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What is the arbitration process like? What can an investor who goes to arbitration expect?
Arbitration, while less formal than court, is still an adversarial proceeding. The respondent brokerage firm will hire lawyers to defend the case. Some defense lawyers are more aggressive than others, but they all do roughly the same thing. Whatever the circumstance, they will argue that their client bears no responsibility at all for whatever happened. That's what defense lawyers do for a living.
To start a securities arbitration, an investor, known as the "Claimant," files a paper called a "Statement of Claim." Then the brokerage firm (known as the "Respondent") files an Answer. These counterstatements are called the "pleadings," and they should describe, in understandable English, each of the parties' version of events.
The typical Statement of Claim blames the brokerage firm for losses suffered by the Claimant, and the Answer always denies responsibility (even when the Respondent clearly was at fault). The Answer often tries to portray the Claimant in a negative light. It will almost always describe the Claimant as someone who was warned about all the risks but who now wants the brokerage firm to be an insurer of losses. The terms "20/20 hindsight" often appears repeatedly in a brokerage firm's Answer. Some Answers are downright nasty.
That Answer will usually characterize the investor as "sophisticated" (regardless of whether that is accurate). Any level of business acumen or higher education will quickly elevate the Claimant to the status of Wall Street wiz. Investors of even modest means will be labeled "wealthy."
If there were losses, the Answer will blame them on the investor, the market or anyone else in sight. Respondents never concede even the slightest bit of fault. Often the Respondent will assert the Claimant didn’t lose money, although their definition of "losing money" may be different from yours.
The Answer will usually aggravate the Claimant, but what comes next is even worse. Just as Claimants get to ask Respondents to produce documents in discovery, Respondents get to do the same. Even though there are no depositions in arbitration, there is a required exchange of documents. The Financial Industry Regulatory Authority (FINRA) has a set of guidelines for what ought to be produced, but lawyers usually ask for more, and there are often issues that need to be resolved by the arbitrators.
Under the FINRA guide, Respondents must produce the customer's new account documentation, monthly statements, notes, correspondence and commission information -- stuff that pertains to the accounts in question. Claimants need these documents because so much of the securities business is done behind the proverbial curtain. The business between broker and client is usually oral, but brokerage firms are required to maintain records to insure their diligence and honesty. Claimants' lawyers will try to push the discovery envelope, seeking other documents they hope will incriminate the broker. Respondents will object, and the chair of the arbitration panel will decide what must be produced.
The FINRA guide says that Claimants have to produce statements from every brokerage account going back years and years, tax returns for themselves and any businesses they own, correspondence, notes, phone records and more. One of my adversaries representing a brokerage firm once described it as a "financial colonoscopy." The legal system calls it "discovery."
When doing discovery on a Claimant, the Respondent is looking for information to support their "blame-the-Claimant" defense. Investments at other brokerages, both before and after, will be used to support defense assertions of experience and sophistication. Tax returns will be used to identify assets and sources of income in an attempt to prove that the investor can afford the loss. Losses in other accounts will be used to demonstrate the Claimant's supposed appetite for risk. Like Claimants, Respondents' lawyers will push to get as much ammo as they can get.
The next step is the hearing. In the arbitrations arising from the so-called "tech wreck" of the early 2000s, many brokerage firm Respondents started to make legalistic "motions" seeking prehearing dismissals of nearly every case. Claimants had to respond to these "motions to dismiss," and the arbitrators had to decide them. Even though dismissals were rarely granted, such motions kept coming and coming. Last year, FINRA outlawed most motions to dismiss, and they are rarely seen today. So, after the pleadings are filed, the arbitrators selected and discovery completed, the arbitration hearings (having been scheduled months before) will commence.
An arbitration hearing is a lot like a trial, except that it takes place sitting around a conference table. With the arbitrators presiding from one end, the lawyers for the parties will make speeches (called "opening statements"), call witnesses, ask questions, introduce documents into evidence, argue about admissibility, make objections, conduct cross-examination and make more speeches (called "closing statements").
The hearing can take one day or 10 days depending on the case, the lawyers and the arbitrators. I try to complete my cases in three days or less, but it depends. The proceedings should be businesslike, though the emotions of the parties and the heat of battle sometimes take over. While the lawyers may make arguments about the law, the principal subject of any arbitration hearing is the facts. The arbitrators' main mission is to figure who actually said what to whom, who knew what when, and how much, if anything, to award the Claimant. It's not an easy job.
After the hearings are over, the arbitrators deliberate and decide the case. An arbitration award will then be typed up by FINRA, signed by the arbitrators and sent to the lawyers for the parties. That happens within 30 days of the last hearing date, so it's pretty quick. The award will say who won, and if the claimant won, how much. Regrettably, arbitrators almost never give reasons for their award -- that subject will be addressed in a future column. The whole process, from pleadings to award, takes a little more than a year -- much less time than a court case takes. The arbitrators' decision is final. For all intents and purposes, there is no appeal.
The best part of arbitration is collection -- if the Claimant won, that is. Collection is relatively easy. FINRA will suspend any member that does not satisfy an award within 30 days. That's a powerful weapon, and even though it is subject to some exceptions, and it is not a guarantee of payment, suspension is a formidable threat to any ongoing brokerage business. It's pay up or close up. So, when they lose, Respondents usually pay up.
After that, life goes on. Win or lose.
Seth E. Lipner is Professor of Law at the Zicklin School of Business, Baruch College, CUNY. He is also a member of Deutsch & Lipner, a law firm in Garden City, N.Y. that represents investors in arbitration. Professor Lipner is a member of the Forbes.com Investor Team.
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