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March 06, 2019 Articles

Six Things to Know about Arbitrating Diminished Capacity Issues in FINRA Customer Cases

Unique situations arise when litigating competency issues in the FINRA forum

By Josh Jones

Litigation before the Financial Industry Regulatory Authority (FINRA) involving the elderly and other vulnerable clients is likely to increase significantly in the coming years given the aging of the investing population, that population’s unique vulnerabilities, and their substantial wealth. In addition to financial elder abuse claims, disputes are likely to involve competing claims to assets or claims that the firm wrongfully prevented a customer from making transactions or distributions. One thing is clear: Issues involving the competency of the elderly and vulnerable clients are certain to become more common in arbitration.

Senility and its effect on a person’s competency to direct his or her affairs raise complicated medical issues and unique concerns in litigation and arbitration. The following is a quick discussion of several of these concerns, along with a number of practical considerations for lawyers in this space.

1. Potential Litigation Concerns Associated with 2018 Changes to FINRA Rules

In February 2018, FINRA implemented Rule 2165, which enables member firms to place a temporary hold on disbursements from accounts based on a reasonable belief “that financial exploitation of the Specified Adult has occurred, is occurring, has been attempted, or will be attempted.” The rule applies only to “specified adults” or those who are either (1) age 65 and older or (2) age 18 and older and “who the member reasonably believes has a mental or physical impairment that renders the individual unable to protect his or her own interests.”

As part of the same process, FINRA amended Rule 4512 to add section (a)(1)(F). This amendment requires that firms request the contact information of “a trusted contact person age 18 or older who may be contacted about the customer’s account” from clients in connection with the account opening process. Moreover, firms must inform clients upon opening the account that firms may reach out to the trusted person when they suspect that the client is being financially exploited.

Rule 2165 is permissive in that it does not require firms to place a hold on assets or accounts even if the firm suspects that a vulnerable client is being financially exploited; it simply permits such holds. If implemented in good faith, such holds provide firms with a safe harbor from certain FINRA rules regarding improper use of client accounts and funds, expedition of certain customer requests regarding the transfer of securities, and its general provision relating to standards of commercial honor and just and equitable principles of trade. However, firms that implement Rule 2165 must maintain certain records as well as develop written supervisory procedures and training policies.

From a firm’s perspective, there are several potential litigation concerns raised by the rule changes:

  • As noted above, FINRA Rule 2165 does not require a hold even when a firm suspects financial exploitation. However, firms should anticipate that counsel for adverse parties will argue that the rule provides firms with a means of safeguarding assets and that a firm’s failure to protect a vulnerable client even when it suspects or is actually aware of financial exploitation constitutes negligence or a breach of some duty owed under the law or equity.
  • The rule requires that a firm’s belief regarding the exploitation be reasonable. Similarly, a firm’s belief that an adult under the age of 65 is covered by the statute must be based on a reasonable belief that person suffers from an impairment that prevents the person from being able to protect his or her interests. Firms should anticipate attacks on the reasonableness of their beliefs by supposed victims who now allege that they have been damaged by the wrongful freezing of their assets or a firm’s refusal to enter trades or other transactions on their behalf. In such cases, claimants are likely to assert claims for lost profits or other resulting damages.
  • The supplementary materials to Rule 2165 provide that firms implementing the rule “must develop and document training policies or programs reasonably designed to ensure that associated persons comply with the requirements of this Rule.” Firms can expect to see claims that the training policies and programs were somehow defective or negligently implemented, as well as discovery directed to these issues.
  • Rule 4512 could also create litigation concerns given that it is quite often someone close to the client, including children, who are exploiting the client. What happens when the “trusted contact” cannot be trusted? Firms must be wary of assisting the fox with guarding the henhouse.
  • In addition, what happens when a client who may be showing some signs of diminished capacity wants to change an account beneficiary in a way that affects the trusted contact, favorably or unfavorably? Fact patterns could involve a client disinheriting a trusted contact, or a firm reaching out to a trusted contact to discuss a change that could dramatically affect the trusted contact in the future. These scenarios are not difficult to hypothesize, but they could be very difficult to address in real time or in hindsight when in a FINRA arbitration.
  • Litigants should also be aware of the distinctions between the requirements under FINRA rules and the various state statutes designed to prevent exploitation of seniors and other vulnerable clients.

2. The Importance of Recognizing the Sensitive Nature of These Issues

Cases involving financial exploitation of vulnerable adults can be difficult cases to try. Parties and witnesses are litigating in what is often a very emotional context involving loved ones who may have suffered and declined for a number of years. And the process does not necessarily lend itself to addressing what are often long-held family tensions and underlying issues in personal, and what are normally private, relationships. Lawyers trying these cases are well served to approach these issues with the delicacy and tact that they warrant.

Practitioners must also recognize the potential strong reaction that arbitrators may have to these issues. It is quite possible that the arbitrators themselves have seen someone whom they care about affected by dementia. According to the Alzheimer’s Association’s 2018 Alzheimer’s Disease Facts and Figures, roughly 5.7 million people in the United States suffer from Alzheimer’s dementia. That number is expected to exceed 7 million by 2025. Hearing testimony about a person’s decline or medical evidence regarding cognition or even seeing a witness become emotional on the stand can affect an arbitrator—just as it would any caring person.

The following issues merit consideration:

  • Are potential arbitrators more likely than most to have dealt with diminished capacity issues in their profession? These could include estate attorneys, regulators, medical professionals, brokers, caregivers, and advocates for the elderly.
  • Is it possible that the arbitrators themselves have begun to experience some diminution of their faculties? FINRA has recognized that the arbitrator pool contains a significant number of seniors. I regularly see panels with arbitrators in their late seventies or eighties.
  • Consider how your panel might be affected by these issues. If they have seen a loved one suffer from Alzheimer’s, they will almost certainly feel some sympathy both for the person suffering and for those who care for the person. Accordingly, they might look harshly at the loved one, financial advisor, or third party whom they view as attempting to take advantage of the victim. Similarly, they might appreciate a firm’s reasonable attempts to prevent such exploitation but fault a firm that stood by and did nothing. Practitioners should consider the effect that firsthand experience with dementia can have on a panel’s decision-making process.
  • An aging panelist might very well resent a firm’s efforts to place limits on an elderly investor who is vigorously asserting his or her competency to decide his or her own financial affairs, when the firm has concerns that person is being exploited or otherwise appears unable to maintain his or her investment accounts. Such cases can be very difficult to litigate or resolve, particularly in instances in which the client appears to have “good days and bad days.”

3. Cases Are Generally Won on the Facts

As with most FINRA arbitrations, these cases are generally won on the facts. For that reason, you will want to make sure that you have a fully developed record from which the panel can draw its decision.

  • The financial advisor will likely be a key witness. It is helpful for a panel to understand the length and depth of the client relationship. Of particular interest are in-person meetings supported by the broker’s communications, notes, and calendar, and any recordings. Other fact witnesses in the branch could include the client associate and managers who interacted directly with client.
  • Documents to consider include other agreements entered into during the time frame at issue. For instance, if a beneficiary change is being challenged, did the client execute a will around the time of the change, or open a bank account, take out a loan, buy real estate, or otherwise contract to legally bind himself or herself? Similarly, financial records can be critical. Did the client manage his or her personal checking account, file tax returns, operate a business, or direct investments at another firm? All of the above could shed light on the client’s competency to direct his or her affairs.
  • Others potential witnesses could include those who knew the client over time, including professionals (lawyers, accountants, other advisors), family, neighbors, and friends. I have examined witnesses who were visitors at the hospital during a client’s final days.
  • Medical personnel may also offer key testimony. Was the client capable of making binding medical decisions? Did the doctors or nurses (who are often better witnesses, in my experience, given the nature of the patient relationship) believe that the client was competent? Did that change over time?
  • Along these lines, medical records are critically important. If you are in litigation with an estate, it should be able to access and produce the decedent’s medical records. If you are not able to secure medical records from the parties, you will need to seriously consider availing yourself of the subpoena process outside the scope of FINRA orders of production and appearance.
  • Finally, firms need to consider the possibility of testimony by the person or persons within the firm who made a decision at issue in the case. For instance, who made the decision not to release funds requested by a client or to freeze a client’s account pending direction from a court? Such decisions may lie at the heart of the litigation, but of course firms will struggle with issues relating to the attorney-client privilege, work product, and related concerns. The last place that most attorneys or even non-attorney compliance professionals want to be is on the witness stand, and firms are right to be concerned about opening their decision-making processes to discovery.
  • FINRA Rule 2165 contains a retention provision that requires firms to maintain a number of records relating to requests for disbursement that may constitute financial exploitation, the basis of the firm’s belief that the requests constitute exploitation, and other related information. Firms can likely anticipate discovery requesting production of the materials and information required to be retained.

4. Potential Need for Expert Witnesses

Cases involving competency issues may also require expert testimony. For instance, parties on both sides may call industry experts to discuss industry standards, best practices, rules, and regulations. Depending on when the events giving rise to the claim occurred, such testimony may also need to address how the industry’s understanding of these topics and implementation of related processes have changed over time.

Parties also need to consider whether to call a psychiatrist to opine on issues relating to competency. Although such an expert likely will not offer an ultimate opinion on competency, he or she can expound on the record before the panel, including explanation of medical records and summarizing important takeaways from the testimony of both lay witnesses and medical personnel. Testimony from a recognized expert that the record before the panel does or does not support a finding of competency can be quite persuasive while also serving to focus the panel’s attention on the key factors at play.

5. When the Money Is Still There . . .

Consider a common fact pattern in cases involving diminished capacity issues: Someone alleges that he or she is the rightful beneficiary on an account despite a firm’s records reflecting otherwise. In cases in which the moneys have not been distributed, firms are advised to consider interpleading the funds when available or otherwise seeking a court order directing the distribution of the proceeds. Firms may also consider seeking such guidance from an arbitration panel. Issues to consider with this approach include whether a firm can compel a nonparty to arbitrate such a dispute, a FINRA panel’s limited ability to grant equitable remedies available to a court, and enforcement of the panel’s order. Difficulty can arise when a firm seeks to secure direction from a court while also maintaining its ability to arbitrate claims that it damaged a party through its actions or inaction. Along these lines, firms may also face claims in arbitration brought by purported beneficiaries or other parties who are not its customers and with whom they are not required to arbitrate under FINRA Rule 12200. Such disputes can lead to sometimes tricky litigation in court when a firm seeks declaratory or other relief directing that it not be compelled to arbitrate against noncustomers.

6. Once the Money Is Gone . . .

A firm’s exposure increases substantially once the funds are withdrawn or disbursed from the account. I have litigated beneficiary disputes in cases in which the money is sitting in the account waiting on a court or arbitrator order directing disbursement, as well as cases in which the moneys had long since been disbursed and spent soon thereafter. You can guess which causes more sleepless nights for in-house counsel and their business clients.

Under Rule 2165, the hold placed by a firm expires “not later than 15 business days after the date that the member first placed the temporary hold” unless “otherwise terminated or extended by a state regulator or agency of competent jurisdiction or a court of competent jurisdiction[.]” In addition, the hold may be extended for an additional 10 business days if the firm’s internal review supports its reasonable belief as to exploitation. So firms have roughly a month from the initial hold to take action seeking direction from a court or regulator that would serve to protect the investor’s assets, which could also serve to limit a firm’s potential exposure in the event of litigation.


Unique issues arise when litigating competency issues in the FINRA forum. Practitioners would be wise to give them due consideration given the likelihood that they will be addressing them soon enough with an aging investor population, increased regulatory scrutiny, and growing realization of the need to recognize and prevent exploitation.

Josh Jones is a principal with Bressler Amery Ross in  Birmingham, Alabama.

Copyright © 2019, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).