Securities Arbitration Part II: A Hypothetical Securities Arbritation Case
An attorney is visiting with an existing client on another matter, and the client makes a comment that she lost $50,000 in an investment in her account at the brokerage firm of Dewey, Cheatum & How. The attorney explores the issue with the client and learns that the client inherited $100,000 two years ago. The client went to Dewey, Cheatum & How and told the broker assigned to her that she intended to use the money to fund the college expenses of her three small children. The client also told the broker that she had no prior investment experience. The broker recommended that the client place $50,000 into one single investment an $8 stock called Blowup, which was underwritten by the firm.
The client never read her monthly statements, preferring instead to rely on the broker, who continually assured her that she was making money on her investment. A year ago, at tax time, her accountant informed her that her $50,000 investment in Blowup had a market value of zero.Preliminary Groundwork
The attorney consults the Code of Arbitration Procedure ("Code"), a slim brochure-like document that can be obtained from the NASD. The Code provides that the client has six years from the date of the occurrence or event to assert her arbitration claim.
The attorney believes that, because the broker concealed his wrongdoing from the client until a year ago, the "occurrence" took place within the six-year period. In addition, since the client did not discover the wrongdoing until a year ago, the attorney is confident about the statute of limitations. The attorney does some quick research on the issue, however, and is shocked to find an entire body of state and federal case law debating this very issue. The brokerage industry argues, and some courts have held, that if the investment is made more than six years prior to the filing of the Statement of Claim, it is ineligible for arbitration. Colorado state courts, however, have not addressed this issue.
The attorney also discovers a body of state and federal case law on the issue of who should decide the eligibility of the arbitration claimthe courts or the arbitration panel? The Tenth Circuit has adopted the view that the courts, not the arbitrators, should decide the eligibility issue. Because the clients case involves investments made within the last two years, the attorney is relieved that these two hotly debated legal issues are inapplicable.
Next, the attorney obtains a copy of the stockbrokers Central Registry Depository ("CRD"). The CRD lists the stockbrokers address, current employment and employment history, securities licenses, and every other customer complaint ever made against him. This information also can be obtained at the NASD web-site.
From the CRD, the attorney learns that the broker in question has had two prior customer complaints alleging unsuitable investments. In addition, the attorney learns that the broker was licensed in Colorado two days after the $50,000 purchase of Blowup was made on behalf of the client. These facts support a claim against the brokerage firm for failing to supervise both the clients account and the broker.
The attorney also requests a copy of the CRD for Dewey, Cheatum & How and learns that the firm has had prior regulatory problems for failing to supervise client accounts and brokers. Concerned about Deweys financial viability, the attorney contacts Disclosure, Inc. and obtains the firms X-17A5. This form discloses that the firm is earning annual commissions of $5 million and has ten offices nationwide with a dozen brokers in each office. The attorney thus concludes that there is a party from whom a judgment can be collected, and the attorney turns to the filing of a claim.Where to File the Claim
The choice of an arbitration forum is usually dictated by the arbitration provision in the customer agreement. If the client no longer has a copy of her customer agreement, the client should request another copy from the brokerage firm. In this case, the agreement provides that arbitration can take place at the American Stock Exchange ("AMEX"), the New York Stock Exchange ("NYSE"), or the National Association of Securities Dealers ("NASD"). These entities are called "self-regulatory organizations," or SROs.
The attorney decides to file the claim at the AMEX, because the AMEX has far fewer cases than the NYSE or the NASD and the case is likely to receive more administrative attention. In addition, the attorney likes the fact that, unlike the NYSE and the NASD, which tape-record the arbitration, the AMEX supplies a court reporter. The attorney ensures that the court reporter has "real time" capability, enabling the attorney to obtain a rough transcript of each days testimony at the close of the day so the attorney can use it in questioning the next day.
The attorney proceeds to prepare the Statement of Claim, which sets forth the background facts and the causes of action alleged, including a recitation of the securities rules and regulations that were violated. The attorney mails the Statement of Claim to the AMEX with instructions to serve the respondents. Within two months, the respondents answer, denying all of the facts alleged and setting forth numerous affirmative defenses.Choosing the Arbitration Panel
Subsequently, the AMEX appoints the arbitration panel. The attorney then immediately contacts the Securities Arbitration Commentator ("SAC") and requests a summary of the prior arbitration awards rendered by each of the panel members. The SAC sends this summary by fax.
The attorney analyzes this summary to determine whether any of the arbitrators have any biases or patterns. The attorney is pleased to see that one of the panel members is a lawyer and that she has awarded attorney fees in a prior case. The attorney also notes that one of the other arbitrators has previously ruled in favor of the claimant in a case against a lower-tier brokerage firm like Dewey, Cheatum & How. The attorney decides, however, to strike the industry arbitrator who has served on five prior arbitration panels and who has ruled for the respondents in every instance. Unfortunately, the replacement arbitrator is even worse. Because the client is entitled to only one peremptory strike, however, the client is stuck with the replacement arbitrator.Discovery
Next, the parties exchange discovery requests. The brokerage firm will likely object to many of the clients requests, such as the request for a copy of the firms compliance manual. Likewise, the attorney will likely object to many of the respondents requests, such as the request for the clients tax returns for the last decade. Respondents will likely seek documents that attempt to show that the client is a sophisticated investor who has previously and since purchased stocks like Blowup and who understands the risks of the market.
The Arbitrators Manual contains a flexible list of documents that may be relevant to each side of the case. The clients retained expert can assist the attorney in focusing on pertinent documents tailored to the facts of the case. The attorney requests documents from the brokers registration file, a file that contains information regarding the brokers licensing and registration at various exchanges and in various states. The attorney also requests the firms order tickets and confirmations for all of the clients trades, in order to show that the purchase of Blowup was made prior to the appropriate registration. The client next requests the firms supervisory and compliance manuals, any communications between the client and the firm, and the firms research reports on Blowup. Finally, the client requests the brokers commission runs, which show the commissions that the broker received from sales of Blowup, not only to the client but also to his other customers.
After serving discovery, the attorney requests that the AMEX schedule a pre-hearing conference, in order to resolve the outstanding discovery disputes. This hearing takes place over the telephone, with counsel for the parties and the chairman of the panel participating. The attorney and opposing counsel argue their respective positions, and the chairman rules as the issues arise. At the close of the conference, the chairman requests that the attorney prepare a summary of the rulings and provide a copy to opposing counsel.
Twenty days prior to the arbitration hearing, each side designates its witnesses and identifies and/or produces its arbitration exhibits to the other side. The claimants attorney decides to hold back documents such as the CRDs of the firm and the broker, because the pre-hearing exchange rule provides that claimant need not produce documents that may be used solely for cross-examination or rebuttal.The Arbitration
The attorney is then notified that the arbitration will take place in the conference room of a local hotel. In preparation for the arbitration, the attorney makes five copies of all of her exhibitsone for each of the three arbitrators, one for the respondent, and one for the witness during examinations. On the day the arbitration is to begin, the attorney appears with her client, the chairman makes a short speech about the process, and the arbitrators affirm their oaths. From that point forward, the arbitration is very much like a courtroom trial. Each side makes opening and closing statements, and each side conducts direct and cross-examination of witnesses. As the attorney proceeds, however, all persons in the room look at their copies of exhibits along with her.
Most arbitrations in which the amount in controversy is greater than $10,000 are completed in no less than two days. This is understandable, given that there are almost always four witnessesthe claimant, the broker, and each sides expert witness. Many arbitrations, however, are substantially longer.
After each side has rested, the chairman thanks everyone and recesses the arbitration. The Code provides that the arbitrators are to render their award "within (30) thirty business days from the date the record is closed." The closing of the record, however, is a vague and amorphous event. In addition, just because the arbitrators render the award and send it to the SRO, this does not mean that the parties immediately receive it. Sometimes, the parties receive the arbitrators decision months after the arbitration.
More than a month after the arbitration, the attorney receives the panels decision. After the summary of the respective claims, the award states, "The arbitrators find in favor of the Claimant and award her $25,000." The attorney is only moderately pleased. She remembers someone saying that arbitrators, if they award for the claimant, frequently "split the baby." This is what happened to her. She dismisses the thought of an appeal, however, because appeal rights are extremely limited and because the client recovered her out-of-pocket costs and then some. That is no victory, however, the client is better off than if she had not filed her arbitration claim.Conclusion
Although the prospect of representing a client in a securities arbitration appears daunting, an attorney should not be dissuaded from doing so. The attorney should consider hiring an expert at the early stages to assist in case development, and might consider co-counseling the case with more experienced claimants counsel. Most securities claims, however, settle, and, for those that proceed to arbitration, the statistics show that claimants win the majority of cases.
It has been said that nothing hides sin like a bull market. Today, there are more investors, more types of investments, and more stockbrokers than ever before. Cases of the future will likely involve claims asserting not just that money was lost, but also that higher returns should have been realized.
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