FINRA Arbitration Asks If Conservative Strategy Was Too Conservative

April 2, 2019

Economists define the Great Recession has having started in December 2007 and ended in June 2009. That 2009 terminus may well be justified by statistics, but for those who lived through that period of economic devastation, the after-effects continued into 2011, and for many, well into 2014. The psychological impact of the economic crisis is still felt today. Look at a chart of most stock indices from 2009 to 2019 and it's almost a vertical line up with a few hiccups along the way. On the other hand, the 10-Year Treasury chart is less rewarding -- in January 2009, the rate was about 2.25% but by April 2019, the rate was only 2.49%. So . . . what happens when you stand atop that high perch of 2019 and look back to 2013/2014, when you ventured back into the stock and bond markets? Are you now angry with your stockbroker, who took you at your word that you wanted to be "conservative?" Are you at peace with your decision to reduce your speculation notwithstanding that you might have achieved better results? Do you wish you had allocated more assets to stocks and fewer to bonds? A recent FINRA public customer arbitration against Morgan Stanley and two stockbrokers explores whether the cause of a purportedly "under-productive" brokerage account was a conservative strategy that was too conservative?

Case In Point

In a FINRA Arbitration Statement of Claim filed in December 2017, public customer Claimants Robert and Eleanora Devenish asserted unsuitability; breach of fiduciary duty; breach of contract; negligent supervision; churning; and violation of the South Carolina Uniform Securities Act. In terms of damages, the FINRA Arbitration Decision offers this somewhat puzzling guidance:

At the close of the hearing, Claimants requested alternatively $1,139,587.00 or $707,705.00 under one theory, and $433,938.00 or $365,673.00 under another. 

Respondents requested the dismissal fo the allegations and requested the expungement of the Central Registration Depository records ("CRD") of Respondents Mamis and Gnall.


The FINRA Panel of Arbitrators denied Claimants' claims. 

The Panel recommended the expungement of Respondent Mamis's and Respondent Gnall's CRD based upon a finding that the Claimants' claim, allegation, or information is false. The Panel found "no misconduct or fault" on the part of either Respondent. 

In a thoughtful "Arbitrators' Report" replete with sufficient content and context, the Panel offered these observations:

Claimants sold a building in Manhattan for a sizeable sum and wished to invest it. In their seventies and having no securities or investment knowledge or experience, Claimants in mid-2013 consulted for advice Respondent Susan Gnall, a financial advisor at Morgan Stanley, and opened an account in March 2014. They informed Ms. Gnall that they were conservative and their objective for any securities account was to replace rental income they had been receiving from the property sold. Ms. Gnall looked to bonds as offering considerable safety and a better return than government paper. Because Claimants owned other real property in Manhattan that was producing rents, and were in a high tax bracket, Ms. Gnall suggested municipal securities as a low-risk means to produce their income tax-free. Claimants chose to invest their available cash in a 100% bond portfolio, not comfortable yet with an equity component. 

Ms. Gnall compiled a retail portfolio largely of highly rated premium bonds with coupons of some 4.5 to 5%, as well as some pre-refunded bonds intended as reserve to meet a pending tax payment from sale of the building, expected to be over $1,000,000 and due in approximately one year. This pre-refunded bond component offered a higher return than money markets until the amount of the tax obligation was determined and paid. 

Overall bond markets became difficult over the next few years, with interest rates flat and even declining, many bonds being called as a result, and retail availability in the bond market shrinking. Conditions also presented some opportunities for re-positioning of the account to capture gains as bond prices rose, to extend maturities and to lock in cash flow. Ms. Gnall moved much of the portfolio to an institutional manager to regularize monthly income, and established a 10% equity component to better balance the portfolio and provide some opportunity for capital appreciation. She kept Claimants informed of her proposed strategy and activity, and obtained their consent prior to executing transactions. Claimants testified that they never really understood these transactions, which were rather complex given the difficult bond market at the time. They became unsatisfied with the performance of their portfolio and suspicious of the reasons for activity in it. In mid-2017 Claimants moved their funds to another advisor, eventually settling into a 60% equity/ 40% fixed income mix. 

Overall, Claimants' account at Morgan Stanley had varied withdrawals over $2,000,000 (more than half of which was for the delayed tax payment), produced tax-free income of approximately $500,000, paid fees and commissions of some $60,000, and ended the period with a net gain of some $248,000, [sic]

After careful consideration of the documents presented in evidence at the hearing and evaluation of the testimony of the parties and other witnesses including experts, we do not find unauthorized trading in this account. Nor do we find evidence of excessive trading, certainly not for the purpose of generating commissions and fees, which we find to have been reasonable. 

Claimants' unsuitability claim appears in several guises. Claimants assert that the account was underproductive, in that it should have produced more income, an assertion based in part on new account profile forms indicating a moderate risk tolerance and a first objective of capital appreciation, with income, aggressive income and speculation following. These forms are in direct contradiction to Claimants' testimony at hearing, Ms. Gnall's testimony and other documents in evidence. Claimants' Statement of Claim itself states that they "selected conservative" and that that was appropriate. We find Claimants' goals for the account were to replace income with low-risk safety. The account maintained at Morgan Stanley achieved significant income with reasonable safety. 

Claimants further argue that they were promised a return on the account of 4.5 to 5% and did not receive it. We find no evidence that any such promise was made, or that Claimants were looking for a specific percentage return as opposed to replacement of lost after-tax rental income. Whether or not the tax-free income generated by this account replaced every bit of former taxable rental income, it appears to us to have at least come close. 

Accordingly, we do not see that Claimants are entitled to damages under either theory advanced at closing. A well-managed portfolio calculation requires assumptions that Claimants' goals were different than those we have found they expressed. The benefit-of-the-bargain theory requires a promise of return that we have found did not occur. 

Bill Singer's Comment

First and foremost, compliments to the FINRA Arbitration Panel for a wonderful rationale. Very compelling!

I've never been a fan of presenting multiple damages calculations or doing so via a "range." Having served on and also chaired arbitration panels, I know that behind-the-scenes, arbitrators often wrestle with proposed damages that seem more like moving targets than actual calculations. Frankly, I was more than a bit puzzled when I read this statement in the FINRA Arbitration Decision:

At the close of the hearing, Claimants requested alternatively $1,139,587.00 or $707,705.00 under one theory, and $433,938.00 or $365,673.00 under another. 

Seriously -- what the hell? Claimants are presenting not one but two theories of damages? And within each theory of damages we have a set of "alternative" damages? And the arbitrators are going to go back into their space after the hearings are done and deliberate about Theory I with alternative damages of $1,139,587 or $707, 05; and also about Theory II with alternative damages of $433,938 or $365,673? Holy crap -- Claimants are asking for damages that could be as low as $365,673 to as high as $1,139,587? That's one helluva a range and quite a complicated set of theories and alternatives.

In hindsight, one can always question any investment recommendation that produces losses or doesn't prove as profitable as other investments. I will not debate the fairness of such hindsight because folks who are getting paid fees and/or commissions for investment advice must accept such criticism as generally fair. On the other hand, it's one thing to challenge a particular investment strategy proved imperfect, and it's quite another thing to allege that the stockbroker engaged in unauthorized or excessive trading. Having resorted to impugning the Respondents' integrity, the Claimants claims were considered and rejected by the three FINRA arbitrators as demonstrating any unauthorized or excessive trading -- and, pointedly, the Panel noted that they the cited commissions and fees "to have been reasonable." The arbitrators appear to have been persuaded that the Respondent stockbrokers pursued a "conservative" strategy dictated, in part, by the customers' age and their relative investment inexperience; unfortunately, the muni-bond market did not prove a fertile ground upon which to produce more profits. That being said, it's hard to consider the Panel's observation as proof of horrific performance for the three years at issue:

Overall, Claimants' account at Morgan Stanley had varied withdrawals over $2,000,000 (more than half of which was for the delayed tax payment), produced tax-free income of approximately $500,000, paid fees and commissions of some $60,000, and ended the period with a net gain of some $248,000, [sic]

Online FINRA BrokerCheck records as of April 2, 2019, disclose that:

Mamis was first registered in 1980, and she was registered with Morgan Stanley & Co., Incorporated and its predecessors since  January 2009 after spending some 39 years at Merrill Lynch, Pierce, Fenner & Smith Incorporated; and

Gnall was first registered in 1994, and she was registered with Morgan Stanley & Co., Incorporated and its predecessors since  January 2009 after spending some 25 years at Merrill Lynch, Pierce, Fenner & Smith Incorporated.

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