Arbitration: Point/Counter Point

This article is reprinted with permission from the June 2000 issue of the New Jersey Lawyer, the Magazine.

Should I arbitrate if I don’t have to?

POINT (Mitchell): As a general rule, if you have a strong case on the facts and on the law, it is more favorable to proceed in state or federal court before a jury. I have, however, on more than one occasion while representing claimants, selected arbitration as the forum of choice even when no new account agreement existed and the matter could have proceeded in state or federal court. Arbitration is speedier and less costly than state or federal court litigation. A hearing is usually scheduled within a year or so after filing of the statement of claim and the arbitrator(s) are, as a rule, experienced in securities laws and industry practices. Since most claimant’s cases are accepted on a full or partial contingency, the reduced time and cost of arbitration are very real factors in determining whether or not to take a case, especially in smaller cases or where collectability is a concern.

COUNTERPOINT (Brian): From the broker’s perspective you usually don’t have much choice. Under the rules of the National Association of Securities Dealers Regulation, Inc. (NASDR) and the securities exchanges, a public customer is entitled to demand arbitration of a dispute with the broker as long as the claim arises out of or is in connection with the broker’s business. The broker does not, however, have a reciprocal right to compel arbitration of the customer’s claim.¹ However, most brokerage firms require their customers to sign some type of an account agreement containing a pre-dispute arbitration clause. The question then becomes whether the broker should move to compel arbitration when the customer files the lawsuit in the courts.

The answer is generally yes. From the broker’s perspective, arbitration offers the benefits of a relatively streamlined and less expensive way of resolving the dispute (although not as streamlined as it used to be, when hearings began in the afternoon and were often finished by the end of the day). It also gives the broker a knowledgeable trier of fact that is generally less likely to deliver an unexpected or aberrant result.

However, there are instances where the broker may choose to let the case proceed in the courts. These may include the following situations: (1) a strong likelihood of prevailing as a matter of law on a dispositive motion (such as statutes of limitation or where the customer is asserting a claim that is generally not recognized as a matter of law); (2) there is a need for an unusual amount of third-party depositions and discovery that may not be available in arbitration; or (3) the broker has a strong claim for contribution or indemnification against a third party who would not be subject to the arbitration process. But these are exceptions to what is a very strong and well-founded preference for arbitration.

Does the securities industry enjoy a home court advantage in arbitration?

POINT: Although the playing filed is leveling out, the securities industry still has an edge. Prior to the 1995 Supreme Court decision in Mastrobuono v. Shearson/Lehmann Hutton, Inc.,² the securities industry clearly had a home court advantage. Most major brokerage firms included New York choice of law provisions in their new account agreements because New York law, prior to Mastrobuono, did not permit an award of punitive damages in arbitration.³ Even after Mastrobuono, although panels are now, under New York law, allowed to award punitive damages⁴, arbitration panels still have a predilection against awarding punitive damages and a reluctance to award attorneys fees. It has, however, been my experience that most arbitrators are sincere in their evaluation of the facts and application of those facts to the law. A word to the wise: When selecting a panel be sure to check beforehand on the background and experience of each arbitrator and his or her award history in order to determine any biases or conflicts of interest which may exist.

COUNTERPOINT: Absolutely not. Fewer and fewer customers’ attorneys make that objection today. Indeed, many investors’ attorneys opt for arbitration even where there is no pre-dispute arbitration agreement requiring them to do so. I’ll bet that Mitch wouldn’t voluntarily file claims in arbitration when he doesn’t have to if the industry enjoyed any type of an unfair edge.

In cases between a public customer and a broker, the customer is entitled to a panel containing a majority of public non-industry arbitrators unless the customer chooses to have the case heard by an all-industry panel (which they virtually never do).⁵

As far as industry arbitrators are concerned, they take their job extremely seriously, and often see themselves as having a special responsibility to keep the industry honest. I have had many cases where the industry arbitrator asked far more penetrating and difficult questions of the broker than did the customer’s attorney.

The NASDR and the exchanges have also expanded their pools of arbitrators greatly in recent years. The NASDR has also begun to select its panels on a random basis in response to concerns by the claimants’ bar that they were preferring certain “professional arbitrators” over others in the selection process. The process has been the subject of numerous blue ribbon panels, Congressional oversight, and public debate. In the past year or two, the courts have also rejected a number of challenges arguing that there is some structural bias in favor of the industry.⁶

Will I get the discovery I need in arbitration?

POINT: Yes, but it may be necessary to make one or more motions to compel in order to do so. Do not hesitate to make a motion if you feel it is necessary to get information which you deem relevant, but first take all steps possible to obtain such information voluntarily from opposing counsel. Determine in advance the documents you believe you are reasonably entitled to and stick to your guns. Obtain a copy of the Discovery Guide distributed by the NASD for items customarily deemed relevant and exchanged between the parties. You can obtain a copy of the Discovery Guide on the Internet at 222.nasdr.com. If you have any questions, call the NASD at (212) 858-4000 or the offices of General Counsel of the Securities & Exchange Commission at 202-7280-8982 (ask for Eric Moss, Esq.). Also, make certain you always obtain a copy of the compliance manual and/or supervisory procedures for the broker-dealer. Look to the Internet and other referral sources for information about the broker-dealer and the registered representative before you start the arbitration. The NASD has a Freedom of Information Act hotline available to the public which provides background and enforcement information on persons and firms licensed with the NASD. The telephone number for this hotline is 1-800-289-9999. Background and enforcement information can also be obtained on the Internet at www.nasdr.com. It is a good idea to write to the securities commissions in states in which securities were sold to determine if the registered representative was validly licensed to sell the securities. The New Jersey Bureau of Securities is an excellent source of information and assistance. Send your Freedom of Information Act request to the bureau at 153 Halsey Street, Newark, New Jersey 07102. Their telephone number is (973) 504-3600.

COUNTERPOINT: To paraphrase Mick Jagger, you can’t always get what you want, but you get what you need. The parties can serve document and information requests upon each other.⁷ They can also serve third-party subpoenas to firms and personnel that are registered in the securities industry, as well as to non-industry third parties to the extent permitted by applicable law.⁸

Over the years a fairly good consensus has developed as to the core types of documentation that should be discoverable in various types of broker-customer disputes. These were more recently memorialized in the NASD Discovery Guide, which sets forth lists of documents that are presumptively discoverable depending upon the type of claim. These presumptions can be rebutted, and the parties can also request documents that are not on a list. While neither side of the debate may be entirely happy with every item that is (or is not) on the list, it represents a consensus that is generally fair and adequate for both sides.

Information requests should generally be targeted to discrete items of information, such as the identity of knowledgeable persons, key dates or numbers, and other discrete items of information. Panels will generally not permit full-blown interrogatories that require the other side to lay out all of its claims or defenses in writing – although some panels will permit more latitude in this area than others.

Panels can order depositions if necessary. But this power is used sparingly, and generally only in cases where there is genuine reason to believe that the witness will not be available or able to testify at the hearing. Routine depositions of parties and witnesses are not permitted, except if the matter is treated as a “complex case” under the NASD Code of Arbitration Procedure (which the vast majority of cases are not).

Should I bother with motion practice?

POINT: Yes. Discovery motions generally resolve outstanding issues in a fair and reasonable manner, usually by telephone conference with the chairperson. Even before a panel is selected, motions for joinder, dismissal because of pending class action, or violation of Section 10304 (statute of limitations) can be made directly to the NASD. Sometimes these motions are granted. Motions can alert panels to unusual questions of law that may need to be briefed. Motions may also be necessary to compel parties to comply with discovery requests.

COUNTERPOINT: In the right case, yes. Obviously discovery motions should be brought only if necessary. The question of substantive dispositive motions can be a little trickier. Panels are generally reluctant to dismiss a case on the papers prior to a hearing. There is a strong tendency to reserve judgment on dispositive motions until the customer has had a chance to put on their case. However, in recent years, panels have shown a somewhat increased tendency to dismiss claims that are time-barred, that name tangential parties with no real connection to the case (such as senior management or the wrong branch manager) or even – in some cases – claims that do not withstand scrutiny as a matter of law.

Panels are not, however, well disposed to motions attacking the particularity of the claim or raising legal defenses that may appear esoteric or technical (particularly if you have lay panelists). I would save dispositive motions for the case that truly warrants it, and would not wear out my welcome with routine motion practice.

Does the law really matter in arbitration?

POINT: Absolutely. It is my experience that arbitration panels are sincere in following the law. Every once in a while, a brief may be instructive if you sense that the panel is in need of guidance on a particular issue. Usually, the panel will let you know whether they need briefing or not.

COUNTERPOINT: Yes. Unfortunately, I have too often heard arbitrators urged to disregard the law on the grounds that it is a “technicality” and that they should do “equity” instead – as if the courts and legislators who created modern securities law jurisprudence were somehow attempting to be anything other than equitable. While my perception may be colored by my experience in representing the industry, I have found that this argument is made far more frequently by customers’ counsel than by the industry. It is a dangerous argument to make. Once you convince a panel that they are free to disregard those laws that favor your adversary, they are equally free to disregard those laws that favor you. And if cases are not going to be decided on the basis of the law, then on what basis should they be decided?

While we tend to take the arbitration of securities disputes for granted, it has to be remembered that federal securities law claims were not considered arbitrable prior the United States Supreme Court’s 1987 decision in Shearson/American Express v. McMahon.⁹ At that time, investors’ counsel overwhelmingly opposed arbitration on the grounds that arbitrators could not be trusted to apply the federal securities laws. In upholding the arbitrability of such claims, the Supreme Court held that a party seeking to assert statutory rights does not forego them, but merely agrees to assert them in a different forum.

The irony is that many opponents of the process asserted that arbitration failed to provide the full measure of relief that courts would provide when following the “law.” But where the “law” requires an unwanted result, should it be ignored? What goes around comes around. Do we really want resolutions with no legal “spine” running through the process?

Arbitrators may not be judges and may not have law clerks, but adherence to the law is an ideal toward which we should strive even if we cannot completely achieve it.

What do customers’ attorneys do wrong?

POINT: Attorneys without an in-depth understanding of the securities industry have been known to commence arbitrations simply because a lot of money was lost and they believe a settlement offer will be made. Be mindful that most broker dealers who determine that they have no liability will vigorously defend that arbitration. Attorneys not familiar with the law may start lawsuits in state or federal court despite an arbitration clause contained in the new account agreement. Motions to compel arbitration then need to be made to transfer the matter to arbitration. Claimants’ attorneys should not draft statements of claims that resemble state or federal court complaints or fail to set forth the facts with specificity. The most effective statements of claim are in letter form and, when read, leave the reader with the conclusion that the claimant was wronged.

Remember, in three-member panels one or two members of the panel are usually not attorneys. A three-member panel will usually consist of one attorney, one person experienced in the industry and a “neutral” person subject to the current selection process at the NASD which allows the parties to prioritize their choice of panel members. The arbitrators will not be persuaded by a document, written in legalese, that they cannot understand. Customers’ attorneys should always be willing to discuss the law and facts with opposing counsel. Some claimant’s counsel, if not experienced in arbitrations, may not be aware of which documents to request in discovery. These same counsel may resist the turnover of relevant documents from their own clients (e.g. tax returns in a suitability case).

Both sides should make a serious effort to produce all relevant documents to the opposition without waiting for a motion to be made. If sensitive documents need to be produced (e.g. tax returns) I suggest that confidentiality orders be signed requiring the return of all copies to the claimant at the conclusion of the arbitration. When filing a claim, the NASD will now assign a single arbitrator to hear a case if the amount in controversy is $50,000 or less, unless a party, in its initial filing, requests otherwise. Although the initial filing fee is higher, I recommend that customers’ attorneys always select three arbitrators, whenever permitted.

COUNTERPOINT: Because we all love lists, here is my effort at five things that customers’ attorneys do wrong:

exaggerating the naivete´ of the claimant when they clearly have a higher level of intelligence and acumen, even if their expertise is far less than that of the broker (of course, if the customer genuinely lacks these qualities, then go for it);
failure to bring out bad facts (such as similar trading activity by the customer in the past) during their direct case, and letting the broker’s attorney score a direct hit on cross-examination;
demonizing the respondent by trying to turn every case into a fraud case, when the broker may be a credible and presentable witness and it would have been far easier to present a case sounding in malpractice rather than fraud;
exaggerated damage schedules which contain unrealistic assumptions or fail to give the broker credit for investments that turned out to be profitable; and
belaboring the obvious and spending too much time dwelling on insignificant details, or repeating points that have already been made.

What do brokers’ attorneys do wrong?

POINT: Broker’s attorneys usually do not produce all relevant documents unless compelled to do so. Don’t be afraid to adjourn a hearing in order to have the time necessary to receive and evaluate all documents you feel are relevant to your case. Counsel for brokerage houses always respond to complaint letters from customers with a letter stating that the brokerage house and its registered representative did nothing wrong. Do not let this sway your evaluation of the facts. I find that in-house counsel are sometimes less experienced than outside securities counsel and, on rare occasions, may be “over zealous” in their defense of their client.

COUNTERPOINT: In the spirit of evenhandedness, there are five things that I think brokers’ attorneys sometimes do wrong:

trying to overplay the customer’s sophistication or risk tolerance (this is the flip side of number one on the customer’s side);
taking too much comfort in the documents and the paper that the customer received, i.e., monthly statements and prospectuses, where the customer genuinely may not have understood what they were getting;
introducing too many documents and exhibits;
relying too heavily on what the panel may perceive as technical legal defenses rather than trying to take the moral and ethical high ground back from the customer; and
not being prepared to own up to mistakes by the broker (such as the use of unwritten discretion or sloppy account documentation). It is far better to step up to the plate if you have to and then show that the conduct was not malicious and in any event did not injure the customer.

Should I use an expert?

POINT: I do not use an expert unless I feel it absolutely necessary. Experts are expensive and compel the opposition to hire their own expert. Experts always contradict each other and sometimes serve only to confuse the arbitration panel. Every experienced securities attorney has been involved in cases in which one of the parties lost the case because of the cross-examination and poor performance of an expert. Now that I have said that, experts are invaluable in analyzing whether a case should be pursued or not. The experience and testimony of experts may be very helpful in cases where industry practice is in issue, the securities sold are unique, or damage calculation is difficult.

COUNTERPOINT: Unfortunately, the most common reason for using an expert is that the other side is going to use one. They are generally unnecessary in fairly simple and straightforward cases. Moreover, if the broker cannot explain a product or recommendation to the panel’s satisfaction, then there is generally very little that a hired expert can do to salvage that. That having been said, I think that experts can be valuable in cases involving a novel or unusual product, industry custom and practice, or in a large and complex case where their presence may provide an extra level of comfort. While they are also helpful in the calculation of damages, in most cases the parties should be able to compare each others’ damage calculations and stipulate to the relevant numbers by the time the hearings has arrived.

Should I mediate?

POINT: Absolutely. In our adversarial system lawyers act as advocates for their clients without the benefit of first hearing the other side of the story. In mediation, which should always be non-binding, the parties are able to tell their stories to an objective third party, the mediator. The mediation process allows the attorneys to assess the veracity of the opposing party, hear facts they otherwise would not have learned about until the hearing, and meet face to face with opposing counsel and the opposing party. My experience is that a free flow of information exchanged early between the parties softens animosities and aids in the settlement process. Mediation works.

COUNTERPOINT: If the objective is to settle the case and put the problem behind you, then mediation is an excellent way to get that done. Before incurring the cost of mediation, the parties should first attempt to settle the case on their own. If that is not feasible, mediation can be valuable where: (1) there is an emotional component to the case and one or more of the parties needs to express their feelings or position; or (2) one (or both) of the parties or their counsel need education or a reality check by a neutral mediator who can give them a sense of how their claims or defenses may actually play out in front of a panel.

Can I overturn the award if arbitrators get it wrong?

POINT: Don’t count on it. Under the Federal Arbitration Act, there are only four grounds for appeal:

Where the award was procured by corruption, fraud, or undue means.
Where there was evident partiality by or corruption of the arbitrators.
Where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy; or any other misbehavior by which the rights of any party were prejudiced.
Where the arbitrators exceeded their powers, or so imperfectly executed them, that mutual, final and definite award upon the subject matter submitted was not made.

A fifth ground for appeal, called “manifest disregard,” has evolved from case law.¹⁰ A recent decision of the Second Circuit Court of Appeals¹¹ has confirmed the theory of “manifest disregard” and, possibly, opened the floodgates for a flurry of appeals by disgruntled arbitration participants.

COUNTERPOINT: I will close out the point/counterpoint with a moment of unanimity with Mitch. Don’t count on it. In the vast majority of routine cases, the answer is safely no. It takes a very high level of arbitrator misconduct to even create a question worthy of judicial intervention. That simply rarely occurs. If panels merely call it as they see it, there is no basis at law to re-decide the result.

ENDNOTES

National Association of Securities Dealers Regulation Inc. (“NASDR”) Code of Arbitration Procedure Rule 10301(a); New York Stock Exchange (“NYSE”) Arbitration Rule 600(a).
Mastrobuono v. Shearson/Lehman Hutton, Inc., 514 U.S. 614 (1995).
Garrity v. Lyle Stuart, Inc., 40 NY2d 354 (1976).
Mulder v. Donaldson Lufkin & Jenrette, 224 AD 2d 125 (1^st Dept., 1996).
NASDR Code of Arbitration Procedure Rule 10308(b); NYSE Arbitration Rule 607 (a).
Rosenberg v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 170 F.3d (1^st Cir. 1999); Cowle v. PaineWebber, Inc., 1999 WL 194900 (S.D.N.Y. 1999); Desiderio v. National Association of Securities Dealers, 2 F.Supp. 2d 516 (S.D.N.Y. 1998).
NASDR Code of Arbitration Procedure Rule 10321(a) and (b); NYSE Arbitration Rule 619(a) and (b).
NASDR Code of Arbitration Procedure Rule 10322; NYSE Arbitration Rule 619(f).
Shearson/American Express v. McMahon, 482 U.S. 220 (1987).
This doctrine grew out of dicta in the case of Wilko v. Swan, 346 U.S. 427, which stated, at 436-437 that “In unrestricted submissions such as present margin agreements envisage, the interpretations of the law by the arbitrators in contrast to manifest disregard are not subject in the Federal court to judicial review for error interpretations” (emphasis added). In his dissenting opinion in Wilko, Justice Frank further stated that “Arbitrators may not disregard the law” (at 440).
Piper Jaffray, Inc. v. Halligan, 148 F.3d 197 (2d Cir., 1998), U.S. No. 981172, cert. denied