IN 12 OR SO YEARS OF REPRESENTING securities professionals in arbitrations, I have heard a near-constant refrain from my clients and other members of the financial community: The arbitration process is not fair. The general complaints are that arbitrators are biased in favor of customers, particularly those who are sympathetic; that arbitrators ignore the law and decide cases with their hearts, not their heads; and that the process is slow, inefficient and unpredictable.
When these comments and complaints arise, I typically assure my clients that while the process is not perfect, in the hundreds of arbitrations I have participated in, I have found the process to be at least as fair as traditional jury trials. There are certainly problems with the system slow speed, inefficiency and lack of predictability are some major concerns. Still, securities arbitration is one of the best methods of resolving customer disputes and is far more efficient and cost-effective than traditional litigation.
With these constant complaints from brokers and broker/dealers in mind, I almost laughed when I opened the November 1996 issue of Money magazine and discovered the article “Wall Street’s Stingiest Judges.” Any regular reader of Money knows that the magazine is hardly a fan of Wall Street, nor is it a bastion of fair reporting of the arbitration process. Even so, the article was interesting.
The article is based upon a survey performed by the Securities Arbitration Commentator, a publication that tracks and provides analysis of securities arbitrations across the country. The survey, published earlier this year, confirmed what securities attorneys already knew: Investors win more than half of the time. To be exact, investors won 52 percent of the cases filed in 1995.
Rather than report this fact, Money decided to focus on another aspect of the report that investors receive only 34 percent of their claimed losses. This was not a surprise to those who practice in the field. In securities arbitrations, claimants and their attorneys are notorious for vastly overstating damage claims, asking for multiples of actual losses and sometimes even asking for more money than their initial investment with a reasonable investment return.
While ignoring this absolute fact, Money went on to profile the “stingiest” arbitrators, those who awarded the least on a percentage basis to winning customers. The article then blasted the process for not being able to remove “inept” arbitrators and suggested that arbitrators who did not award claimants their entire damages were somehow incompetent.
If a problem exists, it is not that arbitrators are stingy, stupid or biased. Rather, customers who sue their brokers are very often unrealistic in their damage claims. Two recent cases demonstrate the point clearly.
I recently represented a firm and broker, defending a claim brought by a woman who had invested $180,000. The customer, who was relatively young, was looking for investments to generate high income with moderate risk. Her broker recommended a mutual fund, a bond fund and a few mid-cap stocks. Over the course of four years, the customer withdrew $80,000 from the account in principal, interest and dividends. When she closed her account, her securities were worth $82,000 because, over those four years, she lost approximately $18,000 in her securities purchases and sales.
She started an arbitration, claiming that she did not understand the risks of her investments and that the investments were unsuitable for her. Assuming for purposes of this article that the investments were not suitable, what are her damages? Those damages are simple to calculate she invested $180,000, withdrew $80,000 and liquidated her account, generating another $82,000. Therefore, on this simple analysis, she lost $18,000 in principal. Her damages are $18,000. She is, in theory, also entitled to a reasonable investment return on her original investment. The withdrawal of principal over the years complicates the math a bit, but the interest figure was an additional $16,000.
Awards of a reasonable investment return are by no means certain, and plaintiffs are not automatically entitled to such damages. The customer’s best case for damages was $34,000.The amount of damages that she claimed, and the number upon which a Money magazine-type analysis would be based, is the incredible sum of $206,000.
While I did not believe the customer’s claim had merit, the arbitrators disagreed with me and awarded the customer $21,500, or 20 percent more than her actual loss. According to a Money magazine-type of analysis, she was treated unfairly since she only received 10 percent of her claimed damages. Therefore, she was a victim of “Wall Street’s Stingiest Judges,” although she won more than she actually lost in the market.
In a widely reported case that I handled in 1995, a customer in San Francisco purchased 2,000 shares of a particular stock at $13. He claimed he placed an order to sell those shares at $15 that was not executed. He said he learned of the failed execution when the stock was at $12 and decided to hold the security. A year later when he filed the claim, the stock was at $6. His damages? Assuming his claim was correct and true, one analysis says he is entitled to his actual loss, i.e., the difference between his purchase price of $13 and the $12 that he could have sold it for. Another theory says that he is entitled to the benefit of his bargain the difference between the $15 price and the price of the security when he learned that the sell was not executed $12. His damages are therefore $6,000.
The amount of damages claimed by this customer? Not $2,000, nor even $6,000, and not even the difference between $15 and $6, which would be an outrageous claim. This customer claimed that he was damaged in the sum of $26,000 his total investment in the security. Such a damage claim does not have any chance of being granted, and fortunately, the broker and brokerage firm won this claim. (In fact, the customer had to pay the brokerage firm $2,500 for a frivolous claim.) Even so, suppose that the arbitrators had awarded the customer the reasonable sum of $6,000. The customer would have won 100 percent of his damages, but Money magazine would say that he “only” received 23 percent of his damages and would label the arbitrator stingy and perhaps even incompetent.
This type of pie-in-the-sky damage claim is all too familiar in securities arbitration, and in litigation in general. These examples are not out of the ordinary. Customers and plaintiffs frequently overstate their damages because in some jurisdictions a plaintiff cannot recover more than is requested. It is therefore prudent to ask for the maximum possible amount and prove whatever damages were sustained.
There really is nothing wrong with this, since a customer only recovers the damages proved. A problem arises when outsiders looking to criticize the process ignore simple reality and come to conclusions based on these incredible figures.
There are a number of problems with securities arbitrations, but it is still one of the best methods of resolving customer disputes. One problem that the industry and the arbitration forums cannot resolve, however, is biased reports in the mainstream press that fuel the perception that the process is not fair to those using it to seek resolution.
Mark J. Astarita, Esq., is a partner in the law firm of Sallah Astarita & Cox, LLC, which represents brokers, broker/dealers and issuers in a wide variety of legal and regulatory matters. He is also the sponsor of The Securities Law Home Page b (http://www.seclaw.com) and can be reached by e-mail at firstname.lastname@example.org. This article originally appeared in the December 1996 edition of Research Magazine.
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