Here is a piece from Chris Seps, who has a bit of a reputation around here for being angry.  Judge for yourself.  But, for what it’s worth, I do want to say that I have had the pleasure of being involved in several cases in which the subject of this post, Dr. Craig McCann, appeared on behalf of the opposite party.  While I generally disagree with his opinions, Dr. McCann is a gentleman, and has been nothing but courteous and respectful to me.  I guess he’s just misguided.  – Alan


Craig McCann, who testifies regularly (but not exclusively) for claimants in FINRA customer arbitrations, must not be as busy as he would like. A few days ago, he published a report from the “Securities Litigation & Consulting Group” – i.e., Dr. McCann’s own company – regarding the number of Puerto Rico securities arbitrations filed and settled since the Puerto Rico bond market collapse in 2013.  His report includes some interesting statistics, but then goes off the rails with a self-serving conclusion: that more Puerto Rico arbitrations should go to hearing rather than settle.

But before we get into the erroneous assumptions baked into his conclusion, let’s look at the stats he provided. First, Dr. McCann reports that at least 1,874 Puerto Rico securities arbitrations have been filed with FINRA since the bond crash of 2013.  That’s not really big news.  Every time a particular market sector crashes, whether it is PR bonds or the ARS market or whatever, hundreds of claimants’ attorneys chum the waters with advertising and convince investors that somebody should be made to pay for their losses. That’s the American way.

In Puerto Rico, it was no different. In fact, it was even easier for claimants’ attorneys this time around because you could literally stand in San Juan and throw a rock in any direction and hit someone who was invested in Puerto Rico bonds and closed end mutual funds.  Why?  Taxes.  Puerto Rico’s unique set of tax laws allow residents of the island to invest in Puerto Rico securities with little or no income tax burden.  The result is that the yields on such bonds – which were all investment grade or close to it – were much higher for residents than taxable bonds.

Moreover, unlike Americans, for whom the 2017 federal estate tax exemption is now up to $5.49 million/person, relatively speaking, Puerto Rico’s exemption is a mere fraction of that. But, estate taxes are not payable on any Puerto Rico securities in the estate.  As a result, most investors, especially very wealthy investors looking to avoid a big estate tax hit, focus heavily on Puerto Rico securities, even while disregarding the risks of failing to diversify.

The McCann report then states that of those 1,874 cases filed, 742 have settled while only 30 have been tried at a final hearing (1,083 are still pending). In other words, the report says 96% of the Puerto Rico arbitrations that have been resolved have been settled rather than tried.  The report notes that this is a much higher percentage than the nationwide arbitration figures, where only 73% of cases settle.  The other half of the story is that in those 30 Puerto Rico arbitrations that went to hearing, customers were victorious a surprisingly high amount of the time – 83% of the time (in 25 cases) – whereas nationally, customers are only victorious 40% of the time.  The report concludes: “The much lower proportion of Puerto Rico cases which go to a hearing than the mainland cases and the fact that customers are winning in Puerto Rico at twice the national average strongly suggests too many cases are settling in Puerto Rico rather than going to a hearing.”

Besides being self-serving – if he convinces more customers to go to hearing rather than settling, then Dr. McCann gets to bill more fees for his expert services – these statistics and conclusion are rather misleading.

What the report fails to say is the reason why so many Puerto Rico arbitrations settle: they usually are of dubious merit and often include bloated damages claims. Claimants’ counsel often tout their high track record of success at trial, and for good reason – they only take cases all the way to trial (rather than settle them) if they are strong.  But, the strength of a case has nothing to do with whether it gets filed in the first place.  Claimants’ attorneys file cases all the time without much thought to the merits as long as they can tell a good story in the Statement of Claim.  And that part is easy in FINRA arbitrations, since the filing fees are only a few hundred dollars and there is no codified obligation only to file a case in good faith (as there is in court, i.e., Rule 11).

The result is that Statements of Claim spin the “facts” as aggressively as possible, and often include irrelevant but horrible stories, sometimes about other broker-dealers who aren’t even named as respondents. Months after the claim is filed, when claimants’ counsel get around to a serious evaluation of the facts, one of two things happens.  First, they might discover their case has great facts, that they have a high likelihood of success at hearing, and there is a big loss involved.  If the potential payoff is great, they may put in the time and effort to take it to a hearing.  It is little surprise, then, that the Puerto Rico cases that actually go to hearing achieve such success because they are the cases with the best facts for claimants and largest losses.

On the other hand, and this is the scenario that plays out more often than not with these Puerto Rico cases, claimant’s counsel realizes how bad the facts are for his client, decides that there is little chance of success at a hearing, and so settles cheaply. In other words, once claimant’s counsel realizes that his client received a 50-page presentation from the broker analyzing his portfolio and recommending diversification (which claimant rejected), and that the client signed documents stating that all he wanted was tax free income and nothing else, claimant’s counsel is usually smart enough to realize they won’t fare well at a hearing.  So, they settle.

How do we know this is true? Look at the damages numbers in the report.  Dr. McCann reports that the 742 cases settled for $162,484,574 in total, or $218,981 per case.  The 25 customers who received a favorable award at a hearing won $64,206,348 in total, or $2,568,253 per case.  Dr. McCann simply compares these two numbers and concludes that more cases should be tried because successful claimants receive so much more, on average, than claimants who settle.

The simple fact is, whether you are looking at Puerto Rico specifically, or across the board in all jurisdictions, from the claimant’s perspective, the cases that don’t go to hearing are the ones that, based on their merits, shouldn’t go to hearing (or, in some cases, even be filed in the first place). And when the case has no merit, claimants’ counsel settles it.  The side effect is that Dr. McCann doesn’t get to show up at more hearings.  And that isn’t necessarily good for Dr. McCann.