A recent Wall Street Journal article chronicles some recent events involving mandatory securities arbitration giving some hope the system may be improving for investors defrauded or otherwise injured by their stock broker or money manager.
Excerpts from the article appear below:
Many investors who suffered massive losses in their portfolios are filing complaints against the brokers and brokerage firms that sold them poor-performing stocks and mutual funds. When these individuals get to their arbitration hearings, they will experience a process that should be more investor-friendly than in the past.
Investor claims against securities brokerage firms are up 110% this year through May compared with the same period in 2008, according to the Financial Industry Regulatory Authority, the nongovernmental regulator that runs the arbitration forum investors must use when they want to press claims against their brokers. Last year, complaints involving funds outnumbered complaints involving stocks for the first time, with investors arguing that “firms sold funds with more risk in them than they were told,” according to Linda Fienberg, who heads Finra’s dispute-resolution program. That trend has continued into 2009.
After years of criticism that the system favored the industry, FINRA recently introduced changes that could make the process fairer to investors, including a rule and a pilot program that allow more investors to have their cases heard by arbitrators who aren’t affiliated with the securities industry.
To be sure, some investors’ attorneys say they won’t be satisfied until industry-affiliated arbitrators are completely eliminated from panels. Others say investors will never get a fair shake until they have the option to bring their complaints to court. Indeed, the Obama administration, as part of its proposal to reform financial-services regulation, called for legislation that would give the Securities and Exchange Commission authority to examine, among other issues, whether mandatory arbitration clauses in contracts between customers and brokerage firms actually harm investors.
But at least one promising sign for investors is evident so far in 2009: Through May, investors received awards in 47% of the cases that were decided by arbitration panels, up from 42% in the same period in 2008. While it is too early to say that the higher win rate is due to the recent changes, attorneys representing both investors and brokers say they are watching developments closely.
In bear markets, the number of investor complaints filed against brokerage firms typically spikes. Lawyers who represent both investors and the securities industry say they are starting to see an increase in claims comparable to what they found in the years following the collapse of technology stocks.
Industry advocates, and even some investors’ lawyers, say many allegations made in downturns lack merit.
“The market goes up, the market goes down—it doesn’t mean the broker was acting inappropriately,” says Kevin Carroll, managing director and associate general counsel with the Securities Industry and Financial Markets Association trade group. “The mistake is this thinking, ‘The market went down; my broker must have done something wrong.’ ”
Chief among investors’ concerns in the recent rash of complaints is that products investors believed to be less volatile than stocks—such as mutual funds that invest in bonds and investments that pay a fixed rate of return—plunged in value. As Finra doesn’t have jurisdiction over funds, investors have filed complaints against the brokers and the brokerage firms that sold them these products, saying they misrepresented the risks.
Bond mutual funds that have been subject of this type of complaint include: The Regions Morgan Keegan Bond Funds, the Charles Schwab Yield Plus Ultra Short-Term Bolnd Fund, the Wachovia/Evergreen Ultra Short-Term Bond Fund and the Oppenheimer Champion Income Fund.
Kathy Ridley, a spokeswoman for Morgan Keegan, says: “The increased volume of arbitrations and legal action is a natural reaction to the loss of personal wealth that resulted from unprecedented declines across financial markets. In the case of the RMK Funds, the results of arbitrations continue to support our belief that there were no improprieties in the management of these funds and that the funds’ unanticipated decline was directly attributable to the cascade of events that has devastated the financial sector over the last two years.”
OppenheimerFunds, a subsidiary of MassMutual Financial Group, believes the claims are without legal merit and intends to defend itself, a spokeswoman says. A Schwab spokesman says the company generally doesn’t comment on ongoing litigation or arbitration matters.
Some investors, meanwhile, are claiming they were put in portfolios that were far too aggressive for their situations. Many are alleging their brokers put them disproportionately into financial stocks and didn’t encourage them to get out when values started dropping.
Jury Still Out
Generally, large investor claims are heard by a three-arbitrator panel consisting of two ”public” arbitrators who have no link to the securities industry and one who is connected to the industry. On March 30, Finra increased the size of claims that can be heard by a single public arbitrator to $100,000 from $50,000. The move is expected to save time and arbitration-related costs for both investors and brokerage firms. Finra says about one-third of investor complaints are less than $100,000.
Finra also started a two-year pilot program in October 2008 that allows a total of 276 cases against 11 participating brokerage firms to be heard each year by an all-public, three-person panel. The program gives investors the option of choosing an all-public panel when they file their complaints. If an investor doesn’t request the all-public panel, Finra will notify the investor of the option. As of mid-June, 55% of eligible investors had tried the pilot program, Finra says.
The changes are a win for investors’ advocates, who have long argued that an industry arbitrator not only creates a perception of bias, but can tilt a panel against the investor. Finra has disputed that allegation, saying the fact that most arbitration decisions are unanimous indicates that industry arbitrators don’t view cases differently than public ones. The industry also says that industry arbitrators are actually tougher on questionable behavior because they find it professionally offensive.
Another change meant to benefit investors is a rule that ensures their cases will go to hearings. In recent years, there has been an increase in the use of a “motion to dismiss,” in which defense lawyers try to prevent cases from ever making it to a panel. Under a rule that took effect in February, motions to dismiss may be granted only in limited cases, such as when investors name the wrong broker in their complaints.
Some investors’ lawyers say the changes, while not a cure-all, represent progress.
If you have losses associated with a mutual fund or brokerage account, please contact our firm for a free consultation with a securities arbitration attorney. Thank you.