Overview of Securities Arbitration

Securities Arbitration is a process of dispute resolution for broker-dealer disputes. The goal of arbitration is to provide a system for resolving disputes without using the courts. The general procedures of a court trial and arbitration are similar, however, in arbitration, a panel of arbitrators decides on the outcome of cases rather than a jury. Depending on the forum selected, the forum may provide for limited opportunities for the parties to review the award histories of the arbitrators and to select the arbitrators on the panel by allowing the parties to give input as to the members appointed onto the panel.

Arbitration is governed by state and federal law, and most states govern arbitration with specific arbitration provisions or have adopted the Uniform Arbitration Act. There are several self regulatory organizations ("SROs") which provide arbitration including the FINRA's arbitration program.

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Obligation to Arbitrate

Members of the Financial Industry Regulatory Authority (“FINRA”) and members of the various stock exchanges are contractually bound to arbitrate their disputes with their clients. Members include all registered representatives and their firms. The members of FINRA are bound by the FINRA Code of Arbitration Procedure. Although this code binds members to arbitrate, there is no reciprocal obligation that binds clients to arbitrate. Clients may only be bound to arbitrate by contractual obligation.

When enlisting the services of a brokerage firm, clients are typically required to sign a contractual agreement to arbitrate any disputes that may arise from their relations. If the client signs this agreement, then the client has agreed instead to resolve disputes through arbitration. If there is no contract providing for arbitration, the client can either choose to arbitrate or to opt for a court proceeding.

General Information for the Aggrieved Investor
In order to bring a claim against another party, the claiming party (“Claimant”) must be able to identify and locate the wrongful party; he must have at least one claim that has occurred within a certain time frame; and he must have suffered monetary losses (a loss in profits for claims such as churning is adequate) as a result of the wrongful party’s actions. Although each state has specifications for the time limits in which to bring a claim for arbitration, generally, the cause of action should occur within FINRA's requirement for filing a claim.

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Types of Claims

There are numerous claims that can be brought under securities arbitration. Some common claims include Fraud; Misrepresentations and Omissions; Negligence including Unsuitability, Unauthorized Trading, Order Failure, Churning, Failure to Supervise; various Breach of Contract claims, and Breach of Fiduciary Duty.

Fraud
Federal securities laws contain anti-fraud provisions that require stockbrokers to apprise the client of the risks of an investment.

Misrepresentations and Omissions
A misrepresentation occurs when a broker intentionally or unintentionally misrepresents the risks of an investment. An omission occurs when a broker intentionally or unintentionally fails to disclose information that the broker knew or should have known that the client would rely on regarding the risks of the investment. Generally speaking, the client must have reasonably relied on the broker’s misrepresentation or omission and must have made his decision to buy or sell the security based on the broker’s conduct. The client’s reliance should be reasonable based on his sophistication with securities; the availability of relevant information; his relationship with the broker, and other factors.

Negligence 
FINRA and the stock exchanges have rules and regulations that apply to stockbrokers. The actions of a broker are compared to those of the standard and must comply with those of the industry. Any breach of the duties described below may constitute a claim under negligence.

Unsuitability
A broker has a duty to make recommendations to the client that he reasonably believes are suitable for the client, and that are consistent with the client's objectives and needs. If the broker recommends an investment that is inconsistent with the client's investment objectives and the broker knew or should have known that it is inconsistent, then the broker may be liable for unsuitability. Additionally, a broker is required to conduct due diligence to determine the suitability of a particular security to the needs of the investor.

Unauthorized Trading
A stockbroker has a duty to obtain approval for a trade from a client before the transaction is completed. With limited exceptions, stockbrokers and other registered representatives can not use discretionary power within a client's account without first obtaining written consent.

Failure to Supervise
A brokerage firm or supervising broker has the duty to supervise stockbrokers with extensive disciplinary histories; firms and stockbrokers also have a duty to report every written complaint made against them. In addition, the firms must execute transactions and follow other supervisory procedures in a manner which complies with the industry’s regulations. Additionally, a brokerage firm generally has an obligation to supervise the securities business conducted by a stockbroker outside of a firm.  Hence, a brokerage firm may be held liable for any misconduct associated with investments that a stockbroker sells or solicits outside of the firm ("selling away").

Churning
A broker has a duty to put the interests of the client first. He can not engage in trades that are designed to generate commissions for the broker rather than to the benefit the client’s account. A broker has an incentive to increase the volume of transactions when he is compensated on the volume of transactions conducted for the client. The practice of engaging in trading activity which is excessive in light of the objectives and resources of the client's account is called churning.

Breach of Contract Claim
Clients enter into a Client Agreement with the brokerage firm which provides that the brokerage firms and the brokers are contractually bound to follow the applicable rules of all exchanges of which the firm is a member and of exchanges through which trading is conducted. In addition, the brokerage firms enter into a license agreement with FINRA or with various stock exchanges which require each party to comply with all of the rules and regulations of that exchange. Clients may be able to raise claims for breach of the Client Agreement or under the License agreement as a third-party beneficiary.

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The Process of Arbitration

Once the party has decided on a potential claim or claims and its ability to bring the claims, then the party may choose to arbitrate.

Arbitrations are commenced by filing a Statement of Claim along with the filing fee and hearing session deposit and by signing a Submission Agreement, which binds the parties to the decision reached by the arbitrators to the Director of Arbitration for the proper forum. The statement of the claim should consist of the identification of the parties; statement of all of the relevant facts and circumstances surrounding the dispute detailing the nature of the dispute, including the relevant dates or time frame, the transactions in dispute, the securities involved; and amount of damages or type of relief requested.

After the party being served with the complaint (“Respondent”) has received the complaint, the respondent has the opportunity to Answer with its defenses along with the facts relevant to those defenses; Counterclaim and assert claims against the claimant; or Cross-claim and assert claims against other respondents or third parties.

Next, the parties engage in discovery. Traditionally, discovery in arbitration was limited in order to keep costs low and to maintain the expediency of the process. However, more commonly today, both parties engage in a more thorough discovery process to obtain as much financial information as they can about the other.

Hearing Procedures
Arbitration hearings are typically scheduled for two or more consecutive days, months in advance. The Arbitration session is conducted in a roughly similar manner to that of a court trial. The Claimant starts with opening statements. Then, the respondents follow with their opening statements. The openings are followed by introduction of evidence by the claimant including testimonies of witnesses. After each claimant's witness testifies, the witness is cross-examined by the respondent’s attorneys and then by the arbitrators. Following the arbitrators’ examination, the claimant has another opportunity to clarify any questions that were raised during the arbitrator’s cross examinations. The respondents also have the opportunity to cross examine the witnesses again regarding questions raised by the arbitrators. After each witness has testified and has been repeatedly cross-examined, the respondents then have the opportunity to introduce their witnesses. The same procedure ensues. After, each party has the opportunity for a rebuttal, and then, each party gives their closing arguments. Some arbitrators may also allow post-hearing briefs.

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Outcome of Arbitration

Most securities arbitration claims settle before a hearing is held. If the case does not settle, m ost SROs render awards within 30 days of the last hearing date or of the submission of post-hearing briefs. Arbitrators are not required to provide a reason for their decision or for their calculation of damages. Generally, after the arbitration award has been served, there is no appeal of the decision, however, depending on the state's rules regarding arbitration; there may be an opportunity to file an appeal to the state or federal court.

Awards
Arbitration awards can include monetary compensation for trading losses; realized and unrealized losses; various account charges; commissions given to brokers; general expectancy losses; and punitive damages. If both parties agree to seek attorney’s fees, then, if the jurisdiction permits, the arbitrators can consider awarding fees during the awards decision.