Background
Arbitration
is a dispute
resolution
process,
which is
an alternative
to the traditional
lawsuit
in court.
Rather than
have a matter
decided
by a judge
and jury,
participants
to an arbitration
proceeding
have their
dispute
resolved
by impartial
persons
who are
knowledgeable
in the areas
in controversy.
Those persons
are called
arbitrators.
Although
arbitration
and mediation
have existed
as dispute
resolution
mechanisms
for well
over 200
years, it
was not
until the
decision
of the United
States Supreme
Court, in
Shearson
v. MacMahon,
482 U.S.
220 (1987)
that arbitration
became the
most widely
used means
of resolving
disputes
in the securities
industry.
Arbitration
of broker-dealer
disputes
has long
been used
as an alternative
to the courts
because
it is a
prompt and
inexpensive
means of
resolving
complicated
issues.
There are
specific
laws which
govern the
conduct
of an arbitration
proceeding
from both
the federal
government
and the
various
states.
One of the
most important
legal aspects
of arbitration
is that
arbitration
awards are
final and
binding,
subject
to review
by a court
only on
a very limited
basis. Parties
should recognize,
too, that
in choosing
arbitration
as a means
of resolving
a dispute,
they generally
give up
their right
to pursue
the matter
through
the courts.
Duty
to Arbitrate
In general,
and in the
securities
industry,
a party cannot
be compelled
to arbitrate
a dispute
unless he
has contractually
bound himself
to do so.
However, the
reader should
not be misled
by this statement,
as a contractual
obligation
to arbitrate
a dispute
does not arise
solely from
a written
contract,
but rather
may be created
in a variety
of ways.
Registered
representatives
and their
firms are
contractually
bound to
arbitrate
their disputes
with their
customers,
even in
the absence
of a written
contract
with the
customer.
The contractual
obligation
arises,
not from
a customer
agreement,
but from
membership
in the National
Association
of Securities
Dealers
or in the
various
stock exchanges.
Every stock
broker is
a member
of the NASD.
Upon applying
for membership
in the NASD,
the broker-dealer
and the
stock broker
agreed to
be bound
by the rules
of the NASD.
Sections
1, 8 and
12 of the
NASD Code
of Arbitration
Procedure
provide
that members,
and associated
persons
must be
arbitrated
at the demand
of the customer,
or another
member firm.
Other self-regulatory
agencies,
of which
a stock
broker may
or may not
be a member,
have similar
rules, see
NYSE Constitution,
Article
IX and Arbitration
Rule 600;
and AMEX
Constitution
Article
VIII, and
Chicago
Board of
Options
Exchange
Constitution
Chapter
XVIII and
Arbitration
Code Rule
18.3
While a
broker is
bound to
arbitrate
his disputes
with his
customer,
and a customer
can force
a broker
to do so,
the reverse
is not true.
Brokers
cannot force
their customers
to arbitrate
their disputes
based on
the SRO
rules. Rather,
the broker
who wishes
to force
a customer
to arbitrate
a dispute
must find
a contractual
commitment,
by the customer,
to arbitrate.
Before
the MacMahon
decision,
this presented
a problem
for brokers
and brokerage
firms, as
many relied
upon what
is known
as a "pre-dispute
arbitration
agreement";
that is,
an agreement
that is
entered
into by
the customer,
before any
dispute
arose, to
arbitrate
any dispute,
that might
arise later.
This pre-dispute
agreement
was typically
contained
in a customer
agreement,
or in a
margin agreement,
and was
widely used
by the brokerage
industry.
However,
such pre-dispute
agreements
were not
widely accepted
by the courts,
and many
courts refused
to enforce
pre-dispute
arbitration
agreements.
However,
the Supreme
Court decision
in MacMahon
resolved
that issue,
holding
that such
agreements
were enforceable,
and thus
began the
nearly universal
use of arbitrations
in customer-broker
disputes.
While there
is no "standard"
arbitration
agreement,
most of
the brokerage
firms use
similar
language
to the following:
I agree
that all
controversies
that may
arise
between
us concerning
any order
or transaction,
or the
continuation,
performance
or breach
of this
or any
other
agreement
between
us, shall
be determined
by arbitration
before
a panel
of arbitrators
selected
by the
National
Association
of Securities
Dealers
or the
New York
Stock
Exchange,
Inc.,
as I may
designate,
pursuant
to the
rules
of the
organization
in existence
at the
time of
the submission
to arbitration.
I understand
that a
judgment
upon the
arbitration
award
may be
entered
in any
court
of competent
jurisdiction.
Firms which
are members
of a stock
exchange
typically
add their
exchange,
if it has
an arbitration
forum, as
a possible
forum, and
many firms
also add
the American
Arbitration
Association
as a possible
forum. See
also, the
discussion
of the Amex
Window,
later.
Arbitration
Rules and
Procedures
Arbitration,
while being
styled a "businessman's"
method of
resolving
disputes,
is governed
by state and
federal law,
as well as
by the rules
of the arbitration
forum itself.
A host of
disputes can,
and do, arise,
regarding
the location
of the hearings,
the composition
of the panels,
which disputes
can be arbitrated,
what discovery
can be obtained,
and other
disputes.
Most states
have provisions
in their
civil practice
rules for
arbitration,
which provide
a basic
framework
for the
arbitration
and due
process
considerations,
as well
as procedures
for confirmation
of an arbitrators
award, a
procedure
which gives
an arbitration
award the
force and
effect of
a judgment
after a
trial in
a court.
Many states
have adopted
the Uniform
Arbitration
Act, although
some states,
most notably
New York,
have specific
and individual
rules for
oversight
of arbitrations.
New York's
arbitration
statute
is contained
in Article
75 of the
New York
CPLR.
The Federal
Arbitration
Act is located
at 9
USC Sec.
1, et. seq..
Starting
an Arbitration
Arbitrations
are commenced
by filing
a statement
of claim
with the
applicable
arbitration
forum, together
with a submission
agreement
and the
required
fees, which
are based
on the amount
of money
in controversy,
and the
type of
arbitration,
but which
are typically
$1,500 but
when combined
with "hearing
deposits"
can run
into the
tens of
thousands
of dollars
depending
on the nature
of the case
and the
particular
forum.
Submission
Agreement
All of the
securities
forums utilize
what is known
as a Uniform
Submission
Agreement,
which provides
a written
agreement
by the parties
to the arbitration
to submit
the dispute
to the arbitrators.
Sometimes
a party to
an arbitration
will refuse
to sign such
an agreement,
under the
theory that
by no doing
so he can
avoid the
consequences
of an adverse
decision.
However, the
author is
unaware of
any case where
an arbitration
award was
dismissed
because of
a parties
refusal to
sign the agreement,
and courts
have held
that parties
are bound
to the decision,
despite the
refusal to
sign the agreement
by virtue
of their participation
in the hearings.
In the author's
experience,
the refusal
to sign the
Uniform Submission
Agreement,
particularly
in the case
of a registered
person, only
serves to
annoy the
arbitrators
and the forum,
and to place
the credibility
of the party
in doubt before
the hearings
even begin.
The
Statement
of Claim
The Statement
of Claim does
not have to
be in a particular
format, and
may even be
in narrative
form, although
many practitioners
use the format
that a complaint
to be filed
in court would
take, with
a caption,
identification
of the parties,
statement
of facts,
and requests
for damages,
in numbered
paragraphs.
There are
few ironclad
requirements
for a statement
of claim.
Generally,
it must
specify
all of the
relevant
facts and
circumstances
surrounding
the dispute,
detailing
the nature
of the dispute,
the relevant
dates or
time frame,
the transactions
in dispute,
the securities
involved
and the
amount of
damages
sought,
or the type
of relief
sought.
After the
filing of
the Statement
of Claim
and the
Submission
Agreement,
the SRO's
staff serves
the documents,
along with
instructions
for the
arbitration
process,
on the named
respondent.
Service
is typically
done by
mail to
the address
of the party.
If service
cannot be
completed,
or the respondent
can not
be located,
the SRO
staff will
typically
seek the
assistance
of counsel
for the
claimant,
in effectuating
service.
While a
technical
reading
of the caselaw
and rules
regarding
service
might lead
one to the
conclusion
that the
mere mailing
of the documents
to the last
known address
of the party
is sufficient,
such is
often not
the case.
A better
course of
action,
where a
party cannot
be located
or does
not file
an answer,
is for counsel
to have
copies of
all relevant
documents
served upon
the party,
in a manner
that is
considered
effective
service
in accordance
with the
rules of
a court
that has
jurisdiction
over the
errant party.
Then, if
required
to do so,
counsel
can demonstrate
to the arbitrators,
or to a
court when
attempting
to enforce
the award,
that all
of the due
process
requirements
of the court
were met,
and hopefully
be able
to obtain
enforcement
of the award,
or avoid
having the
arbitration
award vacated
because
of the failure
to notify
the missing
party.
Answers,
Counter-Claims
and Third
Party
Claims
Like the Statement
of Claim,
the Answer
does not have
to be in any
particular
form, and
can be a narrative.
The Answer
however must
specify all
of the available
defenses that
the party
relies upon,
and all facts
relative to
those defenses.
A general
denial (the
equivalent
of the statement
"I didn't
do it") is
not a sufficient
answer, and
according
to the rules
of most arbitration
forums, may
lead to an
order precluding
the respondent
from offering
evidence at
the hearing.
Respondents
who are
filing answers
have the
right to
assert claims
against
the claimant
(known as
counterclaims),
claims against
other respondents
(known as
cross-claims)
and claims
against
persons
or entities
who are
not parties
(known as
third party).
Each SRO
has its
own procedures
governing
the filing
of such
claims.
Filing fees
are required
for each
of these
claims,
and must
be paid
to the SRO.
Hearing
Location
After the
filing of
all claims,
answers and
replies, the
SRO will typically
notify the
party of the
location of
the hearing.
Unfortunately
for members
of the industry,
the NASD and
the NYSE have
established
procedural
guidelines
which utilize
the location
of the customer
at the time
of the dispute
as the deciding
factor for
selecting
a hearing
site. This
means that
brokers should
be prepared
to defend
arbitration
claims in
every major
city where
they have
customers,
and be prepared
to bear the
expenses of
traveling
to such cities.
The hearing
situs decision
has become
a point
of controversy
in many
arbitrations,
as often
broker dealers
are being
forced to
pay the
expenses
of flying
witnesses
and attorneys
to far away
hearing
locations,
simply because
a customer
resides
in that
city. While
the response
to these
complaints
are that
the broker-dealer
chose to
accept the
customer
in a far
away city,
such an
argument
is far too
simplistic
and self
serving,
for the
customer
too chose
to deal
with a broker
dealer in
a far away
city. While
a traditional
legal analysis
would often
lead to
the opposite
result,
forcing
the customer
to have
his case
tried in
the distant
city, the
SROs have
been unwavering
in their
decision
to hold
hearings
where the
customer
resides,
and rarely
do so.
The location
of the hearing
is an important
factor in
an arbitration
proceeding,
particularly
if a customer
names as
a respondent
each and
every individual
he ever
spoke with,
and every
officer
of the corporation,
or every
supervisor
whose name
he can find.
The costs
of flying
these witnesses
to hearings,
which typically
take place
in multiple
sessions
over the
course of
a few months,
can quickly
escalate
into thousands
of dollars,
just for
airfare.
lodging
and meals.
Obviously
the smaller
the case,
the larger
the problem.
Fortunately,
recent administrative
changes
at the SROs
have expanded
the pre-hearing
conference
to allow
the parties
to address
the inclusion
of parties
with no
substantive
relation
to the case,
and to remove
those parties
before the
hearings
commence.
Prehearing
Discovery
In the "usual"
court proceeding,
all parties
are entitled
to "discovery",
that is, the
taking of
depositions,
and exchange
of documents
prior to the
actual trial.
In arbitration,
there is very
little discovery,
keeping in
line with
the intended
purpose of
arbitration,
which is to
provide speedy
and cost efficient
methods of
resolving
disputes.
The limited
discovery
concept
of arbitration
has proven
over the
years to
be a major
issue in
the area
of securities
arbitrations,
and over
time, discovery
has expanded,
and the
various
security
arbitration
forums have
modified
their rules
to address
rising concerns
about discovery
in securities
arbitrations.
The main
problem
in securities
arbitrations
was that
customer/claimants
often require
documents
from the
brokerage
firm/respondent
in order
to prove
their claim.
The firm's
financial
records,
stock ledgers,
order tickets,
commission
runs, restricted
securities
list, and
a host of
other documents,
are often
an essential
element
of a customer's
case. Pre-1989,
with extremely
limited
discovery,
customers
often found
themselves
at an arbitration
hearing
without
the necessary
documents,
particularly
in cases
involving
a manipulation
of a security,
or in cases
involving
sales practices.
In May,
1989, the
various
SROs amended
their arbitration
rules to
not only
provide
for expanded
discovery,
but to formalize
a procedure
for resolving
discovery
disputes.
The changes
had an enormous
impact on
the securities
arbitration
process.
Before 1989,
a respondent
could virtually
guarantee
a delay
in the start
of an arbitration
hearing
by refusing
to produce
documents
to the claimant.
There being
no mechanism
for the
resolution
of disputes
before the
state of
the arbitration
hearing,
the first
hearing
day was
often used
to resolve
discovery
disputes,
and the
remainder
of the hearings
would typically
be adjourned
to permit
the parties
and their
counsel
time to
produce
and review
the documents
that the
Arbitrators
had ordered
to be exchanged.
Copyright
2001 Mark
J. Astarita.
astarita@seclaw.com
Today,
any party
to an arbitration
can request
a pre-hearing
discovery
hearing
with an
arbitrator
prior to
the start
of the hearings,
to have
those disputes
resolved.
The NASD
for example,
will attempt
to schedule
a telephone
conference
call with
the parties,
and the
arbitrators,
or at least
the Chairman
of the Arbitration
Panel, a
month in
advance
of the actual
hearings,
in order
to have
the arbitrators
resolve
the disputes
before the
hearing,
and thereby
avoid the
attendant
delays.
Depositions
are still
not available
in arbitrations.
However,
having participated
in well
over 150
arbitrators,
and a vast
number of
court proceedings,
it is my
belief that
when balancing
the benefits
of arbitration
process
over court
litigation,
depositions
are not
necessary
in all but
the extreme
case. Arbitrations,
which are
not governed
by the rules
of evidence
which apply
to a court
trial, have
a certain
amount of
leeway in
questioning
of witnesses,
which enables
the skilled
attorney
to obtain
information
from a witness
during the
course of
the hearings
themselves.
This procedure,
coupled
with the
usual month
long breaks
between
arbitration
sessions,
provides
attorneys
with ample
opportunity
to investigate
claims made
during the
testimony,
without
delaying
the proceedings
further,
and without
encumbering
the financial
resources
of the party
with endless
depositions.
In discovery,
it is essential
for the
broker-dealer
or broker,
attorney,
to obtain
all of the
financial
information
he can about
the claimant.
Many cases
have been
won because
of the pre-hearing
work done
by an attorney,
in an effort
to learn
all of the
essential
facts about
the customer.
The inquiry
into the
financial
information
of a customer
in a suitability
or churning
case, typically
starts with
a document
request
to the customer,
asking for
identification
of all brokerage
accounts,
security
and commodity,
maintained
by the customer,
or for his
benefit,
during recent
years. I
say recent
years, because
depending
on the details
of the particular
case, "recent"
can mean
as few as
2 years,
and as many
as 10. This
information,
coupled
with a request
for the
claimant's
tax returns,
often provides
an invaluable
insight
into the
customer's
financial
and investment
sophisfication..
From there,
the attorney
can request
the actual
account
documents,
and can
subpoena
to the hearing
the documents
that the
other brokerage
firms maintained
for the
customer.
This inquiry
often leads
to valuable
information.
For example,
in one case
where the
author was
defending
a broker
against
a 1.2 million
dollar churning/unsuitability/fraud
claim, the
customer
claimed
that one
of the accounts
he maintained
was for
his 92 year
old invalid
mother,
and that
the options
trading
that was
in the account
was totally
unsuitable
for her.
In fact,
option trading
for a 92
year old
invalid,
is, by most
criteria,
unsuitable.
However,
the broker
claimed
that he
was not
aware that
the woman
was 92,
nor an invalid,
and insisted
that the
information
which he
had on the
new account
form was
that the
woman was
65, with
a large
net worth,
and that
only a small
percentage
of her total
assets were
placed in
options.
A dispute
then arose
over who
placed the
information
on the new
account
form, with
the customer
claiming
that the
broker fabricated
the information,
and the
broker claiming
that it
was exactly
what he
was told
by the customer
when the
accounts
were established.
While my
other suggestions,
contained
elsewhere,
for verification
of new account
information,
could have
gone a long
way toward
resolving
this dispute,
those procedures
where not
followed
in this
case. However,
discovery,
and third
party subpoenas
to the three
brokerage
firms, revealed
that the
exact same
information
was contained
on the new
account
forms at
the other
brokerage
firms, establishing
that it
was the
customer
who was
lying about
his mother's
age, in
order to
trade options
in the account,
and not
the broker.
While there
were many
other factors
involved
in that
particular
arbitration,
the customer's
claims were
denied in
full, the
customer
was ordered
to pay approximately
$50,000
in outstanding
margin debt
to the brokerage
firm, and
$190,000
to the broker,
personally,
for filing
a false
and malicious
claim. Without
full discovery
from the
customer,
to identify
the other
brokerage
accounts,
and subpoenas
to the firms
themselves,
we would
have never
known about
the falsification
of the mother's
age, and
could very
well have
had a different
result.
Copyright
2001 Mark
J. Astarita.
astarita@seclaw.com
Discovery
should be
done as
exhaustively
as the case
will permit,
and one
should not
be shy in
asking for
documents
from the
other side.
My guiding
principal
has always
been one
of reasonableness,
is the specific
request
reasonable?
will it
help resolve
an issue?
is it overly
burdensome
on the other
side to
produce
it? a yes
answer to
those two
questions
will virtually
guarantee
that an
arbitrator
will order
the production
of the documents,
despite
the objections
of the other
party.
Hearing
Procedures
Securities
arbitrations,
in fact all
arbitrations,
are conducted
in the same
manner that
a court trial
is held. There
are opening
statements,
then the introduction
of evidence
by the claimant,
introduction
of evidence
by the respondents,
rebuttal cases,
and closing
arguments.
Evidence
is typically
introduced
through
the testimony
of witnesses.
In the typical
customer-broker
case, the
customer
testifies
about his
relationship
with the
broker,
and then
calls any
other witnesses
who support
his case.
Those witnesses
may offer
documents
into evidence,
such as
correspondence
between
the parties,
account
statements,
and similar
documents.
After each
claimant's
witness
testifies
on "direct
examination"
(questioning
by the claimant's
attorney)
the witness
is cross-examined
by the respondent's
attorney.
If there
is more
than one
respondent,
the attorneys
typically
select one
attorney
to bear
the brunt
of the cross-examination,
and the
rest of
the respondents'
attorneys
examine
the witness
when he
has completed
his examination.
Copyright
2001 Mark
J. Astarita.
astarita@seclaw.com
Cross-examination
of witnesses
in arbitrations
is more
lenient
in arbitrations
than in
court proceedings.
In the typical
court proceeding,
cross-examination
is "limited
to the scope
of direct",
that is,
the cross-examiner
cannot ask
the witness
questions
about areas
or topics
that were
not addressed
on direct
examination.
In arbitrations
however,
the procedural
rules are
not so closely
followed,
and cross-examinations
often go
beyond direct
examination,
so long
as the area
of inquiry
is related
to the issues
in the case,
or the credibility
of the witness.
When all
of the respondents'
attorneys
have cross-examined
the witness,
the Arbitrators
may ask
questions
of the witness.
Some arbitrators
may interrupt
the examination
of a witness
to ask a
question,
but those
are usually
to clarify
a witnesses
answer.
However,
at this
stage, the
arbitrators
can ask
any questions
they may
have. The
extent of
the examination
by the arbitrators
varies widely,
and depends
on how extensive
the attorneys'
questions
were, and
the particular
arbitrator
involved.
Some arbitrators
seem to
ask a great
deal of
questions,
others ask
none, regardless
of the examination
by the attorneys.
After the
examination
by the arbitrators,
the claimant's
attorney
has the
opportunity
to question
the witness
again, and
here the
limitations
on examinations
are enforced.
At this
point, called
"re-direct"
most arbitrators
will only
allow questions
which were
raised by
answers
on the cross-examination,
or by the
arbitrators
questions.
When re-direct
is complete,
re-cross
begins,
limited
again by
the scope
of the arbitrators'
questions,
and the
redirect.
This process
continues
for all
of the claimant's
witnesses.
When the
witnesses
have testified,
the claimant
"rests",
that is,
he has no
further
evidence
to introduce,
and the
process
starts again,
with the
respondents
witnesses.
After all
sides have
produced
their witnesses,
either or
both sides
may introduce
charts or
summaries
of the evidence
produced.
Since charts
and summaries
are not
technically
evidence,
but merely
summaries
of evidence,
they can
be introduced
by the attorney,
although
some arbitration
panels will
require
that they
be supported
by a witness.
A good practice
is to ask
the arbitrators
before you
"rest" if
such summaries
will be
permitted
at the end
of the case.
If the answer
is no, then
you still
have the
opportunity
to introduce
the summaries
or charts
through
a witness.
However,
if the summary
is truly
a summary
of evidence,
it is rare
that an
arbitration
panel will
refuse to
accept the
summary
from an
attorney.
Copyright
2001 Mark
J. Astarita.
astarita@seclaw.com
Stipulations
Stipulations
entered into
between the
parties, as
to factual
matters not
in dispute,
can go a long
way towards
moving a hearing
along, and
can considerably
shorten the
presentation
of evidence.
While stipulations
are actively
encouraged
in most courthouse
across the
country, the
arbitration
forums do
not actively
encourage
the parties
to enter into
stipulations.
With "the
judge" not
"forcing"
the parties
to at least
meet to
discuss
possible
stipulations,
there are
frequently
countless
hours wasted
in arbitrations
where parties
attempt
to prove
facts that
are really
not in dispute,
and which
could easily
be resolved
by a stipulation.
Rules
of Evidence
It is often
said that
the rules
of evidence
do not apply
in arbitrations,
and this statement,
while true,
is, standing
alone, misleading.
Rules of evidence
DO apply in
arbitrations,
they are just
not as strictly
applied as
they would
be in a court
proceeding.
Participants
in an arbitration
are well
advised
to keep
this in
mind, for
many arbitration
participants
have been
surprised
that rules
of evidence
were applied
to their
cases. While
the application
of a particular
rule of
evidence
to a particular
fact pattern
will vary
with the
rule, the
evidence,
and the
arbitrator,
a few general
observations
may be in
order:
- 1. The
more significant
the evidence,
the more
likely
the rules
will be
strictly
applied;
- 2. Double
and triple
hearsay
are rarely
admitted
into evidence;
- 3. While
the rules
relating
to authenticity
are not
strictly
enforced,
the arbitrators
will often
permit
an attorney
to "testify"
as to
the source
of a document,
and third
parties
are rarely
forced
to appear
solely
to authenticate
documents;
and
- 4. No
arbitrator
will exclude
evidence
based
on the
Best Evidence
Rule.
Arbitrators
are often
guided by
their common
sense, both
in a legal,
and practical
sense, in
deciding evidence
questions.
Therefore,
true hearsay,
on insignificant
points, will
often be admitted,
such as when
a customer
is describing
how he met
the broker
- "My friend
Jack said
that the broker
was a good
broker." However,
if a claimant
attempts to
admit third
party statements,
such as "Jack
said the broker
ripped me
off" the claimant
will find
himself on
the receiving
end of a motion
to strike
the testimony,
and most probably
an irate arbitrator.
Evidence
issues can
be easily
resolved
with some
preparation.
Years ago
the arbitration
forums had
no requirement
for the
mandatory
exchange
of documents
and witness
lists prior
to the hearing.
Then a requirement
for a 10
day exchange
was enacted,
and in 1995,
the NASD
increased
the requirement
to 20 days.
Arbitration
participants
are well
advised
to address
the evidence
issues before
the hearing,
if for no
reason other
than to
prevent
looking
foolish
in front
of the arbitrators
when you
are unable
to get a
particular
document
into evidence.
Most attorneys
with experience
in arbitrations
will stipulate
to authenticity
issues,
particularly
those relating
to account
documents,
correspondence,
tax returns,
research
reports,
stock prices
and similar
facts and
documents
that the
attorney,
with a minimal
amount of
effort,
can verify
before the
hearing,
on his own.
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