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Briefly Noted

Broker Arbitration Rule Change

Investors will soon be able to choose an all-public panel for arbitration cases against brokers. The Securities and Exchange Commission (SEC) approved a recommendation by the Financial Industry Regulatory Authority (FINRA) to give individual investors more choice over arbitrators. The changes are being made in response to criticisms that the existing process for selecting an arbitration panel favors brokerage firms over individual investors.

An investor who files a claim for more than $100,000, for an unspecified amount or for non-monetary damages will have his case heard by a three-person arbitration panel. A claim between $25,000 and $100,000 can also be heard by a three-person panel—instead of a single arbitrator—if both parties agree.

The old rules were criticized for leading to arbitration panels that favored brokerage firms over their clients. The rules called for a panel comprised of a chair-qualified public arbitrator, a public arbitrator and a non-public arbitrator. Both the claimant and the defendant could reject up to four names from each 10-candidate list for the three panel positions. This is known as the Majority Public Panel.

The new rules still call for a three arbitrators picked from a list of 10 candidates for each panel position. Like the old rules, they also allow both parties to reject up to four people from the 10-person lists for the chair-qualified arbitrator and up to four people from the public arbitrator list. Both parties, however, can reject all 10 candidates listed on the non-public list. This is viewed by regulators as effectively creating a panel of “three public arbitrators,” or an Optional All Public Panel.

The Majority Public Panel will continue to be in existence and will serve as the default option for determining the arbitrators unless an investor specifies otherwise. To choose the Optional All Public Panel, an investor will need to notify FINRA of their preference within 35 days of filing a claim.

Maintaining good records and regularly reviewing all paperwork, including brokerage statements, will help you avoid and potentially resolve a grievance. In addition, if you work with a financial advisor or a broker, always ask why an investment is being suggested, what the costs are, how easy it will be to sell and whether more suitable alternatives are available. Most importantly, avoid making any investment you do not fully understand.

Source: Securities and Exchange Commission Release No. 34-63799.

From the Bookshelf

“Never Buy Another Stock Again” (FT Press, 2011) may come across as a provocative title to those of you who invest in individual stocks, but the book contains lessons that are applicable to all investors.

Thomson Reuters columnist David Gaffen identifies many of the pitfalls that hurt investors and provides strategies for avoiding then. Chief among his concepts is the need to properly diversify. In his book, Gaffen provides examples of how mutual funds may appear to be different, but have return characteristics that are surprisingly similar.

The author further cautions that “it isn’t possible for 85 percent of the investing public to be a better-than-average investor.” Thus, he advises serious consideration be given to every investment. Gaffen stresses the importance of keeping costs under control and rebalancing regularly. Though he does advise against individual stock selection, the author suggests those who choose to do so should maintain strict sell rules, such as exiting a position when the security falls 15%.

Gaffen is a talented writer and his personality shines throughout the book. Though the subject matter is serious and several statistics are presented, this is a book that can be read quickly and understood easily.

“The Little Book of Sideways Markets: How to Make Money in Markets That Go Nowhere” by Vitaliy Katsenelson (John Wiley & Sons, 2011) is the latest in Wiley’s Little Book Big Profits series of small, quick-to-read books.

The title implies a text about technical analysis, particularly trading between support and resistance lines. We were pleasantly surprised to see it was firmly based on fundamental analysis instead.

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Katsenelson tells readers to invest only in stocks with three key characteristics: quality, valuation and growth. He defines quality as the ability to generate cash flows, maintain positive cash flows and enjoy significant barriers to entry. In other words, Katsenelson advocates buying well-managed growth companies on the cheap—a strategy we can’t argue with.

The author does recommend a market timing strategy, selling when price-earnings ratios are high and buying when low. While we don’t advocate market timing, high valuations increase risk and can be a justifiable reason to sell a stock.


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