Defense of Investment Professionals: Securities Litigation in the finra arbitration Setting By

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Defense of Investment Professionals:

Securities Litigation in the FINRA Arbitration Setting


Thomas D. Jensen, Esq.

Lind, Jensen, Sullivan & Peterson, P.A.

1300 AT&T Tower

901 Marquette Avenue South

Minneapolis, MN 55402

(612) 333-3637
Professional liability claim allegations against investment advisors follow a familiar script: duty, breach, causation and damages. The tort-based duty generally alleged is fiduciary duty; infrequently are the terms “malpractice” or “professional negligence” referred to. But the defense response employed is not unlike more traditional E&O causes, so it makes sense for malpractice defense specialists to acquaint themselves with developments in this field to be prepared for claim assignments at the next market crash.

Investors can lose money purchasing common stocks, preferred stocks, corporate bonds, annuities, universal or variable life insurance policies, auction rate securities, certificates of deposit, limited partnerships, mutual funds, options, government securities, commodities futures, REITS, limited partnerships, derivative securities, collateralized debt obligations, and so on. They may allege claims against their investment advisors under the Securities Act of 1933 (e.g., registration statement fraud, control person liability), the Securities Exchange Act of 1934 (e.g., price or market manipulation, fraud, control person liability, suitability), the Investment Company Act of 1940 (e.g., excessive mutual fund fees), the Investment Advisors Act, Sarbanes-Oxley Act of 2002, S.E.C. Rule 10b-5, state securities or “blue sky” laws, and the common law of fraud and breach of contract. Although such claims may trigger large class actions and other headline-prominent investment suits, many ordinary one or two investor cases are resolved in private, by way of arbitration. This occurs because arbitration clauses are often found in investment account agreements and in other situations involving customers of broker-dealers.

Background of the Financial Industry Regulatory Authority

The arbitration program is administered by the Financial Industry Regulatory Authority (“FINRA” - – successor to the National Association of Securities Dealers (NASD)). FINRA is a Self-Regulatory Organization authorized by the Securities Exchange Act of 1934, to establish and enforce standards of conduct of broker-dealers and their registered representatives. 15 U.S.C. §§ 78f, 78o-3. As an SRO, FINRA is subject to oversight by the United States Securities and Exchange Commission.

FINRA is the largest regulator of securities firms and operates the largest securities dispute resolution forum in the world. Its mission has been described as follows:

"To promote through cooperative effort the investment banking and securities business, to standardize its principles and practices, to promote therein high standards of commercial honor, and to encourage and promote among members observance of federal and state securities laws;" "[t]o adopt, administer, and enforce rules of fair practice and rules to prevent fraudulent and manipulative acts in practices"; and "[t]o promote self-discipline among members, and to investigate and adjust grievances between the public and members and between members."

UBS Financial Services Inc. v. Carilion Clinic, 706 F.3d 319, 325 (4th Cir. 2013). Most customer-broker disputes are resolved via FINRA arbitration.1 The program is administered out of regional offices located in New York City, Boca Raton, Chicago, and Los Angeles. Recent data shows that new investment loss arbitration claims filed after the 2009 high of 7,137 have fallen steadily to 3,714 in 2013 (likely due to rising markets of late). Cases filed through June 2014 by type of claim and claim count were as follows: margin call account liquidation (30), portfolio churning (105), unauthorized trading (116), failure to supervise representatives (868), negligence (1,021), omission of facts (655), breach of contract (914), breach of fiduciary duty (1,053), unsuitability of investments sold (679), and misrepresentation (781). From 2009 through June 2014, FINRA arbitrators awarded in favor of investors 45% of the time on average.2

Is Arbitration Required?

FINRA arbitration involving investors is governed by the Code of Arbitration Procedure for Customer Disputes (“Code”) (attached). (Disputes between industry FINRA members may also be arbitrated pursuant to the Code of Arbitration Procedure for Industry Disputes.) Disputants must arbitrate their differences pursuant to FINRA if arbitration is required by an account agreement or if it is requested by a broker-dealer’s customer. Customer Code R. 12200. Arbitration clauses routinely appear in broker-dealer customer accounts, and mandatory arbitration is obvious in such circumstances.

But whether an investor is a customer of the respondent(s) (i.e., the defendant(s)) entitled to arbitrate the claim has triggered litigation. Sometimes investors seeking to avoid arbitration of their dispute may contend that they are not customers. E.g., Credit Suisse Securities (USA) LLC v. Sims, 2013 WL 5530827, *2 (S.D. Tex. 2013). But oftentimes the party seeking to avoid arbitration is an affiliate of a broker-dealer with whom the customer has no contract. The Code merely defines the term “customer” to mean something other than a broker or dealer. Customer Code R. 0160(b)(4). The ambiguous scope of the definition of “customer” has thus triggered judicial commentary that ought to be considered when the arbitration right is arguable. See, e.g., Berthel Fisher & Co. v. Frandino, 2013 WL 2036655 (D. Ariz. 2013). Courts have concluded that the term "customer" refers to "an entity that is not a broker or dealer, who purchases commodities or services from a FINRA member in the course of the member's business activities, namely, the activities of investment banking and the securities business." TradeStation Securities Inc. v. Capone, Civil Action No. 3:14-CV-107 (W.D.N.C. 2014). Courts have also defined customer as "one, not a broker or a dealer, who purchases commodities or services from a FINRA member." Pershing LLC v. Bevis, 2014 WL 1818098, *2 (M.D. La. 2014) (also rejecting arbitrability on grounds of third party beneficiary status or equitable estoppel). Thus the purchase of a good or service from a FINRA member may create a customer relationship. Citigroup Global Markets, Inc. v. Abbar, 3765867, *6-7 (2d Cir. 2014) (holding that a "customer" under Rule 12200 is one who, while not a broker or dealer, either (1) purchases a good or service from a FINRA member, or (2) has an account with a FINRA member).

Absent an agreement or a customer relationship, FINRA arbitration is not required. E.g., SunTrust Banks Inc. v. Turnberry Capital Management LP, 2014 WL 1924449 (2d Cir. 2014); Raymond James Fin. Servs., Inc. v. Cary, 709 F.3d 382 (4th Cir. 2013); CIG Asset Mgmt. v. Bircoll, 2013 WL 4084763, *2 (E.D. Mich. 2013) (finding also that the investors purchased the private offering without using a FINRA broker-dealer). But parties also may elect to arbitrate their dispute under FINRA if they agree in writing to do so. Customer Code R. 12201. (Sometimes persons or entities affiliated with a respondent may desire to resolve the dispute via arbitration, and thus will agree to do so.)

Oftentimes investment companies maintain affiliates, some of which are FINRA members while others are not. The customer account contracts may refer to binding arbitration, or they may not (or they may even exclude it). Investors seeking to make claims against investment entities must scrutinize the contracts carefully. While the courts will quickly rule to enforce arbitration against companies when the contracts call for it, complexities in the entity relationships may doom access to arbitration. An example is J.P. Morgan Chase Bank, N.A. v. McDonald, 2014 WL 3673493 (7th Cir. 2014). Investors had accounts with the plaintiff bank, and with the bank’s affiliated securities dealer (a FINRA member). The latter account had an arbitration clause, the former account did not. Rather, it had a forum selection (court) clause. Investors sued the securities dealer and two bank employees alleging malfeasance. Their investment losses were limited to their bank account, not their securities. The court ruled that the investors’ claims against the bank had to be litigated in court and not arbitrated in the FINRA forum.

Class actions and shareholder derivative actions may not be arbitrated under the Code. Customer Code R. 12204, 12205.

FINRA Arbitration – Initial Steps

Arbitration cases are initiated by filing of a Submission Agreement and a Statement of Claim with FINRA. Customer Code R. 12302. The Director of FINRA then will serve the same upon the other parties. (Thereafter parties may serve each other directly. Customer Code R. 12300.) Responding parties must serve within 45 days a signed Submission Agreement and an Answer specifying the relevant facts and available defenses. Customer Code R. 12303. The Answer – like the Statement of Claim – need not follow form to Answers filed in court. (This is not the time for notice pleading or use of a general denial. Customer Code R. 12308. Use your Answer to present a strong first impression to the arbitrator, explain the facts in detail, and attach documents that show the claimant is wrong, sophisticated, experienced, and a risk-taker.) Use the Answer also as an opportunity to humanize the respondent. Grannum, Litigating Arbitrations in the FINRA Forum, Securities Arbitration 2011, pp. 155-56 (P.L.I. 2011) (“Sec. Arb. 2011”). Defenses may be barred if not articulated in the Answer. Customer Code R. 12308. Counterclaims, Cross-claims and Third-Party Claims may also be asserted. Customer Code R. 12303. Filing fees are itemized in FINRA Rule 12900.

Parties may represent themselves in the arbitration proceeding, they may engage counsel, or they may retain non-attorneys subject to certain limitations. Customer Code R. 12208. No party may bring a legal action while the arbitration proceeding is pending. Customer Code R. 12209. The rules provide for payment of arbitrator fees by FINRA according to a set schedule. Customer Code R. 12214. Mediation may be made available to the parties pursuant to FINRA’s Code of Mediation Procedure. Customer Code R. 14000. All parties must agree. Customer Code R. 14104. The Code establishes Mediation Ground Rules relating to the procedure. Customer Code R. 14109.

Arbitrator Selection – A Key Step

Arbitrator selection is among the most important aspect of representation of parties in FINRA arbitrations. FINRA disputes are heard by one arbitrator if the claim value is $50,000 or less. Claims worth between $50,000 and $100,000 are heard by one arbitrator, unless the parties agree in writing to three arbitrators. Claims worth more than $100,000 are heard by three arbitrators, unless the parties agree to one arbitrator. Customer Code R. 12401. Within 30 days of filing the last Answer in one arbitrator cases, FINRA staff will send to the parties a list of 10 arbitrators generated by the Neutral List Selection System. In three arbitrator cases, FINRA staff will send to the parties three lists of 10 arbitrators generated by the Neutral List Selection System. (The lists come from FINRA’s rosters of “non-public” arbitrators (who often have a securities industry background), “public” arbitrators, and arbitrators eligible to serve as chairperson (by completion of extra training and other eligibility requirements)). Each party may strike four candidates from the one arbitrator list within 20 days, listing the remaining six in an order of preference. (Different procedures apply to the striking of arbitrator candidates in three arbitrator cases.) FINRA’s Director of Dispute Resolution will then select the highest-ranked available arbitrator from the combined lists. Customer Code R. 12402. If no candidate survives the list striking process FINRA will appoint an arbitrator not appearing on the list. Customer Code R. 12402(g)(3); 12403(e)(3). Before finalizing the appointment the director notifies the arbitrator or panel candidates of the nature of the dispute to determine conflicts of interest.

The rules require certain disclosures by the proposed arbitrators. Customer Code R. 12405. Parties are also entitled to the employment history of each candidate for the past 10 years. FINRA also will disclose the roster members’ prior award histories.3

Once chosen, removal of an arbitrator must follow a process. According to the FINRA Code of Arbitration Procedure:

The Director will grant a party's request to remove an arbitrator if it is reasonable to infer, based on information known at the time of the request, that the arbitrator is biased, lacks impartiality, or has a direct or indirect interest in the outcome of the arbitration. The interest or bias must be definite and capable of reasonable demonstration, rather than remote or speculative. Close questions regarding challenges to an arbitrator by a customer under this rule will be resolved in favor of the customer.

A party may ask the arbitrator to recuse himself or herself; the arbitrator will decide the question. Customer Code R. 12406. Removal of the arbitrator for bias may be considered by the Director before or after the first hearing session, subject to limitations. Customer Code R. 12407. Judicial motions to vacate awards based upon alleged arbitrator partiality face a steep uphill climb. See, e.g., Stone v. Bear Stearns & Co., 538 Fed. Appx. 169, 170 (3d Cir. 2013); Matter of Bortman, 2014 N.Y. Slip Op. 31457(U) (Sup. Ct.) (denying motion to disqualify arbitrators as without cause where one had filed bankruptcy and another had worked for claimant’s attorneys).

The Initial Prehearing Conference and Motion Practice

The arbitrator or panel will then schedule the Initial Prehearing Conference, generally via telephone. A prehearing schedule will be set, that typically will follow form to pretrial schedules litigators are familiar with (e.g., Case Management Order). Other prehearing conferences may be set to resolve discovery disputes and dispositive motions. Again, these motions ordinarily are heard telephonically. Customer Code R. 12500, 12501. Motions need not follow any particular form and response timing is short. They must be served at least 20 days before the hearing. Non-moving parties have 10 days to respond. The moving party may reply within five days. Customer Code R. 12503(a)-(c). Discovery motions in panel cases are decided by the chairperson; the full panel decides all other motions. Customer Code R. 12503(d). Motions to dismiss prior to conclusion of a party’s case in chief are expressly discouraged. The usual sanctions risks are present. Customer Code R. 12504.

Claim Timeliness

FINRA arbitration claims are time barred “where six years have elapsed from the occurrence or event giving rise to the claim.” Customer Code R. 12206(a). This is known as the rule of “eligibility”; the arbitrator or arbitration panel decides eligibility questions. Id.; Quality Air Services LLC v. DiPippo, 2013 WL 693052, *3 (D. Md. 2013). By filing a motion to dismiss a claim as time barred, the moving party must agree that the non-moving party may pursue the claims in court. Customer Code R. 12206(b). (Assuming other limitation periods have not expired.) If the motion is denied the non-moving party must be awarded the cost of forum fees. If the motion is deemed to be frivolous attorneys fees and costs may be awarded against the moving party. Moreover, sanctions may be issued against the moving party if it is determined that the eligibility motion was filed in bad faith. Id., Sanctions may include monetary penalties, evidence preclusion rulings, adverse inference determinations, fees and costs, and potentially a disciplinary referral. Customer Code R. 12212. Needless to say, if your client is penalized by the arbitrator or panel before the hearing serious consideration ought to be given to settlement since your client’s position will not have been started on the right foot with the decision-maker.

Scope of Discovery

The FINRA Discovery Guide describes the scope of available discovery in the arbitration process. FINRA has established standard form document production requests (“Document Production Lists” that are available on the FINRA website) (attached) that describe documents presumed to be discoverable in all arbitrations. Customer Code R. 12506. Arbitrators have discretion to order production of documents not provided for by the Lists. Arbitrators may issue subpoenas for production of documents. Customer Code R. 12512. Cost/burden, privilege, and confidentiality objections may be considered by the arbitrator. Privacy or confidentiality concerns may be addressed by entry of a protective order. Although parties may make certain “requests for information”, standard interrogatories are not permitted in arbitration. Customer Code R. 12507. Moreover, depositions “are strongly discouraged in arbitration.” Customer Code R. 12510. Limited exceptions to this rule are specified. Id. In short, the institutional viewpoint is that “[d]iscovery is the chief culprit of current complaints about arbitration morphing into litigation.” Philip S. Cottone, The Pre-Hearing Conference in Arbitration – A Step By Step Guide, 5 (Sec. Arb. 2012 (PLI)).

Proof that the customer engaged in trading with other brokers that may appear inconsistent with the claims being made in arbitration must be a key defense discovery focus. Sec. Arb. 2011, p. 164. Investor sophistication and risk tolerance, churning-was-profitable, client ratification through receipt of account statements, investments were suitable and similar to client’s other investments, lack of justifiable reliance, puffery, no scienter, immaterial information, no causation (e.g., loss was caused by market collapse), representative performed due diligence, in pari delicto, standard of care compliance, contributory negligence, good faith, truth, eligibility, trading was authorized,

FINRA Liability Standards

Absent contractual language in the arbitration agreement requiring the application of a particular jurisdiction’s law to a dispute, FINRA arbitrators are not necessarily required to apply the law, as long as they do not manifestly disregard it. But certainly they may be presented with law applicable to typical securities litigation claims and defenses. Exchange Act, Securities Act, Investment Company Act, Rule 10b-5 precedents, and common law claims and defenses are fair game for argument at the arbitration hearing.

As for FINRA rules themselves, most courts hold that they will not create a private right of action for violation of the rules. See, e.g., Sadler v. Retail Properties of America, Inc., 2014 WL 2598804, *24 (N.D. Ill. 2014). Thus, negligence per se claims should fail as a matter of law. See, e.g., Owens v. Stifel, Nicolaus & Co., 2014 WL 2769044, *5-6 (M.D. Ga. 2014). But FINRA rules may establish the standard of care of investment professionals. See, e.g., Id. (ruling also that failure to comply with the rules may provide evidence of a breach of the duty of care, "which includes a duty to act in accordance with the standard of care used by other professionals in the community"); Remington v. Newbridge Securities Corp., 2013 WL 4496504, *4 (S.D. Fla. 2013).

Rules provide that FINRA members “shall observe high standards of commercial honor and just and equitable principles of trade.” Customer Code R. 2010. “No member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance.” Customer Code R. 2020. Members must “[k]now [their] [c]ustomer” and “must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based upon the information obtained through the reasonable diligence of the member … to ascertain the customer’s investment profile.” Customer Code R. 2111. Suitability is determined by evaluation of the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and other information disclosed by the customer. Sec. Arb. 2012, p. 189; see In re Am. Express Fin. Advisors Securities Litig., 672 F.3d 113, 139 (2d Cir. 2011) (allowing suitability claim to go forward; investors alleged defendant knew it should invest for them in a conservative fashion). Members must also use reasonable diligence in regard to maintaining customer accounts to know the essential facts concerning the customer. Customer Code R. 2090. Thus there is an ongoing duty to find out and update customer information. Sec. Arb. 2012 p. 180. Special obligations are imposed upon registered representatives with respect to OTC equity securities (Customer Code R. 2114) and day-trading accounts. Customer Code R. 2130.

In some circumstances, the investment professional’s rule compliance burden is lessened. Where a customer has a self-directed or non-discretionary account with a broker, the broker ordinarily has no obligations to the customer except to carry out transactions accurately. E.g., Press v. Chem. Inv. Servs. Corp., 166 F.3d 529, 536 (2d Cir. 1999). But, in limited circumstances courts will hold that the broker-customer relationship may involve enhanced duties in non-discretionary account situations. Corrie, Investment Advisors and Brokers: When is a Broker Subject to Fiduciary Duties?, 2 Securities Arbitration in the Market Meltdown Era, p. 93 (P.L.I. 2009).

Recent cases have evaluated whether broker-dealers may be vicariously liable for registered representatives’ conduct in the absence of the firm’s knowledge or involvement in the security, whether expert testimony is necessary to establish the broker-dealer’s standard of care, whether duties may be owed to non-customers, whether the apparent authority doctrine may trigger vicarious liability, whether the broker-dealer may be liable on a failure to supervise theory, whether control person liability standards are met, whether investments sold were suitable, whether the “know your customer” rule was followed, whether broker-dealers have duties to third persons, and whether contracts were breached or misrepresentations were negligently made. Sec. Arb. 2011, pp. 278-284.

When FINRA claims are brought against the registered representative and his or her broker-dealer, and the investment involved was not the latter’s product (“selling away” liability), the broker-dealer may seek to avoid respondeat superior or control person liability by proving the sale was not within the course and scope of employment. Sec. Arb. 2012 pp. 249-254. This will be in addition to the routine defense theory that the investment was suitable and fairly disclosed to the customer.

Arbitration Hearing Processes

Most litigators are familiar with arbitration hearing processes, and FINRA’s processes are likely consistent with that experience. The hearing is ordinarily scheduled at a location nearest the claimant’s residence at the time in question. Claimant goes first in the presentation of evidence. Accountants (on damages), portfolio analysts (on suitability and churning), industry experts on standard of care and fiduciary duty compliance and similar experts will be called. Dismissal motions at the close of claimant’s case may be brought. The defense case is then presented. Final summations are made and the arbitrator or panel retires to determine the award, which is typically due in 30 days from the close of the record. Customer Code R. 12904(d).

When the registered representative and broker-dealer are joined to the proceeding, generally it is wise for the respondents to maintain a cooperative attitude in regard to general strategy, finger-pointing, and the like.

A few FINRA-specific rules are noteworthy. Witnesses or documents not identified on a party’s witness and exhibit lists may not be presented. Customer Code R. 12514. The arbitrator or panel will decide what evidence to admit at the hearing. “The panel is not required to follow the state or federal rules of evidence.” Customer Code R. 12604; Questar Capital Corp. v. Gorter, 909 F. Supp. 2d 789, 816, 819 (W.D. Ky. 2012). A record of proceedings will be made, typically in digital format. Customer Code R. 12606. A simplified procedure is available when the amount in controversy is $50,000 or less. Customer Code R. 12800. To receive an “explained decision” with the award parties must submit a joint request therefor within 20 days of the hearing. Customer Code R. 12904(g).

Although courts may decide “gateway” issues going to arbitrability, arbitrators decide FINRA procedural disputes. E.g., Nath v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 2014 WL 2438435, *4 (N.Y. Sup. Ct. 2014) (ruling that consolidation is a procedural issue to be determined by arbitrators, not courts).

Preparation for the arbitration hearing ought to be guided by this rule: “[t]he simpler you have made it for the arbitrators to grasp the substance of your case, the more likely you are to prevail. This will only be possible if you thoroughly know your case and your witnesses are comfortable presenting their facts and explaining inconsistencies. In addition, make your closing arguments concise and persuasive.” Sec. Arb. 2011, p. 165.

Limitations on Judicial Review

Awards must be in writing, they are final, and generally are not subject to judicial review. Customer Code R. 12904. Arbitrator interpretation of the Code is final and binding. Customer Code R. 12409. But arbitrator bias, manifest disregard of the law, and arbitrator limitation of powers arguments may trigger judicial review. See Sec. Arb. 2011, pp. 225-232. The Federal Arbitration Act provides the only grounds available by which a court can vacate an arbitration award. Hall Street Associates LLC v. Mattel, Inc., 552 U.S. 576, 586-88 (2008). The burden is extremely high. Stolt-Neilsen S.A. v. AnimalFeeds Int’l Corp., 559 U.S. 662, 671 (2010). The Federal Arbitration Act ("FAA") permits a court to vacate an arbitration award in four narrow instances:

(1) [W]here the award was procured by corruption, fraud, or undue means;

(2) [W]here there was evident partiality or corruption in the arbitrators, or either of them;

(3) [W]here the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or 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; or

(4) [W]here 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.

9 U.S.C. § 10(a)(1)-(4). Allied Beacon Partners, Inc. v. Bosco, 2014 WL 551712, *3 (N.D. Ill. 2014).

Of course, awards may be vacated if procured by fraud. See, e.g., Morgan Keegan & Co. v. Garrett, 495 Fed. Appx. 443, 446-47 (5th Cir. 2012).

Whether an arbitration award may be vacated on grounds the arbitrators manifestly disregarded the law is uncertain in light of the foregoing Supreme Court precedents. Regardless, it the grounds remain, the award may only be vacated in such circumstances if: (1) the arbitrators knew of a governing legal principle yet refused to apply it or ignored it altogether, and (2) the law ignored by the arbitrators was well defined, explicit, and clearly applicable to the case. FBR Capital Markets & Co. v. Hans, 985 F. Supp. 2d 33, 36 (D.D.C. 2013) (rejecting manifest disregard argument when evidence showed the panel reached its decision only after it heard extensive testimony from both sides as to the facts and controlling law); Murray v. Citigroup Global Markets, Inc., 511 Fed. Appx. 453, 455-56 (6th Cir. 2013) (rejecting manifest disregard challenge to the award when an explained award was not requested). Manifest disregard of the law means something more than just an error in the law or a failure on the part of the arbitrators to understand or apply the law. To vacate an arbitration award on this ground, it must be clear from the record that the arbitrators recognized the applicable law and then ignored it. An error of law or a failure to understand the law is insufficient. Gavaldon v. StanChart Sec. Int’l, Inc., 2014 WL 1292907, *2 (S.D. Cal. 2014).

Arbitrators are not required to state reasons for their findings, but are presumed to have made their award on permissible grounds. Gavaldon v. StanChart Sec. Int’l, Inc., 2014 WL 1292907, *2 (S.D. Cal. 2014). "The rule that arbitrators need not state their reasons presumes the arbitrators took a permissible route to the award where one exists." Johnston v. Calton & Associates, Inc., 2014 WL 3724191, *4 (D. Ariz. 2014).

Failure to provide a reviewing court with transcripts of the arbitration proceedings poses particularly steep obstacles in seeking to vacate an arbitration award. Allied Beacon Partners, Inc. v. Bosco, 2014 WL 551712, *3 (N.D. Ill. 2014).

Courts may also consider motions to vacate arbitration awards on grounds of arbitrator partiality, but the movant’s burden, again, is high. See, e.g., Fornell v. Morgan Keegan & Co., 2012 WL 3155727, *1 (M.D. Fla. 2012) (finding no grounds by which a reasonable person would believe a conflict existed); Charles Schwab & Co. v. Vollstedt, No. CIV 11-0709 (D.N.M. 2012). Evident partiality is shown where a reasonable person would have to conclude that the arbitrator was partial. Watts v. Morgan Stanley Smith Barney LLC, 2014 WL 1924143, *3 (E.D. Pa. 2014). Evident partiality requires specific, definite proof that is powerfully suggestive of bias. Morgan Keegan & Co v. Starnes, 2014 WL 2810209, *9 (Tenn. App. 2014) (noting that small-talk not related to the matter and the exchange of pleasantries among panel members and arbitration participants during breaks in the proceedings do not indicate bias or evident partiality).

To show evident partiality, a party moving for vacatur "must establish specific facts indicating actual bias toward or against a party or show that [the challenged arbitrator] failed to disclose to the parties information that creates a reasonable impression of bias. Pacific West Securities, Inc. v. George, 2014 WL 894843, *2 (N.D. Cal. 2014). Examples of the "level of partiality" found to constitute "evident partiality" include cases where (1) an arbitrator's financial interest in the outcome of the arbitration was not disclosed to the parties, (2) a familial relationship made the arbitrator's impartiality suspect when not disclosed, and (3) an arbitrator's former employment by one of the parties was not disclosed. Id. The test is whether a "well-informed, thoughtful observer" would conclude that an arbitrator could be biased and should not sit in judgment in the case. Vitale v. Morgan Stanley Smith Barney, LLC, 2014 WL 2931588, *6 (Cal. App. 2014).

As well, awards may be vacated if the arbitrators exceeded their powers. See, e.g., Fisher v. Wells Fargo Advisors LLC, 2012 WL 6607025, *2 (D. Kan. 2012). Or if they engaged in misconduct. See, e.g., Morgan Keegan & Co. v. Sturtevant, 2012 WL 3685975, *3 (S.D. Miss. 2012). Awards may also be vacated when the panel made an award on a claim that was never submitted to the panel. Meeder Asset Mgmt. Inc. v. ICON Advisors Inc., 2013 WL 1232299, *1 (D. Colo. 2013) (finding the issue of attorneys fees was never submitted to the panel). When a customer’s claim involves arbitrable and non-arbitrable claims, courts may stay the companion suit pending completion of the arbitrable claims even against non-parties to the arbitration. Cook v. John Hancock Life Ins. Co., 2013 WL 942384, *3 (N.D. Va. 2013).

Parties filing court motions to vacate arbitration awards face Rule 11 sanctions risks. See, e.g., Waveland Capital Partners LLC v. Tommerup, 928 F. Supp. 2d 1227, 1235 (D. Mont. 2013) (denying sanctions although the question was “close”).

Adverse Outcome Record Expungement

Investment professionals’ reputations and licensing rights may be affected by the reporting of customer complaints or arbitration outcomes. FINRA maintains broker background information in a computer database called the Central Registration Depository ("CRD"). FINRA, along with commissions from all 50 states, developed the CRD for the purposes of storing "information about regulatory, enforcement and arbitration actions taken against registered representatives and other securities personnel." Bridge v. E*Trade Securities LLC, 2012 WL 3249508, *1 (N.D. Cal. 2012) (evaluating circumstances in which arbitration outcomes may be expunged from representatives’ records). The Securities Exchange Act requires that certain aspects of a representative's CRD file be made available to the public through BrokerCheck. Santos-Buch v. Financial Industry Regulatory Authority, Inc., 2014 WL 3610810, *1 (S.D.N.Y. 2014). BrokerCheck data is available to the public on the FINRA website.

FINRA allows for expungement rights in the event of settlement or an award (Customer Code R. 12805) but the bases for expungement are quite limited, and FINRA must be advised of the effort. Customer Code R. 2080. Expungement may be granted if: (1) the claim, allegation or information 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. Customer Code R. 2130. As is evident, this is a very difficult burden to sustain. Respondent’s counsel may assume the client will want to seek expungement relief. It will inform the strategy to follow throughout the pendency of the claim because the client will always be concerned about it.

Customer complaints and disciplinary history, award and settlement information may appear on the registered representative’s Form U-4 (Uniform Application for Securities Industry Registration or Transfer). This form is used by the representative to update the CRD databank. The representative’s Form U-5 is filed by member firms when representatives are terminated, and it also may include claim and award history. Representatives covet clean U-4 and U-5 records because investors may learn of the data, and therefore defense and settlement of FINRA claims oftentimes is influenced by client U-4 and U-5 concerns. As well, FINRA may impose sanctions upon members or persons associated with a member for violations of the securities laws or FINRA rules including revocation of the person’s registration. Customer Code R. 8310. Discipline facts may be disclosed to the public. See generally Customer Code R. 8313.


Breach of fiduciary duty and allied tort, statutory and contract claims may be brought when investors lose money and blame their broker, dealer, financial planner, wealth manager or other investment professional. Malpractice defense and claims practitioners are well suited to add investment loss professional liability expertise to their experience portfolios. Typical investor claims are brought in the FINRA arbitration system. That system has straight-forward rules of procedure that are readily mastered. PLDF members are encouraged to learn more about FINRA arbitration practice to be prepared for the next market downturn that inevitably will occur.

1 FINRA also administers arbitrations between broker-dealers (or other members) and registered representatives (or other associated persons) in employment disputes.


3 One can access online FINRA’s Arbitration Awards Online database to find a plethora of data pertaining to awards going back decades.

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