INVESTORS DEFRAUDED

by rogue stockbrokers often wind up feeling as if they've been burned twice.

The first swindling occurs in the scam itself. The second comes months later, when investors discover they'll probably never recoup their losses through the securities arbitration process. Even if the bad guys are convicted of a crime, they rarely leave enough money behind to cover the arbitration claims brought by the victims. And as investors are often stunned to learn, the Securities Investor Protection Corp., the industry's main insurance program, doesn't reimburse them for losses stemming from most securities frauds.

Now, there may be another place victims can find relief: the deep-pocketed Wall Street firms that clear and process trades for legitimate small brokerages and illegal "boiler room" operations alike. Courts and arbitrators have long ruled that these "clearing" firms aren't liable for the misdeeds of those client firms, even the rogue ones. That's because clearing is a back-office job that involves little contact with brokerage customers and is largely a ministerial task.

In the controversial ruling, a National Association of Securities Dealers arbitration panel ordered the stock-clearing arm of Wisconsin-based Fiserv to pay $1.7 million to six former customers of Duke & Co., a boiler-room operation that New York prosecutors shuttered last year. The arbitrators ruled that Hanifen Imhoff Clearing, a firm acquired by Fiserv in 1997, is liable to the investors because the clearing firm's officials had reason to suspect Duke's brokers were engaged in fraud yet continued doing business with the company.

A $1.7 million award may not seem like a lot of money to a diversified financial-services company like Fiserv, which has more than $1.5 billion in annual revenues and a $6 billion market cap. But at one point Duke had 34,000 customers, meaning the recent ruling could open a Pandora's box of litigation. It also could spell trouble for some 60 other firms including such Wall Street heavyweights as Bear Stearns, Donaldson Lufkin & Jenrette, PaineWebber Group and Merrill Lynch that offer stock-clearing services to small brokerages.

Even more troubling for clearing firms: The arbitrators penned a 40-page legal decision to support the ruling. It's rare for arbitrators, who are usually attorneys, to issue written opinions, because their decisions aren't meant to carry the same legal weight as judicial rulings. Naturally, securities lawyers are hailing the lengthy Fiserv opinion as a useful road map for future litigation. The arbitrators rejected Fiserv's argument that it wasn't liable because it took no active part in the fraud.

"Obviously, people are going to show it to other arbitration panels," says New York attorney Leslie Trager, who usually represents investors in disputes with brokerage firms. "I hope it will have some influence."

Fiserv, predictably, is challenging the ruling in federal district court in Portland, Ore., where the arbitration was held. A Fiserv spokesman says the award isn't supported by "applicable law" and the company believes it will be thrown out.

But even before the Fiserv decision, the once-impenetrable armor worn by clearing firms had begun showing cracks. In nine other recent cases, an NASD arbitration panel awarded damages to investors in disputes with clearing firms. Perhaps the biggest blow to the clearing industry came last year when, after months of heated negotiations, Bear Stearns agreed to pay $38.5 million to end an investigation by the Securities and Exchange Commission and New York prosecutors into its role in the famous A.R. Baron stock-fraud operation. Bear, which runs one of the biggest clearing operations on Wall Street, never admitted any liability. But some legal experts predicted the settlement would lead to a changed attitude in the legal system about the culpability of clearing firms in fraud cases.

"The SEC action against Bear Stearns was influential," says Robert Banks, a Portland lawyer who represented the plaintiffs in the Fiserv case. "I've gotten calls from lawyers all over the country about this. I hope it will cause clearing firms to perform a little more due diligence before they sign clearing agreements."

It's too soon to know what the lasting impact of the Fiserv ruling will be. The courts could reject it outright, or the ruling could prove to be an isolated event, since arbitrators aren't obligated to follow precedents. Moreover, the ruling's effects could be limited since the arbitrators based their reasoning on California and Washington state securities laws.

Still, the arbitrators have sent a loud warning shot across the bow of the clearing industry. Wall Street's big clearing firms are on notice: The days of simply walking away scot-free from boiler-room blowups may be coming to an end.