There is no magic to drafting a securities arbitration claim. Indeed, crafting an effective statement of claim is an art, and there are as many ways to tell the story as there are storytellers. As an attorney representing investors who suffered losses in their brokerage accounts, it is your task to persuade whoever is in charge of the purse strings to compensate your aggrieved clients. That could be the in-house lawyer of the brokerage firm, the business people at the branch office where the misconduct occurred, your opposing counsel, a panel of one to three arbitrators, a mediator, and sometimes even an insurer.
In order to position your clients for the most beneficial outcome, whether you are aiming for a pre-filing resolution or preparing to take your case through a final hearing, you must begin with a well-articulated and convincing statement of claim. Knowing both your client and your client’s case from the onset as well as anticipating any defenses that may be raised will greatly increase your odds of recovery at any stage. While there is no one-size-fits-all template for drafting a securities arbitration claim, seasoned lawyers know that certain steps are taken, and pitfalls avoided, can maximize your chances of successful results.
II. Case Evaluation and Intake
The most important task a Claimant’s attorney can do is to vet the viable claim and choose the right cases to file. Knowing what cases to reject is just as important as knowing what cases to file. Not every client who loses money in the stock market has a claim against their broker or brokerage firm. Key considerations are: knowing the pertinent facts about the client; the prospective Respondents; the investments sold; and, the strategy pursued before accepting the representation. Accepting clients before adequately evaluating the claims can have serious repercussions. You are not doing your clients a service if you bring a case that has no merit. Nor are you burnishing your reputation with defense counsel when you bring a frivolous claim. It also affects your bottom line, since most investor counsels are retained on a contingency fee basis. How can you engage in adequate evaluation at this stage?
A. The Client Interview: Know your Client
Just as FINRA Rule 2090 requires the broker and firm to know their customers (“KYC”), you, as his or her counsel, should know your client.1 And, you should know them better. Nothing is more humbling than first learning from your opposing counsel about your client’s notorious career as a professional poker player or about the mezzanine financing capital she raised for a start-up she formed with her private equity pals. The best starting point is a thorough interview with your client in which you ask the questions that the broker should have asked. Give your client the FINRA Rule 21112 (suitability) and FINRA Rule 2090 (KYC) examination by asking their: age, marital status, education, employment experience, prior investment experience, risk tolerance, investment horizon, tax bracket, number of dependents, where the money originally came from and the like. This interview should be followed-up by a review of your client’s relevant tax returns, monthly statements, and new account forms from the brokerage firm, as well as other outside brokerage account statements and new account forms.
If your client does not have these documents in his/her possession, have that client sign a letter of authorization to be sent to all of the firms at which securities accounts were maintained allowing the release of these statements and new account forms to your office. Old tax returns can be obtained by your client from their accountant or taxing authority. If your client is reticent about disclosing tax returns, a red warning light should go off. If your clients owned a joint brokerage account, make sure that you collect the relevant information from both account owners. If you are representing someone who gave a power of attorney to another, or if your client is a trust, you must interview the representative parties as well and obtain the relevant documents from these individuals. You must also understand the nature of the trust, and the powers and duties of the trustee, as well as any trading restrictions on the trustee or attorney-in-fact.
Similarly, if your client is a corporate entity or partnership, you should delve into the finances of the entity, the prior trading history of the controlling officers of the entity and understand who has authority over the entity or could approve the opening of the account or its trading. The same analysis should be done of the controlling officers and investment advisors. Also, if there are board minutes or other committee minutes (such as those from an investment committee) make sure you review them prior to drafting the claim. Often, the broker will have made presentations to such a board or committee and it is important to understand what was presented to and considered by the members. By determining the scope of authority prior to drafting the claim, other violations by the brokerage firm may become apparent – such as lack of the entity’s authority to engage in certain securities transactions or the lack of the agent’s authority to effect the transactions at issue. This will also assist you in deciding who should enter into any retainer fee agreement with you on behalf of any account owners, trusts or entities.
B. Know Your Story
There are two distinct parts to a securities arbitration claim:
1. The first is the “people” part, which encompasses the interactions between the broker, brokerage firm and the client; and
2. The second is the trading of the investments in the account and the degree of supervision of the account.
While the trading and information in the new account documents regarding suitability are easily verifiable by looking at documents, client- broker interactions are generally not. Ask
your potential client to tell you the “story” of what happened from beginning to end. That will provide needed context to the trading at issue. When conducting the client interview, don’t be afraid to ask “tough” questions; you will need to anticipate the defenses which the brokerage firm may raise.
Next, “test” the veracity of these facts. You can accomplish this by taking the following steps:
1. Collect all of the correspondence (emails, letters and texts) between the client and the broker to see what was discussed.
2. While most often times the client’s interactions with the broker are verbal, see if your client has any notes to support the facts.
3. Ask if there are any calendar entries to support the dates of the discussions with the broker.
4. Determine if there were any witnesses to the discussions or meetings. To the extent that your case may turn on the testimony of any third-party witnesses, you should contact those witnesses (to the degree that the potential witnesses are not current employees of the Respondent) prior to filing.
Many arbitrations turn on witness credibility. Probe your client on the aspects of his or her personal life that may become relevant in the arbitration and may bear upon his or her credibility:
1. Have they ever been arrested?
2. Have they been involved in litigation prior to this?
3. Have they ever have issues with taxing authorities?
4. Do a quick Google search to see if your client’s name comes up in connection with anything that may be deemed harmful to them.
5. Look your client up on Linkedin to verify his/her stated employment and educational background.
6. At this stage, it is beneficial to get all of your client’s social media accounts and peruse them for public information. You can be sure that an experienced defense counsel (and most are) will be doing the same
upon receipt of your claim.
C. Know Your Broker, Branch Manager and Firm
Other than your own client, the most important witness will be your client’s broker. Therefore, prior to drafting your claim, look up the broker’s Central Registration Depository (“CRD”) record. The Web CRD, operated by FINRA, is the central licensing and registration system for the U.S. securities industry and its regulators. It can be accessed
BrokerCheck contains the registration records of more than 3,800 registered broker-dealers and the qualification, employment and disclosure histories of more than 630,000 active registered individuals, including branch managers.3 For investment advisors, the IAPD website contains similar information.4
While not all reportable information is listed in the Web CRD,5 reportable customer complaints and regulatory actions against the broker will appear on this site. Terminations and bankruptcies are also reported, as well as the list of states in which the broker is or was licensed and the dates of such licensing. You want to review these dates to determine if the broker was licensed in the state in which your client was living when the transactions at
issue took place.
If you know the name of the broker’s branch manager, do a search for this person as well. If the manager was named or involved in arbitration claims where there were allegations of failure to supervise, this fact may be relevant to your case analysis.
CRDs also reference regulatory actions, including any Acceptance, Waiver and Consent (“AWC”). An AWC is a settlement between the brokerage firm and/or broker and FINRA consenting to a penalty (e.g., a fine or agreement to cease conduct which the regulators alleged breached the securities laws). Such regulatory activity is helpful to evaluate a potential claim as it generally shows that certain actionable misconduct repeatedly occurred at the brokerage firm.
The SEC also has a database to look up individuals who have been named in federal court actions or SEC administrative proceedings.6 Individual states likewise have their own securities broker data bases that may contain additional helpful information.7 These public records should be requested and reviewed as well. Some states provide more information than others, so the experienced practitioner may wish to request CRDs from certain other states in which the broker is licensed, even if neither the client nor broker lives in those states.
Finally, do a Google search of the broker and check his/her social media accounts. You might find some gems that will help you in your case.
D. Know Your Investment
You should also know and understand the client’s investments and the broker’s strategy. Complex investments or strategies are oftentimes the subjects of securities arbitrations. Today, more than ever, there are new investments and investment strategies invented by creative investment bankers. Market events, “black swan” occurrences or other economic or political turmoil may affect the performance of such investments. If you are dealing with an exotic or particularly complicated investment product, engage an expert to discuss how the investment worked and why it failed.
You should also ask your client for any literature, sales material, quarterly reports and prospectus received when the investments were made or provided by the investment sponsor. Review these documents to determine whether the risk tolerance stated in the materials was consistent with your client’s stated investment objectives and risk tolerance. These may contain some helpful nuggets.
For example, illiquid investments should not be sold to customers with a need to access their money. Leveraged investments contain additional risk which may not be consistent with an investor who has a low to moderate risk profile and equity mutual funds may very well be inappropriate for someone living on a fixed income. With investments such as private placements or other types of unregistered securities, check to see whether this was an investment which required your client to be an “accredited investor,” requiring the client to be both sophisticated and able sustain the risk of loss.8 Then, see if they actually met the
standards to invest.
E. Know Your Claim
At the client intake phase, you need to understand if there is a viable legal claim. Although a client may arrive with a $1 million investment which became worthless—those facts alone don’t give your client the right to bring an action. Add a few more facts, though, and it may be. If the investment was unsuitable or represented 100% of an account’s portfolio, these facts could constitute actionable claims for unsuitability or overconcentration.
Similarly, there could be egregious facts, but no losses. For example, the broker might have made unauthorized trades which resulted in a gain for the client. Make sure you review the account statements and do a quick analysis of the losses to ensure that there are damages. Often, if improper trading in the account went on for a number of years, it is difficult to ascertain the amount of money lost. Sometimes, a client may believe that he/she has suffered losses, when in fact those losses were the result of the client’s withdrawals from the account. Ask for all brokerage firm year-end statements for the years of the conduct at issue. By examining these documents for the trading (buy and sell) summary, cash deposited, cash withdrawn and value of the account at year-end, you can get a rudimentary understanding of the losses before going further.
If a case has particularly complicated trading, a long investment history, or has complex strategies that were employed (making it hard to determine how the losses were incurred), retain an expert to prepare a profit and loss statement (“P&L”) for your client before taking the case. Many times, this P&L can help determine where the losses were incurred and assist in showing trading patterns which could be helpful to your case analysis.
F. Know Your Chances of Collection
A strong case on the merits is only as good as its collectability. If you are considering a claim against a small brokerage firm or investment advisor, make sure that, if you are successful, there is a way for your client to get paid. SEC’s Rule 15c3-19 – the “Net Capital Rule” – requires brokerage firms to maintain certain levels of their own liquid assets. The minimum net capital a firm must have on hand depends on its size and business.
Often, a smaller firm may only act as an introducing broker, meaning that the firm accepts your client’s buy and sell orders, but has an arrangement with a carrying firm (known as a clearing firm) to maintain custody of customer assets. Because a carrying firm has custody of customer assets, it must maintain higher levels of net capital than introducing firms.10 If you have a claim against a smaller firm, such as one with only one branch or two offices, or against an introducing firm, look up the firm on FINRA BrokerCheck (see section II C) to determine if it is still registered. If it is no longer registered, this is a sign that you probably should go no further. You can also look up a firm’s most recent financial statements by looking at its FOCUS report on the SEC’s Edgar website.
G. A Word About Fee Agreements…..
Once you have vetted your case and decided to sign up for the client, you must enter into a fee agreement. A thorough discussion of fee agreements could be the subject of an entire treatise. For the purposes of this article, however, there are some important points to be highlighted. The individual state bars have specific rules governing fee agreements and it is important to review those rules when being retained. Some states have sample fee
agreements on their websites. Here are some suggestions:
1. Make sure all owners on all of the accounts at issue are signatories to the fee agreement. If an account owner is a trust or corporate entity, make sure the proper representative is signing. Custodial accounts must be represented by a custodian.
2. Spell out clearly and in detail the nature of your representation. Most commonly, you are being retained “to investigate and file potential arbitration claims in FINRA against [brokerage firm] and [broker]”.
3. Include any additional fees or percentage charges for appeals and collection work if you will be doing this work as well. Otherwise, state that you will not be responsible for this portion of the case.
4. Include a provision on costs as separate from fees.
5. You will need to decide whether to take the case on contingency, at an hourly rate, for a fixed fee or a blend of these arrangements. If hourly or blended, set forth the hourly rates of the attorneys and paralegals who will be working on the case.
6. Given that settlements are often subject to tax reporting, it is also a good idea to include a provision that clearly states that you are not providing any tax advice.
7. If you want the ability to hire local counsel (which some FINRA hearing jurisdictions require) , include a provision on how that counsel will be compensated.
8. Importantly, some states, such as Florida, have fee-shifting provisions in their securities fraud statutes.12 If a fee shifting statute applies, make certain that the fee agreement discloses this risk in the event that the client decides to proceed on a feeshifting statute.
9. Finally, make sure you have all of your client’s contact phone numbers, email addresses and residential addresses so that you know how to best contact him/her as the case progresses. You will also need this information when filing the Statement of Claim electronically with FINRA.
III. Drafting the Statement of Claim
Now that you have vetted and signed up your client, you can begin the process of claim drafting. At this point, most of the hard work should have already been done. Focus on these two questions:
(1) Who will be reading your Statement of Claim? and
(2) What might you need to include to persuade those readers of the merits of your case?
A. Who is Your Audience?
There are a number of factors to consider when putting pen to paper (or keystrokes to edocument). Keep in mind just who the ultimate audience will be. You are not just drafting for the Respondents themselves, but rather a whole host of readers, any of whom might influence the ultimate decision in your action. These readers may include:
(1) in- house counsel;
(2) (outside) defense counsel;
(3) broker-dealer management;
(4) an insurer;
(5) one or three diverse arbitrators;
(6) a mediator; and,
Each audience category has a different agenda and each will view aspects of your claim differently. Remembering who your readers will be can assist you in focusing your attention on the areas that each party will likely seize upon in making a decision in your case.
1. Who will get your case: Early Dispute Resolution Team, Inside Litigation Lawyer or Outside Law Firm?
While there are no guarantees as to the route your claim will follow, the experienced Claimant’s attorney can measure certain variables in drafting a claim to anticipate how the case will be “triaged” when it lands at the Respondent brokerage firm. What happens to your claim, and who handles it, will affect the pace at which it is resolved, the manner in which it is resolved and how much (if any) the offered resolution may be.
Certain allegations might make it more likely for the case to be referred to outside counsel versus being handled internally. In-house counsel must make a decision early on how your case will be defended. Will it retain outside counsel who will be compensated hourly (or on retainer) for defending the action and, therefore, have an incentive to spend more time and effort in litigating the case? Or, will it be handled in-house, and perhaps proceed in a different fashion without getting as much individual attention?
While transferring your case to outside attorneys may ensure that it gets more individual attention, it may also mean more costly and combative tactics. In most cases, it also means that there is little hope for an expeditious resolution. You should determine early whether you believe that in- house or outside counsel will be most effective in the final resolution of your case, and, if possible, tailor your claim accordingly.
a. The Pre-Filing Demand Letter
Generally, with a pre-filing demand, the case stays inside the brokerage firm and is handled internally. Many larger brokerage firms have early dispute resolution teams, whose task it is to get claims resolved at this level. While it is sometimes easier to get a smaller matter resolved through this route, the pre-filing settlement of a larger claim is rare. Unless you have a particularly egregious situation coupled with the happenstance of getting the right inhouse lawyer’s ear, your chances of early resolution are slim.
That being said, it is still not a bad idea to attempt to settle a particularly noxious case, or just a small one, pre-filing. If you decide to go this route, a fully articulated Statement of Claim provided to the brokerage firm but stamped “draft for settlement purposes only” will go a long way in assisting the decision-makers in an early evaluation of your client’s claims.
A well-drafted Statement of Claim is quite helpful if you are aiming for a pre-filing resolution. First, it lets the in-house people know that you are ready to file a claim if there is no resolution. Second, there is simply no substitute for putting the facts down in a narrative fashion so that everyone can see just how badly your client was wronged, by whom and in what compensable way. Drafting a Statement of Claim can also help you refine your case. Working with your client to get all of the salient facts on paper will focus the issues and allow you to see many of the strengths and weaknesses of your claim at an early stage in the process. In this way, you, as the Claimant’s attorney, are better equipped to evaluate the
case from a settlement standpoint.
At the pre-filing stage, several things may make your claim more likely to resolve. The relative size of your claim and potential settlement target are important factors. FINRA member firms are required to report all claims involving a broker otherwise referred to as an “associated person” that are settled for more than 15,000.14 Even if the broker is not named in the case caption but appears in the body of the demand letter or Statement of Claim, this reporting requirement applies.15 Similarly, that same reporting requirement applies if the firm can reasonably determine that a demand letter or Statement of Claim involves a particular broker even if that broker’s name is nowhere in the body of the letter or claim.16 If a firm can resolve your case under this reporting limit, this may be an impetus for an early pre-filing resolution.
Certain hallmarks that the case may be indicative of a larger issue at the brokerage firm may also make pre-suit settlement more likely.
1. Things such as a broker’s sale of an unsuitable investment to all of his or her clients may be settled early to avoid publicity stirring up other complaints.
2. Similarly, a product case where a proprietary investment blew up may be settled early so as to keep a lid on the problem.
3. Press sensitive claims, regardless of their size, are also more likely to be resolved pre-filing.
4. If you represent a well-known athlete or personality, or simply a highly regarded person in your community, there is a public relations benefit to the firm for the early settlement of the claim in return for a confidentiality agreement.
Make sure that these “important” facts are highlighted either in the draft claim or a cover letter sent with the claim.
b. The Filing Stage
Most cases are simply filed without a pre-filing demand. The claimant’s counsel should consider the following issues which determine the route your claim will take once it is filed as a formal arbitration.
1. Size matters
The sheer size of a claim is a factor. A million-dollar claim is more likely to justify the use of an outside lawyer from a pure cost perspective. If your client has lost a million dollars, but the compensable portion of the claim is really only a fraction of this, you may want to consider keeping your claims narrowed to the limited issue and demand the more realistic number to keep the case in-house. This will earn you credibility with Respondents and the arbitrators and may streamline any proceedings and shortcut anticipated defenses, making it easier for the case to stay in-house.
2. Product cases
There are always new investments and investment strategies created by investment bankers. These types of investments often perform as they were intended. However, sometimes they don’t. Proprietary investments “gone bad” often warrant the use of outside defense counsel. Complex investment strategies such as the use of affiliated credit facilities, loans against securities accounts or reverse repurchase agreements for the financing of securities may also mean the case gets sent to outside attorneys.
Similarly, leveraged products like Exchange Traded Notes (“ETNs”), Exchange Traded Funds (“ETFs”) or other leveraged mutual funds may be referred to a big law firm to handle. So, too, for illiquid investments such as private placements, unit investment trusts, real estate investment trusts, promissory notes and annuities.
3. Don’t give away your age
The apparent age of the claim may also be the reason for a case to go “outside.” If the claim is drafted so that it appears on its face to fall outside of the six-year FINRA eligibility rule,17 outside counsel may be retained to file a motion to dismiss in order to prevent the matter from being arbitrated at all.
If your client purchased the investment more than six years prior to the filing of the Statement of Claim, your opponent will be instructed to move to dismiss the case even though the date of purchase is not the automatic triggering event. Where the facts deem it appropriate, Claimant’s counsel should allege an ongoing fraud, wrongdoing after the purchase of the investment, or another continuing wrong (again, where the facts justify this) so that it is clear from the your Statement of Claim that the claim falls within the six-year
For example, fraud may go on for years, span several brokerage firms and may not be detected until a market downturn. Likewise, until there is a product failure, the impropriety
of an investment may not have been detectable, which could be well after the purchase date. An ongoing fraud – lulling the Claimant into a false sense of security – should be pleaded where applicable to avoid an obvious eligibility defense. Similarly, a hold recommendation
in the face of clear evidence that a recommendation to sell should have been made may breathe new life into an older claim.
In a scenario where an investment was purchased more than six years prior to the claim, the experienced Claimant’s counsel knows to uncover such facts as to demonstrate subsequent wrongdoing. Additionally, facts demonstrating the separate tort of fraudulent concealment within the six-year eligibility period (such as carrying a false value of an investment on a monthly statement) may also assist in avoiding a motion to dismiss.
4. Beware of the possible conflict
There are times when the Respondent firm will hire an outside firm to represent a broker individually due to a potential conflict. In this situation, the brokerage firm will either retain two separate law firms (one for the broker and one for the firm) or hire outside counsel for the broker and continue to represent just the firm in-house. In either instance, this happenstance is certain to complicate the proceedings because each time there is a motion or objection, Respondents will have two sets of lawyers briefing and arguing the issues. This opportunity to “double team” can create havoc at pre-hearing conferences, allowing Respondents to get several bites at the apple.
Certain claims, such as those demonstrating that the broker intentionally concealed something material from their employer (e.g,. selling away or taking money from a client), or has acted in a criminal or quasi-criminal manner, may increase the odds that the broker will be represented by a separate attorney . Likewise, in cases of fraudulent activities such as theft from an account, forgery or outside business dealings, the Respondent firm may be required to argue that the fraud was perpetrated on it as well, placing the blame on the individual broker.
In these situations, the Claimant’s attorney should attempt to allege as many facts as possible establishing the brokerage firm’s knowledge of, and complicity in, the wrongdoing.
For example, if firm letterhead was used for an outside business deal or if emails came in
and out of the firm’s offices relating to the fraud or misconduct, these would assist in proving joint liability and tend to show that “the shooter did not act alone.” Facts evidencing the involvement or approval at the firm’s management level may also assist Claimant’s case, establishing any negligent supervision or respondeat superior claims against the brokerage firm itself.
Finally, if it appears from the broker’s U-5 that there was a termination for cause, you should anticipate that the broker will be represented by separate counsel.20 When you know that this is the case and you have enough ammunition against the firm, you should consider not naming the broker to avoid the multiple representation issue.
B. The Regulators
Regulators of the securities industry include the SEC, FINRA and state securities departments. Any of these (or all three) may open investigations into your arbitration claim. Claimant’s counsel should also be aware that certain facts could make it more likely that the regulators will get involved in your case. If your action involves any of the following,: (1) a broker with a checkered CRD (three or more customer claims); (2) a problem branch office; (3) serious allegations of theft or forgery; (4) selling away or outside business activities; (5) market manipulation or other fraud on the market theories; (6) elder abuse issues; (7) problem investments in the press; or, (8) firm wide supervision issues, it is possible that a regulatory inquiry may be instituted as a result of your claim:
(1) a broker with a checkered CRD (three or more customer claims);
(2) a problem branch office;
(3) serious allegations of theft or forgery;
(4) selling away or outside business activities;
(5) market manipulation or other fraud on the market theories;
(6) elder abuse issues;
(7) problem investments in the press; or,
(8) firm wide supervision issues.
The firm is required to amend the broker’s U-4 or U-5 and report your claim whether it is formally filed as an arbitration or merely comes in as a letter of complaint. Once it is reported, regulators may become interested and open an investigation into the conduct of the broker and firm. They can be valuable to the extent that Claimant’s counsel may be able to subpoena records and disciplinary action information from them. Public documents in SEC or FINRA enforcement actions may also help you add evidence of the bad acts alleged in your claim. Regulators may also provide you information “off the record” to assist in your
If a claim has resulted in regulatory action, a brokerage firm may be more likely to settle the matter in order to appear to the regulators that it has “done the right thing.” This is particularly true in the case of a notorious investment or broker. In the “garden variety” claim, however, the brokerage firm may be just as likely to arbitrate the matter to prove to the regulators that the broker (and firm) did not act improperly. Accordingly, the experienced Claimant’s attorney should carefully include all FINRA, SEC, state and federal securities violations clearly and concisely in the body of the claim if the action is one that may appear to lead to a regulatory investigation or action.
Attaching evidence of your client’s allegations may also help in a quicker resolution of the claim. If the branch office is one that has had repeated violations, state this in the claim. Similarly, if the broker has a CRD that reads like a phone book, attach it to the Statement of Claim. If you perceive registration issues – such as failure to register the security in your state or the broker was not registered in your state when he or she sold the securities to your client -attach the relevant public documents.
If there has been an AWC between the broker or firm relating to the investment or conduct as issue, or if any other sanction has been issued by a Regulator, attach it to the claim as an
C. Broker-Dealer business people: “We make money the old-fashioned way….”
When drafting the claim, keep in mind that brokerage firms are in the business of generating revenue. At the end of the day, a settlement check is a business decision based on an evaluation of several factors as well as internal approvals. The resolution of your claim is driven by certain tangible and intangible business factors, including:
(1) a balancing of the defense costs verses likelihood of success of the claim;
(2) whether an important broker or manager has been implicated;
(3) value of confidentiality clause in settlement due to possible negative public relations;
(4) concern there may be other claimants with the same complaint;
(5) the identity of the named Claimant;
(6) the overall financial health of the brokerage firm;
(7) the availability of insurance coverage;
(8) to appease regulators; and,
(9) the firm’s fiscal year versus the time of year of the settlement.
There are some firms which flat out refuse to settle claims above a certain threshold (such as 50% of out-of-pocket damages) simply because they want to establish the reputation of being a difficult target. Take the time to understand these business issues prior to trying to settle a claim pre-suit.
D. The Arbitrators
While you will not know who your arbitrators are until months after filing your claim, you do know that, in the typical customer case, you will have the option of an all public panel of three arbitrators or the choice to make one of your three arbitrators an industry
In smaller cases – those under $50,000 – the claims will be decided by one public arbitrator.23 In cases between 50,000 to $100,000, the parties will have one public arbitrator unless they agree in writing to have three.24 In any circumstance, you also can assume that, while you might have at least one attorney on the panel, other panel members may not be lawyers. You might have one person familiar with the brokerage industry, but
sometimes there are none. Following these assumptions, you must draft your claim to explain clearly: (1) your client’s investments and any operational issues to the non-industry arbitrators and (2) your legal issues to the non-lawyers. To the extent possible, define the issues in layman’s terms.
In the investment and operational context, explain the nature of the securities or investment strategy. Then, if possible and appropriate, draw an analogy for the non-industry arbitrators.
For example, in explaining varying levels of risk in options strategies you might include something like this: “Covered calls are like buying an insurance policy—they protect the investor in the event that the market moves in a particular direction. Naked options, on the other hand, are like putting your money on ‘black’ at a roulette wheel—it is an all or nothing proposition.” Legal issues should, as well, be put in simple terms for the nonlawyers. For instance, rather than simply stating that the investments were unsuitable, spell out what constitutes “unsuitability” or “overconcentration” in the context of your claim. If your 90 year old client, living on social security, was invested 100% in the preferred shares of an e-commerce company, write this: “In order for the account to earn 5% a year rather than the CD rate of 2%, which Mrs. Garcia had at her credit union, the account was concentrated 100% in Flamazon preferred stock. When that company failed, she was left with nothing––and no way to generate future income. Had 100% of her funds not been put at risk in one stock, she would not have lost all of her retirement savings.”
Non- lawyers can easily understand this example of the legal claim, rather than just a label. This can go a long way in educating the non-lawyers as to what your client’s claim is all about.
E. “Insure” a good result
Finally, the broker or brokerage firm may have insurance for particular claims. While the existence of insurance is often a closely guarded secret (even in cases where the insurer is paying part of a settlement), there are certain scenarios that are likely to bring an insurer into the picture.
There is often insurance coverage for the brokerage firm in cases of broker theft or forgery. So, if you have hard evidence of such misconduct, attach it to your Statement of Claim. Other policies may be written to cover the individual broker’s conduct and generally contain clauses excluding intentional wrongdoing. For this reason, including a negligence count in your Statement of Claim – where the facts warrant such a claim – may be enough to bring your action within this type of insurance coverage. Generally, until a claim is filed with FINRA, the duties of the insurer to defend and pay any arbitration Award will not be invoked.
IV. Anatomy of a Statement of Claim
Once you know what audiences you will be addressing in your claim, you are ready to begin drafting. It should contain six separate sections: (1) the case caption; (2) jurisdictional allegations; (3) introduction; (4) fact section; (5) legal claims; and, (6) damages. In order for the reader of the Statement of Claim to easily find a particular section it is good practice, if possible, to break up the sections into smaller sections divided by sub-headings. This also
has the effect of making your claim easier to read and follow.
A. The Caption of the Case: What’s In a Name?
Do not underestimate the significance of determining who will become Respondents in your arbitration. There are several schools of thought on this issue. Some believe that the scorched earth, name everybody in the zone of danger approach is best. There are times when this may be appropriate. For example, if you have a “serial broker” who has hopscotched from firm to firm leaving a trail of mass destruction in his or her wake, naming multiple firms can help. This may cause each of the brokerage firms to blame the other for the losses, causing infighting in front of the arbitrators and thus adding more credibility to your claims. A quick settlement with one Respondent early in the case may help fund the remainder of your client’s case. And, if you must try your case against the other nonsettling
Respondents, the fact that another Respondent has chosen to settle should make it
appear to the arbitrators that your claims have serious merit.
The downside to this strategy of naming as many Respondents as possible is that at all of your prehearing conferences there will be numerous Respondents’ counsel, each of whom will get a chance to oppose any motions you make and further complicate the proceedings. Numerous Respondents will also be able to get more far- reaching financial and investment history on your client as the relevant time-frame gets broadened with each additional brokerage firm Respondent. The further back you allege misconduct, the further back Respondents will try to obtain discovery into your client’s finances.25 Make sure you evaluate the client’s investment behavior in the earlier years when determining how far back you want to allege the claims. Another factor you might want to consider when there are multiple firms involved is whether you will be able to allege an ongoing fraud to defeat
any eligibility arguments the earlier brokers may raise.
There are also times when you will consider naming fewer than all responsible parties. It is becoming more common for customer attorneys to forego suing the individual brokers for several reasons.
1. First, particularly in the case of an egregious wrong or simply an unlikeable broker, there is the chance that the arbitration panel may choose to allocate losses between the parties, rather than enter a joint and several award. You want to avoid the situation where the panel allocates 90% of the Award to the broker and only 10% to the firm. Your client may never get a recovery in this situation. Therefore, if you are certain that your respondeat superior and/or failure to supervise claims are airtight, consider not naming the broker if you fear the looming fault allocation and
2. In a product failure case, it is best to forego naming the individual broker who probably had no idea that the investment he or she was told to peddle was in fact risky or inherently unsuitable from the inception.
3. Not naming the individual broker may also make the broker more likely to cooperate with you or be a more friendly witness. While the broker will still want to prove his or her innocence (because the firm will still have to report the claim on the broker’s U-4 or U-5),26 as a witness the broker may be less hostile if you are not
after his or her personal funds. That said, the firm can still seek contribution from the broker for any sums it is required to pay your client if there was actual broker wrongdoing.
Naming the individual broker may have benefits. If, for instance, the broker is a big producer and important to the firm, it may have some incentive to settle the action in order to seek expungement in connection with the settlement.27 You should name the broker as a Respondent only if the broker actually committed the wrongdoing. In the situation where the broker has simply sold a defective product, or the firm has problematic clearing or
back office procedures, you should only name the firm.
If the Claimant has named a broker as a Respondent who is not the real party at fault, this may engender sympathy from the panel when the broker takes the stand and may not assist your case, unless the broker points the finger at his current employer (which is unlikely if the firm is providing the broker with a defense attorney). Similarly, the branch manager or other control persons should be named only where there is evidence that they actively
participated in the wrongful conduct through some deliberate or grossly negligent means.
B. Jurisdiction and Venue: What Are You Doing Here?
FINRA’s jurisdiction, as well as the jurisdiction of any particular self-regulatory organization (“SRO”), such as the National Futures Association (“NFA”) or Commodities Board Options Exchange (“CBOE”), is a creature of contract or of the SRO’s own mandate. To determine where jurisdiction is proper, ask your client for his or her arbitration provision (contained in the new account forms or margin agreement). That provision will set forth the
arbitration forums that are available to your client.
If your client held a securities account at a FINRA member firm, FINRA will likely be the specified forum. If there is no arbitration contract, your client is still given the right to bring an arbitration by virtue of the Respondent firm’s membership in FINRA.28. FINRA similarly has jurisdiction over the individual broker because the broker is “associated with a
Allege the jurisdictional basis at the beginning of your Statement of Claim. FINRA has jurisdiction only if the “dispute arises in connection with the business activities of the member or the associated person.”30 There is an exception against “disputes involving the insurance business activities of a member that is also an insurance company.”
Be sure to include your choice of venue. FINRA provides 70 arbitration hearing locations in each of the 50 states, Puerto Rico and London.32 Unless you specify a choice of venue (and sometimes even if you do specify a choice), FINRA will assign your arbitration to the venue where the client resided at the time the account was open.
You may wish to request a different venue if your client has since moved or if your client has multiple residences or simply if you wish to choose what you believe to be a more Claimant-oriented venue that has some ties to the dispute at issue. For example, if the broker’s office was located in Florida, but the client resided in Washington, D.C. (a venue that some practitioners believe has a large pool of conservative defense-oriented arbitrators), you might wish to allege that venue is proper in Florida for a host of reasons, including that Florida law governs (allowing attorney’s fees for securities violations) and that most of the defense witnesses reside there.
C. The Narrative Part of Your Statement of claim: Just the Facts Ma’am
The beauty of arbitration is that it is a fact-driven process, as opposed to one that is based substantially on the law. In many arbitrations, the majority of your arbitration panel will not be attorneys. As such, the audience of your claim will give greater focus to the fact section of your claim than they will to the legal section.
This is not to say that the law is unimportant to your claim, but drafting pages and pages of legal jargon setting forth the legal bases of your claims is simply not warranted or even required in an arbitration.
Draft the claims in a narrative fashion and make the facts both interesting and easy to read. Many subheadings breaking apart the different sections of your narrative can help the reader get through it and later go back to any particular section .
The facts should address the who, what, when, how, how much, and in which compensable way.
It’s always a good idea to have a snappy introduction to set the tone of your claim. Although this section will come at the beginning of your Statement of Claim, write this section after you have completed the entire pleading so you know where you emphasis should be.
Personalize your clients and try to make them the sympathetic victims of the securities wrongdoing for which they are seeking recovery. Summarize your case in one to three short and punchy paragraphs and explain what happened in a simple summary fashion.
An example of a brief Introduction would be something like this: “Manny Jones is the hometown hero of the Springfield, Illinois Springboks baseball team. He went straight to the minor leagues from Springfield High School and soon became an All Star short stop. He hit the winning run for the Springboks when they clenched the World Series in 1962. His chain of fast food restaurants – ‘Jones’ Wingbones’ – employs 50% of Springfield residents. His stockbroker and former son-in-law, Dwight Dumfy, recommended that Manny cash in his low returning CDs and use the proceeds to invest in a risky options strategy in his account at Springbok Securities. In just three short months, Respondent lost the entirety of Manny’s life savings. Manny had to sell his World Series ring in order to pay for his kidney transplant.” This paragraph alone should let the readers know what result is compelled in this case. Enough said.
2. Background of the Claimants
Next, begin with a chronological narrative explaining in detail who the Claimants are, detailing their background and highlighting things about them to both make them sympathetic as well as credible.
Who the Claimants are is one of the most important parts of your case. Begin with personal things such as your client’s age, how long the client has been married (if married) and how many children and grandkids were raised (if any). If the Claimants were in the military or participated in charity work, add these facts. If others, such as elderly parents, rely on their financial support., mention this fact. If your client has a college degree, but was always a full
time homemaker, be sure to include this. Also, if the client suffered from any mental or physical defect that would have been apparent to the broker, this is relevant to the investment decisions made contemporaneously.
Explain where the money invested came from and, if compelling, how it was earned. If it represents retirement savings from years in the workforce, detail this. This is also the place to explain how the Claimants met the broker, their investment history and how they ended up opening their account.
If you happen to represent a wealthy client, make sure, if applicable, to emphasize their inexperience in the market or in the type of investment at issue. When the client is a widow, and previously relied on her spouse to make investment decisions, this too is an important fact to include.
This is the only chance your arbitrators have to evaluate your client prior to the hearings, so use this section to vividly paint the portrait of your client and set the tone for the case.
3. What Was Purchased? Investing 101
The claim should clearly identify and explain the investments or strategy at issue. Because two and possibly three arbitrators are not “industry” people, you should identify the investments at issue and explain the nature of the investments involved. Even with the most common investments – such as stocks and mutual funds – it is helpful if the arbitrators ca be educated.
An experienced Claimant’s attorney will identify the particular investment vehicle and explain its characteristics This is even more important in the case of a complex investment or strategy. Many cases today involve new and creative vehicles. You should identify the investment along with an explanation of how it works and what the investment terms mean. Thus, rather than just alleging “Respondents sold Claimant Exchange Traded Notes,” you can add “Respondents represented to Claimant that J.P. Brogan Energy Index Exchange Traded Notes were a ‘guaranteed’ investment, never disclosing the risk that if J.P. Brogan – the issuer – collapsed, so did its guarantee. Exchange Traded Notes are dependent on the credit quality of the issuer. As an underwriter of the offering, Respondent knew these risks, but failed to disclose them.”
With respect to more exotic investments, explaining their nature and dangers can go a long way in making your case. Investments such as exchange traded products, unit investment trusts, real estate investment trusts (REITs) and private placements should be clearly explained in a separate section.
Similarly, particular investment strategies such as the use of credit facilities of affiliated banks, hedging, options strategies, short selling, collars, dollar cost averaging and the use of margin should be explained for the non-industry arbitrators. The characteristics may be set out in a separate section entitled “A Primer” on whichever investment or strategy you are explaining, including definitions and explanations of risks and dangers from reputable financial publications. Consider attaching articles and giving the URL address for the internet
4. What was Represented and What Did Respondents Receive?
The Statement of Claim should detail the facts surrounding the sale of the offending product. You should also be clear about the representations that were made and by whom they were made. Articulate both the broker and the firm’s involvement in the transactions at issue. There are certain investments for which FINRA and SEC have issued sales guidelines and/or a Notice to Members (“NTM”)33 providing guidance to brokers and firms. Structured products, leveraged exchange-traded funds, inverse exchange-traded funds, variable annuities, bond and bond funds and mutual funds fall into these guidelines.
Check the FINRA Regulatory Notices for the particular investments at issue to ascertain whether there have been sales guidelines articulated by regulators. Importantly, investment strategies, as well as investments, can be the subject of a claim. FINRA has made clear that brokers must ensure that investment strategies, as well as the securities themselves, are suitable for investors.
Just like a jury is called upon to judge the credibility of witnesses, arbitrators must evaluate the truthfulness of your client and the broker. Establishing a motive can go a long way in setting forth and proving a credible claim. The arbitrators will all want to know: What compensation did the Respondents receive?
A prepared Claimant’s attorney will have a profit and loss evaluation done, including a commission and cost analysis (if warranted), prior to filing the arbitration and will be able to state with reasonable certainty the remuneration paid to the Respondents, at least to the degree that compensation has been disclosed through confirmations, prospectuses or other offering documents.
One effective strategy is to set out the commissions, fees and costs as compared to the total investment return to the client or as compared to the average equity in the account. The comparison can be compelling, for example, where you can state: “Claimant lost $250,000 in the account while the Respondents received approximately $250,000 in commissions, fees and margin interest” or “the cost of the investment strategy to Claimant was 25% of the average equity in the account, meaning that Claimant’s account had to earn 25% just to break even.”
Annuities and life insurance products often contain staggering sales charges and should always be reviewed prior to filing the claim. Although commissions are part of the equation, other sales charges such as management fees or wrap fees can sometimes be charged in addition to the commission.
Other fee-generating situations should be highlighted. Review the prospectus or other offering document to see what fees were charged and what other ways the Respondent received money from the investment. Underwriters or placement agents can make fees on sales of new issues.
Where it appears that there was no investment purpose other than to generate commissions – such as mutual fund switching among similar funds – spell this out. Finally, if the investment is a proprietary one created and sold by the firm , explain that fact. If the firm or its affiliates received compensation for managing an investment, this is also relevant.
In sum, allegations establishing a financial motive can greatly enhance your claim.
5. How Could it Have Been Prevented or Detected?
You are drafting a claim to recover money from the brokerage firm, which is generally the “deep pocket” in the case. Although the broker is often the primary wrong-doer, the firm is liable for his or her acts under two different legal principles: (1) under respondeat superior, the brokerage firm, as the principal, is liable for the acts of the broker, acting as its agent and (2) the brokerage firm can be liable for negligent supervision, negligent hiring or
negligent retention of the broker.
With respect to principal/agent issues, allege facts showing that the broker was acting within the scope of his or her employment. Any actions by the broker in connection with providing investment advice or in connection with the purchase or sale of any investment should meet this criteria.
FINRA has set forth procedures for the vetting and supervision of complex investments, which may include security with novel, complicated or intricate derivative-like features, such as structured notes, inverse or leveraged exchange-traded funds, hedge funds, and securitized products, such as asset-backed securities.35 There are also other FINRA NTMs regarding specific investments such as bonds and bond funds,36 hedge funds37 and variable annuities.38 Due to the number of new investments being introduced, FINRA instituted a catch-all NTM on all new products, setting forth procedures which firms must follow in approving them for sale to customers.39 To the degree that such supervisory procedures were violated or ignored, these may serve as the basis for a failure to supervise claim.
With regard to negligent supervision, you should set forth facts demonstrating both the lack of management’s communication with the client and the apparent failure to monitor the accounts at issue. Where there is a particularly active account or an account with large losses, overconcentration in a particular security or sector, or large margin or loan positions, the claim should explain how the lack of oversight allowed the conduct of the broker. The claim should state clearly in what ways the firm is at fault and how the misconduct could have been prevented or detected earlier.
Similarly, the failure to monitor a broker who has ongoing personal issues that may impact his or her judgment or conduct, may also be a basis for supervisory claims. For instance, a broker with substance abuse problems or one who has financial problems such as bankruptcy or divorce-related economic pressures should be carefully supervised. Setting forth how the firm should have seen such “red flags” but failed to monitor the broker or accounts properly will help support a claim of failure to supervise.
D. Your Legal Section: I Fought the Law and the Law Won
A brief minute on legal claims. Because FINRA arbitrations are fact-driven, there are several schools of thought on how much of the law should be included in a Statement of Claim. A Claimant’s attorney should be able to explain how a statute, common law principle or regulation was violated by Respondents’ actions.
Since many FINRA arbitrators are not attorneys, this should be done in an easy-to-read and concise fashion. The claims should be identified and the basic elements set forth so that the arbitrators can see how your facts fit into the legal theories of your case.
Typical claims in a securities arbitration are: federal Securities Act violations; state securities law violations; breach of fiduciary duty; negligence (predicated on violations of FINRA or SEC regulations); common law fraud; breach of contract, respondeat superior; negligent supervision and negligent hiring. Some states have elder abuse laws which may also come into play and which often allow for attorneys’ fees.
State securities statutes vary, but most are modeled on the federal law, Section 10(b) of the Securities Exchange Act of 1934.40 Some states, like Florida, have less stringent standards and do not require the Exchange Act’s “intent or scienter” element. Other state securities statutes are desirable since they provide for the awarding of attorney’s fees to a successful plaintiff.
You should also carefully review your state’s securities law statute to determine if it has a “fee-shifting” provision, which provides attorney’s fees to the prevailing party and, if so, carefully explain to your client the risks associated with including such a claim in your pleadings.
Respondeat superior, negligent hiring and negligent supervision are important to the outcome of your case because they impose liability on the brokerage firm. The doctrine of respondeat superior confers liability on a corporation for the acts of its agents committed while acting in the scope of their employment. Make certain to include these claims, where applicable, when you are bringing an arbitration against a brokerage firm.
E. Damages: When to say “When”
Finally, the claim must notify the firm, FINRA and the arbitrators what your client is seeking to recover and the recognized claims for recovery. This is important for several reasons.
1. First, the damages portion of your claim determines the amount of the FINRA filing fees your client will be required to pay. FINRA’s website includes a link to a filing fee calculator to prevent the miscalculation and consequential delay as a result of sending the statement of claim with the incorrect filing fees.41
2. The damages section of your Statement of Claim also notifies the brokerage firm and the regulators how significant the case is in terms of the potential financial exposure. The brokerage firm is required to state how much your claim seeks when reporting it to FINRA and the amount sought will ultimately appear on the broker’s U-4 or U-
3. Publicly-traded brokerage firms usually set up a reserve to pay claims made against it in the event that the firm settles or is required to pay an arbitration Award or court judgment.
4. The amount of damages at issue dictates whether your claim qualifies for simplified arbitration, which allows for a single arbitrator in cases under $50,000 with the option to have the case decided on the papers (almost never recommended) rather that at an in person final hearing.42 There are a number of factors to consider when determining whether to proceed on the papers alone and it is a decision that should
be discussed extensively with your client. If your claim is between $50,000 and $100,000, you are entitled to have your case decided by one arbitrator unless the parties stipulate to three.
The damages section should state your client’s different theories of damages such as, but not limited to:
1. “compensatory damages,” which are meant to compensate the claimant for he wrongdoing;
2. “benefit of the bargain damages,” which are meant to place the claimant in the position represented to him or her when the investment was sold; or,
3. “well-managed account damages,” which awards claimant the amount the
account should have returned had it been properly managed.44
4. There are other compensable damages such as disgorgement of commissions or rescission.
Your claim should also address exemplary or punitive damages and the basis for such a damage claim. You should set forth your clients’ claims for pre- and post-judgment interest, but without specifying any statutory rate, since this can be done at the final hearing and may change during the course of the case.
Finally, any claims for attorney’s fees and costs – and the basis for these claims – should be spelled out in the Statement of Claim. In Florida and other jurisdictions, the parties must both agree that the arbitrators have the authority to both assess the entitlement to and amount of an attorney’s fee Award.46 To the extent that you do not want the arbitrators to assess the amount of attorney’s fees, but only your client’s entitlement to them (the amount
to be later determined by a court), you may wish to specify this request in the claim so that there is no argument that your request for a fee Award waived this right to proceed to court on the assessment of fees.
A well-articulated damage portion of your claim alerts the firm (and the regulators) to the potential exposure that your case could engender. This is not to say that you should make unrealistic damage claims. Overinflated damage claims may backfire when you are in front of arbitrators with respect to your client’s credibility. Outlandish claims can also turn off in-house and defense lawyers, causing them to believe that the case can never settle at a reasonable number. While you should be a zealous advocate for your client your claim for damages will often be a starting point in settlement negotiations and defense counsel expects that your demand will go down from the number initially alleged. Taking these facts into consideration, the seasoned Claimant’s counsel knows when to say “when,” or, to
put it another way, how to ask for damages that reasonably fall within the parameters of accepted legal theory without going overboard.
F. Tidying Up: Numbering, Exhibits and Personal Information
In accordance with the guidance of the FINRA Arbitration Filing Guide,47 you should number the pages of your claim to include the total number of pages. If, for example, your Statement of Claim is 20 pages, the first page should be numbered “Page 1 of 20”. If your Statement of Claim refers to documents, copies of the documents should be attached as exhibits. Exhibits must be clearly identified and a complete set should be attached to the Statement of Claim. Importantly, confidential information in those exhibits should be redacted. 48 Where such data must be referenced, use only the last few digits of social security, bank or securities account numbers, or similar information.
Choosing the right cases to accept is paramount to your practice and an investor’s life. Taking the time to know your client and your client’s case before drafting the Statement of Claim will go a long way in paving the road for a positive resolution. And, while there is no tried-and-true formula to drafting a securities arbitration Statement of Claim, making it interesting to the readers and setting it out in an easy-to-understand fashion for non-lawyers
and non-industry personnel can be quite effective.
The Statement of Claim is often the first look any decision-maker has of your client’s case and preparing a well-drafted and supported pleading may place your client in an excellent position to resolve claims prior to a full hearing. While brokerage firms often say that nobody has a crystal ball to predict markets, you may be able to help predict the outcome of your client’s case through effective use of your most powerful weapon: your keyboard.
*This article is an update of an article that appeared in the PIABA Bar Journal 18 No. 3 PIABABJ 333(2012).
Copyright © 2020 Melanie S. Cherdack, All Rights Reserved. Ms. Cherdack is of counsel to the law firm of Genovese Joblove & Battista, P.A. Her practice primarily consists of representing individual and institutional investors in securities arbitration claims before FINRA and other SROs. She formerly served as assistant general counsel to PaineWebber Inc. (now known as UBS Financial). For more information, go to: www.investorfraudlaw.com. As a final note, the author wishes to thank her editor extraordinaire, David Robbins, who greatly enhanced both the original and new versions of this article with his thoughtful and practical comments.