A recurring problem in civil litigation is the filing of claims by plaintiffs which lack merit, or are which are filed for purposes other than to address a grievance or a wrong. The problem is particularly acute in the securities arbitration arena, where in addition to the cost, expense and time involved in defending such claims, the frivolous claim remains on a brokers license during the time that the claim is pending, and in some instances, even after the customer’s claim has been dismissed. I originally addressed this issue in 1997 in my column in Research Magazine, which was titled Rogue Customers. A followup the next month offered suggestions and strategies for attacking the problem. The column was Fight Back.

The columns created something of an uproar. I got some nasty email and alot of telephone calls. The email was from customers who had lost arbitrations, complaining about the biased arbitration system. The telephone calls were from brokers and other attorneys relating their own horror stories and dealings with rogue customers. Some claimant’s attorneys starting calling me the “Right Wing Defense Lawyer” (a title I carried with some pride), I was accused of industry bias, and other assorted nonense. Years later a prominent claimant’s attorney attacked the article, myself, and a few other prominent defense counsel is a poorly reasoned and rambling diatribe against the new expungement rule. The article clearly hit a nerve. But did it have any positive impact?

Background on the Problem

The original Rogue Customers article provided some admittedly andetocial evidence of such abuses. In the years since then, we continue to see these cases being filed, and dismissed by arbitrators. Recent examples from my own cases include customers who claim they are unsophisticated, yet have years of extensive investment background. Customers who claim to have lost hundreds of thousands of dollars, then refuse to provide documentation of their losses, and the forensics accounting shows that the accounts were significantly profitable. We have seen customers who admit on cross-examination that they were aware of every transaction despite their claims of unauthorized trading, who admit to having significantly more assets than they disclosed to their broker, and even their own attorney. Customers who claim that they did not know that they were losing money and that they were not aware that the market was declining during 2000 and 2001 because despite having their life savings invested in the market, they did not open a single account statement, confirmation slip, or correspondence from the firm, and did not even read a newspaper, nor magazine, nor watch the news or listen to the radio.

Such anecdotal evidence abounds, but it is exactly that, anecdotal, and statistically insignificant. Despite the fact that many of us spend the overwhelming majority of our time in arbitration, the reality is that we only see a couple of dozen cases a year, at most. If I conduct hearings in two cases a month, I have only cross examined 24 customers in a year where 8,000 claims were filed. On the other hand, if I have two or three of these examples each and every year in my practice, how many claims like these are actually out there? There are a lot of experienced securities defense counsel out there, they are all doing the same number of cases I am, if not more, and are certainly having the same experiences.

So, the problem continues, and the NASD statistics show that there are something on the order of 1,500 cases per year that are filed, that do not have any merit. The problem continues, and while some steps have been taken to address the issue by the arbitration forums, the most effective strategy that I suggested was to Fight Back – to file counterclaims against rogue customers, to force them to consider their allegations, and to insure that their was a cost to their frivolous claims. The strategy, once considered absolutely taboo and a public relations nightmare for firms and brokers, has been gaining momentum.

In August 2004, Emily Thornton wrote a column in Business Week titled The Brokers Strike Back. The piece contained information regarding firms being fined in arbitration for not cooperating in same, but detailed a number of problems with customers, including customers who were not cooperating in discovery in tehir own cases and who were being sanctioned by panels. Ms. Thornton wrote that firms feel beset by former customers who refused to accept the risks of investing in the market and then try to recoup their money by blaming their brokers. “That’s easier to do now because, in the wake of the tech bust, personal-injury lawyers started taking on securities cases in return for a share of any award or settlement they win” she said. Ms. Thorton detailed a $17,511 award in favor of a brokerage firm in legal expenses and damages after an investor failed to comply with two orders to produce certain documents, and an award in favor of a firm against its customer for $46,225 in punitive damages, attorney fees, expenses, and interest for her “reckless, malicious, grossly negligent behavior.”

The continued problem was raised again by Dan Jamison in his column in On Wall Street in December 2004 addressed another recurring problem, injustice in the CRD reporting system, and compulsory disclosures. His column, titled Fighting Back echoed the comments in Fight Back, and provides an analysis of filing counterclaims against customers who file false claims.

The Current Problem

The frivolous claimant issue is not limited to securities arbitration. The problem exists in court cases as well. .The courts have procedures to combat frivolous claims. Our federal court system has Rule 11, which provides for sanctions against parties, and their attorneys, for filing frivolous claims. In the federal court system, and in most states, there is a procedure known as an Offer of Judgment. The concept is relatively simple. A defendant in a federal court case has the ability to file an offer of judgment. He offers to pay the plaintiff a sum certain. The plaintiff has 30 days to accept or reject the offer, and if accepted, the case is over, there is a judgment for the amount of the offer in favor of the plaintiff.

This procedure has the unique ability to weed out frivolous cases. While it is not the preferred method of addressing a frivolous claim, since its ultimate result is an award for some amount of money, it is successful because of the other alternative. If the plaintiff does not accept the offer of judgment, and does not recover more than the offer at trial, he is liable to the defendant for the defendant’s defense costs from the time of the filing of the offer of judgment. Creative, and good faith use of the Offer of Judgment can have a significant impact on a rogue plaintiff. The defendant who cannot convince a plaintiff to dismiss the defendant from the lawsuit, files an offer of judgment for $1,000.00. The plaintiff rejects it, and now becomes liable for the defendant’s costs from that point forward. Not a perfect solution, but one which gives the palintiff some pause in continuing a frivolous or meritless action.

In arbitration, there is no Rule 11, and no procedure for an Offer of Judgment. In fact, there is no penalty for filing a frivolus claim. Arbitrators have the abiltiy to address frivolous defenses – they simply increase the amount of damages, or award the customer attorneys fees, or punitive damages, but without a counterclaim, they have no way of addressing the frivolous claimant. I am not suggesting a Rule 11 for arbitration. Arbitration proceedings are less formal than court proceedings, arbitrators who do an excellent job of resolving disputes, are not provided the training and support to enable them to effectively dole out punishment and sanctions. Permitting arbitrators to sanction parties for frivolous conduct will generate its own problems, similar to the problems that occur with the unbounded power of arbitrators to award punitive damages. One poor decision, one emotional response from a panel can wipe out a brokerage firm or a broler.

The Proposed and New Solution

The original Fight Back article suggested the filing of counterclaims for malicious prosecution, bad faith litigation and similar tort claims. The article also cautioned against the wide spread use of such counterclaims, as the backlash could be significant. My original column mentioned the $180,000 counterclaim that I received years ago for a broker on a counterclaim against his customer. Since then, we have been awarded attorneys fees against a customer in San Francisco, and had three arbitrations withdrawn by the customers who had filed frivolous claims. At the same time, we have been involved in at least a dozen claims where the customer was awarded no money, his claims dismissed, and no award was made in favor of the brokerage firm or the broker to compensate them for their losses incurred in defending the claim.

Not every case warrants a counterclaim. In fact, the overwhelming majority do not. I have filed a defamation/malicous prosecution counterclaim less than a dozen times in my career – each time the case was outrageous, and I was convinced that we were going to prove a fraud by the customer. But there are a significant number of cases where the arbitrators dismiss the claims – in fact, that happened in over 1,500 cases last year. A full dismissal by the arbitrators with no award in favor of the customer. My analysis of the NASD statistics is in the accompanying article, NASD Statistics and Dismissals.

Clearly there needs to be a middle ground between the counterclaim, and doing nothing. Arbitrators need to be given an alternative. We have no way of knowing how many of those arbitration panels thought the dismissed claims were frivolous, becasue there is no mechanism for the arbitrators to award anything to the Respondent. Occasionally the arbitrators will assess all forum fees against hte claimant, but since the forums have no way to collect those fees, it is usual that the fees are asseesed agains thte firm, where the forum can collec those fees.

There is clearly a need for an alternative, a defense that is not as aggresive as a counterclaim, but one which will provide the arbitration panel with a way to address the frivolous claim, and to protect respondents from the losses occasioned by such claims. Since the publication of Rogue Customers and Fight Back, that alternative strategy has developed. The courts have recognized a new defense, one that is gaining momentum, and being used with increasing frequency – an award of attorneys fees in favor of respondents against a claimant.

Traditionally, a successful party is not entitled to be reimbursed for its counsel fees by the losing party unless the right to such an award of fees is expressly provided by statute or an agreement of the parties. This rule is generally known as the American Rule to distinguish it from the English practice which provides for recovery of such fees. For years, the focus has been on cases where attorneys fees were authorized by statute. To my knowledge there is not a single statute in the federal system or in the 50 states which permits a broker to recover attorneys fees against a losing customer. Unfortunately, virtually every state (except New York) has a statute which permits an investor to recover his attorneys fees against a broker. The provision is included in each state’s securities statutes.

The lack of a loser pays system in the American civil court system is not unique to arbitration. The problem persists in civil litigation. For example, see The Lack of a Loser Pays System, which addresses the similar problem for small business owners. Various movements occur from time to time to address the issues. For example, see Securities law: time for loser-pays, Loser-Pays makes lawsuits fairer in Europe. It could work here, too. One website contains a collection of links to dozens of articles and commentaries addressing the issues. Over the years, some statutes have been amended to provide a loser pays alternative, for example Article 5 of the UCC now contains such a provision.

Let me be clear. I am not advocating a mandatory loser pays system. I believe that such a system is harmful to society, will stop important court cases from being filed, and in the arbitration context, will stop claimants from filing smaller cases against firms and brokers. All of those cases should be filed. Securities customers are sometimes wronged, after all, over 70% of all claimants recover something in their cases. Threatening claimants wiith a mandatory loser pays system will only harm the system. However, making loser pays an alternative, making that remedy availalbe to arbitrators, who can award, or not award attorney fees is the reasonable alternative to these competing interests.

Over the years, such an alternative has become available, although not widely used. Relying on the second exception to the American Rule, a line of cases has developed which allows arbitrators to award attorneys fees to a respondent. Keep in mind that arbitration is premised upon an agreement by the parties to submit their dispute to an arbitration panel. Parties can pretty much structure their arbitraiton any way they agree, so long as they agree. Of course, in the securities arbitraiton context, the agreeement is forced on the parties by the NASD and the NYSE, which have rules that require firms and brokers to arbitrate their disputes with their customers, and which mandate the language that can be used for such agreements.

The new theory, adopted by some courts, is that since the customer asked for an award of attorneys fees, and the broker or brokerage firm asked for attorneys fees, both sides to the dispute have agreed that the Panel can award attorneys fees, and the arbitrator can award them to either party.

The request for attorneys fees may in fact be a reasonable alternative to the full blown counterlcaim. From the public relations aspect, the inclusion of a sentence in a pleading where the respondent requests “that the request for relief be denied in full, and the respondent be awarded his reasonable costs and attorneys fees” is much better than a full blown counterclaim for damages. The attorney fee request is also easier to prove, since it does not involve proof of malicious or intentional conduct by the claimant, it mere involves proof of what reasonable attorneys fees are.

I have always included a request for attorneys fees in my pleadings when representing a respondent in an arbitraiton, it is so common, that it is almost rote. I am certain that virtually every other attorney does the same, it is a “standard” pleading request. However, has not been any real caselaw to support such a request by a respondent, and respondents are relying on another execption to the American Rule, the bad faith exception. That exception is so insignificant, and so rarely applicable, that it has little impact on claimants, or their attorneys.

With the development of this new line of attorney fee cases, in the case where I believe there are meritless claims, I now include a paragraph in my pleadings addressing the request, and we include a discussion of the new line of cases in our prehearing briefs, if they are filed, or in our opening statement, if the case warrants such an award. Of course, on those instances where I have a true Rogue Customer, we include the full blown counterclaim as well.

The problem is that there is no way to know how arbitrators view these requests, and one could argue that the fact that awards of attorneys fees are so infrequent, even for a prevailing claimant, that arbitrators do in fact consider the fact that both sides had litigaiton costs, and by refusing to award the claimant attorneys fees, they have recognized that the respondent was forced to pay attorneys fees.

However, awards of attorneys fees to respondents when dismissing a customer’s claim, while admittedly drastic, is something that needs to be done, and arbitrators need to know that they have the power to make such an award. There needs to be a downside for these claimants. Those who are pursuing valid claims in good faith have nothing to worry about, as a losing respondent is never awarded attorneys fees. However, for claimants in securities arbitrations, there is no risk of loss. Their attorneys represent them on a contingency, the filing fees are minimal, less than $1,800, and the only other significant cost is the expert witness. A million dollar claim can be filed and prosecuted for a couple of thousand dollars.

There needs to be an element of risk for the claimant, and that element of risk should be the fact that they may have to pay attorneys fees to the respondent that they sue, if they do not prevail. Such an award is not mandatory, it is subject to the discretion of the arbitrators. Since claimants recover something 70% of the time, the inclusion of the request will not impact a significant number of cases.

However, the request will have a significant impact on those Rogue Customers. As noted in the accompanying article, 15-20% of customers file claims which are dismissed. A significant number of those are frivolous. If recognition that attorneys fees may in fact be awarded, rogue customers will think twice about bringing those frivolous claims.

If the recognition of attorneys fees causes even 1/2 of those cases not to be filed, we have removed over 500 cases from the arbitration dockets, saved firms and brokers hundreds of thousands of dollars in defense costs, and saved over 500 brokers a year the injustice of carrying a frivolous claim on their CRD reports.

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