Securities Law Prof Blog

FINRA Tells SEC It's Premature to Mandate Elimination of Industry Arbitrator in Customer Disputes

One of the persistent criticisms of arbitration of customer-broker disputes before FINRA Dispute Resolution is the requirement that one of three arbitrators must come from the securities industry.  Many investors and their advocates are suspicious of an industry-sponsored mandatory dispute resolution system that mandates industry representation on the arbitration panel.  Defenders of the system argue that an industry arbitrator adds expertise and knowledge of industry practices to the panel. 

Beginning in October 2008 FINRA launched a two-year pilot program that allows investors to choose a panel consisting of three public arbitrators.  Eleven brokerage firms volunteered to participate in the pilot program, each contributing a set number of cases sto the pilot per year for two years. In June the Public Investors Arbitration Bar Association (PIABA) filed with the SEC a proposed rule change petition requesting the SEC require by rule that the parties in an arbitration have the power to select an all-public panel in any investor claim in which the amount in controversy exceeds $100,000.  In essence, PIABA seeks to make the key elements of the pilot program permanent before the pilot's expiration in October 2010.

FINRA filed a response to PIABA's petition, which the SEC has posted on its website.  As described by FINRA , PIABA's petition incorporates most aspects of the pilot, with one notable exception.  PIABA would mandate the pilot rules for all investor cases rather than providing investors with a choice in panel composition.  FINRA notes that investors and their counsel in many pilot-eligible cases have elected not to participate in the pilot, suggesting that choice is important to preserve.

FINRA's position is that the pilot program should continue for its two-year term, after which the SRO would study its results and assess its effectiveness.  It plans to survey participants in the pilot and seeks input on other ways to measure the results.  In short, FINRA argues that it is premature for the SEC to mandate elimination of the industry arbitrator.

(hat tip:  Jill Gross)

Pace Investor Rights Clinic Investor's Guide to Securities Industry Disputes

The Pace Law School Investor Rights Clinic has published an Investors' Guide to Securities Industry Disputes( Securities Dispute Guide).  This extremely useful guide first provides basic information on how to avoid disputes with brokers and sets forth investors' rights and responsibilities.  It then provides information on the dispute resolution process, including both arbitration and mediation.  The Guide contains practical information in a very readable format.  Kudos to its editors Jill Gross and Alice Oshins. 

FINRA Files Proposed Changes to Arbitration Code

FINRA has filed with the SEC a proposed rule change to amend Rules 12100(r), 12506(a), and 12902(a) of the Code of Arbitration Procedure for Customer Disputes (“Customer Code”) and Rule 13100(r) of the Code of Arbitration Procedure for Industry Disputes (“Industry Code”) to amend the definition of “associated person,” streamline a case administration procedure, and clarify that customers could be assessed hearing session fees based on their own claims for relief in connection with an industry claim.  According to the accompanying releases, these amendments are necessitated by inadvertent deletions of language from the previous Code. 

Comments are due 21 days after publication in the Federal Register.

PIABA Submits Petition to SEC to Eliminate Requirement of Industry Arbitrator in Customer Disputes

The Public Investors Arbitration Bar Association ("PIABA") submitted to the SEC, pursuant to SEC Rule of Practice 192A, a rule change petition to eliminate the requirement that an arbitrator affiliated with the securities industry sit on all customer cases in which the amount in controversy exceeds $100,000 which are arbitrated before the Financial Industry Regulatory Authority ("FINRA"). PIABA proposes that investors and industry parties be given the choice to decline to have an industry arbitrator sit on panels that hear and decide their cases.  PIABA believes that FINRA Dispute Resolution (FINRA-DR) Code of Arbitration Rule 12402, mandating one industry arbitrator on all three person panels in arbitration actions between customers and industry members, unfairly and systemically shifts the balance of justice against customers and that requiring customers who believe they have been wronged by the securities industry to have claims decided by panels that must include a representative of that securities industry creates at the least the appearance of bias, if not outright bias. 

(thanks to Jill Gross for calling this to my attention)
 

NASAA Supports Arbitration Fairness Act of 2009

NASAA today announced its full support of the Arbitration Fairness Act of 2009 (S. 931, H.R. 1020), which seeks to protect the right of Americans to have their day in court by making pre-dispute agreements requiring arbitration for any employment, consumer, franchise or civil rights disputes unenforceable.  The legislation was introduced by Sen. Russ Feingold (D-WI) and seven cosponsors in the Senate and Rep. Hank Johnson (D-GA) in the House, where H.R. 1020 has the support of 57 cosponsors. 

NASAA specifically noted that the Senate version of the proposed legislation specifically includes services relating to securities.  Currently almost every broker-dealer includes in their customer agreements a provision that requires public investors to submit all disputes that they may have with the firm and/or its representatives to mandatory arbitration. NASAA has long supported reforms to this system.

Federal Court Refuses Government Request to Stay FINRA Arbitration

U.S. v. FINRA, a recently issued opinion from the federal district court (E.D.N.Y. Apr. 9, 2009), presents an interesting issue stemming from the collapse of Bear Stearns hedge funds.  The U.S. sought to enjoin FINRA from conducting arbitration proceedings brought by a customer pending completion of a related criminal case against the hedge fund managers.  Although the defendants in the criminal case were not parties to the arbitration, both proceedings involved the same subject matter --whether the criminal defendants' conduct was securities fraud.  The court denied the government's petition.  It concluded that the only "prejudice" to the government in allowing the arbitration to proceed was that the criminal defendants would have more information than they would otherwise be entitled to under the Federal Rules of Criminal Procedure and that "this loss of the government's usual tactical advantage is insufficient to justify enjoining the arbitration."  (Thanks to Jill Gross for calling this to my attention.) 

SIFMA Calls Proposed Changes to Arbitration Discovery Guide "Fundamentally Unfair"

On March 6, 2009 the SEC published for public comment FINRA's proposed rule change on  Amendments to the Discovery Guide to Update the Document Production Lists (Release No. 34-59534; File No. SR-FINRA-2008-024).  Comments were due April 3.  A number of comment letters have been filed in response to the proposal.  SIFMA filed a lengthy response asserting that some of the proposed changes were "fundamentally unfair" to brokers:

Our overarching general concern with the proposed amendments is that they go too far in certain areas – for example, in calling for the production to claimants of a broker’s own trading history and the trading history of wholly unrelated customers without any showing of relevance, need, or bearing on the case to justify production of these personal and sensitive records. This is particularly so for claims of excessive trading (List 3), unauthorized trading (List 9), and claims involving particular products or securities (List 12). To the extent the proposals require production of these records without such a showing, they are fundamentally unfair.

FINRA Arbitration Filings Up 90% Over 2008

Summary Arbitration Statistics from FINRA's website:

New Case Filings through February 2009:
 
2007        535
2008        561
 2009        1,065
 2009  vs 2008    90%
 
 
 

FINRA Panel Awards Customer Over $30 Million in Damages from Merrill

On March 16, A FINRA arbitration panel awarded claimants $30.6 million in compensatory damages (the full amount of claimant's claim), plus 9% interest, against Advest, Inc. and Merrill Lynch, one of the largest awards in a customer dispute.  The claimant, the Trustees of the Masonic Hall and Asylum Fund, charged Advest and Merrill with negligence, breach of contract, misrepresentation and breach of fiduciary duty in connection with the purchase of interests in Sphinx Managed Futures Index Fund.  The award also ordered the claimant to assign to Merrill its interest of its claims in New York State courts against Price Waterhouse Coopers and in the liquidation proceeding of the Sphinx Fund to the extent of the monetary award recovered in the arbitration.

The arbitration was conducted in Albany, NY.

FINRA Announces Explained Award Rule

Effective April 13, 2009, FINRA will require arbitrators to provide an explained decision at the parties' joint request. An explained decision is a fact-based award stating the general reasons for the arbitrators' decision. Parties will be required to submit any joint request for an explained decision at least 20 days before the first scheduled hearing date. The chairperson of the arbitration panel will write the explained decision and will receive an additional honorarium of $400 for doing so.  Regulatory Notice 09-16

SEC Settles with Four Individuals Charged with Insider Trading in Dick's Sporting Goods Stock

The SEC announced that on February 6, the U.S. District Court Judge for the Western District of Pennsylvania entered Final Judgments against four individuals charged with insider trading in advance of Dick's Sporting Goods Inc.'s June 21, 2004, announcement that it intended to acquire Galyan's Trading Company, Inc. via a tender offer. The complaints, which the SEC filed on September 30, 2008, alleged:

Joseph J. Queri, Jr., who was Dicks' Senior Vice President of Real Estate, tipped his close friend, Gary Gosson, and his father, Joseph Queri, Sr., about the acquisition.

Gosson tipped several friends, including defendants Joseph A. Federico, Philip J. Simao and Mark J. Costello, who all bought shares of Galyans stock.

Queri Sr. also tipped several friends, including Gino M. Ferraro. Ferraro tipped his son-in-law, defendant Franko J. Marretti III, who traded and tipped a business colleague.

The day after the public announcement, Galyan's stock closed at $16.68, a 50.3% increase from the previous day's closing price of $11.10.

Without admitting or denying the allegations in the complaint, Federico, Simao, Costello and Marretti consented to the entry of a Final Judgment in which they are permanently enjoined from future violations of the antifraud provisions of the securities laws, Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 and Rules 10b-5 and 14e-3 thereunder. Federico also agreed to pay disgorgement of $23,326.00, plus prejudgment interest of $7,540.22, and a one-time civil penalty for trading in the amount of $23,326.00. Simao agreed to pay disgorgement of $13,390.00, plus prejudgment interest of $4,328.37, and a one-time civil penalty for his trading in the amount of $13,390.00. Costello agreed to pay disgorgement of $9,540.00, plus prejudgment interest of $3,083.85, and a one-time civil penalty for his trading in the amount of $9,540.00. Finally, Marretti agreed to pay disgorgement of $9,552.00, plus prejudgment interest of $3,150.92, and a civil penalty for trading and tipping a colleague in the amount of $54,817.00. The Commission has now obtained settlements from nine of the sixteen defendants.

SEC Approves FINRA Rule to Raise Amount for Single Arbitrator to $100,000

The SEC approved a proposed rule change submitted by FINRA to amend the Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes to raise the amount in controversy that will be heard by a single chair-qualified arbitrator to $100,000. Publication is expected in the Federal Register during the week of February 2.

SIFMA Holds TARP Summit

SIFMA held on Summit on TARP on November 10, at which Interim Assistant Secretary for Financial Stability Neel Kashkari presented remarks.  In addition, the SIFMA website has webcasts of both Kashkari's remarks and Senator Charles Schumer's speech.

FINRA Dispute Resolution Expands Discovery Pilot Program

FINRA Dispute Resolution expanded its voluntary discovery arbitrator pilot, which it first launched in its Southeast and Western Regional hearing locations in 2005, to address concerns about discovery in arbitration. FINRA has also added non-public arbitrators to the pilot for certain intra-industry cases. Under the pilot, the Director of Arbitration appoints a single discovery arbitrator to resolve all discovery disputes before the hearing. The discovery arbitrators do not serve on the panels that decide the cases; they only decide the parties' discovery disputes. Parties participating in the pilot have described it as cost effective with arbitrators providing consistent decisions on discovery issues.

If parties wish to participate in the pilot, they must sign a stipulation and be represented by counsel.

FINRA Releases Report Card on Securities Arbitration

Editor's Note to FINRA's Arbitration Policy Task Force Report—A Report Card:

In 1994, NASD, now the Financial Industry Regulatory Authority (FINRA), assembled a group of outside experts, led by former Securities and Exchange Commission Chairman David S. Ruder, to conduct a thorough examination of the nature of securities arbitration and recommend a roadmap for the future. It was the first comprehensive assessment of securities arbitration since the Supreme Court decisions in the late 1980s that held predispute arbitration agreements enforceable.

The task force report, Securities Arbitration Reform, recommended comprehensive proposals to revamp securities arbitration. The recommendations in the report formed the framework that currently guides FINRA's dispute resolution policy and rulemaking. FINRA has implemented nearly every key recommendation and has worked extensively to preserve and respect the basic elements of a fair and efficient dispute resolution system. FINRA's Arbitration Policy Task Force Report—A Report Card traces the actions taken in response to those recommendations.

What is the Problem with Securities Arbitration?

Critics of the securities arbitration process frequently express concerns about bias -- the fact that in a three-person panel one arbitrator will be a member of the securities industry and the fact that public arbitrators may have ties to the industry.  See Gretchen Morgenson's article in today's New York Times for an expression of these concerns.  However, in my opinion, a more serious concern goes to the competence of arbitration panels, or, more charitably, whether it is reasonable to expect individuals who serve as occasional arbitrators for minimal pay, to perform the functions of a judge.  A recent 2d Circuit opinion, Porzig v. Dresdner, Kleinwort, Benson, North America, LLC, provides a good illustration.  In this arbitration, the panel found that "age was a factor" in the termination of Porzig's employment by Dresdner.  Despite the fact that the federal statute requires an award of attorney's fees and costs to a prevailing plaintiff in an age discrimination claim, as Porzig's attorney advised the panel, the panel originally denied both to Porzig.  The federal district court concluded that denial of attorney's fees and costs was in manifest disregard of the law and remanded the case to the arbitration panel to award attorney's fees and assess costs against Dresdner, not Porzig.  On remand, Porzig's attorney submitted detailed information of his services, the time spent, and the rate charged, documenting $250,000 in attorney's fees and another $12,000 in costs.  Porzig's attorney also provided the panel with clear legal authority supporting his costs.  Dresdner's attorneys submitted an opposing affidavit, arguing that Porzig's contingency fee agreement with his attorney should set the maximum amount of the attorney's fee; that an award of attorney's fees may be unnecessary to achieve the statutory purpose; and that Porzig's fee application should be substantially reduced, if not denied in its entirety.  After requiring submission of Porzig's contingency fee agreement, the panel awarded $75,000 in attorney's fees and another $8,5000 in costs, an amount approximately the same as the amount of the award Porzig's attorney retained as his contingency fee and costs.  The panel also ordered Porzig's attorney to remit to his client the amount of the award that he retained as his contingency fee and costs.

Porzig again sought vacatur and modification of the award, and, in vacating the modified award, the Second Circuit clearly expressly its annoyance at the behavior of both Dresdner's counsel and the arbitration panel.  The court comes close to accusing Dresdner's counsel of misstating the applicable law to the panel; the law is clear that the prevailing party in an age discrimination case is entitled to attorney's fees, not limited by the amount of any agreed contingency fee, and that amount includes time spent in litigating the fee.  The court emphasizes that vacatur of an award for manifest disregard is rarely granted, and that the law does not require arbitrators to give reasons.  However, in the absence of any explanation, the award of an amount approximating the amount of the contingency fee demonstrated that the panel acted in manifest disregard of the law, particularly in this case, when the award had been partially vacated and the case remanded to the panel for the purpose of calculating attorney's fees and costs.  The court clearly expected the arbitration panel to pay closer attention to the district court's instructions.

The opinion nicely illustrates a common problem facing arbitrators -- what are they to do when each side presents legal arguments that are (as is frequently the case when material issues are disputed) completely opposed to each other?  NASD Regulation (and presumably now Finra as well) instructed arbitrators that they were not to conduct independent research on any legal issue, but rely on parties to brief them on the law, and, of course, arbitrators, unlike judges, do not have support staff to research the law for them.  How are arbitrators, particularly those without legal training, supposed to assess strengths and weaknesses of the proponents' legal assertions?

The Second Circuit also deals with another issue that has been much debated in recent years -- whether an arbitration panel has any authority over the attorneys who represent parties to an arbitration.  The Second Circuit held that the arbitration panel had no authority to order Porzig's attorney to return his contingency fee to Porzig.  While the opinion specifically prohibits interference with the attorney-client relationship, it may have broader applicability.  The recent debate focused on whether the SRO rules could authorize panels to impose sanctions on attorneys for discovery or other violations; NASD Regulation withdrew the rule when many (including me) filed comment letters challenging the SRO's power to sanction private party's attorneys.      

Thanks to Jill Gross, for calling this case to my attention.

Study on SRO Arbitration of Customers' Disputes

Edward S. O'Neal, Securities Litigation and Consulting Group, and Daniel R. Solin, a securities arbitration attorney representing investors, released their report, Mandatory Arbitration of Securities Disputes: A Statistical Analysis of How Claimants Fare, this week.  The report is available at http://www.smartestinvestmentbook.com or http://www.slcg.com.  Here are the report's major  findings:

The raw win rate for investors in arbitration has dropped from a high of 59 percent in 1999 to 44 percent in 2004. This overall figure includes a lower win rate (39 percent) at the three largest brokerage firms that do business with the largest numbers of investors.

Award percentages reached a high in 1998 of 68 percent and have steadily declined to stabilize at approximately 50 percent in the 2002-2004 time period.

Investors in arbitration were awarded 22 cents on the dollar in 2004 (as a percentage the amount claimed) versus 38 cents on the dollar in 1998.

The larger the award and the brokerage firm involved, the smaller the recovery. Claimants in arbitrations against top 20 brokerage firms face an expected recovery percentage that is approximately 28 percent in claims under $10,000. The expected recovery percentage plunges to approximately 12 percent in claims over $250,000.

Award requests increased significantly over the entire period while average awards remained nearly constant. In 1998, the average award was $56,000 while in 2004 it was $59,000. This 6 percent increase in real awards is dwarfed by the difference in award requests, which rose over 300 percent from $168,000 in 1998 to $540,000 in 2004.

This is a significant research effort that is an important contribution to the literature on the fairness of securities arbitration of customers' disputes.  The authors collected information on NASD and NYSE arbitrations that occurred between January 1995 and December 2004.  Their database consisted of 13,810 arbitration awards, 90% from NASD and the remaining 10% from the NYSE.  Their conclusions about the drop in investors' win rates and the decrease in the percentage recovery are not new information; SRO statistics reveal the same trend.  No previous study, to my knowledge, has focused on correlations between the size of the requested damages and the size of the brokerage firms and the percentage recovery. 

I remain unconvinced, however, that these statistics demonstrate the existence of a serious "repeat player" problem that advantages major brokerage firms.  The problem with any study of awards is that it excludes the great numbers of cases that are settled and do not result in an award.  Thus, we are left with what may ultimately be an unrepresentative sampling.  In addition, any assessment of the fairness of a system without any examination of the merits of the claim and the assessment of damages (an impossible undertaking given the absence of meaningful information in the awards) must necessarily be incomplete.  The authors argue that brokerage firms have an advantage here because they have greater familiarity with the merits of settled claims than do claimants, but most claimants, at least those claimants seeking recovery of large amounts of damages, are represented by experienced claimants' attorneys who are equally knowledgeable about the system.

Finally, the authors' endorsement of the view that SRO arbitration is "a damage containment and control program masquerading as a juridical proceeding" is not supported by their findings and seems overblown.

SEC Approves New NASD Arbitration Code for Customer Disputes

Today, after a long wait, the SEC approved the NASD's rewrite of the Code of Arbitration.  A complete re-write of the Code to make it more user-friendly, there are now three separate codes -- one for customer disputes, one for industry disputes, and one for mediations (which had been approved by the SEC earlier).  Among the substantive changes are: broader authority for arbitrators to impose sanctions; enhanced qualifications for Arbitrator Chairs; changes in discovery procedures; and improved arbitrator selection provisions.  See the SEC's press release and its Order; see also the NASD's press release.

Percentage of Customers' Wins in NASD Securities Arbitration Down Again

The 2005 statistics show that a customer "wins"  (i.e., the customer recovers something) 43% of the time in NASD securities arbitration.  This continues a downward trend since the 2001 high of 54%. Results of Customer Claimant Arbitration Award Cases