securities arbitrations in finra · pdf filearbitration act and similar state laws, there are...

Securities Arbitrations in FINRAA Guide to What Every Securities Broker Needs to Know

Louis H. Castoria and Fred N. Knopf February 2009

©2009 Wilson Elser Moskowitz Edelman & Dicker LLP page 1 Nothing in this Guide constitutes legal advice about any actual or potential claim,

or creates an attorney‐client relationship. This Guide is solely for educational purposes.

What Every Securities Broker Needs to Know.............................................................................................. 3

Why It Is Important to Understand FINRA Arbitrations Today..................................................................... 3

Customer Claims on the Rise .................................................................................................................... 3

FINRA Trumps Your Right to a Jury Trial and to an Appeal....................................................................... 4

Regulatory Implications of FINRA Arbitrations ......................................................................................... 6

Intra‐industry Disputes in FINRA Arbitrations .......................................................................................... 6

Pre‐Arbitration Steps to Improve Your Prospects for Success ..................................................................... 7

Before the First Shot is Fired..................................................................................................................... 7

Preserving the Files ................................................................................................................................... 8

Responding to an Unhappy Customer ...................................................................................................... 9

The Arbitration Process Begins ...................................................................................................................10

How to Read a Statement of Claim or Complaint...................................................................................10

Notifying Supervisory and Compliance Managers..................................................................................11

Notifying the Broker or Professional Liability Insurer.............................................................................12

Appointing Defense Counsel...................................................................................................................12

Do I Need Separate Counsel? .................................................................................................................14

Your First Meeting with Defense Counsel ..............................................................................................15

Is it better to be in Court or Arbitration?................................................................................................17

The Answering Statement, Cross‐Claims, Third‐Party Claims, and Early Motions in FINRA.......................18

Arbitrator Selection Under FINRA Rules .....................................................................................................20

Experts ........................................................................................................................................................24

Discovery and Preparation Up to and Including the Hearing .....................................................................25

The Pre‐Hearing Conference...................................................................................................................25



Discovery in FINRA Cases ........................................................................................................................25

Mediations: What Have I Got to Lose? ...................................................................................................28

The Pre‐Hearing Exchange ......................................................................................................................29

Final Preparation for the Hearing ...........................................................................................................30

Preparing to Testify.................................................................................................................................30

Testifying at the Hearing.........................................................................................................................31

How Arbitration Hearings Proceed .........................................................................................................32

The Award ...............................................................................................................................................33

Concluding Thoughts ..................................................................................................................................33

About Our Financial Institutions Defense Practice .....................................................................................34

What Every Securities Broker Needs to Know

“Forewarned is forearmed,” as the saying goes. We present this guide to arbitrations in the Financial Industry Regulatory Authority (FINRA) because securities brokers are facing serious repercussions from the current Credit Crisis and downturn in the economy in the form of increased and widespread investor claims. By helping brokers, financial planners, and other professionals understand the FINRA arbitration process now, we hope to make you better able to manage risk and prevent future claims, to bring disputes to early and economical resolutions, and to fully defend matters that should be contested on the merits.

This is not a “legal” guide to securities law or FINRA procedures, strictly speaking. Instead, this paper is a simplified user’s manual for the professional who may be on the receiving end of a customer’s Statement of Claim filed in FINRA.

Effective legal representation is only one element in successfully defending against a FINRA claim. With due deference to Benjamin Franklin, who wrote, “And whether you're an honest man, or whether you're a thief, depends on whose solicitor has given me my brief,” the fact is that the outcome of a FINRA claim against you largely depends on the extent you are prepared, and actively participating in your defense. Franklin also said, “An investment in knowledge pays the best interest.”

Why It Is Important to Understand FINRA Arbitrations Today

Customer Claims on the Rise



We have only seen the first volley in a coming fusillade of new FINRA claims.

It is as predictable as the tides – claims filed in FINRA against securities broker‐dealers and registered representatives increase when the financial markets experience a dramatic rise or fall. Volatility in a bull market triggers investor dissatisfaction if the customer is not seeing the impressive gains that his or her

neighbors and co‐workers are enjoying. During the high‐tech market run‐up in the late 1990s, many investors whose accounts were in conservative, diversified portfolios complained that they had not doubled or tripled their money as others had done in more aggressive positions. By the early 2000s, the pendulum had swung,

and those who had stayed with aggressive stocks during the bear market complained that they should have been in conservative, diversified portfolios.

In the current bear market, there are few safe havens for investors, particularly those who need to generate current income from their investments or who have short time horizons. The tide of FINRA

customer arbitration filings is thus on the rise. In the first 10 months of 2006, 4,060 FINRA claims were filed, a high number that was fueled by the tech‐led market drop in the early years of the decade, and by investors who had missed out on the general recovery that followed. During the same period in 2007, the number of new FINRA claims took a nose‐dive, down to 2,672, but the trend quickly turned upward again in January‐October of 2008, with 3,972 new claims being filed, a 49% increase over 2007.

Looking ahead, 2009 may be a record‐setting year for new FINRA claims, due to the generalized bear market. Although financial institutions have been hit the hardest, other market sectors have not been immune to the Credit Crisis illness. The Dow Jones Industrial Average, which was near 14,000 in late 2007, has traded in a band between 8,000 and 8,500, nearly a 50% drop. Over the same period, the broader S&P 500 Index fell 41%, from just over 1,500 to 887.

Stock market indicators do not tell the whole story. The daily headlines – increasing foreclosures, layoffs, bankruptcies, falling pension funds – speak of other trends that can turn investors into FINRA claimants. Brokers who also offer financial planning services are particularly susceptible to claims during such downturns because, with benefit of 20/20 hindsight, there is always something that could have been done to lessen the impact of bad times on an individual customer.

We have only seen the first volley in a coming fusillade of new FINRA claims. Financial professionals should know the rules of engagement before they find themselves battling claimants in binding proceedings that will affect their professional futures.

FINRA Trumps Your Right to a Jury Trial and to an Appeal

FINRA Arbitrations are governed by a document called the “Code of Arbitration for Customer Disputes” (the “Code”). Investors can force FINRA members and “persons associated with a member” to have their claims decided by a panel of FINRA arbitrators. This is a one‐way street: the securities broker does not have the right under the FINRA Code to compel the investor to arbitrate disputes in FINRA or other arbitral organizations. (As we discuss below, there may be two‐way contractual rights to compel arbitration.)



Challenging an arbitration award in court is a very low percentage shot.

In a FINRA Arbitration, there is no right to a jury trial and no right to appeal the resulting award. Those can be positive or negative factors, depending on the case. Most FINRA arbitrators who serve on panels will have heard other securities cases, and thus may better understand the roles of broker‐dealers, registered representatives, financial planners, and clearing firms than the average lay juror. That is a mixed blessing, because a given arbitrator may have predispositions based on prior cases. In a jury trial, the defendant’s counsel can ask potential jurors questions to find out if they have any preconceived ideas that are relevant to the case; not so in FINRA arbitrator selection, a process that we describe later in this guide.



Like a jury’s verdict, a FINRA Arbitration Panel’s award is part of the public record; anyone can access more recently filed awards through FINRA’s Web site, www.finra.org. FINRA awards must be reported on a broker’s U‐4 registration statement, as must jury verdicts in securities‐related cases. Although the public has no right to attend FINRA hearings, they are not “private” adjudications, in terms of their outcomes.

FINRA provides no right for any party to appeal from a FINRA Arbitration award. Under the Federal Arbitration Act and similar state laws, there are very limited grounds to vacate an award. The arbitration panel is not required to strictly follow the law or the rules of evidence that apply in courtrooms, so the fact that a different result might have been obtained in court is not a basis to vacate the award. State laws vary regarding grounds to vacate, but, in general, the party who seeks court intervention must show that one or more arbitrators committed actual fraud against the aggrieved party, or that the arbitrators exceeded their powers. Judges give very wide latitude to arbitrators. Challenging an arbitration award in court is a very low percentage shot, and may even make a bad situation worse by adding the other side’s attorney’s fees and costs in opposing the Petition to Vacate to the amount of the arbitration award.

Except in rare cases, the party who decides to proceed to Hearing in an Arbitration, in FINRA or elsewhere, must be prepared to accept the panel’s decision as the final word on the dispute. FINRA’s statistics regarding arbitration cases that resolved in 2007 – the most recent full year for which statistics are available – show that 66% resolved through settlement, either through private negotiations or mediations. The arbitrators decided 21% of the cases on the merits. Seven percent of the cases were withdrawn by the claimant, and six percent were closed by other means, such as the bankruptcy of one of the parties. Looking just at the 21% that the arbitrators decided, 37% of those cases resulted in monetary awards to the claimants. That figure is significantly lower than figures for the preceding four years, which ranged from 42% to 49%, and the partial data for 2008 show 42% of arbitrators’ awards in the customer’s favor. Combining settlements and awards to claimants, customers whose cases were resolved in 2007 received money in about three out of four cases, though the FINRA data do not reveal how much money was paid or awarded.1

1 We note that FINRA is not the only arbitral forum for securities‐related disputes. Private arbitrators and organizations such as AAA and JAMS can hear securities arbitrations, although they may cost more and have less expertise than FINRA arbitrators. Private arbitrations only take place by the agreement of the parties, either in a pre‐dispute contractual arbitration clause or in an agreement to arbitrate a specific dispute after it has arisen. A detailed description of non‐FINRA Arbitrations is beyond the scope of this guide.

Regulatory Implications of FINRA Arbitrations



It is a lot easier to file a claim in FINRA than to expunge one.

As we noted earlier, FINRA Arbitration awards must be reported on a representative’s U‐4 statements. These become public record on the representative’s Central Record Depository (CRD) listing at FINRA. There is no threshold limit for reporting awards, unlike settlements. A

settlement below $10,000 does not need to be reported, but even a $1 arbitration award must be reported.

In recent years, FINRA has severely limited the ability of arbitrators to “expunge” (literally, to “wipe off the books”) arbitration claims and awards. Earlier, expungement could be agreed upon by the parties as part of a settlement, if later approved by the arbitration panel. In cases filed after April 12, 2004, the arbitration panel may order expungement after an actual hearing on the issue, and must make one or more of the following findings: (1) the information, claim, or allegation is factually impossible or clearly erroneous; (2) the registered person was not involved in the alleged investment‐related sales practice violation, forgery, theft, misappropriation, or conversion of funds; or (3) the claim, allegation, or information is false. The panel’s order must also be confirmed by a court having jurisdiction over the parties, and the court must support the panel’s findings. (FINRA Rule 2130.) FINRA has warned members not to settle cases with a “nudge‐nudge, wink‐wink” agreement that the claimant will provide a declaration in support of a post‐settlement expungement motion. “[M]embers and associated persons who engage in this conduct may be subject to disciplinary action by [the] Department of Enforcement.” (NASD, now FINRA, Notice to Members 04‐43.) In short, it is a lot easier to file a claim in FINRA than to expunge one.

Another regulatory implication of arbitrating disputes in FINRA is that the industry parties are, by definition, in front of the self‐regulatory organization that oversees their business. Although the Dispute Resolution side of FINRA is technically separate from its Enforcement Division, which conducts disciplinary hearings, an arbitration panel may cross that line by recommending that the Enforcement Division open an investigation of regulatory violations that have come to the panel’s attention during the hearing. (FINRA Rule 12104(b).) This is very unusual, but is an additional consideration for the FINRA member to consider, especially if the member has concluded that there were violations of FINRA rules in its conduct of business with the customer.

Intraindustry Disputes in FINRA Arbitrations

This guide is primarily meant to assist securities professionals in avoiding and effectively responding to claims by customers; however, we note that FINRA Arbitration is also available to adjudicate intra‐

industry disputes. These can include claims by current or former employees or independent contractors alleging wrongful termination, employment discrimination, harassment, and other improper employment practices.

There is a developing body of law that exempts from contractual arbitration agreements, claims that are based upon statutes that create a private right of action in court. For example, in Armendariz v. Foundation Health Psychcare Services, Inc., 24 Cal.4th 83 (2000), the California Supreme Court held that two employees who claimed that they were sexually harassed, in violation of a California statute, were not required to arbitrate their claims against their employer, despite a clause in their employment contract requiring that such claims be arbitrated. As of this writing, FINRA Arbitration appears to still be a required forum for such disputes, because the arbitration clause is a part of the FINRA member’s and employee’s licensing by FINRA, which supersedes clauses in private employment contracts.

Recently, the Texas Supreme Court held that a former employee of a FINRA member must arbitrate a retaliatory termination claim against his former employer. The employee, a registered representative, contended that he was fired for refusing to hide another trader’s churning of customer accounts from FINRA’s predecessor, the NASD, during an NASD audit of the office. The NASD Code of Arbitration Procedure required arbitration of disputes “arising out of the business activities of a member or an associated person,” except for claims “alleging employment discrimination, including sexual harassment, in violation of a statute.” Since the Texas law forbidding retaliatory termination based on an employee’s refusal to perform an allegedly illegal act was not based on a statute, but rather a prior court decision, the state Supreme Court held that the claim must be arbitrated. (In re: NEXT Financial Group, Inc., Case No. 08‐0192, Texas Supreme Court.)

There are different rules that apply to intra‐industry arbitrations in FINRA. We encourage the reader to visit the FINRA Web site if further information is needed about those rules: www.finra.org.

PreArbitration Steps to Improve Your Prospects for Success

Before the First Shot is Fired Even before a FINRA Statement of Claim lands on your desk, you can take affirmative steps that will aid in your later defense, if a defense becomes necessary.

Sometimes, claims come in with no warning signs – no angry phone calls, no e‐mails expressing dismay, and no sudden cutoff of communication by the customer. We have defended many claims in which our securities professional clients have said, “I never saw this coming. Of all my customers, this is the one whom I would least have suspected to make



http://www.finra.org/

a claim against me.” It is a sad circumstance, especially in a long‐term professional and personal relationship.

More often, there are harbingers of trouble ahead, ranging from unreturned phone messages to outright accusations of wrongdoing. It is human nature to avoid the unpleasant, to assume that “things will work out,” and sometimes they do. But from our perspective, we see many claims that are preceded by omens that could have served as bugle calls to action.

What can a broker do in response to such early warnings to prepare for a potential claim? The answer is always found in brokerage firms’ compliance or procedure manuals, which prescribe steps to take in response to a dissatisfied customer. Every broker should review the firm’s written procedures regarding what to do in responding to an unhappy customer, and follow those rules to the letter. Doing otherwise only compounds the problem. Issues do not get resolved by sweeping them under the rug. It is a mark of self‐confidence and teamwork, as well as compliance, to strictly follow the firm’s procedures.

Preserving the Files

Financial professionals are required to maintain their files for several years, the length of time depending upon both FINRA rules and some states’ laws. But what is “the file,” for purposes of dealing with an unhappy customer?

Some investment professionals keep their “official” customer files free of any personal communications. They should look for and preserve any other written communications that do not appear in the main client file. These can include birthday or holiday cards, handwritten notes, newsletters or clipped articles that were sent to the customer, e‐mails sent or received on non‐business e‐mail addresses, support staff’s notes, physical or electronic calendar items that relate to the customer, travel reimbursement vouchers, phone bills, and anything else that aids in showing the complete record of communications.

In some cases the most important piece of evidence can be the customer’s own voice, recorded on the firm’s answering system. If you genuinely suspect that a claim is about to be made, it is important to have the firm locate and preserve any recorded messages from the customer.

Apart from the pragmatic reasons to preserve the total record of communications, there are two very important legal reasons to do so. Most states now recognize a relatively new kind of civil claim, called “spoliation of evidence” (sometimes misnamed as “spoilation” of evidence). This simply means that the defendant failed to preserve evidence about the case. Under some states’ laws, a plaintiff may be awarded separate damages that result from spoliation, and, more importantly, the jury may be instructed that if evidence has gone missing, it should presume that the missing evidence



would have been hurtful to the party who lost it. In arbitration, the same evidentiary rules may not apply as in court, but arbitration panels may view with distrust a broker who is unable to produce a complete written record.

To summarize, an important early step in being ready to defend against a potential claim is to make sure that all the records of communications with the unhappy customer will still be there when the potential claim becomes a real one.

Responding to an Unhappy Customer

Now that you have involved others in the firm, complied with any internal procedures, and preserved and reviewed the file, what do you say to a disgruntled customer? We reiterate that no response should be made without first fully complying with the brokerage firm’s internal rules about what to do when a customer expresses dissatisfaction.

In our experience, there is fairly universal agreement about what not to say. Those two little words, “I’m sorry,” can loom large in an arbitration or civil lawsuit.

Claimant’s counsel: “After you complained to your investment adviser, Mr. Friendly, and told him that he had mishandled your account and lost your money, did he respond to you?”

Claimant: “Yes, he did. He called me the next day.”

Claimant’s counsel: “And what did he say to you?”

Claimant: “He said that he was sorry.”



The only two words that stick in the claimant’s mind are “I’m sorry.”

Note that Mr. Friendly may have actually said, “I’m sorry that you feel this way,” or “I’m sorry that the market has been so volatile.” The only two words that stick in the

claimant’s mind are “I’m sorry.” Claimant’s counsel will argue that those two words were an admission of wrongdoing, and may outweigh all the expert testimony and other evidence to the contrary. Of equal concern, an admission of liability may violate the terms of the broker’s errors and omissions (E&O) insurance, thus jeopardizing coverage for the claim.

In our view, if a response is going to be made by phone, it is also generally advisable to follow up in writing, so that there is a permanent and contemporaneous record of what was actually said. Before sending anything in writing, remember that all writings must be pre‐approved by the firm’s Compliance Department. The response should be factual rather than emotional, and should refer to real dates when meetings took place, documents that were signed, written disclosures that were provided, and similar



objectively verifiable information. Be very aware that any written communication to an upset investor will become an exhibit in a later arbitration. You want that exhibit to fairly portray the professionalism of your work for the customer. However, these are generic suggestions, and should not be followed unless the Compliance Department has approved them.

The Arbitration Process Begins

Now the overture has finished, the curtain rises, and Act One begins. The claimant has made a demand. It may be a letter from the claimant or his/her lawyer demanding money, or it could be a FINRA Statement of Claim, a Demand for Arbitration in another forum, or a Summons and Complaint filed in a civil court case. You are now a “Respondent” or “Defendant.”

As with the pre‐claim topics discussed above, the steps that the broker or associated person must take are spelled out in the firm’s manual and the terms of its (and/or the individual’s) professional liability insurance policy. Those sources trump any suggestion in this guide that deviates from them.

Your first reaction to receiving a Statement of Claim may be anger, dismay, or even an impulse to pick up the phone and lash out at the writer. Do not do it. Set all those feelings aside and read the Statement of Claim with a rational, critical eye.

How to Read a Statement of Claim or Complaint

Statements of Claim are usually written by lawyers, and that means that they probably will not be in plain English. The claimant’s lawyer may not have a very complete view of the case before the Statement of Claim (“SOC”) is written. You will likely find factual inaccuracies, and perhaps even read allegations that were inadvertently left in from an SOC in another case.

Here are some things to look for when reading the SOC, and to compare with your memory and records as to what really happened:

• How did you first meet the claimant? Was it through a seminar that you spoke at, a chance meeting on an airplane, a referral from a customer, mutual friend, etc.? Depending on the circumstance, the way that you met and began discussing investments can lead to insights about the claimant’s original goals, and also to the identity of witnesses and exhibits. Who else was at that seminar and could testify about what you said? Where are the agenda and the sign‐up sheet? How did the mutual friend’s investing profile compare to the claimant’s?

• What were the claimant’s goals, as stated in the SOC, and how do those compare with those on the New Account form or any questionnaire that you had the claimant complete? If claimant’s



goals changed over time, are those changes reflected in the SOC or other paperwork in your file?

• SOCs and Complaints usually plead several legal theories, sometimes called “causes of action,” such as Negligence, Breach of Contract, Breach of Fiduciary Duty, Elder Financial Abuse, and others. Do not be too distracted by the theories, but look carefully to see if any specific actions on your part are alleged, such as churning the account, recommending unsuitable investments, failing to “know your client,” recommending certain investments for the purpose of receiving incentive compensation, or failing to give the customer the advantage of break points. Those are the factual issues that you need to focus on, and to prepare to dispute. Leave the legal theories to the lawyers.

• What are the alleged damages, and what is the basis? Damage figures in SOCs are often inflated, so do not be shocked when you read big numbers – they are often based on comparing the actual results to “ideal” results in a supposedly “prudently managed” account, one that contains, with benefit of hindsight, the best performing holdings. Look for any specific damages that the SOC attributes to particular holdings. Is the claimant “cherry picking” the losing positions without taking into account the gainers? This process of reviewing the SOC should not take long, and, in fact, needs to be done fairly quickly, because the next step is urgent: getting the SOC or Complaint into the hands of the people who can help you. We discuss below the importance of obtaining an early and objective Profit and Loss (“P&L”) analysis of the claimant’s accounts, to challenge inflated damage allegations.

Notifying Supervisory and Compliance Managers

Your brokerage firm’s manual will almost certainly designate whom you must notify in the event of a claim or suit. If so, notify them and only them, until they instruct otherwise. These procedures are usually based on reasons that may not be immediately obvious to you, but may become very important in the case, such as creating and maintaining the attorney‐client privilege for communications, and preventing inadvertent disclosures of confidential information.

Unless the firm’s written procedures require that you submit the SOC or Complaint with a written explanation, we believe that the less said the better. It is not yet important to convey what you think or how you feel about the allegations. That will come soon enough. However, it is important to memorialize in writing when and how you received the SOC/Complaint, because that will trigger the clock to start ticking on certain upcoming deadlines. Your cover memo might be as simple as a large Post‐It note attached to a copy of the document, such as: “Received by hand‐delivery on Tuesday, December 2, 2008, at my desk,” plus your name.



The broker‐dealer or its insurer might request that the named individual respondent provide a written narrative as to the events leading to the claim. Please keep two things in mind about such narratives:

1. Under many states’ laws, they are not privileged communications, particularly if they are not being created for the express purpose of being forwarded to defense counsel. As you write the narrative, be aware that your words may become evidence in the arbitration.

2. As a corollary to our first point, it is very important that the narrative be factually accurate, whether or not it will ever be seen by the opposing party. It will be seen by supervisory and compliance personnel within the firm and by the firm’s insurer. Inaccurate statements can lead to issues in the office, or between the brokerage firm and the insurer. Before writing, check the file, check the facts, and check any unprofessional comments at the door; do not allow them to creep into the narrative.

Notifying the Broker or Professional Liability Insurer

There is one other person who needs to know right away that you have received a SOC or Complaint: the firm’s and/or your own professional liability insurer. Here again, the brokerage firm probably has internal procedures as to who contacts the insurer(s).

We suggest that in your very first discussion with managerial or compliance personnel about the claim, you ask who will be notifying the firm’s E&O insurer (and usually the insurance broker as well) about the claim, and whether you should do so for any personal E&O insurance that you may carry. You might even ask to receive a copy of the transmittal to the carrier, so that you know when it was sent.

Most E&O insurance policies are written on a “claims made” basis, meaning that the policy covers claims that are first made (received by the policyholder) during the policy year. Some of these policies also require that the claim be reported to the insurer during the policy year, or some short grace period following the policy year. Apart from the risk of losing insurance coverage through untimely notice of a claim, there is another strong reason to get the claim into the insurer’s hands right away: to ensure that defense counsel is appointed in time to help you and the insurer make some early, time‐sensitive decisions, such as those we discuss later in this guide.

Appointing Defense Counsel

Large brokerage firms typically have high E&O insurance deductibles or self‐insured retentions (SIR). With the higher financial stake in the case there often comes a greater say in the appointment of defense counsel, though some E&O carriers retain the right to appoint defense counsel of their choice. Other E&O policies provide a list of carrier‐approved law firms, from among which the brokerage firm can select defense counsel. Choosing from such a list helps avoid disputes about the law firm’s billing rates, which have been pre‐negotiated with the insurer and thus may buy more defense efforts for the

same deductible or SIR. Moreover, the appointed counsel will be experienced in defending investment‐related cases, and will be supported by a staff of other attorneys and professionals with similar experience.

In most states, the appointed defense law firm is one party to a tripartite relationship. He or she owes professional duties of care to both the insured (the brokerage firm and its representatives named in the claim) and to the insurance company, and the communications among them are protected by the attorney‐client privilege. (Hawaii is an exception. Under Hawaii law, the appointed counsel owes duties only to the insured.) However, if the insured’s and the insurer’s interests diverge, the appointed counsel must give the insured’s interest priority over the insurer’s. For example, counsel cannot request a specific finding by the jury that would cause the case to fall outside of the policy’s coverage.

E&O policies also contain “cooperation clauses,” which usually prevent the policyholder from taking on certain obligations without the insurer’s prior consent. Those obligations include incurring any expense in the case, such as hiring defense counsel. An investment professional who hires his or her own

counsel without the carrier’s prior consent does so at his or her own expense.

Even under insurance policies that allow the policyholder to appoint defense counsel of his/her choice, one should not base the selection on existing relationships with law firms that do not have considerable experience in defending securities arbitrations and lawsuits. It would be like seeing a general practitioner perform a heart transplant. There is too much at stake in investment claims to rely on on‐the‐job training to educate defense counsel.

If 20 days have passed since you received a Complaint in a civil action, and you still have not been notified that defense counsel has been appointed, it is time to make an urgent request that counsel be appointed. Many states require that defendants file appearances in civil cases within 30 days of being served, or face the prospect of default judgments being entered against them. There is also a 30‐day limit to file a Notice of Removal from state court to federal court, and, under many states’ laws, to file a Petition to Compel Arbitration or any other challenge to the court’s jurisdiction. The time to file answers in state courts may be extended by a written agreement of counsel, subject to local court rules, but deadlines for jurisdictional challenges and removals to federal court cannot be extended.

FINRA’s rules give respondents (as defendants are called in FINRA cases and most other arbitral systems) 45 days from service of SOCs to file their first papers. Since there may be several respondents in a given arbitration, the FINRA Arbitration Administrator will usually state the due date in the written notice that he or she sends out with the SOC.



Do I Need Separate Counsel?

It is conventional wisdom that in most professional liability cases it is best to have individual respondents or defendants jointly represented by the same defense counsel as their professional firm, to avoid “dividing the defense” and making the claimant/plaintiff’s case easier. But there are important exceptions.

One exception in a securities context occurs when the representative has recommended one or more financial products to the customer that were not, at the time of the customer’s purchase of those

products, approved by the broker‐dealer. In these so‐called “selling away” cases, there may also be no insurance coverage for the individual representative under the firm’s E&O policy. There is a conflict between the firm’s interests and the individual’s – the firm will contend that it has no responsibility for the unapproved product, while the individual and possibly the claimant will assert that the firm’s compliance and supervisory system was faulty for not catching the

error. The same law firm cannot represent the broker‐dealer and the individual in those circumstances.

Another exception can occur when a representative leaves Firm A and becomes registered with Firm B, taking the future claimant along as a customer to Firm B. Assume that one holding that was already in the account for three years during Firm A’s period of supervision was unsuitable when recommended, and that it remained in the account for two years during Firm B’s supervision. In Year 5 the claimant then sells the holding at a loss, and brings a FINRA claim against both firms and the individual. Firm A is probably covered for the claim under Firm A’s E&O policy that is in effect in Year 5, the year the claim was made. Similarly, Firm B and the individual are probably covered under the E&O policy that is in effect for Firm B in Year 5, so long as that policy covers prior acts. (Note that the claimant will allege a continuing error, starting with the recommendation that the unsuitable investment be purchased and going forward at both firms because they failed to recommend that it be sold before the loss deepened.) The individual may need separate counsel unless both firms take the united position that the holding always was, and remained, suitable.

Some states allow insureds, individuals or businesses the right to appoint independent defense counsel when their insurer has issued a Reservation of Rights letter, contending that some parts of a claim may not be covered, and defense counsel could influence the outcome on that issue. In California, this rule is codified as California Civil Code section 2860, sometimes called the “Cumis” rule after a court case that set the precedent before the statute was enacted. When a brokerage firm or a representative has the right to appoint independent counsel, the same considerations come into play as for insurer‐appointed counsel: expertise in FINRA securities arbitrations, and hourly fee rates that are within the insurer’s guidelines so that the insured does not get stuck with the bill for the difference between counsel’s rates and the carrier’s approved rates.



Your First Meeting with Defense Counsel

Your lawyer is on board, so it is time to get ready to have a meeting and get started on defending the case. What can you do to start this joint effort off on the right foot? We offer the following ideas.

1. We find that an introductory phone call is very helpful in making the first meeting that you have with your defense counsel as efficient and successful as possible. During that call, we suggest that you agree on at least the following:

• Where to meet. In most cases we prefer to have our initial meeting at the client’s office, not ours. Our securities clients have their own clients who need their help, and time wasted driving to a law office is time away from that important business. Seeing the client’s office also gives us a better understanding of the systems in place in the office and the other people at the office who may have information that will aid in defending the case. Later on, it may be convenient for the client to visit our office, but we prefer that the first, crucial meeting take place where our client works, even if it is a home office.



A written chronology for counsel can be of great help in focusing the initial meeting on the key points.

• Arrangements to copy the file. Lawyers differ regarding whether they want to see the entire file before meeting the client. If the file is small, it may be best to have it copied and sent to counsel in advance of the meeting. If it is large, counsel might ask that the client review the file and prepare a summary or chronology of key events and send it to counsel before the meeting. A written chronology for counsel will be privileged from discovery, and can be of great help in focusing the initial meeting on the key points, instead of a rambling “Tell me what this case is all about” discussion.

• Who else should be there? The answer will depend on whether counsel will jointly represent the firm and the individual. If that is not an issue, there may be other people who should be available for all or part of the meeting.

2. By the end of the initial meeting, or as a follow‐up call afterwards, it is a good idea to establish realistic expectations about the case. No lawyer is going to be able to predict the outcome of an arbitration, especially after only one meeting, but there are some questions that are fair to ask, and to which you should expect straightforward answers:

• “Based on what you have heard and read so far, what do you think our main problems are in defending this case?” This question forces both lawyer and client to think of potential downsides. It is better to get those out on the table early than to be surprised later in the case.

• “Is this case where it belongs?” In other words, if it is in court, should it instead be in FINRA, or some other contractually required arbitration forum? If it belongs in court, is it in the right court? Should the venue be changed to a different county, or should the case be removed to federal court, and are there grounds to do so? There are usually two bases to remove a case: first, a “complete diversity of citizenship,” legalese for cases in which no plaintiff has the same state residency (or state of incorporation or principal place of business) as any of the defendants; or, second, that there is a question of federal law that must be decided in the case.

• If there is a choice between having the case in court or in arbitration, it is fair to ask, “Should we demand a jury?” It is your right, after all, to be tried by a jury of your peers. The easy answer is to always demand a jury trial when filing an answer in court; you can change your mind later and waive your right to a jury, assuming that the other side has not demanded one, but in some states a jury must be demanded at the outset of the case, or not at all.

• “Should we file a counterclaim, or bring any absent parties into the case?” If the plaintiff owes you fees, or has committed trade libel against you (not counting via the litigation itself) there may be a right to file a cross‐claim, either in court or in arbitration, a right that can be lost if it is not exercised. Bringing in third parties is generally easier at the outset of a case, either in court or arbitration, and can provide additional participants for settlement purposes, but that alone is not reason enough to do so. A careful analysis is needed before deciding whether there is probable cause to sue a third party. If the case is in FINRA, complaints cannot be filed against third parties unless they are FINRA members or associated persons. In private arbitrations, the third parties must be parties to, or beneficiaries of, the contract that contains the arbitration clause, or must voluntarily consent to join in the arbitration.

• “How much is this going to cost?” Some lawyers dislike this question, but it is essential for most clients to have a rough idea of future fees and costs in the case, not including what a jury or arbitration panel might award. It is reasonable to ask for and receive an early estimate of fees and costs, with the understanding that legal disputes, like sporting events, are individually unpredictable, though on average there are trends that keep oddsmakers in business.





Is it better to be in Court or Arbitration? Some factors that favor one venue over another:

Factor FINRA Arbitration Civil Court Other Private Arbitration

Jury Trial No Yes, if timely demanded.

No

Answering Deadline

45 days after service. Varies; typically 30 days after service, but some states are shorter.

Varies by organization.

Expertise in securities and investing

FINRA panels are usually the most experienced, though individual arbitrators vary widely.

It is rare to find a jury or judge who has substantial knowledge of the industry. However, they may rely more on expert witnesses’ opinions.

Varies widely. We suggest that specific individuals with prior securities arbitration experience should be selected. Some FINRA arbitrators conduct private arbitrations.

Discovery FINRA requires the production of certain kinds of documents; additional documents may be requested. Depositions are rare. (See below.) Claimants’ tax returns are discoverable.

Wide‐ranging discovery is the norm, including depositions. No tax returns.

Varies widely. No tax returns.

Appeal No Yes No Forum Fees Sliding scale filing fees based

on size of claim, $225 to $3,700, plus Member surcharge from $150 to $3,750, and Hearing process fee between $1,000 and $5,500. Hearing session fees of $600 ‐ $1,000/day.

Varies by state, but are generally the lowest forum fees, including jury fees.

Private arbitral forums can be very expensive. Fees of $6,000/day are not unusual.

The Answering Statement, CrossClaims, ThirdParty Claims, and Early Motions in FINRA

Those who have been parties in civil lawsuits may think of the answer as a perfunctory statement that the defendant disputes whatever the plaintiff has alleged, followed by a boilerplate list of legal defenses. In court, the judge and jury might never look at the defendant’s answer, unless it comes up later in a motion filed by one of the parties.

In contrast, Answering Statements in FINRA Arbitrations may be the only thing that the arbitration panel reads about the respondent’s version of the case before the first day of the arbitration hearing. Some panels do not want to receive arbitration briefs in advance of the hearing, but each of the three arbitrators receives the SOC and the Answering Statement shortly after they are appointed.



Your Answering Statement is your chance – and perhaps your only chance – to tell the panel your version of the facts before the hearing.

We thus urge our clients to think of their Answering Statement as their chance – and perhaps their only chance – to tell their version of the facts to the panel before the hearing. We sometimes do this with an

Introductory Statement that says, in narrative form, what really happened, and then launch into the more legalistic part of the document. We also like to attach exhibits to Answering Statements, especially documents that show the claimant’s acknowledgement of important facts and even a signature, such as an Acknowledgement of Receipt of the Private Placement Memorandum, or a New Account form

that shows the claimant’s stated goals, experience, and risk tolerance. That image of the claimant’s contemporaneous acknowledgement can say more about the case than 14 pages of densely packed legal citations.

Of course, anything that the respondent says in the Answering Statement needs to be 100% verifiable. A respondent will lose credibility by stating things in writing as facts, only to see those “facts” disintegrate at the hearing.

One of the most common allegations by claimants is that the financial professional recommended “unsuitable” investments. Thus, one of the most important things to accomplish in an Answering Statement is to show that the recommendations met FINRA’s suitability rule, which states:

FINRA Rule 2310:

a) In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if



any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.

(b) Prior to the execution of a transaction recommended to a non‐institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning: (1) the customer's financial status; (2) the customer's tax status; (3) the customer's investment objectives; and (4) such other information used or considered to be reasonable by such

member or registered representative in making recommendations to the customer.

“Reasonable grounds for believing” that a “recommendation” is suitable is a far cry from guaranteeing the outcome of an investment. The Answering Statement is an opportunity in a suitability case to plant the seeds for the evidence that the respondent will later introduce at the hearing: (1) there were grounds to believe that the recommendation was suitable; (2) these grounds were reasonable; and (3) they were based upon the facts disclosed by the customer as to his other security holdings and to his financial situation and needs. Stating these facts will be much more powerful than a perfunctory “Respondent denies that the investments were unsuitable.”

A respondent may cross‐claim against the claimant at the same time as filing the Answering Statement. The respondent may also file Third‐Party Claims together with the Answering Statement, but doing so does not extend FINRA’s jurisdiction to non‐members or persons who are not associated with members.

Motions to dismiss may be designed to dismiss one respondent from the case, or to dismiss one of the several causes of action in the SOC. FINRA has imposed a 30‐day moratorium on the filing of such motions, running from January 23, 2009, to February 23, 2009, because new rules governing those motions go into effect on February 23. Under those rules, motions to dismiss will be limited to situations where the non‐moving party signed a settlement and release, or where the moving party was not associated with the account, security, or conduct at issue in the case. These grounds are more restricted than would exist in most courts. Such motions may not be filed before there has been a hearing on the merits of the case, or during the arbitration hearing until after the non‐moving party has rested its case. Please refer to new FINRA Rules 12504 and 13504 for further details about filing deadlines under the new rules.

Another kind of motion to dismiss, called an “eligibility motion,” is based on FINRA’s six‐year eligibility rule, which states:

“No claim shall be eligible for submission to arbitration under the Code where six years have elapsed from the occurrence or event giving rise to the claim. The panel will resolve any questions regarding the eligibility of a claim under this rule.” (Rule 12206(a).)

In other words, if the act or omission took place more than six years before the SOC was filed, a claim based on that act or omission is ineligible for arbitration, though it may still be able to be litigated in court, depending on the applicable statute of limitations. But applying the six‐year rule is not as simple as consulting a calendar. Claimants routinely attempt to skirt around the six‐year rule by alleging that the respondent affirmatively concealed the impropriety of a given investment during the six years that preceded the SOC being filed, or that the respondent failed to recommend that an unsuitable investment be sold during those six years.

In our view, which is supported by many FINRA decisions, the six‐year rule is stated broadly – the “event giving rise to the claim” – and should be applied as written, but we realistically advise clients that even the clearest six‐year eligibility motion may be denied, or postponed until the end of the arbitration hearing, which has the same practical effect on the fees and costs that the client must incur.

Under the new FINRA rules going into effect on February 23, 2009, eligibility motions must be filed at least 90 days before the scheduled hearing on the merits of the case.

Arbitrator Selection Under FINRA Rules

We have been referring to FINRA Arbitration “panels” because most FINRA Arbitrations are heard by three‐person panels. However, FINRA also offers single‐arbitrator hearings for claims seeking $25,000 or less in damages, exclusive of interest and expenses. For claims above $25,000 up to $50,000, there will also be only one arbitrator, unless any party requests a three‐person panel in his/her SOC or Answering Statement. Claims above $50,000, or which do not specify an amount of claimed damages, will have a three‐person panel, unless all parties stipulate in writing to have only one arbitrator.

Single‐arbitrator cases are conducted by an arbitrator who is selected from the “Public Chairperson” roster, which we explain below, unless all parties agree otherwise in writing.



Selecting an arbitrator, or a panel of three arbitrators, is roughly the equivalent of selecting, in a civil case, the judge, jury, Court of Appeals, and Supreme Court, all in one. The arbitrators have wide latitude to vary from the rules of law and evidence that would apply in a courtroom. Their

Selecting arbitrators is equivalent to selecting, in a civil case, the judge, jury, Court of Appeals, and Supreme Court, all in one.

decision is final, and, as previously noted, is not subject to a right of appeal. We thus urge our clients to take a very active role in FINRA arbitrator selection, once we have provided substantial information about the potential arbitrators, because their insights deserve substantial weight – after all, they have to live with the panel’s decision.

Here is how the FINRA selection system works in three‐arbitrator cases:

1. When a Statement of Claim is filed, FINRA appoints a Case Administrator to that file from among its Dispute Resolution staff. An administrator may be handling scores of cases within a given year.

2. Once all parties have filed their appearances in the case, the administrator sends to each party or his/her counsel a list of 24 potential arbitrators, eight from each of three lists:

a. Eight from the Public Chairperson roster – a list of FINRA arbitrators in the geographic area who are not affiliated with a FINRA member or related company, and who have been approved by FINRA as having the necessary training and skills to chair an arbitration. Any party may request in his/her first pleading that preference be given to arbitrators with certain kinds of expertise, such as experience in employment disputes, private offerings, retirement planning, etc.

b. Eight from the Public Arbitrator roster – a list of other FINRA arbitrators in the geographic area who are not affiliated with a FINRA member or related company, but who have not as yet been approved by FINRA to chair arbitrations.

c. Eight from the Non‐Public Arbitrator roster (formerly called the “Industry” roster) – a list of FINRA arbitrators in the geographic area who are, or have previously been, in some way affiliated with a FINRA member or related company. The word “affiliated” is interpreted quite broadly: the arbitrator need not even be licensed to sell securities to be designated non‐public. The affiliation may be as tenuous as a familial relation, or having represented a FINRA member as counsel.



The real work and art of arbitrator selection happens between client and counsel.

3. Each separately represented party may “strike” from each list up to four of the eight potential arbitrators on that list, and “rank” the remaining ones in order of preference. All parties have the same deadline to deliver their strikings/rankings to the FINRA case administrator. These are, in effect, secret ballots – no party is required to divulge his/her selection forms to any other party, and FINRA will not disclose them.

4. For each of the three lists, the case administrator compares the rankings of any arbitrators who remain on the list, and the person with the top average score will become the selected arbitrator from that list for the case. However, if the parties have, among them, struck all eight names from that list, the case administrator goes back to the roster for the next randomly selected name from that roster. That person becomes an arbitrator, unless he/she is successfully challenged “for cause” by one or more parties. Good cause for a challenge might be a previously stated bias against one of the parties, or having a financial interest in one of the parties, or in the outcome of the case. There are no more strikes to exercise, and parties cannot save up strikes from the first round.

That is how FINRA arbitrators are selected, in a purely mechanical sense, but the real work and art of arbitrator selection happens between client and counsel. Defense counsel will receive a detailed list of disclosures from each potential arbitrator, describing his/her personal investment experience, education and job history, and prior FINRA cases that went to hearing. There is also a short narrative written by each potential arbitrator. Sharing the disclosures with the client is only the first step in the selection process.

The second step is what might be called “due diligence” in an investment setting. We recommend that defense counsel research the 24 possible arbitrators, and provide the client with the following information, in addition to what is in the disclosures:

1. A brief summary of the case types and results in the prior FINRA awards in which the panelist participated. The awards are available from FINRA’s Web site. Awards are not required to give “reasoned opinions,” as FINRA puts it, so an award will rarely explain the panel’s rationale, but will usually describe the type of case, the damages alleged, and the amount awarded, if any.



It may be very important to know that a potential “public” arbitrator is, in fact, a plaintiffs’ lawyer who specializes in real estate fraud cases.

2. Many FINRA arbitrators have their own Web sites, which can provide a wealth of information. Lawyers who act as arbitrators will normally disclose their areas of specialization; whether they represent plaintiffs, defendants, or both; and some will list large cases that they have won. It may be very important to the investment professional to know that a potential “public” arbitrator is, in fact, a plaintiffs’ lawyer who specializes in real estate fraud cases, or that a “non‐public arbitrator” only dabbles in securities law, but focuses on personal injury work.

3. Defense counsel should determine if anyone in his/her law firm has had a prior case with any of the arbitrators, positive or negative.

4. Counsel should also check with the client’s Law and/or Compliance departments to determine if they have had prior experiences with any proposed arbitrators, or have any reactions to their disclosures.

5. Finally, defense counsel should summarize all the above information and counsel’s recommendations as to striking and ranking to the client in an easy‐to‐follow format. We prefer to use a table for this purpose, which we attach to an e‐mail, and use the e‐mail for any narrative explanation of the recommendations.

As with jury selection, arbitrator selection is an inexact process. Unless counsel or the client has personal experience with a potential arbitrator, there are many subjective factors that come into play. For example, here are some over‐generalizations:

A non‐public arbitrator whose background is in a brokerage firm’s Compliance, Regulatory, or Legal department may be more inclined to decide a case based on technical violations, rather than whether there was genuinely a failure to meet the standard of care, or whether any real harm was done.

We are wary of an arbitrator who has awarded punitive damages in a prior FINRA case. We do not automatically strike such a person, but other factors being equal, we would prefer a panelist who had not made such an award. Before recommending that he or she be ranked rather than struck, we might call the attorney who defended the prior case and ask whether he or she would ever leave that arbitrator on a panel again. After all, there are exceptional cases where punitive damages are warranted.

We look for patterns in prior decisions, when there are enough to do so. As defense counsel, we want to have arbitrators who can make tough decisions and have granted a dismissal at least once before – who do not always “split the baby” and award a compromise amount. Similarly, we look for patterns of arbitrators who have sat on prior panels together, to see if their joint decisions trend toward the larger or smaller awards (in terms of the ratio of claimed damages to awarded damages). Such correlations may affect the high or low ranking for both potential arbitrators.

We also tend to favor arbitrators who have had real‐life business experience, especially in fields that involve public contact, the theory being that such arbitrators understand that public customers sometimes blame unsatisfactory results on their advisers, without looking in the





mirror and realizing their own role in making decisions, or realizing that no adviser can control or predict every outcome. The real world is not that predictable.

In light of all the above disclosures, preconceptions, and investigations, we talk with the client and his/her insurance claims representative, if any, and try to reach a consensus as to who should be struck, and who should be ranked high or low. And then we wait to get the fax or letter from FINRA that tells us who will really be on the panel. If there is a new name, it means that all eight names on an original list were struck, and our inquiry starts anew, this time limited to challenges for cause.

Experts The case is still young. Is it really time to start working with expert witnesses? It may be, for two reasons:

1. Fairly evaluating the case means looking at the downside as well as the upside. The client and counsel need an objective, reliable profit‐and‐loss statement on the claimant’s accounts. The client may be able to produce a P&L, but if the case goes to hearing, the panel will want to have an independent calculation. Especially in cases that have large alleged damages or numerous transactions, an early, independent P&L is worth the cost.

2. The other usual topic for expert testimony in FINRA cases is whether the respondent met the applicable standard of care. In the early stages of the case, this topic can be explored with the client and with internal compliance and supervisory personnel, guided by defense counsel’s views on statutory and other legal standards. However, someone is going to have to explain the industry’s standard of care to the arbitration panel, and neither defense counsel nor internal management at the brokerage firm is in the best position to do so.

Respondents rarely feel that they have done anything wrong, because they know that they never intended to cause any harm, and had the customer’s best interests at heart. Similarly, defense counsel often take the so‐called “defense mentality” too far by assuming that claimant’s counsel is championing an obscure cause. There are some lawyers who are like that, but most lawyers who routinely represent FINRA claimants are careful, methodical businesspeople. They usually take cases on a contingent‐fee basis, and are not going to invest (literally) their time and energy in cases that lack some arguable basis for the panel to find liability. They are an organized group of people, who share ideas, experts, and outlooks on the financial industry with one another. (We suggest that you take a moment to visit www.piaba.org to see this for yourself.) The defense side of the case needs to be likewise careful in its early analysis.

We do not suggest that an external expert’s opinion on standard‐of‐care issues is always needed early in every case; we do suggest that whether such an opinion is necessary should be considered in every case.



Sometimes a simple phone call from defense counsel to a known expert, acting as a background consultant, is all that is needed to help confirm whether it will be easy or difficult to support the investment professional’s conduct through expert testimony at time of hearing. Retaining an expert witness is not a sign of weakness or an admission of wrongdoing – it is going into a gunfight with a loaded weapon.

Discovery and Preparation Up to and Including the Hearing

The PreHearing Conference There is always at least one Pre‐Hearing Conference in every FINRA Arbitration, sometimes more. The conference is conducted by telephone, with only the arbitrators and counsel for the parties participating. Parties may be on the call as well, but typically are not, because the main agenda item of the call is to set deadlines for discovery, motions, and the arbitration hearing itself.

That last point – setting the arbitration hearing – is obviously very important to the client. Most FINRA Arbitrations go to hearing six to twelve months from the filing of the SOC. Longer hearings (more than a week) tend to get scheduled farther out, simply because it is hard to find two or more consecutive, clear weeks on the busy schedules of three arbitrators, two or more lawyers, and the parties themselves. Defense counsel and the client should discuss their upcoming schedules, week‐by‐week for that six‐to‐twelve‐ month period, well in advance of the pre‐hearing conference.

Discovery in FINRA Cases “Depositions are strongly discouraged in arbitration,” as FINRA Rule 12510 succinctly states. Except for preserving the testimony of a dying witness, and a few other extraordinary circumstances, parties to FINRA Arbitrations should consider depositions as nonexistent, under the current rules. We must note that there are proposals pending to change Rule 12510, such as by allowing one deposition of each party. In our view, doing so would greatly increase the expense of FINRA Arbitrations and dilute one of the main advantages of FINRA as a forum for dispute resolution.

FINRA encourages documentary discovery just as strongly as it currently discourages depositions. In fact, in customer‐initiated arbitrations, FINRA has prescribed two detailed lists of “presumptively discoverable” documents, which must be produced in all such cases within 60 days of the respondent’s deadline to file his/her Answering Statement, unless the party required to produce a given document makes a timely written objection. Otherwise the objection is waived.



The respondent must produce: 1. All agreements with the customer, including, but not limited to, account opening documents, cash,

margin, and option agreements, trading authorizations, powers of attorney, or discretionary authorization agreements, and new account forms.

2. All account statements for the customer’s account(s) during the time period and/or relating to the transaction(s) at issue.

3. All confirmations for the customer’s transaction(s) at issue. As an alternative, the firm/associated person(s) should ascertain from the claimant and produce those confirmations that are at issue and are not within claimant’s possession, custody, or control.

4. All “holding (posting) pages” for the customer’s account(s) at issue or, if not available, any electronic equivalent.

5. All correspondence between the customer and the firm/associated person(s) relating to the transaction(s) at issue.

6. All notes by the firm/associated person(s) or on his/her behalf, including entries in any diary or calendar, relating to the customer’s account(s) at issue.

7. All recordings and notes of telephone calls or conversations about the customer’s account(s) at issue that occurred between the associated person(s) and the customer (and any person purporting to act on behalf of the customer), and/or between the firm and the associated person(s).

8. All Forms RE‐3, U‐4, and U‐5, including all amendments, all customer complaints identified in such forms, and all customer complaints of a similar nature against the associated person(s) handling the account(s) at issue.

9. All sections of the firm’s Compliance Manual(s) related to the claims alleged in the Statement of Claim, including any separate or supplemental manuals governing the duties and responsibilities of the associated person(s) and supervisors, any bulletins (or similar notices) issued by the Compliance Department, and the entire table of contents and index to each such manual.

10. All analyses and reconciliations of the customer's account(s) during the time period and/or relating to the transaction(s) at issue.

11. All records of the firm/associated person(s) relating to the customer's account(s) at issue, such as, but not limited to, internal reviews and exception and activity reports which reference the customer's account(s) at issue.

12. Records of disciplinary action taken against the associated person(s) by any regulator or employer for all sales practices or conduct similar to the conduct alleged to be at issue.



The claimant must produce:

1. All customer and customer‐owned business (including partnership or corporate) federal income tax

returns, limited to pages 1 and 2 of Form 1040, Schedules B, D, and E, or the equivalent for any other type of return, for the three years prior to the first transaction at issue in the Statement of Claim through the date the Statement of Claim was filed.

2. Financial statements or similar statements of the customer’s assets, liabilities and/or net worth for the period(s) covering the three years prior to the first transaction at issue in the Statement of Claim through the date the Statement of Claim was filed.

3. Copies of all documents the customer received from the firm/associated person(s) and from any entities in which the customer invested through the firm/associated person(s), including monthly statements, opening account forms, confirmations, prospectuses, annual and periodic reports, and correspondence.

4. Account statements and confirmations for accounts maintained at securities firms other than the respondent firm for the three years prior to the first transaction at issue in the Statement of Claim through the date the Statement of Claim was filed.

5. All agreements, forms, information, or documents relating to the account(s) at issue signed by or provided by the customer to the firm/associated person(s).

6. All account analyses and reconciliations prepared by or for the customer relating to the account(s) at issue.

7. All notes, including entries in diaries or calendars, relating to the account(s) at issue.

8. All recordings and notes of telephone calls or conversations about the customer’s account(s) at issue that occurred between the associated person(s) and the customer (and any person purporting to act on behalf of the customer).

9. All correspondence between the customer (and any person acting on behalf of the customer) and the firm/associated person(s) relating to the account(s) at issue.

10. Previously prepared written statements by persons with knowledge of the facts and circumstances related to the account(s) at issue, including those by accountants, tax advisers, financial planners, other associated person(s), and any other third party.

11. All prior complaints by or on behalf of the customer involving securities matters and the firm’s/associated person(s’) response(s).

12. Complaints/Statements of Claim and Answers filed in all civil actions involving securities matters and securities arbitration proceedings in which the customer has been a party, and all final decisions and awards entered in these matters.



13. All documents showing action taken by the customer to limit losses in the transaction(s) at issue.

There are also specialized lists of documents for cases alleging certain causes of action (churning, failure to supervise, and unauthorized trading, among others) that are also presumed to be discoverable. Parties may request other documents that are not on any FINRA list, but in the event of a dispute regarding such requests, there is no presumption of discoverability.

In addition to documents, parties may request “information” from each other. These requests differ from interrogatories in civil actions in that they “are generally limited to identification of individuals, entities, and time periods related to the dispute; such requests should be reasonable in number and not require narrative answers or fact finding. Standard interrogatories are generally not permitted in arbitration.” (FINRA Rule 12507(a)(1).)

Responses and objections to discovery, other than the applicable FINRA lists, are due 60 days from the date the discovery request was received.

FINRA panel chairs typically hear discovery‐related motions, including motions to issue subpoenas to non‐party witnesses to produce documents and to appear at arbitration hearings. “Discovery‐related motions are decided by one arbitrator, generally the chairperson. The arbitrator may refer such motions to the full panel either at his or her own initiative, or at the request of a party. The arbitrator must refer motions relating to privilege to the full panel at the request of a party.” (Rule 12503(c)(3).)

Most arbitrators disfavor discovery motions, preferring that the parties work out their disagreements. We support the practice of trying to work out discovery disputes before resorting to motions, and making a written record of those efforts. That way, if a motion does become necessary, it will be clear to the chair that our client is not wasting the chair’s time on trivial disagreements.

Mediations: What Have I Got to Lose? “Mediation” may rhyme with “capitulation,” but the resemblance ends there. FINRA encourages mediations, and even sponsors a “Mediation Month” each October with reduced mediator fees to encourage cases to settle.

For those new to mediation, either in FINRA or in other settings, here is what happens. The parties and their counsel meet privately, aided by a mediator, a mutually agreed‐upon neutral. The mediator has no power to force any party to settle. Nothing said or exchanged at a mediation can be introduced into evidence in a case, including a FINRA Arbitration. Mediators’ styles differ – some begin with a joint session during which counsel and the parties are encouraged to make brief statements; others do not. In either event, the real work at a mediation is done in private caucuses that the mediator holds separately with each side, conducting a version of shuttle diplomacy. A good mediator maintains his or

her credibility with each side by recognizing their strengths and weaknesses, and helping each side focus on the latter. Over the course of a day, and sometimes in phone caucuses that can stretch over several days or weeks afterwards, the mediator nudges, cajoles, and encourages the parties to move closer toward a settlement.

As noted above, FINRA’s statistics for 2007 show that 66% of the cases that resolved that year did so as a result of settlements. Roughly a third of those settlements were conducted under FINRA’s mediation system; the rest were through direct negotiations or private mediations. Very few cases that are mediated fail to settle.



The only outcome that you truly control is the one that you negotiate.

The real question that all parties face at a mediation is the one posed above, “What have I got to lose?” Every party has something to lose in an arbitration hearing or a trial, even if it is only the fees and costs of going through the

process, the lost productive time, and the risk that an adverse result, even a $1 award, will be reported on his/her CRD. There is also the unknown: allowing three strangers to decide your outcome for you. In litigation or arbitration, the only outcome that you truly control is the one that you negotiate.

There are other reasons to mediate a case, even if the respondent has little hope that the case will settle. First, it gives each side a preview of the other side’s “best shot.” It allows the respondent and counsel to test‐drive their view of the case, to hear (through the mediator) the other side’s rejoinders, and to obtain a neutral third party’s observations. That alone is well worth the expense. Additionally, a mediation gives defense counsel the chance to see the claimant and to evaluate whether he or she will make a favorable witness. Finally, a well‐conducted mediation gives all parties the chance to look beyond their subjective impressions of what destroyed their former professional relationship, and to bring closure not only to the case, but also to an unpleasant chapter in their lives, and to move on to more productive endeavors.

In our experience, mediations are the most effective after both sides have the information that they truly need to evaluate the case, but before they are on the brink of an arbitration hearing. Both sides have greater economic incentive to settle at that pivotal juncture, because neither side will have paid for the final push to prepare the case for hearing. If the case does not settle, that does not mean that the mediation process failed. It does mean that each side can move forward with a clear picture of its risks, knowing that a serious effort was made to resolve the dispute.

The PreHearing Exchange Twenty days before the first scheduled day of the arbitration hearing, the parties are required by FINRA Rule 12514 to exchange “all documents and other materials in their possession or control that they intend to use at the hearing that have not already been produced,” and also to “provide each other party with the names and business affiliations of all witnesses they intend to present at the hearing. At

the same time, all parties must file their witness lists with the [case administrator], with enough copies for each arbitrator.” Failing to comply with this rule can result in the documents or witnesses being barred from being introduced at the hearing. The date of the 20‐Day Exchange, as it is commonly called, can actually be moved by a written agreement of the parties. However, there is a great deal of work to do in the last 20 days before an arbitration hearing, and shortening the time for the exchange can lead to unpreparedness, especially if the panel has asked the parties to submit written arbitration briefs in advance of the hearing. There may be something in the claimant’s 20‐Day Exchange that will throw a monkey wrench into the respondent’s brief.

Final Preparation for the Hearing With the 20‐Day Exchange completed, the final preparation for a FINRA Arbitration resembles that for a civil trial, except for jury selection. Counsel will hold final meetings with all defense witnesses, helping them prepare to testify and to be cross‐examined by the claimant’s counsel. Key exhibits will be reviewed and re‐reviewed by the respondent so that he/she has them committed to memory.

One step that does not directly affect the client, but which can greatly expedite the arbitration hearing, is for counsel for all parties to collaborate on a single set of Joint Exhibits. This is not required by FINRA rules, but it makes a great deal of sense, and saves copying expenses for all sides. There are some documents that everyone will want to have in evidence at the hearing: the New Account forms, any questionnaires that the claimant completed, account statements, confirmations, and correspondence between claimant and respondent. It makes no sense for each side to put together its own set of exhibit books, using its own numbering systems, for documents that neither side can truly dispute. Having a single set of Joint Exhibits makes it much easier for the parties, the witnesses, and the arbitrators to follow the testimony, without needing a Rosetta Stone to know that Claimant’s Exhibit 2 is identical to Respondent’s Exhibit F. In some cases, we have even done away with paper exhibits, creating a set of Joint Exhibits on CD‐ROM, with copies provided to the arbitrators, and the exhibits projected onto a large screen for viewing during the hearing.

Preparing to Testify Preparing to give testimony in a FINRA Arbitration can be a significant investment of time, though a very wise one. All investment professionals understand the importance of making a good first impression. Making that good impression is much harder at an arbitration – the broker or financial adviser is not presenting to a group of people who have been referred by another customer or mutual friend, but rather a group of three strangers who have read uncomplimentary things about the respondent.



To help a client make a persuasive and credible presentation, we recommend the following steps:

1. The defense lawyer should prepare an outline of issues in the case for the client to review together with counsel, tying the facts in the case to the issues and to the key documents that will be introduced by any party on each issue.



2. The documents themselves must be reviewed in detail, with special emphasis on such key

documents as the Account Agreement; any written statement of the claimant’s goals, investment horizon, or risk tolerance; any account statements, customer authorizations, or confirmations that show the customer’s knowledge and acceptance of challenged investments; records of the meetings and other documented communications with the claimant; and those portions about the firm’s Compliance Manual or other written procedures about which the witness may be questioned. If the client has had prior claims, those should also be reviewed in detail so that questions about those matters can be responded to without appearing defensive about them.

3. All witnesses bring their emotions to the witness chair. An important part of preparing to testify

is to discuss honestly with counsel the topics that are likely to set off emotional reactions, and to defuse those topics. Conversely, the investment professional may have keen insights into the claimant’s emotional triggers, which may aid defense counsel in preparing to cross‐examine the claimant.

4. As with most activities, practice makes perfect. One or more practice sessions, with counsel

playing the role of the opposing counsel, can be very helpful to a witness, especially one who has not previously testified under oath. We sometimes use a video camera during such practice sessions so that the witness and counsel can review the video and see what messages the witness’s body language and speech patterns are sending, in addition to words that are spoken.

These steps take time, so it is important to pre‐schedule such preparatory meetings for when the client and counsel can be together, at least twice within the weeks leading up to the hearing. Typically, counsel’s office is the best place to meet because the client is less likely to be interrupted there and the case file is at the attorney’s office.

Testifying at the Hearing The goal of the above preparation is to help the client to be as confident and comfortable as possible when the case is heard by the panel. A strong defense witness projects professionalism and confidence, without arrogance or condescension. The strong witness is honest – he or she answers questions forthrightly, whether they are posed by defense counsel, claimant’s counsel, or the panel members, without slipping into a wandering discussion that goes beyond the question that was posed. In appearance, the strong witness dresses professionally, but not ostentatiously. The earmarks of wealth and financial success that may impress new customers may turn off an arbitrator. The strong witness has a good command of the facts, but also understands that an arbitration is not a game show, and that it is better to take a moment to look at an exhibit than to make an inaccurate guess.

As a respondent in a FINRA Arbitration, you have an important role, even when you are not testifying. Your demeanor when other witnesses are speaking will send a message to the panel. You also have a unique perspective on the case, and defense counsel may benefit greatly from a quickly scribbled note that suggests a question or points out an inconsistency in an adverse witness’s testimony.

How Arbitration Hearings Proceed With some variations, a FINRA Arbitration Hearing proceeds similarly to a civil trial. After organizational matters are managed by the chairperson, the claimant’s counsel gives an opening statement, outlining the evidence that he or she anticipates will prove claimant’s case. Respondent’s counsel can either follow immediately with his/her opening statement, or reserve it until claimant’s case has rested. Motions may also be presented before the evidence starts. These can include Motions to Dismiss that the panel has earlier decided not to rule upon until the hearing. Such motions may be raised again at the end of the hearing if the panel decides to hear all the evidence before making a ruling.

The claimant’s case is presented first, but the respondent and other defense witnesses (except experts) may be called by claimant’s counsel. It is common for the respondent to be called “adversely” during claimant’s case, so that claimant’s counsel can present only the facts that aid claimant’s case, rather than allowing the respondent to give a more organized, coherent presentation during the defense case.

As at trial, respondent’s counsel may cross‐examine any witnesses whom the claimant calls, and vice‐versa. Unlike at trial, many arbitrators take an active role in asking the witnesses questions. These questions may provide an insight as to how each arbitrator is reacting to the case. The client can be of great assistance to counsel by watching and listening to the arbitrators, and picking up on any themes that seem to “click” with an arbitrator, or evidence/arguments that upset the arbitrator.

Another difference between FINRA Arbitrations and trials: there is no court reporter (stenographer) at an arbitration. Instead, the entire proceeding is tape‐recorded. A party may bring a stenographer to make a transcribed record, but even so, the tape recording is considered the official record.

When all of claimant’s evidence and witnesses are completed, the claimant “rests,” and the defense case begins, at least in theory. In practice, there will often be scheduling problems that require one or more witnesses to be called “out of turn” during the other party’s case. The panel may allow that in its discretion, and may also allow some witnesses to testify by telephone if travel would be unduly burdensome. The key for both sides is to prevent gaps in the hearing, when no witness is available to testify. Constant communication between counsel and frequent updating of the panel as to scheduling issues are the keys to completing arbitrations within the allotted time.

After the defense rests, each side gives a closing argument. Occasionally a panel will ask counsel not to argue the case at the hearing, but instead to prepare post‐hearing briefs, and in other cases there will be closing arguments and post‐hearing briefs on certain issues specified by the panel.



The Award Suddenly, it is over. The last closing argument is completed, the chairperson asks all parties to acknowledge for the record that they have been given the opportunity to present their evidence, and the hearing ends. And then . . .

And then, nothing happens. Unless the panel has requested post‐hearing briefs, the parties and counsel simply wait for an award to come in through the mail or by fax, usually within 30 days of the last hearing day.

FINRA awards do not need to state the panel’s reasoning, and almost never do. After briefly reciting the procedural history of the arbitration, the award states a very short conclusion: the claimant recovers nothing, or recovers $X from all respondents jointly and severally, or $X from Respondent A and $Y from Respondent B. The award then goes on in some detail to calculate the forum fees and to allocate them among the parties as the panel deems fair.

FINRA monetary awards must be paid within 30 days of receipt of the award.

Concluding Thoughts



The system is not designed to guarantee a fair result, only a fair process that precedes the result.

The increasing number of FINRA Arbitration claims will be stretching the system’s ability to conduct fair and full hearings. Fortunately, FINRA’s rules allow the parties a great deal of creativity in agreeing upon arrangements that work to their mutual convenience. Experienced counsel on both sides of FINRA cases will recognize the value of cooperating where possible, and saving the fighting for the more substantive issues that really matter in the case.

The FINRA caseload will also mean that many less experienced FINRA arbitrators are likely to be hearing more cases. As that becomes a trend, it will become even more important to retain experienced defense counsel, who can more effectively counterbalance some arbitrators’ newness to the process.

FINRA Arbitration is, overall, a fair system. Surely there are cases when an undeserving claimant receives a monetary amount, perhaps even a substantial one, because the arbitration panel reaches a compromise award for the sake of unanimity. There are just as surely cases when a deserving claimant receives nothing because his or her case was presented poorly, or the panel finds the respondent more credible than the claimant.

The system is not designed to guarantee a fair result, only a fair process that precedes the result. The result itself, though never completely predictable, is influenced more by the quality of the financial

professional’s work and of his/her counsel’s knowledge of the system and effective advocacy for the client.

We hope that you have found this guide of help in understanding the FINRA Arbitration process and some of the strategies that can aid financial industry clients when they are confronted with a Statement of Claim filed in FINRA. We welcome your comments and questions. Thank you.

About Our Financial Institutions Defense Practice

Wilson Elser’s experience in dealing with securities claims is extensive and nationwide in scope. We have experience with every type of securities product at issue, from the simple, like stocks and bonds, to the most complex, like derivatives, as well as the manner in which they are traded. In the broker-dealer field, Wilson Elser provides focused, cost-efficient handling of sensitive and complex defense of arbitration and litigation matters. Our attorneys have represented broker-dealer firms in thousands of proceedings. We also provide several forms of consulting to broker-dealers and their insurers. Our team also represents clients in securities enforcement matters. We offer clients a deep knowledge of securities industry practices and relevant governing statutes, rules and regulations.

For more information, please contact our authors or visit our Web site, www.wilsonelser.comLouis H. Castoria Wilson Elser Moskowitz Edelman & Dicker LLP 525 Market Street, 17th Floor San Francisco, CA 94105‐2725 (415) 433‐0990

[email protected]

Fred N. Knopf Ami Shah Wilson Elser Moskowitz Edelman & Dicker LLP 3 Gannett Drive White Plains, NY 10604‐3407 (914) 323‐7000

[email protected] [email protected]



http://www.wilsonelser.com/

securities arbitrations in finra · pdf filearbitration act and similar state laws, there are...

Documents