Investor Victory: NASD Arbitrators Hit SSB with Punitive Damages

Duties of Stockbrokers to Their Customers

21st Century Investment Fraud

• Introduction to arbitration.
• Why arbitrate?
• Where to arbitrate?
• Advantages and disadvantages of arbitration.
• Is a lawyer required for arbitration?
• Arbitration Procedure.
• The arbitration hearing.
• Arbitration awards.

The arbitration process is less formal and quicker than litigation in court. Various arbitration forums have established rules governing the arbitration procedure.

Thousands of securities claims are filed for arbitration each year. The typical arbitration case (if there is such a thing) is processed through completion in approximately one year, from filing to resolution.

Why arbitrate? Most customers of brokerage firms are obligated to arbitrate any disputes relating to their account as a result of a pre-dispute arbitration agreement contained in Customer Agreement forms. All major brokerage forms include arbitration provisions in the standard customer agreements or new account agreements which customers must sign in order to open their account. Although most customers do not carefully read the fine print of these standard, pre-printed forms, and most people do not understand what rights they may be waiving by agreeing to the arbitration provision, and customers have no bargaining power to negotiate the agreement anyway, nevertheless, the United States Supreme Court has held that such pre-dispute arbitration provisions are binding and enforceable.

Even if there is no written arbitration agreement, a broker and brokerage firm may be compelled to arbitrate a customer's claim at the demand of the customer. By virtue of the brokerage firm's and broker's membership in the NASD (to which all brokers must belong) and the various exchanges, they must submit to arbitration of customer complaints pursuant to the rules of these organizations. Therefore, the vast majority of stockbroker/customer disputes are heard in arbitration rather than court if either party so requests.

Where to arbitrate? Most standard customer agreements typically provide which forums will be permissible for arbitration of customer complaints. Generally the customer agreement will provide for arbitration before the NASD and the NYSE forums. Some brokerage firms will also provide for arbitration in accordance with the rules of the American Stock Exchange or the Pacific Stock Exchange.

There are some brokerage firms which also add the American Arbitration Association ("AAA") as a permissible forum for the arbitration of customer complaints. Unlike the other forums, the AAA is not a securities industry organization and is entirely independent. Although the AAA has special rules for securities arbitration, and follows many of the same procedures as the NASD and NYSE arbitration forums, it seems as if most of the large national brokerage firms refuse to arbitrate in the AAA. The opposition of the brokerage firms to AAA arbitration may not be totally unrelated to the fact that the AAA is the only totally independent, non-securities industry arbitration forum. However, studies have shown that quantitatively, results do not differ significantly between the AAA and the securities industry arbitration forums.

Perhaps the perception of the AAA as an independent organization gives rise to the securities industry's tendency to oppose arbitration in the AAA and the positive public opinion of the AAA as at least an equally desirable forum. One procedural difference of note, however, is the absence of a six year eligibility rule in the AAA, unlike the NASD and NYSE. (See section on Issues of Timeliness and Eligibility for further discussion.) This may make the AAA the forum of choice for claims relating to older investments.

There has been a great deal of controversy surrounding the use of the so-called "AMEX window". This is a method through which customers may avail themselves of a provision in the American Stock Exchange Constitution which permits arbitration before the AAA (which is totally unrelated to the American Stock Exchange). Brokerage firms generally fight such efforts and in recent years have tightened the language in standard customer agreements relating to the American Stock Exchange so as to try to close the "AMEX window".

Specific types of investments may also result in differences in arbitration. For example, complaints regarding options trading may be subject to arbitration pursuant to the Chicago Board of Options Exchange constitution. Commodities trading will be subject to arbitration before the National Futures Association as well as reparations proceedings before the Commodities Futures Trading Commission.

Generally the arbitration forums will provide for the arbitration hearing to be held in a large city closest to the residence of the customer, or where the customer resided at the time of the trading, if the arbitration organization maintains an office in that city. Some arbitration forums will try to accommodate the request of the customer to arrange for the arbitration to be held at a more convenient location, even if the organization does not maintain an office in that city.

Advantages and disadvantages of arbitration. Securities arbitration is intended to be a fair and efficient method of dispute resolution by impartial persons who are knowledgeable in the subject in controversy. As an alternative to the courts, arbitration has been considered preferable as a quicker and less expensive means of resolving problems. Since arbitration has less formal rules of procedure and evidence, it is designed to avoid getting bogged down in procedural or technical problems so as to be able to focus on the facts and issues in dispute.

Securities arbitration is binding on the parties and the award is enforceable. Except in extraordinary circumstances, the arbitration decision is non-appealable.

The pre-hearing discovery (procedures for obtaining documents and information from the other side) in arbitration is far less broad than the pre-trial discovery in litigation. This may be viewed as a positive and a negative. On one hand, it avoids lengthy, onerous and costly exercises such as depositions, interrogatories, etc. However, documents which are vital to supporting the customer's claim are often in the possession of the brokerage firm. The arbitration rules for production of documents have been frequently criticized as "lacking teeth." Some brokerage firms often ignore deadlines for the production of documents, fail to produce all requested documents, or produce documents only at the last minute when it is too late for the customer to thoroughly review such information.

The rule for the exchange of exhibits in advance of the arbitration hearing is also a source for problems. Customers must produce their exhibits and witness list to the opposing side in advance, whereas rebuttal exhibits and rebuttal witnesses need not be identified in advance.

As the securities arbitration process has become more developed in recent years it has in some ways become more formalized with preliminary and procedural matters becoming much more involved and time-consuming. As a result, in certain cases, the complete arbitration process may become extremely lengthy and expensive. However, in comparison to formal court litigation, arbitration still generally provides a more economical and efficient, fair method of dispute resolution.

Is a lawyer required for arbitration? There is no requirement for a customer to be represented by an attorney in the arbitration. But it should be noted that the large brokerage company will typically have teams of lawyers working for them in their legal departments. The brokerage company and broker may often also retain an outside law firm to vigorously defend their interests. These highly trained and experienced, polished professionals will frequently take advantage of any opportunity and not hesitate to escalate to "hardball" tactics (within the bounds of the law) in order to defeat the customer's claims.

A customer appearing without legal counsel may quickly find himself at a severe disadvantage and outgunned by the legal representation of the opposition. A customer should consider retaining a qualified attorney or at least consult with an attorney prior to the filing of the claim. Since arbitration is binding and final, it will be too late for an investor to go to a lawyer after losing the arbitration, even if he failed to assert important points as a result of an ineffective effort to represent himself.

Customers may feel comfortable representing themselves in smaller cases and there are procedures for simplified arbitration of claims which do not exceed $10,000. There are also attorneys who will take cases on a contingency fee basis (so they only get paid out of any award or other recovery) in appropriate circumstances.

Arbitration procedure. The arbitration process is initiated by the customer filing a Statement of Claim and Demand for Arbitration. The Statement of Claim should set forth the relevant facts, the basis for the claim and the damages, in a clear and straightforward manner. Relevant documents may also be attached to the Statement of Claim as exhibits. There is no special legal form required for the Statement of Claim. Although the Statement of Claim will generally include legal arguments, there is no requirement that it be drafted by an attorney. It should be remembered that generally one or more of the three arbitrators will not be an attorney.

The Statement of Claim must be accompanied by a signed Submission Agreement. By executing the Submission Agreement, the Claimant is agreeing to submit the dispute to arbitration and to be bound by the results. Along with the Statement of Claim and Submission Agreement, the customer must also include a check for the filing fee and initial hearing deposit.

The fees for the various arbitration forums are based upon sliding scales depending upon the amount of the claim. For example, the fee to be paid upon filing a complaint with the NASD for an amount in dispute between $50,000 and $100,000 is $150 for the filing fee plus $500 for the initial hearing session deposit, for a total of $650. The NASD fee for filing a claim with an amount in dispute between $100,000 and $500,000 is $200 for the filing fee plus $750 for the initial hearing session deposit, for a total of $950. It should be noted that this payment will only cover the fee for the initial hearing session, and if additional hearing sessions are required (as typically occurs) the customer will be responsible for additional fees to the arbitration forum. However, the customer may request the arbitrators' award to include an assessment of all fees and expenses against the broker and brokerage firm as part of their decision.

The broker and brokerage firm will then have a certain period of time in which to respond with an Answer to the Statement of Claim. The Answer, including all defenses and counterclaims, must be filed within twenty business days from receipt of the Statement of Claim, according to NYSE and NASD rules.

The parties may then present requests for production of documents and information which must be responded to either with the documents and information requested or objections within a set time period. Disputes regarding document production and discovery may result in a preliminary hearing, sometimes via telephone for resolution prior to the full arbitration.

The parties will be notified of the hearing date and the appointment of three arbitrators (except in NASD cases in which no more than $30,000 is in dispute, when only one arbitrator is appointed). The three members of the arbitration panel will include one securities industry member and two public arbitrators. Either party may object to any named arbitrator for any reason which might prejudice the arbitrator from rendering an impartial decision, such as past contacts or relations which may create an appearance of bias. Each party is also allowed one challenge without cause, by which a person appointed to the panel may be removed for no stated reason within five business days of notice of the appointment. (The AAA uses a different method for appointing arbitrators from lists distributed to each side, and there has been a similar proposal to the NASD.)

The date which is set for the hearing will depend upon the case backlog of the particular arbitration forum, but generally it will be within a year of filing and may be as soon as within five or six months from filing. Sometimes the ability to obtain a quicker hearing date will be a consideration in deciding in which forum to file for arbitration. Once the arbitrators have been appointed, a request to postpone the hearing date may require the payment of a fee.

The arbitration hearing. The arbitration hearing is generally conducted in a large conference room. After a brief statement by the Chairman of the Arbitration Panel, each side is permitted to make a brief opening statement. Although the rules of evidence and procedure are less formal than in court, there are still rules and the parties should conduct themselves in an appropriate manner. The Claimant/customer will then present his or her case through the testimony of witnesses (including the customer) and the presentation of exhibits. The attorney for the broker and brokerage firm will then have an opportunity to cross-examine the witnesses presented by the customer.

Particular questions and exhibits may be objectionable, but most arbitrators prefer that the attorneys for both sides limit their objections and avoid interruptions so as to permit the orderly presentation of each side of the case. Certainly to be avoided would be any outbursts or rude behavior which is generally seen as a poor reflection upon the party or attorney who acts in such an unseemly manner.

The parties may also call expert witnesses to testify on behalf of either side. The use of expert witness testimony may be especially helpful in cases involving extremely complex or technical matters where the expert witness may be of assistance to the panel in explaining various securities industry practices. An expert witness is also frequently used to explain an analysis of trading in the account, for example, to present their opinion as to possible churning or suitability issues, and to explain a calculation of damages which they may have prepared.

The broker and brokerage firm then have an opportunity to present their case, which will generally include the testimony of the broker and sometimes the branch office manager or compliance officer responsible for supervising that broker, and their expert witness.

Besides the direct and cross-examination of witnesses by the attorneys for each side, the arbitrators themselves may ask questions of the witnesses and parties. Finally, each side will be permitted to make a closing argument. The record will then be closed unless the arbitrators request legal briefs or closing memoranda from the parties.

Many arbitration hearings will be completed in one day. However, in the last couple of years the trend has been for longer hearings, and the average arbitration now lasts approximately two days. Some extremely complex cases may involve hearings which extend over a period of weeks. Since hearing dates are not always scheduled for consecutive days, some arbitrations may begin in one month and not end until many months later with gaps of weeks between hearing dates.

Arbitration awards. After the conclusion of the arbitration hearings and the submission of any post-hearing documents, the arbitrators will deliberate. They generally must render their decision within thirty days. The decision must be in writing, signed by the arbitrators. However, the decision need not include a reasoned explanation for how the panel arrived at their conclusion.

The arbitration decision is then prepared by the arbitration forum administrative staff and re-distributed to the panel members for their review and signature. (For some reason this process may take as long as another month.) The decision is then sent to the parties and any award must be paid within thirty days.

As members of the self-regulatory organizations, the broker and brokerage firms must pay the damages awarded by the arbitration panel. Federal and state law provide for the confirmation of an arbitration award by courts. Except in extraordinary circumstances, the decision of the arbitration panel is not appealable.

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