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calculation of damages

Compensatory damages

There are many methods for calculating the damages which one may claim in securities arbitration. Selecting the most appropriate and advantageous method of calculating damages may be a critical aspect of arbitration strategy.

The starting point under most statutory and common law causes of action will be a calculation of the compensatory damages. This method of calculating damages will look to the loss the customer incurred as a result of the broker's wrongful trading.

The trading losses may be simply calculated based upon each trade which was improper. The losses on each such improper trade would be added together, taking into consideration the purchase price less the sales price with commissions. Where the investment has not yet been sold (or is not marketable), the unrealized loss may be calculated by taking the value of the security as of a certain cutoff date such as when the account was closed, when the broker left the firm, or shortly before the Statement of Claim was filed, etc.

Another method of calculating compensatory damages involves an overall money-in/money-out damage calculation. This method of calculating damages takes into consideration all of the activity which occurred in the account, as opposed to just focusing on particular trades as described above. The money-in/money-out calculation starts by adding all of the deposits (of cash and securities) into the account, and subtracting all of the withdrawals from the account (including dividends distributed), less the closing balance of the account. This results in one overall net damage figure for the entire life of the account in light of all activity in the account. The money-in/money-out method takes into consideration the effect of commissions and margin interest, as well as the income generated by the account in profitable trades, dividend and interest income.

Market-adjusted damages

Courts and arbitrators have recognized that defrauded investors may also be entitled to damages for what their account should have been earning absent the wrongdoing of the stockbroker. Market-adjusted damages are calculated by taking into consideration the performance of some model index, such as the Standard & Poors 500 Index, government bonds, money market or certificate of deposit rates. The appropriate index is chosen based upon the customer's investment objectives. The performance of that index over the relevant period of time is examined to determine what the investor's account should have been earning if it had been invested properly as measured by the growth in that index. The additional income that the account should have generated, measured by the appropriate index, is then added to the out-of-pocket loss in determining the full compensatory damages to which the customer is entitled.

Lost profits

On occasion, it is appropriate to consider lost profits in calculating damages. For example, in a failure to follow instructions or failure to execute claim, the subsequent performance of the stock in question may be relevant in determining damages. However, generally lost profits are considered too speculative to determine with any accuracy and are not included in damages awarded in arbitration.

Interest on losses

Arbitrators will sometimes include interest on the losses in their calculation of damages if so requested. In many states, interest is provided for by statute as an element of damages to be awarded in cases of securities fraud. For example, the Uniform State Anti-Fraud Securities Act provides for damages to be calculated based upon the amount paid for the security less all distributions and sales proceeds from that investment, plus interest at 6% per annum (plus reasonable attorney's fees and expenses). In many cases where the broker's wrongful activity persisted over a period of years, or if many years elapsed since the initial investment, the interest factor may be a very important element of the damages.

Attorney's fees and expenses of arbitration

In appropriate cases arbitrators will also award attorney's fees and expenses of arbitration as part of the damages. There are certain statutory provisions which mandate reasonable attorney's fees and expenses as part of the calculation of damages for securities fraud, for example, under the Uniform State Anti-Fraud Securities Act. It has also been frequently held that under the Federal Arbitration Act, arbitrators have the inherent authority to fashion appropriate equitable awards. In order to make the investor whole, and to put him back in the same position he would have been but for the fraud of the broker, the addition of attorney's fees and expenses in arbitration awards may be appropriate. However, customers should not count on receiving an award which includes attorney's fees and interest in all cases, even if they prevail on the merits of their claim.

Punitive damages

Until recently the question of punitive damages had been an area of controversy subject to a conflict of authority between the courts. However, in a landmark victory for investors, the U.S. Supreme Court ruled last year that arbitrators may award punitive damages in securities arbitration. "Punitive damages" means an amount awarded in excess of the actual sum necessary to compensate the customer for the losses, additional damages which go further than the losses so as to punish the perpetrator of the fraud and to set an example to discourage fraudulent activity.

In the past, only a relatively small percentage of securities arbitration decisions included awards of punitive damages. But it has been recognized that merely returning ill-gotten gains or compensating for losses may not be sufficient in all cases. Certain particularly outrageous securities arbitration cases merit awards of punitive damages to provide a disincentive to fraud, to punish intentional, flagrant or reckless activity and to set an example to prevent securities brokers from taking advantage of the public trust. Nevertheless, it may still be just the exceptional case for which punitive damages are included in the award of the arbitrators.