down from 33% in 2003.

Taxing Losses
Here's a bit of good news gleaned from last year's carnage in the financial markets--mutual fund investors experienced a smaller tax bite than in 2007. Cold comfort, for sure, but every little bit helps considering mutual fund investors, like most others, experienced the worst one-year return in decades.

According to Lipper, the mutual fund research company, equity funds on average sank 39.54% last year, the biggest drop since Lipper began tracking funds in 1959, and significantly worse than the previous lowlight year of 1974, when equity funds dropped 24.35%. And even if taxable and tax-exempt funds did "better," they still lost an average of 7.62% and 7.46%, respectively.

But these large shortfalls helped reduce the tax drag on mutual funds. Estimated taxes paid by mutual funds in 2008 fell 53% from the record amount in 2007. Lipper calculates that buy-and-hold taxable mutual fund investors last year forked over $15.8 billion in taxes to Uncle Sam, which roughly tracks the ten-year average. That's still a hefty tax bill, considering how the funds performed. "Personally, I think $15.8 billion is an atrocity," says Lipper senior research analyst Tom Roseen.

And depending on the asset class, some investors fared better than others. Equity funds, for example, saw hefty declines in both short-term and long-term capital gains--84% and 79%, respectively--from the prior year.

On the flip side, taxable fixed-income fund investors took it on the chin, accounting for 40% of the overall tax bill footed by mutual fund investors even though these funds make up just 11% of all assets under management in the open-end funds universe.

Roseen cites two reasons for that. One, income distributions from fixed income are taxed at the highest marginal tax rate, which this year is 35%. (Roseen used a more conservative 28% rate when estimating the tax bite on taxable fixed-income funds.) Second, these taxable funds saw short-term and long-term capital gains distributions balloon by 182% and 296%, respectively.

Municipal funds fared much better on the tax front, and not just because they're tax-free at the federal and state levels (assuming you buy a state-issued fund and are an in-state resident). Munis still pass through short-term and long-term capital gains, but Lipper estimates that the tax hit on muni funds dropped 25% last year from 2007--thanks to declines in short- and long-term capital gains distributions.

For investors, last year's abysmal fund performance should help replenish the tax-loss carryforwards that had basically run dry during the bull market years following the tech wreck. Roseen partially attributes the record mutual fund-related taxes in 2007 to the fact that most of the carryforwards from the 2000-2002 period had already worked their way through the system and were no longer available to offset taxable gains. That probably won't be a problem in the near future. "The big downturn will be beneficial for the next several years," Roseen says.

Roseen says fund investors typically underestimate the impact taxes have on their investments. He suggests that fund investors use some kind of tax efficiency screen when selecting funds to avoid needlessly handing over money to the tax man. He adds that advisors can help mitigate the tax bite by putting high-income-paying funds into tax-exempt accounts and by putting tax-efficient funds into the taxable portion of a portfolio.

Cure Sought For Ailing 401(k) Accounts
Reports of the death of 401(k) plans are greatly exaggerated. The plans are still very much alive and well. But at the same time, they're not performing at their best because of the ongoing financial crisis, which is eroding the retirement confidence of their participants. This, in turn, is leading many participants to seek guaranteed income in retirement.

The average 401(k) investor lost one-third, or 28%, of his accumulated balances in 2008, according to Barclays Global Investors, which released the findings of a comprehensive survey at a press briefing in New York in April. The BGI-sponsored study, entitled 401(k) Participant Attitudes, Behaviors and Intentions, was based on results of a March 2009 survey by the Boston Research Group.

Among the 1,000 401(k) survey participants, 63% said their confidence in their ability to retire had declined in the past year, and 15% said they were worried they might never be able to retire. Eighty percent of the respondents indicated they lost assets in the last year. Of those who lost assets and are worried they will never be able to retire, 58% indicated they will make up for their losses by working until they die, while 41% said they will delay retirement.

"Despite this, we'd characterize the average 401(k) investor as in critical but not terminal condition," said Kristi Mitchem, head of BGI's U.S. defined contribution business, at the press briefing. Even with the dramatic market sell-off, a combination of continued savings and a return to normal conditions, she said, would bring a quick recovery for most investors.

Warren Cormier, president of the Boston Research Group and co-founder of the Behavioral Finance Forum, pointed to data indicating that one-third, or 33%, of 401(k) plan participants in the U.S. are delaying reading their statements because they are afraid of the losses. "The troubling aspect is that participants are shutting down," he said. "We know that lack of communication tends to significantly raise fear."

Another concern, he said, is that participants believe the best way to recover losses is to save more or extend their tenure in the labor market. "But it is unlikely that people will save more," Cormier said, "because they don't have the propensity to save, and they may not have the option to stay in the labor market due to forced retirement or health problems."

Much of the discussion at the press briefing centered on the need to include an income distribution phase within 401(k) plans. The group also discussed steps plan sponsors and policy-makers could take to restore the confidence of participants facing an unstable economic future. Barclays, for example, is pushing plan sponsors to adopt more annuitization programs. "Our view is that annuities should be an essential component of any retirement system because annuities allow participants to hedge against longevity risk," said Mitchem.
-By Bruce W. Fraser

Capital Analysts Debuts New Platform
In a move designed to stop treating its reps as commission-based salespeople, Capital Analysts has unveiled a new technology platform and initiated a new flat-fee business structure for its advisors, a program designed to reposition the firm in line with new realities in the business.

According to the firm's president and CEO, Matthew Lynch, those changing realities include the need to provide advisors affiliated with the firm "integrated services to run their offices via technological and operational efficiencies, empowering them to build transferable equity in their firms." The new affiliation model is called Wealth Manager Access.

The fee for firms with up to three advisors typically ranges from $40,000 to $120,000 depending on the firm's revenues. Larger firms pay more.

The flat fee includes all compliance and technology costs Capital Analysts provides. The firm's new technology platform, Advisor Portal, allows single sign-on access to the firm's tools and data, allowing advisors to move data among different applications.

"Whether advisors leverage our RIA, have their own RIA or use a hybrid approach, our flat-fee model does not have hidden charges, markups or usage fees," Lynch says.

Vice Chairman Robert Cogan says the Cincinnati-based firm had considered the move for several years but finally followed through after extensive consultation with its reps.