Monthly Archives: August 2014

FINRA Arbitration Requirement Is On Its Deathbed

25 Monday Aug 2014

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What a difference a couple of years can make.

When a stockbroker joins a firm the broker is required to register with the Financial Industry Regulatory Authority (“FINRA”). To do so he must complete and sign a Uniform Application for Securities Industry Registration or Transfer Form U-4 (“Form U-4”). The document contains an arbitration clause, in which the broker agrees to “arbitrate any dispute, claim or controversy that may arise between me and my firm, or a customer, or any other person . . .”

Often times when a broker joins a firm the broker receives a bonus in the form of a forgivable loan. This loan is documented by a promissory note or loan agreement which identifies the repayment terms. Disputes arising from defaults of such loans must be arbitrated. Indeed, the arbitration requirement, in addition to the language in the Form U-4, is mandated and codified by FINRA’s Code of Arbitration (“FINRA Code”) that requires “a dispute must be arbitrated under the [FINRA Arbitration] Code if the dispute arises out of the business activities of a member or an associated person and is between or among: Members; Members and Associated Persons; or Associated Persons.” FINRA Code Rule 13200. FINRA’s interpretive material deems it a violation of its rules and “conduct inconsistent with just and equitable principals of trade” for a member firm to require brokers to waive the arbitration requirement. FINRA IM 13000.

This arbitration requirement was recently enforced in 2012, when Merrill Lynch was fined $1,000,000. The firm attempted to skirt the arbitration requirement by utilizing a third party non-FINRA entity to issue the bonus checks, or forgivable loans to Merrill Lynch’s brokers. Merrill Lynch tried to circumvent the arbitration requirement by having the non-FINRA entity include a forum selection clause requiring any and all disputes relating to the loan to be filed before the New York Supreme Court, New York County.

By its fine to Merrill Lynch, FINRA was letting member firms know it would not tolerate firms failing to comply with the mandated arbitration requirement (and avoid paying FINRA the member charges for the arbitration). It was a shot heard around the securities industry world.

The recent decision of the United States Supreme Court of Appeals for the Second Circuit (“Second Circuit”) in Goldman Sachs & Co. v. Golden Empire Sch. Fin. Auth., No. 13-797-cv (2d Cir. Aug. 21, 2014) and Citigroup Global Mkts. Inc. v. N.C. E. Mun. Power Agency, No. 13-2247-cv (2d Cir. Aug. 21, 2014), which confirmed two lower court federal decisions, has now muted that shot. The decision has far reaching implications with FINRA and will test the regulatory entity’s wherewithal. The Second Circuit’s ruling that member firms may utilize forum selection clauses that supersede FINRA’s arbitration requirements opens a gateway of opportunities for firms to sidestep arbitration as it relates to loan agreements with brokers. By way of example, had the decision been in effect in 2012, it appears all Merrill Lynch needed to do to avoid mandatory arbitration was include a forum selection clause in its promissory notes or loan agreements requiring any and all disputes for any actions or proceedings regarding the note to be filed before the New York Supreme Court, New York County. What a difference two years makes!

It will be interesting to see if FINRA utilizes its enforcement authority to fine Goldman and Citibank for avoiding the arbitration requirement, and counter the ruling in one way or another. Will FINRA take the position that the Second Circuit (and corresponding Ninth Circuit) decision does not apply to the internal rules of the entity? If FINRA does not act, it will confirm to firms that the longstanding arbitration requirement in the FINRA Code is on its deathbed.

The Law Offices of Barry M. Bordetsky represents customers and industry representatives in FINRA arbitrations as well as before state and federal courts. If you have questions regarding the process, please contact The Law Offices of Barry M. Bordetsky by calling Barry Bordetsky at (800) 998-7705 or email barry@bordetskylaw.com.

FINRA Members Must Be Careful What They Ask For

22 Friday Aug 2014

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The United States Supreme Court of Appeals for the Second Circuit (“Second Circuit”) handed down a decision yesterday permitting Financial Industry Regulatory Authority (“FINRA”) members to avoid arbitration by including in an agreement with a customer a forum selection clause requiring “all actions and proceedings” related to a transaction between the parties to be brought in court. Goldman Sachs & Co. v. Golden Empire Sch. Fin. Auth., No. 13-797-cv (2d Cir. Aug. 21, 2014) and Citigroup Global Mkts. Inc. v. N.C. E. Mun. Power Agency, No. 13-2247-cv (2d Cir. Aug. 21, 2014)

Hello Sword of Damocles.

The decision on its face may be held as a victory by Goldman and other banks, just as Dionysius surely felt the victory of being able to switch places with his king, Damocles. By enforcing the forum provision, the banks are now able to litigate within the court system, utilizing the process to delay the normal year-long process of an arbitration to what will be years tied up in litigation. For those litigants that do not have the wherewithal to finance the dispute, banks will use their vast resources to challenge the litigant’s resolve with multiple motions followed by significant discovery costs.

But beware of the horse string. For those litigants with the resolve and financial ability to withstand a court case, they hold a threat for the banks. Unlike an arbitration that is a private proceeding, where arbitration awards do not carry the weight of a precedential decision that a subsequent arbitration panel must follow, banks are taking a significant risk litigating matters that ordinarily would be private and before FINRA.

Take the discovery process, by way of example. In a FINRA proceeding, discovery is limited. Interrogatories and depositions are rarely permitted. Sworn statements by parties are not asked for or required in the discovery process, but only at the hearing on the merits. Conversely, in a court proceeding, the banks will be subject to submitting sworn statements from the outset of the proceedings. Smart plaintiff’s counsel will file verified complaints, requiring verified answers. Interrogatories will be served, again requiring a verification as to the truthfulness of the responses. Thereafter bank employees will be required to sit for depositions. A deposition is an oral examination of a witness after the witness is sworn in – – the testimony at a deposition carries the same weight as testimony at a trial. Also, banks will be subject to court discovery orders.

The peril of the recent decision is that plaintiffs’ counsel may very well be able to utilize these sworn statements obtained in the first case won for every other case filed on the same issue. And here is the nightmare for the banks: the moment a decision is rendered against a bank, that decision, unlike an arbitration award, is publicly available. Every litigant with similar facts will utilize the decision, with precedential value, to the detriment of the banks.

In a day and age when Wall Street is not the most popular street in America, one would think the last thing the banks would want is the public gaining access to these proceedings.

The Law Offices of Barry M. Bordetsky represents customers and industry representatives in FINRA arbitrations as well as before state and federal courts. If you have questions regarding the process, please contact The Law Offices of Barry M. Bordetsky by calling Barry Bordetsky at (800) 998-7705 or email barry@bordetskylaw.com.

Don’t Ignore FINRA Arbitrator Bias

05 Tuesday Aug 2014

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When an investor sues his/her broker, a brokerage firm sues another brokerage firm, or a broker sues or is sued by his former employer, those disputes are arbitrated before the Financial Industry Regulatory Authority (“FINRA”).

There are unfortunate instances during such arbitrations where a bias or prejudice of an arbitrator will show, either in the course of discovery, motion practice or during the hearing on the merits. In such a situation, it is critical for a party to proceed cautiously but appropriately act to protect his/her/its interests. FINRA provides avenues for a party to take when an arbitrator openly demonstrates partiality or a bias in favor of or against a party.

FINRA Rule 12406 provides a procedure to remove the arbitrator before a hearing on the merits has commenced. A party may file a motion to have an arbitrator recused, or removed, due to obvious bias or prejudice. But be aware, FINRA Rule 12406 requires the motion to be direct to and decided by the very arbitrator who is subject to the motion. While this process may sound odd and impractical, it is one followed by most courts in the county.

If the arbitrator denies the motion for recusal, maintains his/her position on the arbitration panel and continues his/her biased and prejudicial behavior, a party has one remaining option, found in FINRA Rule 12407(a). This rule permits a party to file a motion before the first hearing day to challenge an arbitrator for cause. A challenge for cause will be granted where it is reasonable to infer, based upon evidence presented in the motion, the arbitrator is biased or lacks impartiality. Unlike a recusal motion, a motion to challenge an arbitrator for cause is ruled upon by the FINRA staff.

When filing either or both such motions, the filing is critical not only to the fairness of the arbitration process, but for what happens next. If the arbitrator remains on the panel, there is an inevitability as to the outcome: an award is rendered against you that falls in line with the arbitrator’s past behavior. There is one remaining course to take, move before a court to vacate the award. In most jurisdictions a motion to vacate an arbitration award on the grounds of arbitrator prejudice or bias will only be granted if the moving party objected to the arbitrator’s behavior during the arbitration process. If this objection is not asserted during the course of the arbitration, courts may rule the party waived the objection and cannot move to vacate on such grounds.

There is a reality that must be faced when making a motion pursuant to FINRA Rules 12406 and 12407(a): if an arbitrator is acting in an outwardly biased or prejudicial manner to you during the arbitration, a motion to recuse or challenge for cause could seal the decision against you. If the outcome is inevitable based upon the arbitrator’s conduct, it is critical you preserve your right to vacate the arbitration award so the improper acts of the arbitrator will not have a lasting effect on you or your case.  Better to have an angry arbitrator than an award rendered against you.

The Law Offices of Barry M. Bordetsky represents customers and industry representatives in FINRA arbitrations as well as before state and federal courts on motions to vacate an arbitration award. If you have questions regarding the process, please contact The Law Offices of Barry M. Bordetsky by calling Barry Bordetsky at (800) 998-7705 or email barry@bordetskylaw.com.

Treat Your Brokerage Account Like Your Car? Absolutely.

01 Friday Aug 2014

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Believe it or not, your car provides a perfect analogy of how you should handle your investment account and the broker working with you. Most people have little if any knowledge of cars or how they work. Similar to how you have your broker guide you with your investments, you bring your car to your local mechanic.

Cars receive oil changes every 3,000 miles, and when it is time for your oil change, you bring the car to the service station. When getting the oil changed your mechanic tells you instead of every 3,000 miles, you should get your oil changed every 500 miles.   This just doesn’t make any sense, but you decide to go ahead anyway, because in your mind, the mechanic is the one who does this work for a living, so he must know what he’s talking about.

Stop there. If it doesn’t make sense to you, chances are, you are right on point.  You don’t need to be an expert in the field to know when something is simply off.  First thing you should do: ask to speak to the supervisor.  This should be no different with your stockbroker.

The Financial Industry Regulatory Industry (“FINRA”) recently filed charges against the New York broker-dealer Newport Coast Securities and five of its current and former brokers, charging them of “knowingly engaging in a manipulative and deceptive and fraudulent scheme to churn the accounts of some two dozen customers to boost their commissions.” FINRA alleges rampant churning of customer accounts and other misdeeds that caused significant losses to retirees and other investors.

FINRA is taking action to correct the alleged wrongs of the firm and brokers, and if the firm and brokers are found to have violated both securities law and FINRA rules, there will be be heavy fines issued, as well as the possibility of suspensions and perhaps expulsions from the industry.   This action by FINRA is similar to what the district attorney’s office does with a criminal that steals money from someone.

The present enforcement action by FINRA relating to churning should be a warning to all investors, old and young. Churning is the act of over-trading an account where an exorbitant amount of commissions are generated from the trading.    By way of example, presume an investor has $100,000 in her account. The broker opens the account with a buy of $100,000 of Facebook stock. The broker then repeatedly sells, buys and then sells again the stock twenty times over a one-year period. Each sale is quickly followed by a repurchase.

When one of the sales results in a quick profit, the broker will undoubtedly call and tell you how happy you should be that he made you money on the trade. But did he? Here’s where the churning analysis comes into play. If the broker did not overly trade the position, but rather bought and held, the position would have grown with the market movement of the stock. Instead, the investor’s portfolio has decreased because the broker’s commissions on the buys and sells have actually eaten into the profits in the account, and in many cases simply decrease the portfolio value. The only parties making money on this trading are the broker and his firm.  This type of trading should raise questions – – questions that must be asked before allowing the activity to continue.  And like your mechanic, ask for the broker’s supervisor before things get out of hand with your account.

In addition to enforcement proceedings, FINRA provides investors the ability to bring a civil action against the broker and his employing firm through the arbitration process, a very condensed court-like action. Those who lost money from Newport Coast or any other firm through churning, or other improper acts and omissions, have the opportunity to seek a remedy on their own. Those investors get their proverbial “day in court” in an expedited arbitration process that streamlines both cost and time to have the merits of the claim heard by a panel of arbitrators.

The Law Offices of Barry M. Bordetsky represents parties in arbitrations involving churning, unsuitable trading and other investment related claims. If you have questions relating to investment issues, please contact The Law Offices of Barry M. Bordetsky by calling Barry Bordetsky at (800) 998-7705 or emailing at barry@bordetskylaw.com.