Arbitration – A Case Study
By Warren Forest
As a securities industry panelist, I recently heard an arbitration which involved two middle-aged claimants, a husband and wife, both retired. They submitted their claim against a large bank Broker/Dealer and the two registered representatives that handled their account.
The claimants, in their Statement of Claim, alleged all of the usual wrongdoings against the company and their reps. Fraud, misrepresentation, unsuitability, and negligent supervision were asserted. At first glance, this case seemed unremarkable, but it quickly became apparent that there was more to it than met the eye.
The first indication that this case differed from most was the types of investments that were involved. Many cases that I have heard involve highly speculative investments. Often, there are illiquid investments involved, and, frequently, the accounts have a very high rate of turnover.
This case exhibited none of those traits. Because the claimant lost a significant amount of money when he attempted to day trade tech stocks years earlier, he changed his investment strategy. After that humbling and costly experience, he only invested in brokered CD’s and conservative mutual fund investments.
The portfolio he brought to the bank brokerage was about as vanilla of a portfolio that one would find, and the pattern of investing that occurred continued to be extremely conservative. The broker continued to recommended CD’s and mutual funds only. At the time that the recommendations were made, the investments carried Morningstar ratings of at least four, if not five stars.
At the beginning of their testimony, the claimant made a very emotional statement that influenced the panel. They shared that they were suffering from a terminal condition, and had but a very short time to live.
The evidence seemed to indicate that the brokers and the brokerage house did everything and more, that I advise my consulting clients to do in order to prevent and successfully defend themselves against adverse arbitration actions. The rep stayed in close and frequent contact with his clients, and he kept fastidious notes about the client meetings and telephone conversations they had. The recommendations that were made based upon the evidence presented appeared to be entirely suitable given the claimants’ investment objectives, risk tolerances and time horizons.
When we looked at the holding period of the account, it seemed clear as to what happened to cause the portfolio to lose value. It was not that the recommendations were flawed when they were made. It was not that the broker had a greedy objective, and wanted to maximize his commissions. Simply stated the market crashed. Only the investments that lost money were unsuitable, the other investments in the portfolio that retained or increased value were perfectly fine.
It is not a requirement that public panelists have any industry knowledge or experience. Yet, this is currently balanced out by the fact that the third panelist is an individual with in-depth industry experience. However, since FINRA recently made a rule change allowing all public panels, hearings will be decided by panels that may have absolutely no understanding of the specific investments involved in the case.
During the course of the hearing it quickly became apparent that the two public arbitrators had absolutely no knowledge or understanding of even the most basic investments, let alone the investments involved in this case. They did not know the difference between a Broker/Dealer and a Registered Investment Advisor, or a discretionary and non-discretionary account. Indeed, on their individual Arbitrator Disclosure Reports, it indicated that both public panelists have “no skill” in Security information.
Many times during the hearing we needed to break in order to discuss the nature of the recommendations, the types of investments and the role of Broker/Dealers and registered representatives versus investment advisors and their agents. Without this critical understanding the public panelists would be hard pressed to render an effective decision.
At the conclusion of the hearing, and as deliberations began, it was evident that there was dissension amongst us. The public panelists wanted to render a large award in favor of the claimants, and wanted to hold the broker fully responsible. It seemed that the full consensus needed to render a unanimous decision would be impossible to achieve.
To the credit of my public panelists, they felt as bad about this outcome as did I. We decided that more discussion would be helpful to see if we could come up with an award that all would be comfortable with. At the end of our second deliberation session we did just that. Our final decision is not one that we individually would have made, but by agreeing to disagree, we have an award that addresses the arbitrators concerns. The claimant will receive something to mitigate the loss, and the registered representative will be held faultless.
While we did not render the award I alone would have given, our joint decision restored my faith in the process. We all had the chance to fully explain our positions, and heard what we each had to say. This communication enabled us to craft a difficult award that addresses many issues to our collective satisfaction.
This case, from the very beginning, was all about communication; the communication that occurs between a registered representative and their customer, as well as with the arbitrators. As the evidence was presented, it was clear that while they talked to each other they were not really hearing. And at the deliberation table, it was clear that members of the panel heard or understood things differently.
Arbitration is a process fraught with hazard and peril. Even when one thinks their case is perfect and cannot fail, you will need to guess again, because fail it certainly can. If you can resolve your case without it going to an arbitration hearing, then make every possible effort to do so. If resolution is impossible, then do everything that you can to make sure you effectively communicate your case.
Posted by: editor June 28, 2011