Most of the time, investors are satisfied with the relationships they have with their brokers or investment advisors. Occasionally, however, an investor may have a serious dispute about how a broker handled an account.
Can the investor file a lawsuit? Probably not. Nearly all brokerage firms have binding arbitration provisions in their client contracts. This is a result of a 1987 Supreme Court ruling that upheld that arbitration agreements in investment firm contracts must be enforced. (Shearson/American Express v. McMahon)
So if an investor has a dispute that he or she cannot resolve with the investment firm’s management or through a mediation process, it will likely be handled through arbitration with the Financial Industry Regulatory Authority (FINRA).
When should an investor turn to FINRA arbitration? Consult with your attorney about your situation, but, in general, arbitration is not going to be beneficial for an investor with a balanced portfolio who has suffered losses because the market is down. It is for cases of fraud, misconduct, or when an investor on a fixed income is put into an excessively risky investment.
Here are some of the claim categories listed by FINRA:
- Account related, which includes breach of contract, collection, dividends, errors/charges, exchanges, failure to supervise, margin calls, negligence, transfer, and other issues.
- Executions, which includes execution price, failure to execute, incorrect quantity, limit versus market order and other issues.
- Account activity, which includes breach of fiduciary duty, churning, misrepresentations, omission of facts, unauthorized trading and other issues.
- Trading disputes, which includes manipulation, markups, buy-in, sell outs, stock loans transfers, and other issues.
Parties have a right to be represented by an attorney and may do so at any point in arbitration.
The entire arbitration process can take a year or more to be complete (upon request, there are expedited proceedings for senior investors or seriously ill parties). Here is a brief explanation of the steps of the process:
Step One – The Investor Files a Statement of Claim with FINRA
On a written form, the investor states the details (relevant dates, names, type of security, etc.) and the legal remedies he or she is seeking (such as money damages). Pertinent documents should be attached.
The Statement of Claim must be accompanied by a Submission Agreement, on which the investor agrees to abide by the decision made. There is a filing fee based on the total amount of the claim (although a waiver can be requested in cases of financial hardship). This fee ranges from $50 to $1,800 for individuals and $225 to $3,700 for firms.
Step Two – The Claim Is Served
The investment firm or broker is served by FINRA with the Statement of Claim and has 45 days to file a written Statement of Answer. (At this time, the respondent can file counterclaims, cross-claims, and claims against a third party.
Step Three – The Discovery Period
This is time consuming and can become contentious. The parties must produce documents that are relevant to the case. FINRA has extensive “Document Production Lists” showing the type of documents that might be discoverable.
What kind of documents might be requested? Those showing names, tax ID numbers, addresses, investment objectives, risk tolerance, margin authorizations, as well as correspondence between the parties, confirmation slips, monthly statements, option programs, research reports, sales materials, recordings, telephone logs, notes of conversations, income tax returns and much more.
Step Four – Arbitrators are Appointed
The exact arbitration procedures depend on the monetary amount of the dispute:
- FINRA classifies claims of $25,000 or less as “simplified arbitration,” which are decided by one arbitrator.
- If a claim involves more than $100,000 or an unspecified or non-monetary amount, a panel of three arbitrators makes the decision.
- Claims of between $25,000 and $100,000 are decided by one arbitrator — unless both parties agree to a panel of three.
Each party has the right to challenge the arbitrators on the case. Further, the parties have the right to make certain motions under certain circumstances.
Step Five: A Hearing is Conducted
There are nearly 50 hearing locations throughout the country. FINRA attempts to hold is hearings near an investor’s homes or at other locations that are convenient to the participants. Here are some of the features of a hearing:
- Each party can make an opening statement.
- Witnesses are sworn in and each party presents its facts.
- Witnesses and parties may be cross examined by the opposing side and by the arbitrators.
- Counterclaims are presented.
- Closing statements are generally made.
Step Six – A Decision is Rendered
Once the arbitrators reach a decision, they send it to the parties. Arbitrators try to reach a resolution within 30 business days. Within another 30 days, brokers must pay arbitration awards unless they file a court motion.
When arbitration is over, the decision is final and cannot be appealed. Arbitration decisions can only be challenged under very limited circumstances (for example, if the investor can demonstrate that an arbitrator was biased).
Some Questions the SEC Suggests Investors Ask Brokers:
- Are you registered with our state securities regulator? Have you ever been disciplined by the SEC, a state regulator, or other organization (such as the Financial Industry Regulatory Authority (FINRA) or one of the stock exchanges)?
- How long has your firm been in business? How many arbitration awards have been filed against your firm?
- What training and experience do you have? How long have you been in the business? What other firms have you been registered with? What is the status of those firms today?
- Have you personally been involved in any arbitration cases? What happened?
- What is your investment philosophy?
- Describe your typical client. Can you provide some names and telephone numbers of your long-term clients?
- How do you get paid? By commission? Amount of assets you manage? Another method?
- Do you make more if I buy this stock (or bond, or mutual fund) rather than another? If you weren’t making extra money, would your recommendation be the same?