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Demystifying the role of the stockbroker.

Psst ... want a hot stock tip? As investors flee from low-yielding certificates of deposit to the higher returns of stocks and bonds, such propositions are apt to bend more than a few ears. But before you ask what's up for grabs, it's crucial to find out who's doing the selling.

We've all heard the horror stories, and yes, it's true: Brokers have long suffered a somewhat shady rap - for hawking dud investments that pay high commissions or for just plain cheating their clients. In part, this explains why many brokers now shun their traditional title and are more likely to call themselves "investment counselors" or "financial advisors."

Can you blame them? Last year, the National Association of Securities Dealers barred 491 brokers from practicing - a 72% increase over 1989. Customer complaints to the National Association of Securities Dealers (NASD) jumped 37% from 1991, while punitive awards to disgrunted investors during the same period soared more than sixfold, to $12.3 million.

Don't be scared off by the statistics, though. The vast majority of brokers are reputable, and millions of investors confidently turn to them for guidance through the maze of financial markets. From collateralized mortgage obligations (CMOs) to limited partnerships - with common stocks, conventional bonds and more than 5,000 mutual funds in between - the array of financial offerings is bewildering, even to professionals.

Before seeking out a broker, "you first need to figure out what you're trying to accomplish with your money, and how long it's going to take," explains Rubye Nasser-Norsig, a financial consultant with Merrill Lynch in Phoenix. "Clients need to know what kind of a return they want, and how much risk they're willing to assume. A broker can tell them what's realistic and what's not."

In view of what's at stake, brokers who sell stocks and bonds must adhere to high standards of professional conduct. The number who run afoul of regulatory authorities is a minuscule fraction of the almost 443,000 NASD-registered brokers. Still, don't forget: A broker's sole means of livelihood is by selling you something. If you don't need it - or, even worse, you end up with nothing - you've been ripped off. How do you avoid that? You can start by checking out the 10 questions and answers posed below.

Q: What, exactly, is a broker's role?

A: A broker's proper role is to understand a variety of financial products, and help find a fit with his or her clients' goals. The task is a complex one: Depending on the product yields and risks vary widely. Some securities are great for quick returns, while others should be held onto for years. A good broker, then, is a sort of financial coach who gets paid - in the form of commissions - to carry out your wishes.

Q: Speaking of commissions, don't brokers make more money selling some securities than others? How can I tell whether the investment advice I'm getting will line my pockets, or my broker's?

A: That's a key question, and you shouldn't be shy about raising the issue with your broker. A reputable broker will always explain how he or she is compensated.

In general, brokers earn the slimmest commissions on high-quality bonds. Some sales carry no direct commission, although you can be sure brokers and their firms are pinching off fees somewhere (such as a markup if the bonds are coming from the firm's own inventory). Commissions on bonds are usually around 1%.

Common stocks are next, with commissions for full-service brokers reaching about 2%. An exception is with initial public stock offerings (IPOs), where commissions can balloon to 10%. But be warned: Few individual investors are ever offered the opportunity to buy top-quality IPOs, since the truly hot ones are usually snapped up by favored big clients such as institutions and mutual funds.

Mutual funds are next up the commission ladder. Funds sold through brokers usually carry commissions of 3.50% to 5.75%. Some funds appear to be cheaper because they are subject to exit fees, called back-end loads.

Brokers make the biggest bucks by selling limited partnerships - deals which carry fees of around 8%. These high-risk, long-term propositions generally tie up your capital in real estate investments such as shopping center developments.

Q: Well if brokers make only 2% on a stock trade, isn't there an incentive for them to encourage me to buy and sell often? Isn't this what they call churning?

A: Churning is indeed the process of buying and selling stock in a customer's account with the goal of generating high commissions. The courts are full of cases - typically brought by the elderly or by unsophisticated investors - of people who lost their entire portfolios to unscrupulous brokers this way.

But there are several defenses against unnecessary trading. First, make sure your broker never executes a trade without your explicit authorization. It's illegal for a broker to do so, but wily brokers create "de facto" control by making such trades anyway. it can take weeks or months for a written confirmation to arrive in your mailbox, by which time you may have forgotten who okayed what. In any case, an unauthorized trade should spell the end of your relationship with that broker.

Q: So, how much power over my money should I give to a broker?

A: Generally speaking, none. Most reputable brokers don't want too much control in any case, since it can leave them wide open to legal liability if things go awry. You should make every single decision affecting your account. The broker's job, again, is to equip you with advice, and then execute your decisions.

In certain situations, you might want to give your broker very limited authority to act in your behalf. If you plan extensive foreign travel, for example, you could establish written ground rules, empowering the broker to defend your portfolio against a stock market decline by selling securities at, or above, specified prices. As for a general "power of attorney" - giving the broker total discretion in handling your affairs - forget it.

Q: What if a broker calls to offer me a hot prospect, but says I have to act fast. How should I react?

A: Hang up the phone. It's a salesman's con. However, legitimate brokers do indeed call total strangers seeking their business. Lemuel Daniels, an associate director with Bear, Stearns & Co. Inc. in Los Angeles and an 18-year veteran of the industry, still does it. "You'd be surprised how many wealthy individuals have never been called by a broker, or are dissatisfied with their current broker," he reports.

But Daniels, like almost all reputable brokers, isn't looking to close a sale with a call. He simply wants an introduction, and the opportunity to show you what he can do. Only hucksters want an instant decision. You should probably steer clear of anybody who calls you cold with an urgent "opportunity."

Q: What's the best way to select a broker, then?

A: Personal referrals, from colleagues, friends, etc., are the best and most common ways to pick a broker. Many brokers also get new business through direct mail, by making cold calls, sponsoring investment seminars or being quoted in personal finance articles like this one.

What you're looking for, ultimately, is someone you can trust. Brokers work for commissions, and honest ones make their money by providing occasional services over a long period of time to numerous clients.

Forming a long-term relationship works to the advantage of the investor. The better the broker understands you, the more knowledgeably he or she can identify investment opportunities. "The more money you make for your clients, the longer they'll stay with you," says Daniels.

Q: Okay, I've done my homework, and I think I can short-circuit this discussion. Shouldn't I just use a discount broker and do the thinking myself?

A: Perhaps. But you'll have to make decisions based not only on your financial I.Q., but on your temperament as well.

By using discount brokers - who charge about a third less than full-service firms - you'll surely save a few bucks. These no-frills pros forego research and advice, rebating the savings through lower fees. Consider: On an imaginary trade of 1,000 shares at $20, a full-service brokerage firm recently was quoting a commission of $374, versus $109 to $144 for the discount brokers Quick & Reilly and Charles Schwab. The so-called deep-discount brokers were quoting $45 or less. in this example, commissions run the gamut from 1.9% for full-service firms to 0.2% at bargain-basement shops.

What's more, many mutual funds can be purchased without any fees at all. So if you're well informed, by all means manage your own money, but only if you also meet this test Do you have the nerves to ride out market storms? Anyone can handle a rising market, but most individual investors panic and turn tail when prices go down. That's usually the worst mistake, since markets have almost always bounced back. Indeed, brokers insist that one of their most valuable services is advising their clients against bailing out at the wrong time.

"I try to keep my clients focused on their goals," says Robert S. Rinfrow a certified financial planner with IDS Financial Services Inc. in Columbus, Ohio. if they've invested for five years, but are ready to bail out after two years (when prices decline) a litlle, "I hold their hand," he explains.

Q: What about track records? Can I find out if my broker is actually making money for his or her clients?

A: You certainly can. One of the first things a prospective broker should do, in fact, is show you a tally of recent home runs.

But if s wise to go even a step further: Did the broker generate these kinds of returns for clients like you? If you invest strictly in blue-chip stocks, the success of a client who made a bundle in small over-the-counter issues is immaterial. Ask how successfully the broker has invested the funds of people who share your investment profile - conservative, aggressive or somewhere in between.

Q: Are there any warning signs I can pick up that will help me stay away from crooks and con artists?

A: Yes. What's the brokers firm? While stock brokers are a highly mobile group - taking their customers with them when they move from firm to firm - the best ones want the kind of services (research, technical and clerical support) that are standard at large national and regional firms. So a household name over the door is one sign that the broker is legitimate.

Even if their firm is a nationwide chain, check out your broker with state authorities. The "securities division" or "securities commission" licenses and supervises brokers, and keeps records of customer complaints against them.

Also check the files kept by NASD; or, if the broker only sells municipal bonds, the Municipal Securities Rulemaking Board. Both are in Washington, D.C. Check for complaints and for records of arbitration. Watch out for brokers that have repeatedly been taken to arbitration by clients - that's a red flag. "If you've got a problem broker, you've got the wrong broker," says John Lawrence Allen, author of Investor Beware: How to Protect Your Money from Wall Street's Dirty Tricks (John Wiley & Sons; $19.95).

Q: What are my rights if things go wrong?

A: You now understand the many potential conflicts between you and your broker, and you've protected yourself against con artists, churning and taking unnecessary risks. Yet it is still possible to lose money, through no real fault of your broker. Don't slam your broker for bad investment moves that you've agreed to. Given the nature of unpredictable markets, some are likely to go sour. You also can't blame your broker for giving you lousy advice, although you can end your business relationship.

But you've got plenty of options if your broker acted without your authority by: buying securities that went belly up; failing to act on your instructions; neglecting to buy stocks that went up or sell stocks that went down; or convincing you to make "unsuitable" investments.

The suitability rule means that brokers aren't allowed to accept your money if the investment is clearly wrong for you - too risky for your tolerance or too difficult for you to understand. Lastly, if you're confused by an investment, don't make it.

When disputes do arise, go first to the broker and make sure if s not a misunderstanding. If that doesn't satisfy you, complain to the branch manager and, if necessary, the chief executive officer of the firm. Brokerage houses value their reputations highly. Securities lawyers say most disputes are resolved at this stage, with the customers being reimbursed quietly and promptly.

You can also complain to state regulators, the NASD, the SEC and possibly others. If the securities were hold in a private pension plan, you can turn to the Department of Labor's Pension and Welfare Benefits Administration. Before you threaten to sue, however, you might want to try arbitration. At many Wall Street firms, binding arbitration is required by the terms of your customer agreement. It's also less costly than court proceedings, and NASD firms are required to submit to ft if requested by the customer.

A final note: You, as a client, have responsibilities too. Know what you want and where a broker may potentially fit into your overall financial plans. So just remember that while k may be a broker's job to help you achieve your goals, it's up to you to set them.
COPYRIGHT 1993 Earl G. Graves Publishing Co., Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:1993 Money Management Guide
Author:Middleton, Timothy
Publication:Black Enterprise
Date:Oct 1, 1993
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