Securities Arbitration - By Marya M. Santor

Billions of dollars are traded by millions of people in the securities industry each year, and each year there are winners and losers.  Unfortunately, in recent years there have been infinitely more losers than winners.  The inevitable disputes that arise when investors lose money in the stock market must be carefully evaluated to sort out those investors with legitimate claims from those who simply rolled the dice in the market and now have to hope it goes back up before they retire. 


As with any other litigation, potential litigants fall into several different categories:  those with great claims, those without, and everyone else.  Many factors must be considered when evaluating a potential claim.  The type of investment must be suitable for a particular investor’s needs.  An investor’s risk tolerance is determined by the investor’s age, retirement status, and financial situation, including his or her assets and the diversity of those assets. An investor’s education and investment experience can be clues into how much an investor understands the investment he or she is making.  Brokers have a higher duty if they solicit or recommend a trade than if the trade is unsolicited.  And finally, brokers have a responsibility to provide investors with all pertinent information about any possible trade, both the upside and downside.


Three individuals who lose 70% of their investment after being given the same advice can be in very different positions when it comes to evaluating their potential claims.  In October 2007 (when the Dow Jones hit 14,164), a broker recommended to three different people that they invest their entire account in a single high-risk stock that had performed very well over the preceding year.  An 86-year-old retired coal miner with no investment experience and limited retirement assets (all of which were contained in one modest retirement account) invested in the stock after he received a cold call from the broker assuring him that it was a great deal and that the stock had made his clients a lot of money.  A 30-year-old multi-millionaire day-trader with an MBA in finance and diverse sizable assets located in separate accounts called the broker to discuss a possible investment in the stock.  She was counseled that it was a high-risk investment with the potential for a high return and decided to invest. A 55-year-old doctor with a healthy income and retirement assets managed by several different firms and a 10-year history of investing in the markets purchased the stock after receiving a cold call from the broker.  The broker recommended the stock purchase and told him it had the potential to make him a lot of money.  The 86-year-old retired coal miner probably has a great claim, the 30 year-old, multi-millionaire day-trader probably does not, and the 55-year-old doctor’s potential claim is worth exploring more fully.


If a claim is against a registered representative (broker) or a brokerage firm, it is generally required to be submitted to arbitration.  Pre-dispute arbitration agreements are wide spread in the securities industry as part of most account opening documents and are generally enforceable under the Federal Arbitration Act.  The Federal Arbitration Act established that pre-dispute arbitration agreements are “valid, irrevocable, and enforceable,” and parties subject to a pre-dispute arbitration agreement must bring their claim to arbitration instead of court.  The Act also limits the grounds on which a court can vacate or modify an arbitration award.   Although an early Supreme Court case craved out an exception to the enforcement of pre-dispute arbitration agreements for securities disputes, the Court later reversed its ruling.  The Court in Shearson/American Express, Inc. v. McMahon 482 U.S. 220 (1987) and Rodriguez de Quijas v. Shearson/American Express, Inc. 490 U.S. 477 (1989) found that pre-dispute arbitration agreements were enforceable in securities disputes. FINRA (which is a self-regulatory organization overseeing the securities market) rules also require that all brokers and brokerage houses submit to arbitration at the request of a public customer.  


Since the regulatory division of the NYSE merged with the NASD in 2007 and became FINRA, virtually all securities arbitrations are administered by FINRA.  FINRA was created under authority provided in the Securities Exchange Act of 1934.  It is overseen by the SEC, which has the power to review and approve or disapprove its rules.  FINRA’s primary charge is protecting the public, and, therefore, many of its arbitration rules are tilted toward the investor in securities disputes.  The Code of Arbitration Procedure for Customer Disputes governs all investor disputes administered by FINRA and can be found on its website.  FINRA also administers arbitration between industry parties under similar though slightly different rules.


To begin securities arbitration with FINRA, a public investor files a statement of claim with the Northeast Regional Office of FINRA.  The statement of claim may be filed online or through the mail.  The Northeast Regional Office then sends the statement of claim to one of the four Regional Offices based on where the hearing location will be.  In public investor cases, the hearing location is generally determined by where the investor lived at the time the dispute arose.  There is at least one hearing location in each state as well as one in Puerto Rico and one in London.  The only hearing location in Washington is Seattle, and it is administered by the Western Regional Office in Los Angeles, California.


Once the statement of claim is received by the Regional Office, it is evaluated for deficiencies before it is served on the respondents.  A claim will be found to be deficient if it fails to set out the basic facts of the dispute, a submission agreement is not filed, the correct number of copies are not filed, or the correct filing fee and hearing session deposit are not submitted.  The filing fee and hearing session deposit are based on the amount in controversy and can be as high as $600 for the filing fee and $1,200 for the hearing session deposit.  Large requests for punitive and treble damages should be considered carefully, because they are included in the calculation for fees and are very rarely granted in arbitration.  A few special rules to keep in mind when filing a claim: (1) elderly or seriously ill parties can request an expedited arbitration proceeding and (2) filing fees and hearings session deposits can be waived for financial hardship.  


Once any deficiencies are corrected, FINRA serves the statement of claim on the respondents.  Respondents have 45 days to file an answer and submission agreement.  After the answer is filed, the arbitration selection process begins. 


Small claims of $25,000 or less are handled on a simplified basis: a single arbitrator is appointed to decide the matter and the decision is made on the papers without a hearing.  The public investor may elect to have a hearing on the matter; the industry parties may not.  For claims between $25,000 and $100,000; a single arbitrator is appointed and a hearing on the merits is held.  For claims over $100,000, a three-arbitrator panel is appointed and a hearing on the merits is held.


Arbitrators are selected from three different lists: (1) a list of public arbitrators with no connection to the securities industry, (2) a list of non-public or industry arbitrators, and (3) a list of public chair-qualified arbitrators.  A single arbitrator panel consists of an arbitrator selected from the public chair-qualified list.  A three-arbitrator panel consists of a single arbitrator selected from each list.  Parties receive a list of eight arbitrators for each list and may each strike up to four arbitrators per list.  FINRA then consolidates the lists and a panel is selected.  If all arbitrators from a particular list are struck by the parties, FINRA will appoint the panel without any further input from the parties. After an arbitrator is appointed, the parties may challenge the arbitrator.  When a challenge is made to the service of one of the arbitrators, close calls are made in favor of the public investor.


After the arbitrators are selected, FINRA sets an initial pre-hearing conference during which the parties and the arbitrators set a schedule for the case and the hearing dates.  During this conference, additional pre-hearing conferences may be scheduled to deal with discovery issues or substitutive motions.  Pre-hearing conferences are held by telephone.  Prior to the hearing on the merits, the parties complete discovery.  Discovery in arbitration is more limited than what is allowed in court.  Interrogatories are limited and depositions are discouraged except in situations such as to preserve the testimony of a dying material witness.  However, extensive document production is conducted in arbitrations. The Discovery Guide sets out detailed discovery lists which are presumptive discoverable in public customer cases.  Parties are required to cooperate in the exchange of documents, but the intervention of arbitrators is often necessary.


The hearing on the merits is structured much the same way as a trial is structured, although it is less formal.  The hearings generally take place in a conference room at a hotel or business center.  The parties start with opening argument, witnesses are called and then the parties end with closing argument.  Witnesses may be cross examined by opposing counsel and questioned by the arbitrators.  Out-of-town witnesses often testify by phone.  Additionally, formal rules of evidence do not apply in arbitration, so documents are more liberally admitted than in court.


When drafting pleadings and preparing for the hearing, it is important to remember that there are significant differences between a FINRA arbitration panel and other commercial arbitration panels.   Most commercial arbitration panels consist of judges, seasoned arbitrators, or at the very least attorneys.  It is not usual for an arbitration panel not to have an attorney on it.  The chair may not even be an attorney.  Because of this, the facts of a particular case often become much more important than the actual law.  


After the hearing is concluded, the arbitrators issue their award.  The awards contain only the basic information and generally no explanation of the arbitrators’ reasoning.  Parties may jointly request that the award contains a recital of the general findings of facts leading to the award.  This request must be joint and filed 20 days before the first scheduled hearing.  Arbitration awards are required to be paid within 30 days.  If an award is not paid within 30 days, FINRA has the power to suspend the respondent from the industry.  This generally means that if an award is granted, it will be paid.


Securities arbitration case filings are cyclical and lag a little behind the market.  Case filing peaked in 2003/2004 near 10,000 per year and fell to a little more than 3,000 in 2007.  Not surprisingly case filings are up 86% this year over last.


Maria M. Santor is an attorney with her own practice, Santor Law Firm.  With offices located in Bothel; she provides legal services in King and Snohomish Counties.  Her areas of practice center around securities arbitration, business and litigation, estate planning and probate, and medical malpractice and personal injury.  Maria may be contacted through her website as

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