FINRA Arbitration – Why Customers Lose

There are a number of commentators, including some consumer groups, who believe that FINRA arbitration is inherently unfair to public investors.  I have heard these commentators refer to FINRA arbitration as a “kangaroo court” where investors do not get a fair hearing because arbitrators are biased.  Evidence of that bias has never been presented.

Surprisingly, some of the most fervent critics are lawyers who regularly practice in these forums.  I can only wonder if they voice their concerns or make a written disclosure when they are asking new clients to engage their services for arbitration at FINRA.

For many years, both parties were required to state on the record at the end of the hearing that they had been afforded an opportunity to fairly present their evidence to the panel. It was rare when someone on either side of the table refused to state that they had.  I think that I refused once in 40 years practicing before FINRA arbitrators and their predecessors.

Much of the “evidence” of bias and unfairness is based upon statistical research.  The researchers start with the mythical assumption that customers should win at least one half of the claims that are brought. That assumption has no basis in fact and belies the fact these claims are far easier to defend than to prosecute.

I was a pretty good defense attorney when I was representing firms for the first 15 years of my career. I learned a lot more about how to defend a brokerage firm from the defense lawyers with whom I tangled during the last 25 years representing customers.  The brokerage firms are almost always well represented and the critics of FINRA arbitration should give some credit to the defense where it is due.

Investors are generally better educated and more aware than average consumers.  A claim against a stockbroker is not the same as a claim against a drunk driver.  Investors usually know that the stock market goes up and down and that they can lose money every time that they invest.

“I lost money” or “I lost more money than I thought I would” may not be the basis for a claim without some affirmative bad act by the broker.  To be successful in a claim the customer may have to prove that the broker or brokerage firm did something out of the bounds of appropriate conduct and that the losses are a direct result of that conduct.

Many of the claims at FINRA involve its “suitability” rule.  The rule requires brokers to ascertain whether the customer understands the risk of loss from a particular investment or strategy, whether they want to take that risk and whether or not they can comfortably afford to take the loss should it occur.

A customer who claims at the hearing to be a conservative investor but who checked the box that they would still be comfortable if the account value declined by 20% is going to have a hard time convincing the panel that they were truly conservative. A 20% decline in account value is not a conservative loss.

Likewise, a conservative investor who follows the broker’s recommendation to invest in stocks is not conservative because there is no such thing as a conservative stock or portfolio of stocks.  Truly conservative investors buy bonds because they want to conserve their account value.

The brokerage industry collects information on a new account form and sends out monthly statements as a way of protecting itself, not the customer.  Customers who do not read the account application form, check the boxes even if the boxes do not set forth what they really want or who sign the forms with some items left blank have only themselves to blame.

Customers receive account statements every month but many never read them or claim at the hearing that they could not understand them but never asked for help.  With statements that are delivered on -line or through e-mail the brokerage firm will have a record of when the statement was sent, when it was opened and in some cases how long the customer spent on-line reading it.

When you get an account statement and do not complain about the transactions or positions in your account the firm will assert a legal defense called “ratification and waiver”.  Once the customer is notified and identifies a problem, they cannot just wait and see what happens next.  Invariably, the losses may get worse.

It is not unfair for a defense attorney to ask the customer a question like “Your account declined in value for 6 months, you knew it because you read the monthly statements and you did not complain about it. Why should the panel now believe that these losses were unacceptable to you?”

In many cases the response will be: “I spoke with the broker and he told me to stay the course and the account value will come back.”  Of course, the broker cannot know what the market will do in the future.

The legal term for this is “assumption of risk” which is what the customer is doing. Once informed that the investments have lost value, the customer is assuming the risk that the account may decline further by not demanding the broker sell the investments that they are now telling the arbitration panel were unsuitable because they were too risky.

Some claims assert that the broker committed fraud. This is frequently the case where the customer bought a private placement, such as a non-traded REIT, and all of the facts that should have been disclosed were not. Where the true facts could have been ascertained with a reasonable amount of due diligence, the brokerage firm is usually liable.

But to succeed on a claim of fraud, the customer must show that the loss was caused by the fraud.  This is not always easy to do.  A customer who was suitable for a real estate fund was not always awarded compensation for their loss.  This became evident after the real estate market collapsed in 2009.

In the case of a non-traded REIT that committed fraud by failing to disclose the operator’s many lawsuits, it could still be shown that the fund collapsed because the properties it owned suffered from high vacancy rates.  Defense attorneys will argue, often successfully, that the customer would have suffered the same loss if the broker had sold him any one of a dozen other REITS that the firm was offering which did not misstate the facts about the operator’s history.

Consider that a stockbroker is a trained salesperson who can usually look the arbitrators in the eye and tell a convincing story. They usually testify well and seem to always remember all the pertinent facts that will discredit the customer’s case. Customers, on the other hand, are often not as good on the witness stand.

All of this would be equally true if these cases are brought in court. Judges and juries are far from perfect and can be biased or worse, they just miss the point.  That is less likely to happen where one of the arbitrators is a representative of the securities industry like a retired branch office manager. A good branch manager who has been listening to stockbrokers for years can often ferret out the truth.

The essential difference is that aggrieved investors can wait years to get a jury trial and spend thousands of dollars on pre-trial motions and depositions before they get there.  Arbitration is quick and inexpensive.  The customer’s counsel usually does better if they understand the transaction from the industry point of view.

Finally, there is a tendency by some lawyers to try to prove too much. In a court case, a lawyer will plead all the alternative ways the court might find the defendant liable to his client.  I never recommend doing thatin an arbitration. Too often, there is a lot of testimony about things that arbitrators do not care about.

A customer in arbitration will always do better by telling the arbitrators “I would not have lost this money if the broker had acted appropriately.”  Arbitrators are fact-finders. Stick with the facts.

I am a fan of FINRA arbitration. Over the years I participated in more claims than most other attorneys.  If I thought FINRA arbitration was biased against the customer to the extent that I could not win, I would have stayed on the defense side of the table.

Any lawyer who frequents courthouses will tell you that there are judges that they do not like for one reason or another.  None would think to argue that the entire system is rigged.  The lawyers who complain about FINRA arbitration should do something else. If you cannot make FINRA arbitration  work, leave it to the lawyers who can.

 

 

 

 

 

FINRA Arbitration- Where Winning Is Not Everything

The Public Investors Arbitration Bar Association (PIABA) has issued a troubling report to the effect that customers who receive monetary awards in FINRA arbitration forums frequently cannot collect.

Using data from 2013, PIABA demonstrated that more than $62 million in awards made to public customers by FINRA arbitrators in that year went unpaid. That amounts to 1 out of 3 cases where investors went through the arbitration process and won, or nearly $1 of every $4 awarded to investors in all of the arbitration hearings that took place that year.

This is a problem that has been ongoing for many years. FINRA has done little over that time to keep track of unpaid awards and has been reluctant to take any remedial steps. In theory, an award made to a customer by a FINRA panel is due within 30 days. After that it becomes a charge against the firm’s net capital and may lead to disciplinary charges and the firm’s expulsion from FINRA. The latter, of course, hinders collection rather than helping it.

Obviously it is the larger awards rather than the smaller ones that do not get paid. Just as obviously, if the customer dealt with one of the larger firms such as, Merrill Lynch, Morgan Stanley or Charles Schwab, even a large arbitration award is rarely going to be a problem.

Because it is the smaller firms that often opt to go out of business rather than pay a substantial award, PIABA has offered a number of potential solutions including an increase in the minimum requirement for net capital, mandatory liability insurance, broadened SIPC coverage and an industry-wide pool to cover unpaid awards.

I cannot see Merrill Lynch and the larger firms agreeing to fund a pool to cover customers at other firms that they would just as soon have as their own.  And just to be clear, most error and omissions policies carried by FINRA firms specifically exclude actions based upon fraud.

The $62 million in unpaid awards for 2013 is skewed by a single $19 million award that went unpaid and which illustrates the actual problem. The firm that did not pay the award, Western Financial Planning (WFP) actually had insurance, just not enough for its business model.

WFP did not decide to close up shop after the large arbitration award or because of it. It was put out of business by the SEC. A receiver was appointed and assets were managed and sold. Not enough was recovered to pay general creditors like the recipients of the arbitration awards (there were more than a few).

The record does however reflect that WFP sold private placements almost exclusively. Several of the private placements were large Ponzi schemes that resulted in billions of dollars of customer losses causing dozens of small FINRA member firms to close their doors. The only reason that these Ponzi schemes were sold to anyone is that the FINRA firms who sold them did not even attempt to conduct legitimate due diligence investigations to detect the fraud.

Years ago I worked for a law firm that was preparing both public and private real estate offerings. We carried professional liability insurance. The cost was scaled to the dollar amount of offerings that we prepared each year. The more money raised by offerings we prepared, the greater amount of coverage we needed and the premium we were charged went up.

The insurance company sent a representative to our offices. He handed out a multi-page detailed list of documents. “We hope you never have to call upon us to defend you”, he said, “but if you do, this is list of documents about the issue that we would hope to find in your files.” Anyone who thinks that a due diligence investigation is anything other than a way for the issuers, lawyers and brokers to CYA does not understand it.

FINRA has a realistic requirement for due diligence investigations of private offerings that requires member firms to independently verify all of the representations being given to investors.  I had several due diligence officers from smaller firms on the witness stand after the 2008 real estate crash. Almost all just took what the issuer was telling them as gospel. None conducted an independent investigation. You could rarely find a title report or title insurance in their files. None had attended the closing for the property where adjustments are frequently made.

The next crash will assuredly result in arbitrations based upon losses from oil and gas private placements. Where the argument can be made that an office building is an office building, due diligence in the oil and gas industry is very different.

Over the years, I worked on offerings for shallow oil wells in Pennsylvania, deep wells in West Texas, gas wells in Louisiana and at least one shale oil project in Colorado. The due diligence investigation required to verify the facts can differ project by project and state by state. One of the few things that they have in common is they can require multiple experts to conduct an adequate investigation which can obviously run up the cost.

The chance of a small FINRA firm doing an adequate due diligence investigation of an oil and gas offering is slim. I am available as a consulting expert witness for both arbitrations and class actions and I expect that I will be busy.

The problem of unpaid arbitration awards is very much centered in the Reg. D private offering market. It is from investments in the Reg. D market that customers take the huge losses that are the subject of many FINRA arbitrations. Many of the largest Ponzi schemes are sold through private offerings for no other reason than crooks do not want government scrutiny on their offerings.

These offerings are most often sold to retail customers by small firms that specialize in private offerings because the commission on each sale may be many times what it would be on a sale of a similar dollar amount of British Petroleum or ExxonMobil. A broker selling $1 million worth of private placements might take home as much as $90,000 in commissions.

In a registered offering, due diligence is performed by the lead underwriter on behalf of the other firms in the selling group. The issuer pays the lead underwriter for the due diligence process up front before the issue comes to market. In the Reg. D market, each member of the selling group frequently performs their own due diligence and is reimbursed after the fact based upon a fixed percentage of the monies that each firm raises.

This business model where the firms do not get paid for due diligence if they reject the offering and then only get paid based upon how much of an offering that they sell is at the root of the problem. For a large firm doing registered offerings due diligence is a profit center with positive cash flow. For small firms in the Reg. D market it can be an out of pocket cost with questionable reimbursement. Therein lays the problem and the solution.

FINRA might consider requiring a lead underwriter for all Reg. D offerings that mimics the investment banking function for registered offerings. As this is a potentially very profitable enterprise, it is reasonable to believe that some firms would be happy to step up. These firms and only these firms would need enhanced insurance coverage which would be folded into their cost of operations and reflected in the fees that they charge the issuers.

Asking each of the small firms selling Reg. D offerings to purchase insurance against offering statement fraud and adding to the cost of what is already an unprofitable part of their business is not going to gain traction at FINRA. A way to shift the risk profitably to a well compensated lead underwriter might do the trick.

The benefit of loss avoidance in the financial markets which is certainly part of FINRA’s charter should take precedence over insuring recovery costs for the few people who deal with the wrong firms.  It should surprise no one that many people in the brokerage industry do not particularly care for lawyers who make their livings filing customer arbitration claims. The PIABA study, while important, is not likely to stir the industry into action.

Arbitration claims based upon the sale of these offerings to unsuitable customers will still occur, but the aggregate losses will be far less and the number of Ponzi schemes foisted upon the public will likely be dramatically reduced. That is good for everyone.

I do have sympathy for the frustration suffered by the PIABA lawyers but the issue of collection is not limited to securities claims or arbitrations. Thousands of people are injured every year by uninsured drunk drivers .I would argue that it would be easier to substantially reduce the number of Ponzi schemes offered through FINRA firms than getting all the drunk drivers off the road.

 

 

 

Expungement- FINRA’s dirty little secret

Both FINRA and the SEC encourage investors to investigate the record of a financial professional before hiring them. It would certainly be valuable for any customer to know if the stockbroker to whom they are considering turning over their life savings had previous problems with other customers.

For more than 20 years FINRA has provided a free online tool called BrokerCheck. It provides potential customers with a history of where the broker has worked and in which states the broker is licensed to do business.

A BrokerCheck report is supposed to provide accurate information about regulatory problems that the broker may have had and basic information about complaints and arbitration claims that other customers may have asserted against the broker. Unfortunately arbitration claims, even those with serious allegations of misconduct are frequently not reported to the public.

From the outset brokers have strongly opposed this disclosure. They believe that many arbitration claims filed by their customers are frivolous, false or factually incorrect. There have never been any facts or data to support that assertion.

FINRA has always had a rule in place that permitted arbitrators to expunge the claim from the broker’s BrokerCheck record after the hearing or if the claim settled. The rule and the procedures have been tightened up over the years, but the fact remains that BrokerCheck’s record of a broker who has been the subject of multiple customer complaints and arbitration claims may reflect none of them.

There are actually reports of brokers who have been the subject of more than 20 customer complaints or arbitrations having some or all of these complaints expunged. In other words the worst offenders may get the most benefit from expungement. Brokers who have had the most serious problems may have those problems affirmatively concealed from investors.

Over the years there have been multiple studies, law review articles and comments regarding the pros and cons of permitting the expungement of customer claims against stockbrokers. The issue is lot easier to understand if you put it into some context.

If your neighbor slips and falls in front of your home on a snowy morning before you have had a chance to shovel the sidewalk and sues you for medical bills and lost wages, the lawsuit is matter of public record and will be a matter of public record forever. If you fail to pay your student loans or are late with a mortgage payment it will be noted on your credit report for many years.

FINRA arbitrations are private matters. If they are not reported on a BrokerCheck report they are unlikely to show up anywhere else that a prospective customer might access.

Some commentators have suggested an arbitration claim is similar to a bad review on Yelp or similar website. But they are not. A FINRA arbitration claim often means that a customer has lost money that they did not expect to lose. This usually means that the broker did not make a full disclosure of the risks involved.

As an attorney who has represented a great many customers in FINRA arbitrations I always understood that my job was to recover as much of my client’s losses as I could. No claim is perfect and every claim has its strengths and weaknesses. It is for this reason that the vast majority of arbitration claims that are filed with FINRA end up settling.

The question of expunging the broker’s record comes up in settlement discussions almost every time. Most of the defense lawyers with whom I have dealt over the years have been ethical and rarely made expungement a condition of the settlement which is not permitted.

More often, I would offer not to oppose the broker’s request for expungement if they made one to the arbitrators because the client rarely cared about anything more than getting the best monetary settlement they could. That is not the same as suggesting that I believed or in any way acquiesced to the idea that the claim was frivolous, false or factually incorrect in the first place.

Any attorney will tell you that clients do not always walk in the door with all of the paperwork that you would like to see or a firm recollection of all of the relevant facts. It was always my practice therefore to send a draft of the claim, with the client’s approval, to the brokerage firms’ compliance department before I filed the claim with FINRA. I would ask them to tell me if I had the facts correct and would solicit their interest in an early disposition of the matter.

Occasionally, they would respond that the broker named in the claim was actually out of the office when the offending transaction occurred and that a different broker had actually spoken with the client and was the official broker of record. Better to deal with these factual glitches up front than to fight over expungement later.

Understand that both FINRA and the SEC consider information about customer complaints to be information that any customer would consider to be important before they began doing business with a stockbroker.

In the context of an offering of securities the SEC routinely sanctions issuers who omit material facts. In the context of a BrokerCheck report, the Commission has sanctioned the omission of facts that everyone agrees are material.

Every year there are articles in industry publications bemoaning the public’s lack of confidence in the industry. Wouldn’t full disclosure of prior complaints instead of burying them help to restore the public’s confidence?

I have every reason to expect that this controversy will continue, in part because many people in the industry will never get over the arrogance of a customer who dares to file an arbitration claim. Even those with the most to gain, the honest brokers who work for years without a single customer complaint are silent.

For this reason FINRA is unlikely to acquiesce to allowing BrokerCheck to report any and all claims made against a broker without providing some type of escape mechanism. In the meantime, it is impossible for a customer to know if the BrokerCheck report that FINRA urges them to read is accurate. As a practical matter a BrokerCheck report is worthless.

Allow me to offer a practical solution.

If you are considering hiring a new broker and find that BrokerCheck reports no complaints or arbitration claims, send the broker the following e-mail:

Dear Mr. Smith: We have done some research and were very pleased to learn that throughout your many years in the brokerage business you have never had a complaint or arbitration with a customer. Please confirm that this is true and that none have been removed from your record.

That should protect any customer and level the playing field. It is one thing for a broker to have arbitration claims expunged from their record and quite another to lie about it.

A Brief History of Securities Arbitration

The US Supreme Court enforced the arbitration clauses that were boilerplate in the account agreements of most stock brokerage firms and sent almost all disputes that a customer may have with their stockbroker or brokerage firm to arbitration in 1987. Shearson/American Express Inc. v. McMahon, 482 U. S. 220 (1987).

The McMahon case did not find its way to the Supreme Court by accident. Some people in the securities industry were looking for a case to walk up the appellate ladder to get the issue of mandatory arbitration before the Court as early as the mid-1970s.

At that time, the industry had been hit by several large punitive damage awards assessed by juries in cases involving customer losses. Many people in the industry wanted nothing to do with juries. Many states did not then permit arbitrators to award punitive damages.

Certainly the industry believed that it could home court customers and their lawyers. To some extent the industry was able to weed out arbitrators who had the audacity to make a large award against a member firm.

The wire houses handled many of the claims with in-house lawyers because as they were self insured. Where there was a separate insurance carrier law firms around the country were enlisted in the industry’s defense. Throughout, defense lawyers have constantly assisted each other and have consistently acted to further their clients and the industry’s interests by shaping the rules and the forum.

I think that the industry would have been happy to keep arbitration simple. Events in the late 1980s and early 1990s conspired against it.

Customers do not file arbitration claims against their stockbrokers unless they lose money. Many customers lost money when the market crashed in 1987. Shortly thereafter, junk bonds began to default. Real estate limited partnerships were failing and a lot of those had been sold to seniors and retirees.

One firm, Prudential Securities, spawned thousands of claims which were resolved individually in arbitration or mediation. Claims against Prudential and other firms selling similar products caused a lot of lawyers from around the country to begin to take on customer disputes.

Up until that point, most claims involved the alleged misconduct of individual representatives such as churning or unsuitable recommendations. Now there were claims involving financial products where every customer who purchased them had been defrauded.

Prudential and the other firms put forward a number of aggressive defenses. The customers’ lawyers began to share information with each other. Eventually some of those lawyers formed the Public Investors Arbitration Bar Association, PIABA. There was now a formal industry of  customer representatives which substantially leveled the playing field.

At that time I would have said that these arbitration claims were easier to defend than to prosecute. The industry always had access to the information, people and documents that it needed to defend the claims. Customers were often limited to those documents that the panel ordered to be produced at the discovery hearing. Basic discovery in arbitration was not simplified and made uniform until 1999.

Tens of thousands of customer claims were resolved in arbitration after losses stemming from the 2001 “tech wreck” and the 2008 “credit meltdown”. The vast majority of the claims settled just like they would have if the claims had been filed in any court.

There have been tweaks to the arbitration rules over time but the basic system is the same. Arbitration still promises a resolution of a customer’s claim in less time and for less money than a resolution of the same claim in most courthouses.

Efficiency has always been a hallmark of arbitration. When I started (in the 1970s) most claims were resolved with a single day of live testimony. The customer and the broker would each tell their story to the panel. Few panels needed experts to explain the rules or the transactions to them.

The issues in these claims are rarely complex. The brokerage industry and the claimants’ lawyers share the blame for adding complexity where none was needed.

FINRA arbitration is far from perfect. I have elsewhere documented that in one case only one FINRA arbitration panel out of 35 thought customers who were sold a particular Ponzi scheme should get their money back. FINRA Arbitration – How investors actually fare.

Some commentators have attributed results like this to arbitrators who are biased or anti-consumer. Some have argued that arbitrators who worked for the industry will not make a substantial award against it. Others have argued that, because it is run by the industry, FINRA arbitration in inherently biased. This has resulted in more neutral panels and panel selection.

Personally, I do not believe that arbitrators should have to be educated by the customers’ attorneys to the fact that selling shares in a Ponzi scheme to any customer is beneath the standards of the industry. There is a difference between an arbitrator who is neutral and one who has no experience with investments or investing.

Unlike many lawyers representing customers who want arbitrators who are neutral, I frequently hope to get a retired branch office manager or compliance professional on the panel. I believe that customers frequently get a better result when the arbitrators are well informed and personally experienced in proper industry practices.

Too many people who comment about the perceived inequities of arbitration fail to consider that there are often legitimate defenses to these claims. Brokerage customers are generally a wealthier and more educated sub-set of the general population. They frequently approve the offending transactions, sign forms that acknowledge that they have read all of the disclosures and receive monthly statements which they are expected to read.

Arbitrators will often apportion the blame for the losses sustained by the customer between the parties. They will frequently consider a customer’s failure to mitigate their losses when assessing damages.

Arbitrators will also consider how the customer would have fared if they had not purchased the offending investments. If the general market was down during the time period of the claim, industry lawyers will frequently assert that the customer would have sustained losses even if they had gone to a different broker who had sold them something else.

The best cure for any perceived ills in the arbitration process will always be loss prevention. It starts with better educated investors but includes better compliance at the firms as well.

FINRA would do well to remember that for all its efforts to make the arbitration process more neutral, FINRA also has an important enforcement function. The greater certainty of the customers’ ability to recover inappropriate losses, the greater the deterrent to the offending conduct.

FINRA Arbitration – How investors actually fare

Arbitration is arguably the most efficient way for public customers to resolve a dispute that they may have with their stockbroker. I have personally been a participant in a great many more securities industry arbitrations than most people.

But the arbitrations themselves have become suspect. Too many customers who have clearly been defrauded by their stockbrokers are walking away uncompensated and shaking their heads. A brief case study will illustrate the point.

I located only 35 awards in the FINRA Arbitration Awards database concerning securities issued by a company called DBSI. DBSI was a national real estate syndicator that filed for bankruptcy protection in 2008 and was shown to have been operating as a Ponzi scheme.

I chose DBSI claims for three reasons:

First, the Examiner working for the DBSI’s Bankruptcy Trustee filed a comprehensive report detailing how DBSI had operated as a Ponzi scheme from at least 2004 at which time DBSI was already insolvent. Like any classic Ponzi scheme, DBSI was using funds collected from new investors to pay obligations to prior investors.

Second, virtually every private placement offering that DBSI made after 2004 (approx. $800 million in total) contained an un-audited balance sheet that stated, falsely, that the company was actually solvent. This was important because with each offering the company was taking on financial obligations to the investors, mostly lease payments for the buildings that it was syndicating.

Third, brokerage industry standards require the firms that sell private placements to verify the information that they are handing out in the private placement memorandums s (PPMs). Verifying DBSI’s claim that it was solvent when it was not would not have been possible. Logic and experience suggest that the approximately 100 brokerage firms that sold DBSI securities failed to conduct a reasonable due diligence investigation if they conducted any investigation at all.

So, we have an independent report filed with the Bankruptcy Court that would seem to establish that investors were given false financial information about DBSI at the time the brokerage firms sold the DBSI securities to them. The principal of DBSI was also convicted of fraud, on basically the same facts, at his criminal trial.

We also have aggrieved investors who begin the FINRA arbitration process knowing that the investment that their stockbroker had sold to them was a Ponzi scheme. The public investors should have a reasonable expectation that a securities industry arbitration panel would find that selling interests in a Ponzi scheme to be beneath industry standards and be willing to award the investors adequate compensation.

So how did the complaining investors actually fare?

Of the 35 awards involving DBSI securities that I could locate in the FINRA Arbitration Awards database, the results were as follows:

In 8 of those claims the brokerage firm had either filed for bankruptcy protection or defaulted and failed to appear at the hearing. In two of these claims the brokerage firm was not a named party presumably because it had gone out of business. A substantial number of the brokerage firms that sold DBSI securities did exactly that. Had they not, I would think that there would have been a lot more claims.

The arbitrators made awards in several of these “defaulted” claims where the customers were able to prove up their claim and establish their damages. There is no indication that the defaulting firms actually paid anything to these customers. A brokerage firm that will not defend a claim will generally not pay the award.

In FINRA statistics these count as a win for investors because an award was made, even though the customers did not actually receive compensation for their losses. FINRA does not require its member firms who sell these private placements to have either adequate net capital or adequate insurance. FINRA does not take any steps to enforce an award against the principals of a firm who sell Ponzi schemes and then close up shop.

In 10 of the 15 claims where the brokerage firm was present and represented by counsel the arbitrators dismissed the claim or awarded the investors nothing. One has to wonder why these 10 panels of arbitrators could not be convinced that selling a Ponzi scheme to public customers was conduct for which the customers should be compensated.

In the 5 fully adjudicated claims where the arbitrators did make an award in the customers’ favor, in only one did the panel order the offending DBSI investment rescinded and the customers fully compensated. The rest of the awards were for much less than the amount that the firms’ customers had invested.

In one of the adjudicated claims the panel dismissed the claim for one DBSI investment and made a small award on a second. Both of these offerings contained fraudulent financial information about DBSI. What could these arbitrators have been thinking?

Twelve of the claims brought by customers seeking compensation for DBSI losses were settled for undisclosed amounts. Pre-hearing settlements are often based upon each party’s evaluation of what might be their worst result if the claim is given to the arbitrators to decide. The fact that only one panel deemed it appropriate to rescind the DBSI transactions and fully compensate the customers would certainly impact the brokerage firms’ idea of what might be the worst result that they might suffer if they did not settle.

When you boil this down to the fact that in only one claim in 35 did the customer get all or a substantial award from the FINRA arbitration panel when all were clearly defrauded, it does give one pause to consider than something may just not be right.

Perhaps it might help to look at the expungement phase of some of these hearings. Claims like these are routinely expunged from the record of the individual registered representatives when the claims settle.

After a settlement, the arbitrators conduct a live or telephonic hearing to determine if the claim should be wiped from the representative’s record. The claimants and their representatives do not usually appear at this hearing, nor should they need to appear. Left alone with the arbitrators some industry firms may be taking advantage.

In more than one claim the expungement order noted that the claim (for selling a Ponzi scheme to a public customer) was factually impossible. In others, the panel held that the offering materials (which contained fraudulent financial information) were within industry standards or that the due diligence (which, if done correctly could not have verified that DBSI was solvent as it claimed to be) was adequate and also within industry standards. I personally refuse to believe that industry standards have fallen that low.

These findings by the panels are often supported by “experts” whom the brokerage firms bring to the expungement hearings to educate the panels without cross-examination. If an arbitrator hears this recitation of “industry standards” from an expert or two provided by the industry over several cases, many apparently start to believe it.

It is certainly logical to assume that after many claims involving DBSI and several other large Ponzi schemes that were sold to public customers in the last market cycle (Medical Capital, Provident Royalties, etc.) the arbitrator pool around the country may have been tainted by the patently false “opinions” of these industry “experts”. Arbitrators get no training in securities law or industry standards from FINRA.

Securities industry arbitration has always been considered to be efficient because it costs less than state court litigation. The cost of the forum should be irrelevant if the customers cannot realistically expect to obtain a reasonable recovery of their losses in cases like this. I cannot fathom that a series of 35 juries sitting in civil courts around the country would come up this many defense victories. If I am right then clearly there must be some defect in the FINRA arbitration system.

As importantly, the lack of compensation awarded to these aggrieved investors in FINRA arbitration forums re-enforces a business model where a broker/dealer can be inadequately funded, carry no insurance, affirmatively flaunt the rules, conduct inadequate due diligence and sell millions of dollars of fraudulent investments to thousands of investors. Once exposed, the principals can simply close up shop and open up across the street under a new broker/ dealer and start over.

Either way, if FINRA intends to advocate its forum as fair and equitable to the public investors, it should take steps to see that it really is.