FINRA arbitration provides a simplified procedure for a customer to resolve any dispute that they may have with their stockbroker or stock brokerage firm. The rules of evidence are relaxed and arbitrators will often ask questions of the parties and witnesses to make certain that they understand what has occurred. That should benefit any skilled litigator representing a customer in this forum.
Notwithstanding, I constantly read articles about how FINRA arbitration is unfair. Lawyers who represent customers claim that the arbitrators favor the industry. Some complain that arbitrators are not required to follow the law nor give reasons for their decisions. Others argue that they cannot conduct adequate discovery because depositions are not allowed.
Many stockbrokers also think that FINRA arbitration is unfair. More than one stockbroker has referred to the arbitration forum as a “kangaroo court”.
There are a handful of elite lawyers who regularly practice in this forum on both sides of the table. There are many more who are competent (if not inspired) and then there are those who complain because they frankly miss the point. The lawyers who complain the loudest about the arbitrators are the lawyers that cannot put the facts in their proper context.
Many lawyers who practice in this forum, on both sides, have no real understanding of the day to day functioning of a brokerage firm or the actual relationship between a broker and a customer. They often cloud the proceedings with irrelevant information and misguided assertions.
Arbitrators are fact finders, not judges. Lawyers should explain the dispute to arbitrators in the way arbitrators understand it, rather than complaining that the arbitrators do not understand the claim the way the lawyers want to present it.
I was trained in broker/dealer compliance. Arbitrators are frequently concerned with the same thing that concerns compliance officers; was this a “good trade”? Whether or not Rule 10b-5 was violated is usually irrelevant. That is why you cannot approach FINRA arbitration in the same way that you would approach a case being filed in court.
When a lawyer drafts a complaint for court, the focus is on the legal causes of action. They make certain that the complaint is legally sufficient because failure to do so will get the complaint dismissed long before the hearing. FINRA arbitrators rarely dismiss a claim except under limited circumstances, so customers are almost always assured of getting their claim heard.
When I draft a claim for FINRA arbitration I tell the panel what happened in a narrative form. I focus on what the broker did wrong or why the investment product was defective. And I tell the arbitrators why those facts caused the loss that the customer suffered.
Many customers want to file claims against their broker because they feel that their trust in the broker has been violated. Trust is hard to prove and often not relevant to the facts at hand.
The securities laws are grounded in the idea of “disclosure”, not trust. Customers must be told everything they need to know. Like all financial institutions, the brokerage industry has systematized this disclosure into the fine print that is included in the customer agreements, margin agreements, confirmations and monthly statements. All of these disclosures have been approved by the appropriate regulators.
Products like variable annuities and private placements which are the subject of many of the arbitration claims usually require a customer to sign a form declaring that they have received everything they are entitled to receive. With private placements customers sign a form that states that they have read the disclosure documents, had an opportunity to ask questions and were told to review the transaction with their own attorney and tax advisor before they make the purchase. Obviously, that makes it more difficult for customers to claim that they did not get the disclosures that they should have gotten.
Many claims invoke FINRA’s suitability rule which requires brokers to have a reasonable basis for any investment recommendation that they make. It rarely comes into play where the customer is self directed using an account at a discount brokerage firm.
You also need to appreciate that a reasonable basis for recommending a stock is that the broker thought that the price would go up. A recommendation can often be justified by good news or bad news about the company or the market. No broker has a crystal ball.
Brokers are required to only make recommendations in accordance with the customer’s “risk tolerance”. At the hearing this is going to come down to a simple question that will be asked of both the broker and the customer: “how much money was the customer prepared to lose?”
Once the answer to that question is ascertained, defense counsel will invariably bring out the monthly account statements. Arbitrators have little sympathy for customers who do not read the monthly statements or who claim not to understand them.
Everyone knows that the stock market goes up and down and sometimes crashes. Customers are often asked: “your account went up 20% from where you started, didn’t it occur to you that it might go down by that much or more?”
Not every customer who has a loss has a cognizable claim. The firm or the broker must do something wrong and the wrong must be the cause of the loss. A suitability claim is essentially a negligence cause of action and legal defenses to negligence such as “comparative negligence” and “last clear chance” come into play even if they are not expressed as such.
Beginning in the late 1980s, more and more “product” cases began to surface. These were easier to prove because there was always a prospectus or similar disclosure document which either made all of the material disclosures or did not. But finding facts that were not disclosed takes work.
In the mid-1990s I worked on about 2 dozen claims against a number of firms that had sold notes issued by a large Ponzi scheme. The operators of the scheme had been indicted by a state regulator. At that time court documents were not available on the internet. I contacted the prosecutor and obtained an affidavit that had been sworn by a Deputy Attorney General that had been submitted to the Court as part of an asset freeze in the criminal case. It laid out the whole scam in great detail.
I would attach the affidavit to my pre-hearing briefs. Most of the defense lawyers who handled multiple claims for their brokerage firm clients had never seen it before, meaning many of the other customers’ lawyers had not bothered to pick up the phone and contact the prosecutor.
I had a similar experience during the tech wreck/research analyst cases. My partner and I flew back to New York and spent two days in the windowless basement of a mid-town office tower reviewing documents that had been produced in one of the class actions. We came away with enough to prove what we needed to prove in our arbitration claims but it took time and effort to do so. I know that a lot of other lawyers representing customers had never bothered to make the effort.
Discovery is the key part of any FINRA arbitration and FINRA has established lists of documents that are presumed to be relevant to different types of claims. These are usually exchanged without incident or discussion although I have seen instances where defense lawyers claim that some of the requests are “vague and ambiguous” even though they have responded to these same requests many times before.
Supplementary discovery requests are permitted but not depositions or interrogatories. It helps if the customers’ lawyer understands the paper flow and record retention requirements of the brokerage industry.
Every single order (buy or sell) that is entered by a broker on a customer’s behalf is approved by at least one supervisor at the firm and a record of that approval is kept. Orders that fall outside of pre-established guidelines become the subject of exception reports and are further reviewed by the compliance department. All marketing materials that a broker hands out and all outgoing correspondence are reviewed and approved as well.
I am frequently amazed how little of a paper trail the industry produces in many cases. The most important documents, such as the broker’s notes setting forth why he told the customer to buy XYZ at $100 per share never seem to find the light of day.
The most outrageous abuse of the arbitration discovery process, in my opinion, was committed by Morgan Stanley which claimed, falsely, to have lost millions of e-mails when its headquarters in the World Trade Center was destroyed on 9/11. Morgan Stanley was fined and a fund was set up to repay customers whose arbitration claims were tainted when its duplicity was ultimately uncovered.
Product cases often become “battles of the experts”. FINRA rules require a high level of pre-offering due diligence by the firm. The customer needs to prove that the firm acted below the industry’s standard of care which usually means setting out the facts that were not disclosed or demonstrating how little due diligence was actually done.
There were a great many claims that were the result of losses from real estate private placements after the real estate crash in 2008. The more successful claims involved private placements or private REITS where the disclosure documents were deficient. But again, you have to prove what is missing. The best experts are people who have written disclosure documents themselves.
Customers’ lawyers have already begun to file claims due to losses on oil and gas offerings as the price of oil has tanked. As these programs cut dividends or file for bankruptcy fraud and other problems are frequently revealed.
These claims should be easier for customers’ lawyers because a due diligence investigation of an oil and gas investment is more complicated and costly than an investigation of a real estate offering. In many cases, the smaller FINRA firms that sell these offerings do not want to spend the money to perform a due diligence investigation properly.
One issue that frequently draws negative comments about FINRA arbitration is the subject of damages. Arbitrators will often apportion the loss between the parties. In times of a market decline, they will often consider the fact that if the broker had done everything correctly or purchased different investments the customer might still have lost money.
Have I ever had a bad arbitrator? Yes. I have been in front of arbitrators who fell asleep, were preoccupied with other matters or just did not understand what was going on. It is rare, but it has also happened with judges.
The organized investors’ bar association has reformed the FINRA arbitration to allow panels to be constituted without any member who has worked for the industry. Personally, I always want someone on the panel who understands how a broker or brokerage firm is supposed to act.
The complaints against FINRA arbitration are part of a larger movement to move many kinds of consumer disputes away from arbitration. That would send these disputes back to courthouses that are already swamped. In many parts of the country consumers can wait 5 years for their case to be heard and spend tens of thousands of dollars in deposition and other preparation costs.
Investment cases are difficult to win because investors are not ordinary people who get struck in by a car in a crosswalk. They know that they can lose money every time that they invest.
Investors are usually given all of the disclosures that they are supposed to get. They certainly know what they are buying, how much they are spending and how much their account is worth, every month. Does it surprise you that defense lawyers frequently ask: “if you were unhappy with the losses in your account, why didn’t you just tell your broker to sell everything and quit before the losses doubled?”
The fact that many of these cases are difficult to win is not the forum’s fault.
I cannot be the only person who regularly practiced before FINRA arbitrators who believes that the system works well enough to be left alone. Well meaning consumer groups should think twice before they argue that investor claims are better heard in court. And lawyers representing investors should consider that the arbitrator bias and other problems they keep complaining about may actually not be as prevalent or as harmful as they seem to think.