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In Focus: Securities Arbitration

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  • Posted on: Oct 30 2017

Investing in the stock market can be challenging.  Understanding investment vehicles like stocks, bonds, limited partnerships, annuities, hedge funds, derivatives and mutual funds can be overwhelming for investors.  For that reason, many investors rely on stockbrokers and financial advisors to provide suitable investment advice to protect their hard-earned money. While most brokers and financial advisors act in their customer’s best interest, some do not.  When that happens, the broker or financial advisor is often in violation of the securities laws or the rules and regulations established by the Financial Industry Regulatory Authority (“FINRA”), the self-regulatory agency that oversees the securities industry. In the event the broker or financial advisor breach their duty to their customer (or acts negligently or recklessly, or fails to disclose material information about an investment that would have affected the customer’s investment decision), investors have recourse through arbitration.

Securities Arbitration: 101

Arbitration is an alternative method of resolving disputes. Although arbitration has been around for over 200 years, it was not widely used as means of resolving disputes in the securities industry. That changed in 1987 when the United States Supreme Court decided Shearson/American Express, Inc. v. McMahon, 482 U.S. 220 (1987).

Before McMahon, brokers and their firms relied on pre-dispute arbitration agreements to compel a customer to arbitrate future disputes between them. The pre-dispute agreement was typically contained in a customer agreement, or in a margin agreement, and was widely used by the investment community.

Despite industry acceptance, pre-dispute arbitration agreements were not widely accepted by the courts. In fact, many courts refused to enforce them. However, in McMahon, the Supreme Court changed that thinking, holding that such agreements were enforceable.

Recently, the propriety of mandatory arbitration agreements has come under scrutiny, especially from consumer advocates and Democrats in Congress, who have objected to arbitration agreements that prohibit consumers from joining class actions. (Here, here, and here.)

Commencing an Arbitration

To start an arbitration, a party must file a statement of claim. The statement of claim must specify the details of the dispute, including, but not limited to, the relevant facts and circumstances surrounding the dispute, the date(s) relevant to the dispute, the transactions in dispute, the securities involved, and the damages sought, or the type of relief sought.

In addition to the statement of claim, each party must file a submission agreement, which memorializes the parties’ agreement to arbitrate the dispute, and pay the required filing fees.

After the claimant files the statement of claim and the submission agreement, FINRA serves the documents, along with instructions for the arbitration process, on the named respondent(s). Service is typically done by mail to the last known address of the respondent(s). If service cannot be completed, or the respondent(s) cannot be located, FINRA typically seeks the assistance of counsel for the claimant in effectuating service. In that event, most practitioners will serve the papers in a manner that complies with the rules of the court that has jurisdiction over the respondent(s).

Answers, Counter-Claims, and Third-Party Claims

After service of the statement of claim, the respondent(s) files an answer to the allegations. The answer must specify the defenses upon which the respondent(s) relies, and the facts that support those defenses. A general denial is not a sufficient answer, and according to the rules of most arbitration forums, may lead to an order precluding the respondent(s) from offering evidence at the hearing.

The respondent(s) must file an answer with FINRA within 45 days of receipt of the statement of claim.  When answering a claim, the respondent(s) must serve every party with copies of the signed submission agreement and answer, as well file an original and three copies of the papers with FINRA Dispute Resolution.  (If the claim is to be decided by a single arbitrator, then the respondent(s) should file only one additional copy.)  FINRA provides copies of the papers to the arbitrator(s) selected to hear and determine the dispute.

Respondents who file answers can also assert claims against the claimant (known as counterclaims), claims against other respondents (known as cross-claims) and claims against persons or entities who are not parties (known as third-party claims). Respondents who are brokerage firms must pay a fee to FINRA simply for being named in the arbitration, and any respondent who files a counter-claim must pay an additional fee, based on the dollar amount of the claim.

Location of the Hearing

After the filing of all claims, answers and replies, FINRA will notify the parties of the location of the hearing. FINRA’s procedural guidelines require the hearing to be held in the location where the claimant resides.

Arbitrator Selection

Securities arbitrations are decided by one arbitrator, or three arbitrators, depending on the dollar amount of the controversy. For investor cases involving claims of up to $100,000, the parties receive a list of 10 chair-qualified public arbitrators.  Each separately represented party may strike up to four arbitrators on the list, leaving at least six arbitrator names remaining on each party’s list. Parties may rank the remaining arbitrators on each list. In investor cases with claims in excess of $100,000, the parties receive three lists (one with 10 chair-qualified public arbitrators; one with 15 public arbitrators; and one with 10 non-public arbitrators).  Each separately represented party may strike up to four of the 10 arbitrators on the chair-qualified list, up to six of the 15 arbitrators on the public list, and up to 10 of the 10 arbitrators on the non-public list.  All parties in investor cases have the option to select an all-public panel by striking all of the arbitrators on the non-public list.  Parties may rank the remaining arbitrators on each list.

For disputes that involve only industry parties, one arbitrator will decide claims involving up to $100,000. In that case, the parties receive one list of 10 chair-qualified non-public arbitrators.  Each separately represented party may strike up to four arbitrators on the list, leaving at least six arbitrator names remaining on each party’s list.  The parties may rank the remaining arbitrators on the list. For claims of more than $100,000 for unspecified or non-monetary claims, the parties receive two lists (one including 10 non-public chair-qualified arbitrators, and one including 20 non-public arbitrators).  Each separately represented party may strike up to four names from the non-public chair-qualified arbitrators and up to eight arbitrators from the non-public arbitrator list.  The highest ranked arbitrator from the chair-qualified list and the two highest ranked arbitrators from the non-public list will be appointed to the panel.

A full discussion of the selection process can be found here.

The Discovery Process

The discovery process allows the parties to obtain facts and information from other parties to the arbitration in order to support their case and prepare for the hearing.  The FINRA Codes of Arbitration Procedure require parties to cooperate with each other to the fullest extent practicable in the voluntary exchange of documents and information to expedite the arbitration process. If the parties cannot agree on their own how to resolve any discovery dispute, then the party who wants more documents or information may make a motion to compel the reluctant party to produce the requested documents.  In the motion, the requesting party should explain to the arbitrator(s) why the discovery is relevant and necessary to the case and ask the arbitrator(s) to issue an order compelling production. The arbitrator(s) may schedule a hearing before deciding the motion.

The FINRA Codes of Arbitration Procedure contain rules that govern the discovery process, including making discovery requests, responding to such requests, objecting to discovery requests, and arbitrator authority to issue sanctions against parties for discovery abuses.

FINRA provides a Discovery Guide which contains guidelines to help the parties and arbitrators during the discovery process. (Here.)

Hearing Procedures

FINRA arbitrations are conducted like a trial in court. There are opening statements, the introduction of evidence by the claimant, the introduction of evidence by the respondent(s), rebuttal evidence, closing arguments, post-hearing submissions, and the close of the record.

In the typical customer case, the claimant will call witnesses to testify on his/her behalf as to the facts within the witnesses’ personal knowledge.  In addition, a claimant can call expert witnesses who have specialized training or knowledge to testify as to their opinion on a technical matter to help the arbitrators draw conclusions and render a decision.

After the claimant’s witness testifies on “direct examination,” the witness is cross-examined by the respondent’s attorney. If there is more than one respondent, the attorneys typically select one attorney to shoulder the responsibility of cross-examination as to all issues common to the respondents. Thereafter, the rest of the respondents’ attorneys will examine the witness on issues specific to their client.

Cross-examination of witnesses is more lenient in arbitrations than in court proceedings. In the typical court proceeding, cross-examination is “limited to the scope of direct,” that is, the cross-examiner cannot ask the witness questions about areas or topics that were not addressed on direct examination. In arbitrations, however, cross-examinations often go beyond direct examination, as long as the area of inquiry is related to the issues in the case, or the credibility of the witness.

When all of the respondents’ attorneys have cross-examined the witness, the arbitrators may ask questions of the witness. Some arbitrators may interrupt the examination of a witness to ask a question, but those are usually to clarify a witness’ answer. The extent of an arbitrator’s examination depends on the depth and scope of the attorneys’ questions and the particular arbitrator involved. Some arbitrators ask a lot of questions, others ask none, regardless of the examination by the attorneys.

After the examination by the arbitrators, the claimant’s attorney has the opportunity to question the witness again. This examination is called “re-direct” and is limited to issues that were raised by answers on cross-examination, or by the arbitrators’ questions. When re-direct is complete, re-cross begins, limited again by the scope of the arbitrators’ questions, and the redirect. This process continues for all of the claimant’s witnesses. When all of the claimant’s witnesses have testified, the process starts again with the respondents’ witnesses.

A summary of the foregoing hearing procedures can be found here.

Rules of Evidence

As a general matter, the rules of evidence are relaxed to make the arbitration a shorter and more cost-efficient proceeding. (It is often said that the rules of evidence do not apply in arbitration.) In this regard, arbitrators often use common sense, both in a legal and practical sense, to decide evidentiary questions.

The Award

After closing the record, the arbitrator (or panel of arbitrators, as the case may be) considers the evidence, deliberates, and decides what relief the claimant is entitled to, if any. In a three-member panel, an award is based on the vote of a majority of the arbitrators; a unanimous decision is not required.

Awards must be in writing, but arbitrators are not required to write opinions or provide explanations or reasons for their decision. The panel will issue an award within 30 business days from the date the record is closed.

All awards rendered are final and are not subject to review or appeal, except under limited circumstances.

Once the award is signed by a majority of the arbitrators, FINRA will send copies of the signed award to each party or representative of the party.  FINRA makes all arbitration awards publicly available for free by posting them on Arbitration Awards Online (here).

FINRA does not have an appeals process through which a party may challenge an award. Thus, any challenge to an award must be made in state or federal court.

Under federal and state laws, the grounds on which a court may hear a party’s appeal on an award are limited.  Specifically, a court may vacate or overturn an arbitration award if it finds that: the award was procured by corruption, fraud, or undue means; there was evident partiality or corruption in the arbitrators; the arbitrators were guilty of misconduct … in refusing to hear evidence pertinent and material to the controversy, or of any other misbehavior by which the rights of any party have been prejudiced; the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made; the arbitrators disregarded a clearly defined law or legal principle applicable to the case before them (Manifest Disregard of the Law); or there was no factual or reasonable basis for the award (Complete Irrationality).

This Blog has previously posted articles about many of these grounds. (Here, here, here and here.)


Initially, many investors expressed concerns that they would be treated unfairly in arbitration proceedings. Studies have shown that investors actually achieve successful outcomes in arbitrations related to securities losses, however. Additionally, those who are represented by an experienced securities arbitration attorney are more likely to recover a higher percentage of their claim. Although most brokers and investment advisors act in their client’s best interest, some fail to do so. Ultimately, if you believe broker misconduct has contributed to investment losses, you are well advised to consult with an attorney who can help you navigate the securities arbitration process.

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