by Richard Elliott
Claims against brokers and brokerage firms for investment losses are handled through arbitration with the Financial Industry Regulatory Authority (FINRA). It is responsible for all arbitration functions in connection with disputes between member firms and their customers. FINRA is now the only forum for securities arbitration. Claims against brokers and dealers are generally not eligible for litigation in court, because the customer contracts that any dispute between the customer and the broker must be submitted to binding arbitration. The rules of procedure and discovery are therefore governed by the Code of Arbitration Procedure and FINRA’s rules, rather than by rules governing trials of cases in court.
Types of Claims and Defenses
There are numerous claims that may be asserted arising out of losses sustained in a brokerage or retirement account. The following are the most common: (1) suitability; (2) failure to supervise; (3) fraud; (4) negligence; (5) breach of contract; (6) breach of fiduciary duty; (7) unauthorized transactions; (8) over-concentration; (9) churning; and (10) statutory violations, such as the Texas Securities Act. There are other, more mundane, claims such as selling away, improper execution of trades, and margin account trading.
The most common claim made is that the investment was “unsuitable.” Pursuant to FINRA Rule 2111, the Suitability rule, brokers owe customers a duty to make suitable investment recommendations. An unsuitable recommendation which causes losses may lead to recovery of damages by the investor. Over-concentration of an investor’s holdings in one or few securities or in a single industry, can lead to claims for failure to diversify. Since the collapse of the financial market in 2007-2008, another claim frequently made is that the product sold was so toxic that it would not be suitable for any investor, regardless of the customer’s level of sophistication or wealth.
There are numerous defenses available to the Respondent, depending on the facts of the case and history of the account. One of the most often used defenses is the “sophisticated investor” defense. Other defenses are simply that the investments were suitable, ratification, failure to mitigate, and contributory negligence. Statutes of limitations are generally not available as a defense in securities arbitration. Instead, FINRA Rule 12206 provides that for a claim to be “eligible” for arbitration, it must be brought within six years from the occurrence or event giving rise to the claim. It often becomes a fact question as to when the cause of action accrued.
The Arbitration Process
The pleadings consist of a Statement of Claim and Answer. No particular form of pleading is required. The parties select the panel from a list of arbitrators provided by FINRA. Discovery is limited to document production and requests for information. Normally, no depositions are taken in arbitration. Jury trials are not allowed. Expert witnesses are typically used by both parties regarding both liability and damages.
Damages may include actual market losses, benefit of the bargain losses or the difference between the value of the account and what it would have it been in a well-managed portfolio. Rescission is also a remedy, in which the damages include a return of the original investment, less any dividends or earnings, plus pre-judgment interest and attorney’s fees.
The panel may award attorney’s fees in addition to actual damages. Attorney’s fees are recoverable under the Texas Securities Act as well as under common law and FINRA’s rules. Arbitrators have authority to award attorney’s fees and costs even in the absence of an explicit statute. Punitive damages are also recoverable by a Claimant in appropriate cases. Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 107 S. Ct. 2332 (1987).
Generally there is no appeal from an arbitration award. If an award is not paid within 30 days, a Claimant may file suit to confirm the award. Either party may file suit in Court to vacate the award. However, vacatur is rarely granted, usually where the arbitrator failed to disclose a material conflict.
The New Fiduciary Rule
The Department of Labor’s new Fiduciary Rule requires advisors to act in the best interests of their clients, and to put their clients’ interests above their own. This is a much higher level of accountability than the suitability standard. Now, financial professionals are obligated to put their clients’ best interests first, rather than finding “suitable” investments. The main impact of the new Rule will be in IRAs and 401(k) rollovers. It is being phased in now, with full applicability by January 1, 2018.
Richard Elliott is a Dallas solo practitioner. He can be reached at firstname.lastname@example.org.