Attorney at Law
4408 Spicewood Springs Road
Austin, Texas 78759
Frequently Asked Questions for Investors
The arbitration process
Questions about me and my practice
Virtually all broker-dealer/customer agreements have a clause requiring arbitration of any dispute related to your account. You sign such an agreement when you open the account. For many years, the Supreme Court had ruled that broker-dealers could not force customers to arbitrate their claims under the federal securities laws. The Supreme Court reversed course in 1987 and 1989 cases, however, and arbitration of claims against broker-dealers has been almost universal since then.
It’s set out in bold, capital letters in the account opening agreement. Unless you never signed the agreement (which I have seen on a few occasions), you are bound to arbitrate.
Most securities arbitrations are sponsored by the NASD. The NYSE provided a separate forum in the past, but as of the time of this writing, the two systems are merging. Occasionally, with the consent of the parties, arbitrations take place before other organizations, such as the AAA or JAMS, but these are rare. AAA and especially JAMS are much more expensive than the NASD or NYSE. The arbitration hearing physically takes place at selected metropolitan cities around the U.S. Investors in Austin, where I live, arbitrate in Houston. Investors further up IH 35 arbitrate in Dallas.
There are a few advantages to arbitration over court, and there are some kinds of cases where I would rather be in arbitration, but the bottom line is that brokers ram arbitration down customers’ throats because it is a more favorable field of battle for them. There are statistics that investors win as often in arbitration as in court, and it is possible that this is true. What is certain, however, is that investors do not win the same damages when they win in arbitration as when they win in court. The NASD staff tries to train arbitrators to chop down investors’ damages in a variety of ways. They particularly encourage them to apply a legal doctrine called “mitigation of damages” in a way that is a travesty of what the law is in my opinion. Also, punitive damages are fairly uncommon in ordinary civil trials (despite the propaganda of the insurance industry and business groups), but they’re very rare in arbitration.
Another unique feature of NASD arbitration is that with the typical 3 person arbitration panel, one member has to be an industry member. This is like trying a civil case against a bank with 4 bankers on the jury. Even if the industry member is trying to do the right thing, and I assume most are, it’s a natural human tendency to think, "There but for the grace of God go I."
There is much more restricted discovery in arbitration than in civil litigation. You can’t take depositions except in very unusual circumstances. Discovery of documents is much more restricted. It is also my sense that there is much more dishonesty in document production because there are few consequences to attorneys if they are found out, unlike a court case where a judge may hammer them. In a fairly simple case, limited discovery may not matter as much, but it can be very disadvantageous in a complex case.
Finally, there are almost no grounds of appeal from an arbitration award, no matter how much it seems to fly in the face of the law and evidence. Only if there is prejudice, such as an undisclosed business relationship between an arbitrator and a party or inappropriate remarks by the arbitrator showing hostility to a party, do you have much of a chance of overturning an arbitration award. There are cases where a court has vacated an arbitration award for gross legal error, but they are few.
Most practicing lawyers feel that arbitrators have a tendency to split the baby. Juries do this too, but arbitrators probably do it more. This might help in a weaker case and hurt in a stronger one.
None of these factors mean you can’t win your arbitration and obtain a satisfactory result. They do mean, however, that the gradient is steeper.
The main expenses and possible liabilities you will encounter in an arbitration are: (1) your own attorneys’ fees; (2) the costs of an expert witness if you use one; (3) payments to the NASD; (4) possible liability for any counterclaim; and (5) possible liability for the broker’s attorney’s fees.
NASD fees. The expense of an NASD arbitration depends on the following factors, primarily:
1. the amount in dispute;
2. the length of the hearing;
3. the number of any pre-hearing conferences; and
4. in the case of small disputes, whether a simplified procedure is used.
Upfront expenses. In any case, the claimant must pay a non-refundable filing fee. That fee ranges from trivial amounts to as much as $1800 for a claim of more than $1 million. The claimant must also make a deposit for one "session" (basically a half-day hearing). Session fees also vary, maxing out at $1,200 per session. For a schedule of current fees under the new NASD rules adopted in 2007, refer to the link to the Customer Code at http://www.nasd.com/ArbitrationMediation/Arbitration/CodeofArbitrationProcedure/index.htm
Later expenses. The charge for the hearing is based on the number of "sessions" in that hearing. Also, if there are any pre-hearing conferences (e.g., one side wants documents produced which the other side is resisting), there are additional fees.
Final liability for expenses. The arbitrators can, after the conclusion of the hearing, apportion the filing fee and the session fees any way they want. Most typically in my experience, they award the fees in favor of a prevailing investor and either split the fees or award them in favor of the broker if the broker prevails, but I’ve seen them impose all the fees against a winning investor or against a winning broker. It's highly discretionary.
Counterclaims. One important expense investors might not typically consider is the possibility of the broker-dealer filing a counterclaim. It is sometimes the situation that broker-dealer firm has a claim against the customer but has avoided bringing the claim because it knows that the customer also has a claim, it wants to avoid the expense and hassle of an arbitration, and it hopes that the whole thing will go away. If the customer sues, however, the broker will of course counter-sue. The investor must carefully weigh whether the broker has any claims, and the strength and amount of both the investor’s claim and the broker’s claim.
Liability for the broker’s attorneys’ fees. It is possible in some circumstances that a losing customer could be liable for the broker’s legal expenses, including attorney’s fees. It's rare, but I know of cases where it's happened. See “Can I recover my costs and attorneys’ fees,” below.
The “American rule” is that parties bear their own attorneys’ fees in litigation, but this rule can be changed by statute or by contract. (“Costs” normally mean such things as filing fees, as distinguished from attorneys’ fees.) Most states provide that the prevailing party can recover attorney’s fees and certain costs in a lawsuit over violations of that state’s securities laws or certain other consumer laws. In Texas, where I live, for example, the prevailing party can recover attorney’s fees under both the Texas Securities Act and the Texas Deceptive Trade Practices Act. Also, it’s common to put attorney’s fee provisions in arbitration agreements, and many broker-dealer customer agreements contain such a provision. (Some have the chutzpah to provide that the broker-dealer can recover such fees if it prevails but are silent on the customer recovering the fees if it prevails.)
One complicating factor is that arbitrators might not award attorney’s fees even if the law says they should. One of the advantages and disadvantages of arbitration is that arbitrators often tend to rule based on their inherent sense of fairness rather than on the law. In a close case, or where they think that both parties are acting in good faith, they might not award attorney’s fees even when they should. In a court, this would be reversible error. In an arbitration, however, it’s probably not appealable.
Attorney’s fees, if available under a state statute or by agreement, are obviously a two-edged sword. The broker-dealer may seek them from you if you lose.
NASD arbitration rules don’t require it, but it’s certainly highly desirable to use a lawyer. The key issue is how much money is involved and whether you can afford a lawyer.
With a large case, you are basically a fool not to employ a lawyer. The broker-dealer will certainly be represented by one. No matter how intelligent you are or accomplished in your field, you probably will not do nearly as good a job as an experienced lawyer of organizing testimony and exhibits, presenting that evidence in a persuasive manner to an arbitrator, cross-examining a hostile witness, dealing with legal arguments, and understanding the industry practice and ethics which will inform the arbitrators’ decision. This may seem self-serving in an article written by a lawyer, but it’s based on 30 years of observation. Most non-lawyers I have seen representing themselves have done a pretty bad job although I’ve seen a few exceptions. You should view with extreme suspicion any advice to the contrary (and I’ve seen such advice on websites apparently run by non-lawyers hoping to charge “consulting fees” to investors).
The keys to litigating are recognizing the issues and organizing the story and the evidence in an understandable, forceful manner. Lawyers do this day-in and day-out. The natural tendency for a lay person is to tell the story in a scattered, stream-of-consciousness manner, with frequent digressions on events that really irritated them but which may not make much difference on the key legal issues. In addition, arbitrations have tended to become more “formal” in the past few years, with lawyers increasingly raising technical issues about statutes of limitation and evidentiary issues.
With a small case, it will be difficult to find a lawyer to represent you unless he or she is doing it as a favor. If the lawyer bills on an hourly basis, the bill might well exceed the amount of your damages. If you have $25,000 in damages and the lawyer bills on a contingency basis, a third or even 40%, assuming that you win, is not going to begin to cover the investment of time and risk factor. It might still be worth your while to pay for a consultation, i.e., a lawyer reviewing a claim and a trial outline that you have written, if you can find a lawyer willing to proceed on this basis.
Nevertheless, the NASD has designed their arbitration procedures so that an investor can represent himself or herself without a lawyer. The playing field is leveled somewhat under the NASD’s “simplified” procedures, which allow for cases with $25,000 or less in dispute to be decided on written submissions. It’s highly undesirable to represent yourself, but you may not have a choice economically. If you are forced to represent yourself, make sure that you read and understand the NASD Code of Arbitration Procedure and NASD Notice to Members 99-90, which deals with discovery in arbitration. Also, you need to do enough research to understand at least the basics of the legal claim that you are making. This is daunting but not as daunting as it was before the era of online research.
Federal and state securities regulators, such as the SEC and Texas State Securities Board, are sympathetic to investors and want to help you, but it’s not their job to represent you like a private lawyer. They may give you useful information, but they would have to be at least a hundred times bigger than they are to represent individual investors. Further, as public agencies, there is no more reason that they should represent investors personally than represent brokers personally; both investors and brokers pay taxes. Public agencies represent the public. I worked for the SEC Division of Enforcement for a dozen years, and occasionally I managed to freeze some money which was later distributed to the victims, but this was incidental to my job. It was not my job. My job was to investigate and to litigate violations of the federal securities laws, disciplining and punishing the wrongdoers. The cases where I got money back were truly outrageous frauds, not your typical civil case where there is an argument about whether the broker’s recommendation was suitable. In summary, I encourage you as a citizen to report any ongoing frauds or misconduct to federal and state regulators, but you cannot reasonably expect them to represent you, as they will tell you in a nice way.
The NASD is a different story. The NASD is, in essence, a trade association, not a government agency. The NASD is tasked by the SEC with disciplining errant brokers, but their investigations are often incredibly superficial in my experience. In fairness to them, I assume they are overwhelmed by the volume. They will receive a complaint from an investor, send the broker a letter asking him or her to respond, then accept a pro forma denial and close the file without taking any testimony or reviewing any documents. They then issue a “no action” letter stating that they didn’t find any reason to proceed, and the broker’s attorney waves the no action letter around at the arbitration hearing, claiming that his client has been vindicated by the NASD. If the arbitrators are unsophisticated, they may believe such claims. The NASD has passed a rule prohibiting brokers from using "no action" letters at hearings, but I have still seen them do it. In short, there is not much upside and lots of downside in complaining to the NASD in my opinion.
This is a complex question, and I emphasize again that these are general comments, not specific advice. If it’s not a particularly serious matter and you intend to continue business with the broker, e.g., the broker made an unauthorized trade but it didn’t injure you, you should immediately complain in writing in a courteous manner with a copy to the broker’s supervisor. This both documents your complaint and gives notice to the brokerage firm’s management. One of the broker’s main defenses if a dispute arises later is that the investor never made any written complaint. When complaining, make it a short, simple statement and instruction, choose your words carefully, and don’t suggest that it’s partially your fault.
If you become aware of substantial damages or there is a long history of problems, my experience is that the brokerage firm is not going to do anything to resolve a complaint unless you hire a lawyer and file a claim. Brokerage firms take the view, like a lot of businesses and quite correctly in my view, that if they just stonewall any demands, a large number of customers will go away without proceeding to arbitration. Filing an arbitration takes a lot of energy, and it may be difficult to find a lawyer, particularly on a smaller claim. While you need to give whatever written instructions are necessary to stop any ongoing misconduct, it is better to have a lawyer analyze the case with you and write any demand letter setting out the background and history. If you’re worried about the lawyer getting a windfall, taking a third or 40% of your settlement for writing a letter, I suppose it’s theoretically possible, but brokers rarely offer anything other than nuisance value settlements up front. Most cases settle in the month and often the week before the hearing.
The main concern in your writing any letter, to the broker, to a government agency, or to your Congressman, is that you may say something inartful or inaccurate that may hurt you later. If you’re using a lawyer, this is what you pay him or her to do.
About 10 to 12 months after you file the Statement of Claim, your initial filing, until the hearing, is typical. It can take longer if the hearing is moved because someone has a valid reason, e.g., sickness, family emergency, an attorney’s conflict that could not be avoided, etc. Awards generally follow within a month after the hearing.
There are three primary sources of law that regulate a broker's conduct: federal, state, and the rules of self-regulatory organizations.
Federal securities laws arise out of the Securities Act of 1933 and the Securities Exchange Act of 1934, enacted in response to the abuses of the 1920's, as well as the Investment Advisors and Investment Company Acts, enacted in 1940, and the rules the SEC has enacted under these statutes. Rule 10b-5, under the 1934 Act, which prohibits a wide variety of fraudulent practices, is perhaps the best known law. These acts have been amended a number of times, mostly in recent years to the detriment of investors. There were a series of amendments in the 1990's pushed by Senator Phil Gramm, a scourge of the investing public now mercifully retired, but the pendulum somewhat swung the other way in 2002 with the Sarbanes-Oxley Act, a response to the widespread corruption on Wall Street that became apparent after the bubble burst in 2000.
Because federal law has been weakened by Congress and the courts to a significant extent in recent years, state securities laws are often more favorable to investors today. These state securities acts are also known as Blue Sky Laws. I practice nationally but, living in Austin, Texas, I am particularly familiar with the Texas Securities Act, a very pro-investor statute. The Texas Deceptive Trade Practices Act (“DTPA”) can also be very useful in some situations. Most states have similar pro-investor laws although a few, such as New York, are very idiosyncratic.
Finally, the National Association of Securities Dealers (“NASD”) and the stock exchanges (the New York Stock Exchange (“NYSE”) is the only important one) have a welter of detailed regulations which apply to their members. The NASD and NYSE are “self-regulatory organizations” under the federal securities laws. All broker-dealer firms are required to be members of the NASD. The SEC looks to the NASD to do most of the day-to-day supervision and regulation of brokers. Many broker-dealers, particularly the larger firms, are members of the NYSE. The fact that a broker has broken an NASD or NYSE rule doesn’t necessarily give the investor a direct right to any recovery, but it can be evidence of negligence and departure from ordinary commercial standards.
No website can answer that question, but some of the most common claims made against brokers are discussed below. It goes without saying that you can’t recover on a claim against a broker just because you lost money. As investors have been reminded from time to time, the stock market goes down as well as up. To recover, you must show that the broker did something wrongful.
Misrepresentations in connection with the purchase or sale of a security are actionable under both federal and state law. Misrepresentations consist not only of affirmative misrepresentations but also omissions which make what was said misleading. For example, Merrill Lynch’s or Morgan Stanley’s touting some stock based on their investment analyst’s report would be misleading if they failed to advise the purchaser that they were corruptly receiving fat investment banking fees from that company and that their investment analyst’s pay depended directly on how many Hosannahs he or she sang about the company. (According to reports of the SEC and N.Y. Attorney General, available online, these firms and many others seem to have omitted the latter disclosure.)
Churning is the practice of buying and selling securities in the investor’s account with great frequency to generate commissions. To prove that churning has occurred, one must prove that the broker exercised control over the account and that the degree of trading was inappropriate given the investor’s objectives. There are several different measures of churning. The most common are turnover ratios, i.e., how often the value of the account is bought and sold on an annualized basis (for a conservative account, a ratio of 6 is almost conclusively considered to be churning, and a ratio of 4 or 5 may be), and cost-equity ratios, i.e., the cost of the account compared to its value on a monthly basis.
It is a broker’s obligation to know his customer’s investment objectives and to make suitable recommendations. The broker is not liable simply for losses; a suitable recommendation may lose money. Suitability is probably the most common claim made against brokers in my experience, and it is often a swearing match. It is hard for arbitrators to know who is telling the truth in these situations, so they usually try to look to more objective indicia. The two most important in my experience are past investment history and any writings which reflect your investment objective, most particularly the box you or the broker checked on the account opening form. If you have a long history of trading gold futures and obscure foreign stocks, or if you checked the "speculation" box as your objective on the new account form, convincing the arbitration panel that you had conservative investment goals will be an uphill struggle. Conversely, if you’ve only held a few conservative mutual funds, you checked "preservation of principal" or "low risk" on the new account form, and the broker recommended dot.coms, you are well-positioned to make this claim.
Unauthorized transactions are made without the customer’s authorization. It often happens that a broker starts the relationship by properly seeking authorization for any recommended trade, then slips into the habit of executing and calling the customer later to inform him or her. Sometimes the broker fails to notify the customer at all. If this pattern continues over a long period of time, the customer may in some circumstances be deemed to have "ratified" the transactions, i.e., authorized them after the fact. These cases are very fact specific, particularly if there is nothing in writing.
It’s the broker’s obligation to obtain best execution for your orders, which means, first that the broker in fact gets the order executed if it’s a limit order and less favorably priced orders are being executed for some period of time, and, second, that the broker routs the order to where the customer will obtain an appropriate price. This claim tends to arise more with active traders than with passive investors.
It’s unlikely, but with a meritorious claim you’ll most likely get some money. Seekers of perfect justice are encouraged to apply in the next world. In this one, the only way you will be made completely whole is if you recover every penny of your damages, every penny of your interest, and every penny of your attorneys’ fees and other expenses of the litigation. I have obtained awards and settlements like this, but you cannot count on it, even with a very good claim. The fact is that there is a large degree of chance in the legal process. One of my friends tells any client who asks for a “guarantee” that the only guarantee he will give them is that if he tried their case 12 different times, he would get 12 different results. Lawyers’ that give you speeches about righting all wrongs as the investor’s avenging angel are just hustling you.
In all seriousness, you need to take a sober, businesslike approach to your case. Despite the vagaries of litigation, you can, with a sagacious lawyer’s advice, rationally evaluate your odds and proceed accordingly. 80 to 90% of cases are settled before trial, and the value of the settlement depends on both the amount of your damages and the strength of your case. Lawyers for both sides know that whatever they expect to happen, once they get to trial, anything can happen. Therefore, both are willing to negotiate to a figure which reflects the risks they both perceive. Although you may be very understandably upset about how you have been treated, you are best advised to approach the matter as a business proposition. You are bringing an arbitration to get back some or all of your money, carefully evaluating your risks and rewards at all stages of the process.
I’ve been practicing as a securities lawyer for more than 30 years. See my bio. While working for the SEC Division of Enforcement in the equivalent of a chief counsel’s office, I reviewed hundreds of SEC cases brought by the agency’s regional offices for legal sufficiency and acted as a liaison with other divisions in the agency on these cases. I then spent about 9 years investigating and litigating a wide variety of civil, administrative, and criminal matters. My cases included suits against a major accounting firm, tax shelter frauds, stock manipulations, sales of unregistered stock by brokers, criminal contempt actions, insider trading, and extensive violations of the federal securities laws occasioned by management thefts. I acquired a thorough working knowledge of broker-dealers and the securities industry, financial institutions, and public accounting and auditing from my work. Since 1991, I have been in private practice with a heavy securities emphasis. About 75% of my time has been spent on litigation and the balance on transactional work. Since moving back to Texas in 1995, I have handled numerous NASD arbitrations, among other litigation matters. In addition to representing clients and brokers in arbitrations, I am an arbitrator for the NASD.
Nothing for a brief review, but I expect you to help me by typing answers to the questions in my investor questionnaire and composing a chronology as indicated.
I work that out with investors on a case-by-case basis. If I am willing to take the case on a straight contingency, I normally charge 35% of the gross recovery and expect the client to pay any out-of-pocket expenses. For transactional work and when representing a defendant or a plaintiff on an hourly basis, I currently charge $200 per hour plus a $5 per hour administrative fee in lieu of itemizing certain small expenses. Sometimes I work on a blended contingency/ hourly fee basis.
don’t have it listed as such to avoid spambots. It’s simply my full
johncourtade, at my website address, johncourtade.com
There isn’t any certification for my areas of legal practice (securities litigation and arbitrations, and securities transactional) and many other less common ones. Nevertheless, the State Bar requires me to post this disclaimer whenever I describe my area of practice.
No. I have always had brokerage firms and investment professionals as clients. Membership in PIABA requires that in broker-investor disputes, I represent the investor at least 80% of the time, and I easily stay within this guideline since most of my work has always been on the plaintiff’s side. At the same time, I believe that it helps my professional development and benefits all of my clients to represent defendants as well as plaintiffs as well as to represent clients in securities transactional work. For this same reason, I serve as an NASD arbitrator. The pay is a pittance, but it is useful to see cases from the other side of the table.
All content Copyright (C) 2004, John Courtade, and may not be used without explicit permission.
*Not Certified by the Texas Board of Legal Specialization [explanation]