Despite this history of volatility, most Americans continue to rely on investments in the financial markets to accumulate wealth and subsidize their retirement income. According to the 2011 Fact Book published by the Investment Company Institute (ICI), 51.6 million U.S. households (44 percent of all households) own mutual funds, and a substantial percentage of these mutual funds invest in stocks.3 Ninety-three percent of those households are saving for retirement, with their retirement assets totaling $17.5 trillion at year-end 2010.4 Typically, American investors hire financial advisers to make investment decisions. According to the ICI, about half (51 percent) of all mutual fund-owning households indicated they had ongoing relationships with financial advisers. Seventy-eight percent of mutual fund shareholders who reported using an adviser indicated that both they and their adviser initiated contact during this time period. Indeed, the nature of the relationship between a financial adviser and a client is one based on trust in that professional’s perceived financial acumen. In fact, many brokerage firms aggressively market themselves as skilled advisers competent to handle every aspect of their clients’ financial lives, from investments to mortgages, life insurance, long-term care, estate planning, and charitable giving. Some brokerage firms advertise that their financial advisers will monitor investments after a recommendation to purchase a security to ensure that the investor meets his or her long-term investment goals.
Studies in behavioral finance demonstrate that financial advisers are highly motivated to cultivate their clients’ trust and allegiance, and clients have powerful incentives to believe that such advisers are trustworthy and acting solely in the client’s best interests.5 Obtaining a client’s trust and confidence, and convincing the client that he or she should rely upon the investment advice given, is often at the heart of the broker/client relationship.
In many circumstances, investor losses are caused by bad investment advice and, in some instances, outright financial fraud. When these occur, a variety of legal claims may help investors successfully recover some or all of their losses. Unfortunately, investors typically do not have the capability and/or investment knowledge to determine whether their losses are caused by malfeasance or whether they were simply a natural consequence of investing in the financial market. As a result, the majority of investors do not know whether they might be able to recover their losses from advisers and/or their firms and many of these same individuals do not know that they may have legal recourse. Statistics provided by the Financial Industry Regulatory Authority (FINRA) Dispute Resolution, the organization that sponsors the arbitration forum handling virtually all disputes between financial firms/financial advisers and consumers, show that only 21,566 cases were filed by consumers between January 2009 and November 2011.6 If one assumes $6 trillion in stock market losses in 2008, these 16,255 cases amount to approximately one lawsuit for every $275 million in losses.
Frequently, attorneys, and other professionals such as accountants, who review client financial records or discuss general financial matters during the course of their representation (e.g., divorce proceedings or filing tax returns) also fail to identify investment abuse even when the circumstances are blatant. This failure can be attributed to (1) a failure to identify warning signs of financial abuse; (2) a failure to identify viable legal claims; and (3) a lack of familiarity with the dispute resolution process for these types of claims.
The purpose of this book is to provide a comprehensive discussion of securities arbitration practices and procedures with a particular emphasis on techniques to identify, evaluate, and pursue legal claims brought by investors against securities brokerage firms, and on the defenses thereto.
Section I provides the reader with general information about the securities arbitration practice. In addition to this introductory material, Section I explains the cast of characters that frequent disputes between retail investors and their financial professionals. The vast majority of disputes between investors and brokerage firms are resolved in arbitrations sponsored by the Financial Industry Regulatory Authority (FINRA). Section I outlines and discusses how FINRA not only regulates the financial services industry but also sponsors the arbitration forum to resolve disputes.
Many attorneys and/or their clients are not aware that FINRA’s Code of Arbitration limits the time period to bring eligible arbitration claims against their financial advisers to six years from the occurrence or event giving rise to the action. This “six-year rule” is different than traditional statutes of limitation. If an arbitration claim is not eligible for arbitration, the investor is required to file the case in court. While the case is eligible for arbitration, however, jurisdictions are split on the issue of whether statutes of limitation apply in the securities arbitration forum.
Section II of this book discusses application of the six-year eligibility rule as well as the interaction between the six-year rule and the application of statutes of limitation in the securities arbitration forum. Section II also provides additional information regarding filing deadlines within the FINRA arbitration process.
Section III of this book discusses the types of legal claims most commonly brought by investors against financial advisers and their firms. Common fact patterns and citations to FINRA rules and regulations are also included to help better explain how these claims arise and to assist practitioners in being able to more readily identify potential cases.
As with all cases, it is imperative for the attorney representing the client to be able to articulate and accurately state how the client has been damaged. Unlike a personal injury case, noneconomic damages such as pain and suffering are not typically recoverable. However, there are many different ways to calculate economic damages in securities arbitration cases. Identifying the correct measure of damages is critical to success. Section III of this book addresses the most common measures of damages.
Two of the most frequently raised arguments in favor of arbitration over court are that the arbitration process is more efficient and less costly. Some of the increased efficiency is due to the fact that the traditional discovery tools such as depositions, interrogatories, and requests for admissions generally are not permitted in FINRA arbitrations. In the vast majority of cases, document and information requests are the only permissible discovery tools for all parties. Pleading requirements are also less stringent than in court proceedings. Further, unless the parties participate in mediation prior to the arbitration hearing (a.k.a. trial), the first time that the attorneys for the parties get a chance to meet and question the opposing party is at the arbitration hearing. As a result, the strategies implemented by practitioners in pursuing and defending claims in arbitration are different than in court. For example, in addition to the limited discovery tools, many experienced securities arbitration practitioners draft and file more narrative statements of claims and answers that provide more detailed facts about the circumstances giving rise to the claims and applicable defenses. For attorneys who do not frequently represent parties in the FINRA arbitration process, this difference can be a big surprise.
Section IV of this book addresses the procedures for conducting meaningful discovery and strategies for initiating and answering claims as well as selecting arbitrators. The section also sets out the applicable discovery rules and provides terminology for crafting concise and probative document requests.
Another feature of arbitrations that makes them different than court proceedings (and in many ways more efficient) is FINRA’s streamlined motion practice. Dispositive motions, for example, are generally not permitted. That does not mean, however, that being proficient in motion practice is not an important ingredient in successfully representing a client in a FINRA arbitration. Section V of this book discusses and analyzes rules and procedures regarding motion practice in the FINRA forum.
Section V also addresses effective hearing strategies. As stated above, FINRA arbitrations can be viewed by those not familiar with the process as a trial by ambush, given that deposition transcripts are rarely available. Section V also incorporates and discusses applicable rules from FINRA’s Code of Arbitration that may affect one’s trial strategies.
3. Investment Company Institute, 2011 Investment Company Fact Book (51st ed.).
5. Donald C. Langevoort, Selling Hope, Selling Risk: Some Lessons for Law from
Behavioral Economics about Stockbrokers and Sophisticated Customers, 84 Calif. L. Rev.
627 (May 1996).