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Fiduciary Duty

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By David Popper

Last December, I received a call from a retired executive of a well known tech company. He wanted to sue his broker for placing him in risky and damaging trades. He lost 1.5 million dollars. He explained that he left an "old economy" company and joined well established tech company because options were available and because the company's stock split and doubled every 18 months to two years. He had made a fortune on his options. In December 1998, he had actually accumulated $1.5 mln and decided to slow down, move to Idaho and do very little.

His company referred him to a well known broker. The broker asked him if he liked the prospects of his company. He responded positively. The broker then recommended that he invest his entire fortune in buying calls on this company. The calls were January 2001 calls with a strike price of $100. The stock's price at the time was $80. Surely this company, which doubled every year, was a lock to race well past $100 a share. My client could just see profits galore. Why, if history were any guide, he would make more money retired than he ever made working.

From time to time during these three years, thirteen times to be exact, the broker, with the consent of my client, would trade in and out of these options and made an average of $20,000 profit per trade. This was pure gravy. Over the course of time, my client began studying trading and even subscribed to a few web sites. Imagine being retired and being responsible for monitoring only one position of a company that you know intimately, which has a track record of doubling and splitting 18 months to two years.

Then came March 2000. The stock plummeted. My client hung in there. He was used to dips and the company's prospects were bright. The year 2001 was pressure packed. My client's emotions rose and fell with the market. He fought with his wife often. He spoke to his broker everyday. They decided to hang in there. If he sold now, he couldn't retire so he might as well ride it out. He also played the "what if" game way too often. On expiration day, the stock closed at $68 a share and with that went the hopes and dreams of this man. The place in Idaho was sold and his marriage was in ruins. There, however, was one last, desperate gambit. Maybe he could sue the broker.

He called me and wanted to know if there was a claim against the broker. After reviewing the situation, I decided that there was no claim. The man was well aware of the risks involved and was only thrilled to make $20,000 thirteen times while the broker timed the market. The man was a subscriber to many stock web sites and was familiar with the risks of holding one position and of the risks in owning straight calls. He went into the trades with his eyes wide open. I agreed with him that there was a breach of fiduciary duty. It wasn't between him and his broker, however, it was between he and his family.

I began managing my own retirement account in 1998 because my broker, who was also a friend, passed away. Before I made the decision to trade myself, I had interviewed many brokers who were only interested in placing me in mutual funds that had mediocre results. Others wanted trading authority but did not want to educate me. I felt that no one would watch out for this account like I would, so I began to read, learn and trade. When I walked away from the mutual funds, I was in effect telling my family that I would watch our account carefully and would use it to maximize returns. I would not use it as my personal escape from reality into a world of risk and excitement. I would not make trades which were high risk until I had the time and knowledge necessary to do so. In short, I had a fiduciary duty to trade prudently, with an eye toward achieving financial security.

Having said the above, I had to determine which plays made sense for someone who had only limited time to trade. I began using many methods and enjoyed mixed results. Then, one event happened which clarified my thinking. In January 2000, I purchase 300 shares of Ariba (NASDAQ: ARBA) for $265 a share based primarily on technical analysis and the fact that the earning were on the next Monday. On Friday, it quickly rose to $300 a share and on that Monday it announced a split. On Tuesday morning, I had a short non-jury trial out of town. On my way to the trial, I called my broker and heard that a split was announced and that the stock was indicated at $365 a share in the pre-market. I won my trial, went outside, called the broker and found out that the stock dropped to $290. Man, I was expecting it to be $400 a share. I realized that it could have caved more and too much money could have been lost while I did my job.

I decide that the ultra go-go stocks were not for me yet. I began trading the Q's (AMEX:QQQ). These never fall out of bed. When Emulex(NASDAQ: EMLX) fell out of bed two weeks ago, QQQ was down 3 points. You do not get great pops, but you don't get nasty surprises either. When they come, you have plenty of notice. They also give you a 5-8% premium, if you are a covered call writer.

I am not advocating using QQQs as trading vehicle per se, what I am suggesting is only using trading vehicles that move no quicker than you have the ability to monitor. After all, I am out for reasonable gains, not the best gains, because with best gains come the greatest risk and I may not have time to monitor that risk. Taking unmonitored risk would be a breach of my fiduciary duty.

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