Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Monday, July 19, 2010

SEC Approves FINRA Rule Allowing Witnesses to have Legal Representation

The SEC approved FINRA's proposed rule change to amend Rule 12602 of the Code of Arbitration Procedure for Customer Disputes  and Rule 13602 of the Code of Arbitration Procedure for Industry Disputes to provide that a non-party witness may be represented by an attorney at an arbitration hearing while the witness is testifying. FINRA explains that it had not perceived that arbitrators were denying witnesses the right, but thought it was appropriate to have a rule explicitly giving witnesses the right

July 19, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

FINRA Files Revised Discovery Guide with SEC

FINRA recently filed with the SEC its proposed new Discovery Guide which includes new Document
Production Lists.  This revision of the Discovery Guide has been a long time in the works and is the product of much discussion among FINRA and practitioners from both claimants' and respondents' sides.  The next step is for the SEC to publish the Guide for public comments.

July 19, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

FINRA Extends Pilot Program Allowing All-Public Arbitrator Panels for a Third Year

FINRA recently announced an extension of its voluntary pilot program of allowing investors in arbitrations with 3-person arbitration panels against participating firms to select all-Public Arbitrator panels.  Initially, the Pilot Program was designed to run for two sequential years. Year One began October 6, 2008, and ended October 5, 2009. Year Two began October 6, 2009, and ends October 5, 2010. Recently, participating firms agreed to extend the Pilot Program for an additional year at the same case levels, while FINRA goes through the evaluation and decision making process. Year Three begins October 6, 2010, and ends October 5, 2011.

July 19, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Saturday, June 26, 2010

FINRA Arbitration Panel Tells Goldman to Pay $20.6 Million to Bayou Group Creditors

A FINRA arbitration panel ordered Goldman Sachs Group to pay $20.6 million (the largest arbitration award against a securities firm) to unsecured creditors of Bayou Group LLC.  The claimants alleged  Goldman, who acted as clearing broker for Bayou, ignored signs of fraud.  The fund's CEO, Samual Israel III, is in prison for fraud.  It is extremely rare to impose liability on a clearing broker for the fraud committed by a broker or an issuer.  As is customary, the arbitration panel did not give reasons.  WSJ, Goldman Told to Pay Bayou Fund Creditors.

June 26, 2010 in Securities Arbitration | Permalink | Comments (1) | TrackBack (0)

Tuesday, June 1, 2010

Arbitration Panel Awards Merkin Investor $1.75 Million for Madoff Losses

An investor in a feeder fund for Bernard Madoff run by Ezra Merkin was awarded $1.75 million in a AAA arbitration.  An unusual aspect is that both the majority and the dissenting arbitrator provided a written explanation for their decisions, which have become publicly available.  The Chair stated that because the claimant requested a reasoned award and given the substantial damages sought and the time and resources put into the case, he felt the parties deserve to know how the panel evaluated the evidence and came to its award.  The majority found that Merkin intentionally breached his fiduciary duties to the claimant by failing to disclose the fund's integral association with Madoff.  It found that Merkin was negligent (but not grossly negligent) in his oversight over the investment and so was not liable under the investment agreement.(Download 1 75M ARBITRAL AWARD V EZRA MERKIN)

June 1, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Friday, May 21, 2010

FINRA Proposes Rule Change to Increase Number of Arbitrators on List

The SEC posted on its website FINRA's proposed rule change, to amend Rules 12403 and 12404 of the Code of Arbitration Procedure for Customer Disputes (“Customer Code”) and Rules 13403 and 13404 of the Code of Arbitration Procedure for Industry Disputes (“Industry Code”) to increase the number of arbitrators on each list generated by the Neutral List Selection System (“NLSS”).  A complaint of the FINRA arbitration selection process has been that after the parties exercise their right to strike names, there are no arbitrators left on the list, and FINRA must select arbitrators that were not on the parties' list.  FINRA explains that the amendment would expand the number of arbitrators on each list (public, non-public, and public chairperson) generated through NLSS from eight arbitrators to 10 arbitrators. Thus, in every two party case, at least two arbitrators would remain on each list after strikes. The additional number of arbitrators will increase the likelihood that the parties will get panelists they chose and ranked, even when FINRA must appoint a replacement arbitrator.

May 21, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Monday, May 17, 2010

Is Mandatory Securities Arbitration Likely to be Abolished?

Today I appeared as part of a panel of experts on securities arbitration before the SEC Investor Advisory Committee.  The Committee appears to be considering seriously a recommendation to eliminate mandatory securities arbitration.  As an investor advocate (particularly for small retail investors), I believe that securities arbitration is a better, fairer process for most investors than litigation.  Accepting that, it presents the question:  if arbitration is better for most investors, and the industry wants arbitration, then won't parties agree to it post-dispute anyway?  The answer is not necessarily.

Scholars who have studied consumer and employment arbitration note that the incentives to support arbitration change when the system becomes voluntary.  Similarly, brokerage firms have cost advantages attributable to mandatory arbitration that may be lost in a voluntary system.  Once a dispute has arisen, each side will have a view about its claim will fare better in court or in arbitration.  As a result, they are unlikely to agree, post-dispute, on a choice of forum.

Suppose, for example, a $25,000 claim for breach of the suitability rule.  The investor is likely to want arbitration, while the firm has strategic advantages to insist on court -- it won't be cost-efficient to litigate this claim, and there is no private cause of action for breach of an SRO rule.  Conversely, if a disabled investor has a $5 million claim for fraudulent misrepresentations, the investor's attorney will want to take the case to a jury, with all the attendant publicity, while the firm would prefer arbitration.

As a result, the number of claims going to arbitration will decrease.  There is some empirical evidence in other types of arbitration (employment and consumer) that post-dispute arbitration agreements are rare.  The incentives on the part of the firm to support arbitration decrease.  In addition, the resources devoted to maintain a fair and efficient arbitration forum -- which, on the part of FINRA, are considerable, would likely decrease.

The complication in the securities arbitration area is that FINRA Rule 12200 provides that a customer can always require the firm to arbitrate its claim.  FINRA takes the position that it is essential for investor protection that FINRA maintain Rule 12200 if Congress and the SEC decide to limit or prohibit mandatory arbitration.  However, in that event, we can expect that the securities industry would campaign to eliminate Rule 12200 as one-sided and unfair to the industry. 

May 17, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Tuesday, May 4, 2010

Amendment to Harmonize Broker-Dealer/Investment Adviser Regulation Will be Introduced in the Senate

Senators Menendez and Akaka plan to introduce an amendment (Download Menendez amendment) to the Senate's version of the financial reform legislation that will require the SEC to enact rules to provide that broker-dealers that offer personalized investment advice about securities to retail customers are subject to the same standard of conduct applicable to investment advisers.  However, the law would not require broker-dealers to have a continuing duty of care or loyalty to the customer after providing personalized investment advice.  In addition, an amendment to the Investment Advisers Act would provide that the standard of conduct for all brokers, dealers and investment advisers, when providing personalized investment advice about securities to retail customers, shall be "to act in the best interest of the customer without regard to the financial or other interest of the advice giver."  The receipt of compensation based on commission or other standard compensation for the sale of securities shall not, by itself, be considered a violation of the standard.  The section specifically provides that any material conflicts of interest must be disclosed and consented to in advance by the customer.  The SEC would have the authority to extend the standard to other customers as well.This amendment would replace the current language in the Senate bill that calls for the SEC to conduct a study. 

As I have discussed in a recent paper, there is a consensus that applying different standards of conduct for those who provide investment advice to retail customers makes no sense; the battle (and it is a fierce one) is what the common standard should be.  Unfortunately, the debate is generally framed as whether broker-dealers should be subject to a fiduciary duty as investment advisers are.  Framing the issue this way is an unfortunate simplication since it is based on two basic misunderstandings: (1) there is a clear understanding of what a fiduciary standard requires of investment advice providers, and (2) brokers do not currently owe their customers standards of care and loyalty. 

I argue in my paper that retail customers will benefit from improved protection if the law gave full effect to the existing professional standards of care and  competence (due diligence, suitability) recognized under SRO rules.  In addition, the disclosure rules with respect to conflicts of interest need to be strengthened; the boilerplate after-the-fact disclosure of possible conflicts of interest on confirmations is manifestly inadequate.  All this can be accomplished by the SEC through its existing rule-making authority without mention of the confusing amorphous "fiduciary duty" language.

Moreover, the Akaka/Menendez amendment has one serious deficiency -- it would not permit the SEC to adopt rules that would extend the broker's duties to the customer after the time of the transaction.  This reflects the current law that generally the broker's duty is transaction-specific and does not include monitoring the customer's portfolio.  However, many brokers sell their services to the customer on the basis of their ongoing attention to the customer's needs.  Where brokers represent that they are monitoring the account, they should be held to their word.

Finally, if Congress is serious about improving investor protections, it should adopt a federal private cause of action for negligent adviser advice.  Unless there is an explicit private federal remedy, brokers can recite the current law that there is no private cause of action for breach of SRO and SEC rules (apart from Rule 10b-5, which requires scienter), to limit their liability.  Fortunately, under SRO arbitration, arbitrators are not required to apply legal tests about the limits of implying private causes of action and frequently will allow customers to recover.  Whatever the deficiencies in manddatory SRO arbitration, this is its great benefit to investors.  However, if Congress determines that mandatory SRO arbitration should be prohibited, investors will be forced to bring their claims in either state or federal court, which will apply the current anti-investor law. There is nothing in the proposed legislation that would give investors any right to recover damages based on any SEC conduct rules adopted pursuant to this legislation.

May 4, 2010 in News Stories, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Sunday, February 21, 2010

Recent S.D.N.Y. Opinion Addresses Arbitrability Issues

In a recent S.D.N.Y. opinion, UBS Securities, LLC v. Voegeli (Jan. 26, 2010), Judge Cote held that a lockup agreement between the underwriter for an issuer in an IPO and an investor in the issuer did not make the investor a "customer" under the FINRA Rules entitled to comepl arbitration of its claims.  In deciding the case for the firm, the judge addressed several important issues: (1) subject matter jurisdiction, when a securities firm brings an action in federal court to enjoin a securities arbitration, (2) the test for granting an injunction against proceeding with a pending arbitration, (3) the definition of "customer" under FINRA Rule 12100(i).  Judge Cote held:

(1)  Since the investor alleges Rule 10b-5 violations in the underlying dispute, subject matter jurisdiction exists. (Complete diversity was lacking, so it was necessary to find federal subject matter jurisdiction.)

(2) Since the firm would suffer "irreparable harm" if required to arbitrate a non-arbitrable claim, injunctive relief was appropriate.

(3)  The lockup agreement did not contain an arbitration agreement and did not make the investors UBS customers.  "Customer" under FINRA Rule 12100(i) refers to one involved in a business relationship with a FINRA member that is related directly to investment or brokerage services.  The investors' broad interpretation of the rule -- that anyone not a broker or a dealer is a customer -- is "absurd."

February 21, 2010 in Judicial Opinions, Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Friday, February 5, 2010

Finra Looking for a Few Good Arbitrators

Concerns have been expressed for some time about whether FINRA will be able to handle the deluge of customers' complaints against brokers resulting from the financial meltdown.  The Wall St. Journal, for example, reports today that FINRA is reaching out to its arbitrators and asking them to handle cases in locations where arbitration hearings on Morgan Keegan mutual funds are centered, including Atlanta, Birmingham, New Orleans and Orlando.  More than 400 complaints have been filed against the firm, whose funds dropped in value by as much as 82% after the financial meltdown.  WSJ, Arbitrator Out of Work? Call Finra.

What would have been the effect on the judicial system if these cases had been filed in court?  Would investors' needs have been better met? 

February 5, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Friday, January 22, 2010

Customers' Arbitration Claims Up 43% in 2009

FINRA reports 7137 arbitration claims were filed in 2009, up 43% from 2008.  Not surprisingly, the most common complaints against brokers were breach of fiduciary duty, misrepresentations, negligence, breach of contract, failure to supervise, omissions and unsuitability.

January 22, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Monday, January 4, 2010

FINRA Arbitration Panel Awards Punitive Damages Based on Elder Abuse

Arbitration awards against online discount brokerage firms are rare, as are punitive damages in general and punitive damages based on elder abuse.  Yet Investment News reports that a FINRA arbitration panel in California awarded $320,000 in compensatory damages and $960,000 in punitive damages, citing elder abuse.  The claimant was a 95-year old investor who alleged that brokers coerced him into unsuitable trades.  InvNews, Discount broker slapped with triple damages in rare elder abuse award

January 4, 2010 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Monday, December 21, 2009

SEC Approves Amendments to FINRA Arbitration Rules

On December 18, the SEC approved amendments to the FINRA arbitration rules.  While mostly of a housekeeping nature, the one amendment that could affect investors is a provision that states that customers may be responsible for hearing fees if they file a claim against the broker in response to the broker's claim against them.  As the FINRA notice (09-74) states:

Under the old Code, arbitrators could allocate hearing session fees against any party.
Rule 10332(c)10 of the old Code protected customers from potentially higher forum fees
(now hearing session fees) triggered by amounts sought in industry claims by
prohibiting the arbitrators from assessing forum fees against customers if the industry
claim was dismissed.Moreover, the rule protected customers from higher forum fees by
requiring that the amount of the forum fees be based on the amount awarded to an
industry party and not on the amount of damages requested by the industry claim.
However, Rule 10332(c) also provided that customers could be subject to potential
forum fees based on their own claims for relief in connection with the industry claim.
During the drafting of the Code Revision, FINRA inadvertently omitted from the
corresponding rule in the Customer Code the provision (in old Rule 10332(c)) that
permitted the forumto assess fees against the customer based on the customer’s claim
in an industry dispute. Thus, FINRA has amended Rule 12902(a)(4) to incorporate the
omitted language, which makes it clear to customers that if they file a claim in
connection with a claim filed by a firm, they may be subject to filing fees and hearing
session fees based on their own claim for relief.

December 21, 2009 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Tuesday, August 11, 2009

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)

August 11, 2009 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Wednesday, July 8, 2009

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. 

July 8, 2009 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Monday, June 29, 2009

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.

June 29, 2009 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Monday, June 15, 2009

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)

June 15, 2009 in Securities Arbitration | Permalink | Comments (1) | TrackBack (0)

Thursday, May 21, 2009

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.

May 21, 2009 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Friday, April 17, 2009

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.) 

April 17, 2009 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)

Tuesday, April 7, 2009

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.

April 7, 2009 in Securities Arbitration | Permalink | Comments (0) | TrackBack (0)