In connection with the recent economic and market meltdown, we have seen a significant increase in arbitration claims filed against fee-based investment advisors. So, what is securities arbitration, and how does it work? To assist me with the answers to these issues, I have called upon the expertise of my partner, Brian A. Carlis, who, as the chair of our Securities Arbitration Group, has successfully defended registered investment advisers in securities arbitration matters for many years.
An alternative to litigating in a court of law, arbitration has been around for more than 200 years but it has only been in the past 20 that it has become the primary method to resolve securities industry disputes. Arbitrators are neutral parties, who are typically knowledgeable in securities and investment related matters.
Arbitration as a means for resolving securities industry disputes gained popularity, in large part, because it is less expensive and less time-consuming than a traditional lawsuit. In many court systems throughout the United States, it can take two, or four, or even more years to get to trial from the time of filing a complaint. Most arbitration claims get to hearing within 16 months and many get to hearing much sooner. Arbitration awards are final and binding and subject to appeal (which would be filed in a court of law) on an extremely limited basis.
Registered representatives and their broker/dealer firms are required to arbitrate customer claims, by virtue of their membership in the Financial Industry Regulatory Authority (FINRA). Parties can be required to arbitrate by virtue of the existence of a pre-dispute arbitration clause in a contractual agreement. Many registered investment advisors have arbitration clauses written into their client investment advisory agreements and we strongly recommend including such provisions.
Because most arbitration involves registered representatives and B/Ds, FINRA is the most popular securities arbitration forum. The American Arbitration Association (“AAA”) is another. Investment advisors who do not maintain FINRA registration typically may not avail themselves of the FINRA arbitration process. For this reason, we often recommend that our investment advisor clients utilize AAA pre-dispute arbitration clauses in their investment advisory agreements. Because arbitration is a creature of contract, there are additional provisions/safeguards that can be written into the arbitration clause. One such provision is that the roster of arbitrators provided by the AAA only include arbitrators on the FINRA roster of arbitrators as well. Advisors who maintain FINRA registration may want to include language that the FINRA forum be utilized if commission-based business was conducted with the client.
AAA vs. FINRA
There are several differences between AAA and FINRA arbitration. More often than not, an AAA arbitration will get to hearing faster than a FINRA arbitration. AAA fees are usually higher than FINRA fees. AAA fees do not cover the cost of hearing rooms, which are available on a rental basis. FINRA provides arbitration hearing rooms at no additional charge. AAA arbitrators dictate how they will be compensated. Most charge on an hourly or per diem basis for their service. FINRA rules mandate what their arbitrators are paid. FINRA arbitrators receive a relatively modest stipend per hearing session. Hearing sessions can last a matter of minutes up to four (4) hours. Depending upon the amount of compensation paid to AAA arbitrators and the number of pre-hearing conferences and/or days of arbitration hearing, arbitration at the AAA can potentially cost thousands of dollars more than FINRA arbitration. The magnitude of the potential fees at the AAA can act as a deterrent to a client filing a claim and/or as a potential catalyst to settlement subsequent to the initiation of the proceeding.
Securities arbitrations are commenced by the complainant (known as the “Claimant”) filing a document similar to a complaint in a court of law. In AAA arbitration, a complaint is referred to as a “Demand,” while at FINRA the initial filing is referred to as the “Statement of Claim.” The Statement of Claim/Demand is required to set forth, at a minimum, the nature of the dispute and the remedy or remedies sought. At the AAA, no answer to the Demand is required. A Demand must be filed, however, at the insistence of the Claimant. At FINRA, a Statement of Answer is required and must be filed in order to avoid a potential default. Like a Statement of Claim, a Statement of Answer need not be in any particular form. Many answers are submitted in a narrative format. It is important that an answer specify all defenses the party intends to rely upon, as well as the factual background for those defenses.
The discovery process in arbitration is far more streamlined than in a court of law. In FINRA arbitration, for example, there are prescribed categories of documents that are considered presumptively discoverable in all cases and additional categories of documents considered presumptively discoverable where certain specified allegations are made (e.g. “unauthorized trading”). Depositions are strongly discouraged at FINRA and may only be taken under extreme circumstances and with arbitrator approval.