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Fraudbuster John Lawrence Allen: II

01/29/02 03:25:47 PM PST
by Bruce R. Faber

When there's something fraudulent in your investing neighborhood, when you've been hurt by stockbroker or securities fraud, who are you going to call? You might want to consider John Lawrence Allen. Allen's interest in investing didn't really get going until after he had started on a legal career at which point he found another calling. As a stockbroker, Allen witnessed the abuse from the money management side and decided to turn back to a legal practice, this time in investor defense. Staff Writer Bruce R. Faber spoke to Allen on October 11, 2001. This is the second part of their discussion.

It has been said that getting into a trade is the easy part, but you should never get in if you don't know when to get out.

I think that is great advice. When I traded I had a chart in front of me for every trade I did. That chart had an entry point at my optimal entry price. It also had the actual entry price, because you seldom get filled at the exact price you want when you are trading in a quick market. In addition, the chart had the number of points I expected to make on that trade, the number of points I was willing to lose, my risk-reward ratio, how much I was willing to risk, and the percentage of money I had invested in that particular trade. Once I entered a trade, each chart also had my optimal exit point. I even knew how much time had to go by before I needed to get out. But if I thought I was going to make 20 points in two hours and after five minutes I was at 10 points, I would consider getting out in another five minutes, since I had already made half of what I wanted. Buying, or selling short, is easy, but it is the exit that is difficult and is usually where people stumble.

What kind of target do you have for getting out?

That really depends on the trading day, the volatility of the market, and the fundamental and technical circumstances. I look to see if the market is oversold, overbought, or in neutral territory; if it's a bear or bull market; or if the market is in a consolidation phase. I consider a lot of different criteria to make the decision.

On those charts you looked at, which were your favorite indicators?

We're talking back in the 1980s. I'm kind of old-fashioned; but I think that while markets change, the psychology doesn't. The psychology of a particular moment may change from day to day, week to week, and period to period, but the natural tendency of people is to be either greedy or fearful, and that hasn't changed in years. Personally, I think charting is a way of indicating people's willingness to get in and out of markets.

So what did you look at?

With respect to stocks, I always looked at fundamentals as well as technicals. On the technical side, I always looked at trendlines, moving averages, stochastics, and Fibonacci retracement numbers. I would use the return to the mean in terms of finding out by how many standard deviations the market was overbought or oversold. I used the McClellan oscillator in stocks to give me a feel for short-term overbought or oversold conditions. When I was a daytrader I had an indicator I called "the dif," which was a differential calculation between the price of the Standard & Poor's 500 index and its moving average. If, during a given day when I was trading, the S&P would shift too far from its current moving average, I would consider it a buy or sell signal. I would have all these indicators running on my computer in real time, and they would generate a weighting through several equations I came up with. I would weight the dif at one value, the trendline analysis at another value, the Fibonacci number at another value, and the moving averages at yet another value. Then I would enter them all into the mix and the computer would generate a buy, or a sell, or a hold, based on how all those indicators were doing. It worked well for two years, but then it came to a grinding halt.

Getting back to equities, what do you think is the heart of the problem that you're now an advocate concerning?

It's difficult to be specific, but a lot of the problem started when investors saw the money being made in the bull market and then decided the market was going to make it for them. These investors shifted from conservative investments into high-risk equities. They overconcentrated their positions in dotcom, Internet, and telecommunication stocks, which ultimately resulted in portfolios with severe losses. And because of these losses they filed claims against brokerage companies.

Do they have a right to recover their losses?

If an investor was fully apprised of the risk of taking their conservative portfolio and investing it in high-tech, dotcom, Internet-type stocks, if they understood that they could lose a substantial portion of that money and were still willing to take that risk, they probably don't have a claim. But a lot of investors do not understand concentration. They don't understand the risks involved in investing 85% of their net worth in one sector. They don't understand that the sector could collapse and take down their entire portfolio. They were happy to make the 150-200% profits, but weren't happy when the prices of their stocks went down and they lost everything. They didn't understand the risk involved because it was never explained to them. These investors probably have a claim against a brokerage company.

Do they really have a chance to reclaim their loss?

There are arbitrations that will be successful, and there are many that won't be. But people should not be disheartened if they end up being the victim of investment fraud. There is an arbitration forum available providing them the opportunity to get their money back at a fraction of the cost and a fraction of the time of a lawsuit; it's like a lawsuit — but without the right to appeal. If they have a legitimate claim, they should not hesitate to pursue it, but they certainly shouldn't be claiming losses merely because their investments were losing money. There has to be fraud involved or reckless, imprudent advice.

Surely there is a lot more to it than filling out a form.

Going after a brokerage company is not going to be a cakewalk. Investors should consider hiring a securities expert who knows the ropes, because the brokerage company is going to have a securities expert sitting across the table when they go to arbitration. It is going to be a hard-fought battle, always coming down to inches. Hopefully, because it is an equitable proceeding, equity will prevail. You must have been defrauded or misrepresented, or a broker must have made a misleading statement or didn't make a suitable investment with a reasonable basis.

You've stated in the past that there are a few reasons arbitrators tend to favor brokers. What are they?

Getting a favorable panel is a matter of luck to a large degree. In the old days you were able to have one preemptory and you knew you could at least knock one person off a panel. These days, the defense attorney is going to kick off everybody I want on a panel and everybody the defense attorney wants I'm going to kick off the panel.

What do you end up with?

We end up with a panel selected by the NASD [National Association of Securities Dealers], not by either party. On every NASD panel there is one industry arbitrator who is a person who supposedly has substantial experience in the industry, one public arbitrator, and a chairperson. A brokerage company is not going to pick arbitrators who historically gave a lot of money back to investors or awarded punitive damages, attorney's fees, or interest. The brokerage is going to knock those arbitrators off of the panel. Likewise, I am going to knock off anybody who has awarded nothing.

What can you expect to end up with, then?

NASD statistics show that panels of arbitrators usually give investors back less than they have lost, many times 50 cents on the dollar. You have to convince the panel that, in this particular case, you don't want your client to get 50% of their losses back; you want them to get all their money back. It is difficult and requires someone with a lot of expertise and a lot of ability to explain why equity declares that your client is entitled to get his or her money back. Over the last few years it has become more difficult.

Why is that?

The arbitrators have become more jaded. The cases are becoming more and more like lawsuits rather than arbitration, but it still has the benefits of a far-reduced timeframe and the right not to appeal. If you win, you get paid within 30 days of the judgment or the brokerage company can be subject to disciplinary proceedings. It is a lot easier to put your case on this way than to confront all of the problems associated with a lawsuit.

Is most of what you do before arbitrators?

Yes, because 99% of the time you do not have the right to go before a judge and jury, because of the pre-dispute arbitration clause you signed in the contract with the commodities trader or broker.

It seems it would be easier to make your points before a knowledgeable three-member arbitration panel than before a jury that really does not understand the fine points of what you are arguing.

On a simple matter, you would rather have a jury, but I think your point is well taken. On more complex matters — options, futures, straddles, margins, whether something is suitable — an arbitration panel is going to be able to better understand a case than a jury. I also think that a wealthy person is going to have a better chance in arbitration than in front of a jury, because juries generally don't favor giving money back to wealthy people. If you have a sophisticated client, you already have two strikes against you, and winning will be very difficult. However, I have been successful in representing sophisticated clients and haven't found them to have any less of an opportunity than a unsophisticated client.

You made the point that investors need brokers they can trust. How do you find one?

That is a good question. There are a couple of things you can do. First, call the NASD and ask if they have any record of disciplinary action against your broker. The NASD will know if he or she has been disciplined. It is possible your broker had 10 actions filed against them, all of which were settled in arbitration. If the actions were settled without any discipline, there will be nothing to indicate that action in the NASD record. Be sure to get your broker's Central Registration Depository (CRD) number. Then call the office of your state securities regulator. The office might have a different name in your state, but you should be able to find it somewhere in your state government's organization. If you have Internet access, your state's contact information is available in the "Find Regulator" section of

What then?

Give your state regulators the CRD number you got from the NASD. With that, they can tell you everything about your broker — arbitrations, complaints filed against them, pending disciplinary actions — all the information you need to know, at least in theory. This may seem like a lot of trouble, but it's not; it is better than giving your money to someone with a history of known problems. If there are no problems found in either of those two places, then there is at least a basis for the beginning of trust. After all, trust is one of the most important ingredients when it comes to giving someone a large portion of the money you have worked so long and hard for. Also, check out the website; it has a lot of practical information about broker fraud and how to avoid it.

Good points. Thanks for your time, John.

Part 1 of this interview, along with current and past articles from Working Money, The Investors' Magazine, can be found at

Bruce R. Faber

Title: Staff Writer
Company: Technical Analysis, Inc.
Address: 4757 California Ave. SW
Seattle, WA 98116
Phone # for sales: 206 938 0570
Fax: 206 938 1307
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