Much has been written about the arbitration process since the U.S. Supreme Court upheld the validity of pre-dispute arbitration agreements in the mid-1980s. While most of the commentaries have focused on what is wrong with the process, little has been written on what the individual registered representative, can do to help him- or herself if he or she is unfortunate enough to be named in an arbitration Claim. This article is directed to registered representatives who want to have an idea of what they can do in such a situation.
Arbitration Increasingly Common
While you may feel that this article has no bearing on you since you have a clean record, never had a customer file a complaint against you, and go out of your way to ensure you are doing what is best for your clients, it is still possible that, at some point in time you may find yourself at the receiving end of an arbitration Claim. While it is true that the majority of registered representatives will never have to face the prospect of an arbitration hearing, the purported low-cost and speed of the arbitration process as well as the increase in the number of attorneys practicing in this area of law, makes it likely that the number of new cases will continue to increase. In my eight years as an NASD arbitration staff attorney I witnessed an explosion of cases from roughly 3,100 in 1990 to nearly 7,000 in 1997, and these were only the cases filed with the NASD. When you factor in the cases filed with the NYSE, AMEX, CBOE and the American Arbitration Association the number of cases filed nationwide are approximately 3,700 and 8,400 respectively.
This drastic increase in cases was caused by several factors. The market corrections in 1987 and 1989; the limited partnership debacle of the late 1980s and early 1990s; and the growing number of boiler-room operations, just to name a few, all served to create a dramatic rise in case filings. As ever greater numbers of clients brought actions against their brokers, the public and their attorneys soon learned that they were required to arbitrate rather than seek redress in court. As the number of attorneys filing arbitration Claims increased, so did their demands for such court-like trappings as motion practice, extensive discovery and procedural safeguards. Unfortunately, the rules of arbitration were ill-equipped to deal with these issues. This resulted in delayed rulings on motions, failure to provide timely discovery, and a concomitant increase in postponement requests and delayed hearings. Notwithstanding these problems, the number of potential Claimants and the publicity generated by some substantial awards and fines imposed by the SEC served to encourage more Claims to be filed. While many of the Claims were meritorious, many others were not and would never have been brought in court since they would not have withstood a motion to dismiss. The lack of such procedural safeguards in the arbitration setting caused many registered representatives to either settle the case and accept a blot on their record or go through the entire process in order to vindicate themselves. In light of all of this, no registered representative should feel that he or she is immune from suit.
During my eight years with the NASD, I saw three basic types of customer Claims.
- The first were those caused by unscrupulous registered representatives who took advantage of their clients' trust.
- The second type were those filed by customers who knew exactly what they were doing but wanted to blame anyone but themselves for their own bad investment decisions.
- The third, and perhaps most common type of case, were what I classify as pure miscommunication. The broker was saying one thing but the customer heard something completely different.
This last type of case is the most difficult to decide from the arbitrators' perspective. Perhaps the customer overstated their net worth or told the broker that they understood what he was talking about when they really just didn't want to admit their own ignorance. Or perhaps the registered representative didn't explain things clearly enough or in simple enough terms so the customer could understand. Maybe the investment looked so good (as limited partnerships did in the early 1980's) that any downside looked too remote to worry about. There are hundreds of these types of examples that I could give, and in nearly every one I realized that the arbitrators could just have easily ruled the other way and could have justified their decision to do so. So how can you increase your odds of prevailing in an arbitration in the event you are named?
Protect Yourself
The first and best advice I can give you is - know the process! Now, before you are embroiled in an arbitration, pick up a copy of the NASD Code of Arbitration Procedure and read through the rules. While you may feel that it is not necessary for you to learn about the arbitration process at this point since your firm's attorney will handle those issues, you should, nevertheless familiarize yourself with the rules since, in some instances, your firm may advise you to obtain your own attorney for one reason or another. In such a situation, you may find that, until you can locate an attorney knowledgeable in securities law, you will be representing yourself. That is not a good time to start learning about your rights and responsibilities under the Code of Arbitration Procedure. I'm not suggesting that you commit the rules to memory, but you should familiarize yourself with certain concepts. For example, you have twenty (20) business days from receipt of the Claim to file an Answer and your failure to file a timely Answer may subject you to a Motion to Bar your Defenses. Additionally, don't be surprised if you receive a Statement of Claim in a letter format with only bare bones allegations. Indeed it is more common for Claims to be filed in a narrative format as opposed to a formal legal-style pleading. Furthermore, you shouldn't be surprised if, after the hearing is scheduled, you receive a bill for several hundred (or even several thousand) dollars in the form of "additional hearing session deposits." These "up-front forum fees" are typically billed to both sides in an arbitration proceeding equally and then reapportioned at the conclusion of the case. The NASD will also charge your employer (either current or previous depending on when the Claim arose) with a "member surcharge" which can also be in the neighborhood of hundreds (or thousands) of dollars depending on the size of the Claim.
Another suggested action you can take to protect yourself is to discuss your firm's new account forms with your branch manager or compliance officer. I would suggest that you, or someone representing the interests of the registered representatives, discuss with your firm the benefits to having the customer fill out the new account form himself or, at a minimum, requiring the customer to initial the section regarding their investment objective in order to acknowledge that it is, in fact, their objective. A frequent issue in arbitrations (especially those involving suitability) is exactly what the client's investment objectives were. During my tenure at the NASD I saw many instances where the new account form had "speculation" checked off and the customer testified that he or she told the registered representative that he or she wanted "safety and preservation of capital." It was then up to the arbitrators to determine who was telling the truth based on the credibility of the witnesses. A real world example might be helpful here. There was one case I handled where the client had an account at brokerage firm XYZ. His new account form had "safety and preservation of capital" checked off. The client subsequently transferred his account to firm ABC where his new broker checked off "speculation" as the client's primary investment objective. During the hearing the client testified that he'd told his ABC broker that he wanted safety and, as evidence of this, he pulled out his old XYZ new account form to show the arbitrators, arguing that his investment objective didn't change. The registered representative testified that the client had told him he wanted to speculate since, when his account was at the prior firm, the customer had needed the money for his child's college tuition and hadn't wanted to put the money at risk. Now that the client's child was out of college, the broker testified, the client felt he could afford to speculate with his discretionary capital. Notwithstanding this seemingly logical explanation, the arbitration panel didn't believe the broker and found for the customer to the tune of $60,000. Had the customer filled out his investment objectives himself, the arbitrators decision may have been very different. Indeed, the case might never even have gotten to arbitration in the first place. The firm has since changed their new account forms and now requires customers to initial their investment objectives.
Similarly, frequent communication with your clients can also prevent problems. You've probably heard it before but I'll say it again. A simple phone call to your clients periodically to learn of any changes in their financial situation can not only alert you that your client needs to be moved into a different investment strategy, but also shows the client that you are concerned about them. I'm not talking about calling them up when you have a new stock they might be interested in, but rather a phone call to simply ask them if there is anything regarding their family, health or financial situation that has changed since the last time you spoke. You may, for example, learn of a major health problem with a family member, or that the client's child has decided to go for a Ph.D. for which your client is helping to foot the bill, or that the client is getting divorced from their spouse of 20 years. Any one of these issues may have a profound effect on the client's investment strategy.
Let's assume, however, that you've learned all about the arbitration process and you've ensured that your client's investments are suitable. You've dotted the "i's" and crossed the "t's" regarding the client's investment objectives and yet you still receive word from your branch manager that a Statement of Claim has been filed against you. Now what? First of all, don't panic. It's not the end of the world and you're a long way off from having to pay out an arbitration award. Nevertheless, you will, most likely, have a mark on your record regarding the Claim. Space limitations prohibit me from going into a discussion regarding when you or your firm must report a customer complaint, but suffice it to say that more likely than not you'll have to report it to the regulatory authorities. I would suggest you discuss that aspect of the complaint with your compliance officer and/or legal counsel. The real question though is: "How do you increase your odds of prevailing?"
We will assume for the sake of argument that you have an attorney and he or she will take care of issues such as filing the Statement of Answer, requesting documents, filing motions, challenging arbitrators and the like. What does that leave for you? First, you may want to consider whether you even want to proceed through a long drawn-out arbitration. What's your alternative? Mediation. Unlike an arbitration proceeding, mediation is a chance to work out a settlement between the parties. Typically a mediation hearing can be scheduled much quicker than an arbitration hearing. The NASD has reported much success with their mediation program, averaging roughly an eighty percent (80%) settlement rate (as compared with seventy percent (70%) of arbitrations which settle). Additionally, rather than leaving your fate in the hands of a panel of arbitrators who act as judge and jury, mediation affords the parties control over the outcome of the case. It is your decision whether or not you want to settle and for how much. The mediation won't delay the arbitration hearing since, as previously mentioned, the mediation hearing can be scheduled many months before the arbitration hearings. If the parties cannot reach a settlement, the case proceeds through the arbitration process.
There are many benefits to mediation in addition to the control it affords the parties over the outcome. The mediator will point out the strengths and weaknesses of your case which can help you to focus on certain issues if you don't settle. Additionally, in some instances, your willingness to work out the customer's complaint in a non-adversarial forum may serve to preserve the broker-client relationship and help you keep an important client. While there are some additional fees involved in a mediation, if the parties are able to resolve the case you can avoid the potential of thousands of dollars in forum fees that could be assessed against you and/or your firm. One concern that many parties have is that, if they request mediation, the opposing side may get the impression that you feel your case is not strong enough. However, to avoid this the NASD can intervene and contact the other side to discuss the possibility of mediation with them. Since the NASD contacts some parties to discuss the possibility of mediation without any prompting by one side or the other, there is little chance that the opposing party in your case will know that you've asked the NASD to explore the possibility of mediation. There are many other benefits to mediation and I would urge you to contact the NASD to obtain copies of their mediation material to learn more about the process.
If, however, the opposing side refuses, or your own firm declines, to engage in mediation how should you prepare for the arbitration? First, be aware that the NASD staff is overburdened with cases and the department has historically been understaffed. The recent fee increases will most likely not go towards the hiring of additional staff, but, rather towards increasing the arbitrators' honorarium. Additionally, since 1997 the NASD has been pushing to make the department "revenue neutral." Historically, the arbitration department has lost money for the NASD as a whole and the department has been striving to eliminate their deficit. Consequently, it is unlikely that the NASD will increase the staff size in any significant way in the foreseeable future.
The effect of being so understaffed is that "the squeaky wheel gets the grease." What this means to you as a party is that you need to continually stay on top of your case. Do not allow unresolved motions to linger for months at a time. Call your attorney and encourage him or her to contact the NASD on a regular basis to obtain a "status report" on your case and any outstanding, unresolved issues. Indeed, at one point the suggestion was made within the department to provide parties with formalized status report letters to inform them of the status of their case. The idea was that, by sending out such letters, the parties would be less likely to call and ask about where their case stood and thereby reduce some of the workload on the staff. Unfortunately, this idea soon died a quick death and the only way to learn whether your motion has been forwarded to the arbitrators is to pick up the phone and ask.
The other aspect to being overworked and understaffed is that, on occasion, errors are made by the staff. For example, the rules provide no set time limit for filing a response to a motion although the NASD generally allows parties ten (10) business days to do so. (I could write several pages on the efficacy of having a "Motion Rule" and the NASD's refusal to do so, but that's a topic for another article). However, with the enormous caseload imposed on each staff attorney, it is not unusual for several days, weeks or even months to pass before the motion is forwarded to the panel for decision. By keeping on top of the status of your motion you can ensure a timely ruling thereon and avoid having to request a postponement (and paying the associated postponement fee).
Another significant problem is the antiquated software which the arbitration department uses. The current system is nearly ten years old and is incapable of simultaneously updating a party's address on every case that the party is involved with. This means that, if you are involved in two or more arbitrations at the same time, and have had a change of address, you need to ensure that the NASD updates your address on each case individually. Since your cases may not be assigned to the same staff member, you may have to write (or call) more than one individual to ensure that the department has your most current address on each case. Additionally, you should also check the Central Registration Depository ("CRD") to ensure that your address is correctly reported on that system as well since the NASD will frequently use that address to serve you with the Statement of Claim and otherwise notify you of all pertinent aspects of the case. Furthermore, bear in mind that, even if you leave the industry altogether, the NASD can retain jurisdiction for certain purposes for two (2) (or in some cases four (4)) years. I have seen numerous cases of registered representatives who were held liable in arbitrations when they failed to appear at a hearing due to non-receipt of the Claim. Trying to get an award vacated based on your non-receipt of the Claim will be nearly impossible as the courts have typically held that its your responsibility to notify the CRD of a change in address.
Preparing for the Hearing
So, you've kept on top of the outstanding issues in the case to ensure they've been resolved promptly. You've received the notices and made certain that your address is current and now you're at the actual hearing. What do you do? There are some practical tips that can help you during the course of an arbitration hearing. Most of these are issues that any good attorney should discuss with you prior to the hearing. Nevertheless, they warrant repetition here. First, be prompt for the hearing and for the resumption of the hearing after breaks. While the arbitrators should not hold it against you if you are late (they are, after all supposed to judge the case on its merits) they are only human and do not like to be kept waiting. One of the most important tasks the arbitrators have is judging the credibility of the witnesses and being late for the hearings may negatively impact your credibility in other aspects of the case. On the other side, however, do not complain to the panel if they are late. If the panel is continually late and you feel you must complain, do so to the NASD staff member out of earshot of the panel. Again, arbitrators are only human and don't like to be taken to task for things like being late. Additionally, there may be a very legitimate reason for the tardiness (such as a medical condition) and you don't want to embarrass them or yourself.
Second, you must realize that there will be times when the opposing side's attorney or a witness will make statements that are at odds with your version of events. Do not engage in argument with the other party, his or her attorney, or a witness. Whisper your comments to your attorney or pass him or her a note. The worst thing you can do is to jump up and yell, "He's lying!" Your comments will have no effect on the arbitrators and will only serve to annoy them. Whether the witness is lying or not is a question for the arbitrators to decide. You will have ample opportunity to present your side of the story and the arbitrators will determine the credibility of each witness.
Additionally, it is not a good idea to get into an argument with the arbitrators either. The arbitrators are entitled to ask questions of the witnesses. Occasionally, their questions may not be phrased in the most appropriate manner and may lead you to believe that they have already made up their minds. Although arbitrators are provided with some training by the NASD regarding how to ask neutral questions, there are times when their questions may reveal which way they are leaning. Keep in mind, however, that, as the hearing progresses, the arbitrators' leanings may go back and forth several times. Nevertheless, if you feel one or more of the arbitrators is demonstrating bias against you, make sure to have your attorney request copies of the tape recordings of the hearing in order to address the issue with the NASD outside of the hearing. The worst thing you can do is confront the arbitrators about their impartiality during the hearing. Additionally, if you feel that the arbitrators are behaving improperly, make sure to insist that an arbitration administrator be present throughout the entire hearing. The workload imposed on the staff makes it very difficult for them to be present during the entire hearing and typically they will only attend the hearing at the beginning in order to get things started. If, however, there are problems during the hearing (such as demonstrations of bias or incompetence on the part of one or more arbitrators, or an opposing counsel who runs roughshod over the panel) the arbitration administrator responsible for the case should be brought in. If you've requested them to be present and they fail to do so, bring the matter to the attention of the Regional Director. In any event, do not wait until after the hearing has been concluded to inform the NASD of problems that occurred since, in some cases, it may be possible to have an arbitrator removed even after the hearing has begun (although doing so is extremely difficult).
Next, remember that your body language speaks volumes. The arbitrators will watch you not only during your testimony, but also during the testimony of the other witnesses. Slouching, rolling your eyes, gritting your teeth, loud exhalations and numerous other non-verbal expressions can give the arbitrators the impression that you are impatient or hot tempered, or they may feel you are nonchalant about the case or that you are showing contempt for them or the process. Any of these impressions could have a serious impact on your case.
As previously mentioned, a large part of the arbitrator's job is determining the credibility of the witnesses. Rarely will there be a "smoking gun" in an arbitration that will reveal who is telling the truth. Consequently, answering questions in an honest, straightforward manner is generally best. Giving an evasive answer will typically not sit well with the panel. By the same token, answer only the question asked. If the opposing counsel asks a question calling for a "yes" or "no" answer, try to keep your answer to "yes" or "no." If, however, you feel you must elaborate in order to give the panel the complete picture, ask the panel first if you may do so. More often than not, the panel will allow you expand on, or explain, your answer. However, jumping right into a detailed explanation when the question originally only called for a "yes" or "no" answer will quite often result in an objection from the opposing counsel, thereby interrupting the flow of your answer.
Finally, you must remember that arbitration is a court of equity not a court of law. This means that the arbitrators are charged with doing what is right as opposed to doing what the law tells them to do. While most arbitrators will try to follow the law and are encouraged to do so whenever possible, there are oftentimes cases where they will rule in favor of a party even though the other side would prevail under the law. Consequently, it is important to show the arbitrators that it would be inequitable and unjust for them to rule against you. This is not as easy as it sounds however and you should keep in mind that the other side will try to do the same thing. Opposing counsel may introduce seemingly irrelevant evidence that attacks your credibility or shows you to be a "bad person" in order to bolster their case. Oftentimes this evidence would not be admissible in court. However, arbitrators are not bound by the rules of evidence and, in fact, one of the few grounds for getting an award overturned is the arbitrators' failure to consider material evidence. Consequently, arbitrators tend to err on the side of letting in more evidence than they exclude in order to minimize the chance of having their award overturned. Don't be surprised, therefore, if a ten year old DWI conviction, a personal bankruptcy, or some other unrelated matter is suddenly offered into evidence. If you have any items in your background such as these that might come up, make sure you have discussed them with your attorney beforehand and be prepared to provide explanations as to why they are not pertinent to the case at hand (i.e., a clean record since that time, participation in counseling, community or charitable service, etc...).
Navigating the minefield of the arbitration process can be a challenge even for the most seasoned attorney. As the number of cases has grown, so has the complexity of the process. What was originally intended to be an informal means of resolving a dispute outside the courtroom has mutated into a quasi-judicial proceeding without many of the safeguards you would find in court. Having an attorney who understands the process can go a long way towards protecting your interests. However, knowing what to expect, conducting yourself in a professional manner, maintaining an appropriate demeanor, and being involved in your case, will increase your chances of prevailing. Finally, the best advice I can give you is to get involved in improving the process now. Don't sit back and think, "It'll never happen to me."