Hospital receives $21.5 million damages, largest ever, in brokerage dispute

A not-for-profit hospital in Springfield, OH, is due $21.5 million in damages and penalties from the huge brokerage house of Kidder, Peabody & Co. in Chicago, after an arbitration panel ruled that the hospital was misled when seeking investment advice. The award sets a new record for the highest amount ever levied against a brokerage house in a customer dispute.

The award should send a signal to health care risk managers and financial officers that they do not have to sit idly by as their organizations lose a ton of money on ill-advised investment programs. If it appears the investment was so inappropriate as to constitute misconduct by the broker, it may be worth your while to pursue a legal remedy, says Jerry Santangelo, JD, an attorney with the law firm of Neal, Gerber & Eisenberg in Chicago. Santangelo represented the hospital.

"It’s not uncommon for hospitals to have a need for investment of surplus cash funds for various needs and uses, so they’re natural targets for the sales investment vehicles and products," he says. "When those vehicles and products turn out to be very bad choices, the hospital usually just takes the loss. For a not-for-profit hospital, that can be an especially bad outcome."

Most hospitals never pursue any legal remedy with the broker, Santangelo says. This case should indicate that the legal remedy is worth pursuing when the loss is big enough and the apparent misconduct is severe enough, he says.

Hospital advised to buy high-risk securities

After six months of evidentiary hearings, an arbitration panel of the National Association of Securities Dealers (NASD) ruled recently that Community Hospital of Springfield and Clark County and its retirement plan are entitled to damages totaling $21.5 million from the brokerage house Kidder, Peabody & Co. The award was made up of $17 million in compensatory and $4.5 million in punitive damages. Santangelo says the award was more than he initially had hoped for.

The arbitration panel held that Kidder sold the hospital high risk, derivative securities in 1993 knowing that the hospital was an unsophisticated investor interested in maintaining a conservative investment portfolio of government-backed bonds. According to the panel, Kidder fraudulently induced the hospital to invest in highly volatile collateralized mortgage obligations (CMOs) by misleading the hospital as to the liquidity and risk of these derivative securities. The panel determined that Kidder had "full knowledge that this investment was inconsistent with the hospital’s needs," Santangelo says.

"The hospital had traditionally purchased certificates of deposit, treasury bonds, and then they were introduced to these government-backed bonds called CMOs," he says. "They never really understood or appreciated what they were buying or the risks of what they were buying. They had been advised that with these bonds they could participate with the big banks because they had a million dollars or more to invest."

In fact, the hospital ended up buying some of the riskiest fixed-income assets around. The market for collateralized mortgage obligations collapsed in 1994 and the hospital lost approximately $17 million on its investment. As part of the evidentiary hearings, the hospital showed that it had relied on Kidder to provide advice for its investments.

"Like many investors in today’s market, the hospital was under the false impression that because CMOs are backed by the government, it is a safe investment," Santangelo explains. "Kidder did nothing to correct this impression, even after a strong warning by the National Association of Securities Dealers reminding brokerage houses not to place unsophisticated investors in the market."

Kidder is now defunct, having been sold by General Electric to Paine Webber in late 1994. General Electric retains the liability for the litigation involving Kidder. Healthcare Risk Management sought comments from General Electric, but the calls were not returned.

Have to admit you don’t know everything about investing

The brokerage firm’s main defense was that the hospital should have known what it was buying. The hospital had a sophisticated board of directors, a chief financial officer with years of experience, and written investment policies that outlined what items were acceptable for investing. CMOs were not listed specifically, but the hospital found a way to make them fit within the policy.

Hospital leaders had to admit publicly they had bungled the investment and then plead ignorance to the extent that they could blame the decision on the brokerage house. That would not be an easy admission for some hospital leaders to make, but in this case, many millions of dollars had been lost.

Santangelo says the extent of the mismanagement was extreme in this case, but he points out that many other hospitals fall prey to the same sort of bad investment advice on a smaller scale. This case shows you do not necessarily have to just accept the loss, he says.

"If it really reaches the level of being misled by a brokerage house that knew better, you can seek a remedy through litigation and arbitration," he says. "And you have to remember that dealing with a big, respected brokerage house is no guarantee against being led astray. Kidder was a big Wall Street firm, and that offered no protection in this case."


Jerry Santangelo, 2 North LaSalle St., Chicago, IL 60602. Telephone: (312) 269-8067.