Here is a very interesting piece from Chris about the fact that some customers who file arbitrations may come to learn the hard way that even when their attorney takes the case on a continency fee basis, they still have real skin the game.  I also want to be clear: while the award that serves as the centerpiece for this post reflects that I was counsel for the prevailing respondent, it was, in fact, Chris’s case, so all the kudos belong to him. – Alan


While the FINRA arbitration system certainly is not perfect – just see Alan’s troubling blog from last week regarding the Motion to Vacate that was granted by a Judge in Atlanta – we like to think that when cases go to hearing and all the facts come to bear, the system usually produces correct results (not all of the time, obviously).  But, the problem is the vast majority of cases never go to hearing, so investors and their attorneys are able to get away with saying anything they want when they file their claims.  In fact, the most frequent question I field from brokers is this: how can an investor get away with filing a Statement of Claim that contains so many false statements?

FINRA purposefully makes it easy to initiate an arbitration – so that the average main street investor can seek to recover losses and keep industry professionals in check without having to expend much effort.  But that’s sort of the problem.  It’s almost too easy to file an arbitration.  Filing fees are modest – less than $1,000 if you allege damages under $100,000, and only $2,000 if you allege damages up to $5,000,000.  So there is relatively little stopping an investor from making an inflated claim for damages, hoping such a large number scares a broker-dealer into inflating its settlement check.  And there are plenty of attorneys out there who will gladly file a case for no cost and will only take a third, or so, of anything recovered.  Many of them have pre-drafted Statements of Claim containing standard allegations about suitability and failure to disclose risks that they spend no more than an hour tweaking before they file them.  And that’s where the real problem lies.

Unlike in court, where an attorney signing a Complaint affirms that to the best of his/her knowledge the allegations have evidentiary support and are not being made for purposes of harassment (Federal Rule of Civil Procedure 11 and the equivalent in state rules), no such rule applies to the filing of FINRA arbitrations.  As a result, attorneys can spend very little time investigating the merits of his client’s potential claims and can file a document containing blatantly untrue statements without any fear of repercussions.  Attorneys can get away with this because they know from historical statistics most arbitrations will settle, so the veracity of their statements will never be tested in front of an arbitration Panel.  According to FINRA’s numbers from 2012-2016, only 18% of arbitrations actually go to a final hearing.  That means customers and their attorneys can say whatever they want in the Statement of Claim and most of the time will never have to put their money where their mouth is.

This creates a “heads-I-win, tails-you-lose” scenario.  An investor who takes risk on an investment and makes money is happy (although sometimes you see the rare gem of a case where an investor actually makes money but complains that if they had been invested differently they would have made even more money in the bull market).  But if the investor loses money, he or she simply files an arbitration hoping to recover something from the broker-dealer in a settlement.  After all, something is better than nothing, and I believe many investors are convinced by attorneys that there’s no downside to filing the claim.  In fact, I am convinced that some attorneys actually promise investors that they will never have to go to hearing and they should just file a claim to see how much the broker-dealer is willing to pay in settlement to make the case go away (rather than spending tens of thousands of dollars to defend a 12-18 month long arbitration).

This can be immensely frustrating for broker-dealers and their registered reps, who have a hard time fathoming that some customers (not all) can get away with making demonstrably false statements in their complaint.  They feel like they have little recourse except seeking to expunge the disclosures that end up on their CRD and BrokerCheck records after the complaint is filed.

The silver lining for broker-dealers, and the harsh reality for investors who might have been talked into filing an arbitration by a zealous attorney, is that investors do, in fact, face some very real monetary risks for filing meritless arbitrations: being charged with paying all the hearing fees and the respondent’s attorneys’ fees as monetary sanctions.

Let’s start with the latter of these, which reared its head in a recent arbitration award in a case we handed for a broker-dealer we will call Infinity.[1]  An investor filed an arbitration against Infinity, even though he never had an account or any relationship with Infinity.  The Statement of Claim made blatantly incorrect statements such as: the customer bought an investment from Infinity (he actually bought it at another BD); Infinity failed to advise him to sell the investment (he never had an account with Infinity, nor was he Infinity’s customer); and Infinity earned high commissions from the customer relationship (since he was never Infinity’s customer, Infinity never made a dime from him).

The Statement of Claim also referred to the investment as a REIT, when it wasn’t.  The arbitrator denied our Rule 12504 Motion to Dismiss in order to give Claimant an opportunity to conduct discovery to ferret out any possible connection he may have had to Infinity.  After forcing us to conduct months of discovery, the facts – which were clearly not vetted prior to filing the claim – remained unchanged.  After Infinity signaled it would not settle the case and was preparing to refile its Motion to Dismiss, Claimant voluntarily dismissed his claims, and did so with prejudice.

Since Infinity had been forced to waste thousands of dollars to defend a claim brought by someone who wasn’t even its customer, Infinity filed a Motion for Attorneys’ Fees and Costs after the claims were voluntarily dismissed.  We argued that under the laws of the States of Washington and Nevada (where the customer was located), this litigation was “frivolous” and Infinity was entitled to recover its attorneys’ fees.[2]  All states have similar statutes, some of which are more generous than others.  They all essentially say the same thing: a prevailing party may recover its attorneys’ fees when the court finds that a claim was brought or maintained without reasonable grounds or to harass the prevailing party.  The Nevada Code is particularly pointed and states that “it is the intent of the Legislature that the court award attorney’s fees pursuant to this paragraph … in all appropriate situations to punish for and deter frivolous or vexatious claims and defenses because such claims and defenses overburden limited judicial resources, hinder the timely resolution of meritorious claims and increase the costs of engaging in business and providing professional services to the public.”[3]

Needless to say, we really believed our case warranted recovery of attorneys’ fees under these frivolous litigation statutes.  More importantly, the Arbitrator agreed, and instructed Claimant to pay Infinity some, but not all, of its attorneys’ fees.  To be clear, this is not an everyday occurrence.  But it is a very real risk that every investor faces when filing an arbitration – and probably one they are never warned about when they think they will just try to squeeze a quick settlement out of a broker-dealer.

A much more common occurrence is for an arbitration panel to charge an investor with paying the hearing fees incurred in an arbitration.  Every time the arbitration panel holds a hearing session, for either a pre-hearing conference or the evidentiary hearing, FINRA charges the parties a fee between $600 and $1,575 per session.  Under FINRA Rule 12902, an arbitration panel can allocate these fees to any party it chooses, and the losing party is often charged with footing the bill.  Even when a case never goes to hearing, if a respondent files a couple of motions on pre-hearing issues such as discovery, the Panel could charge all of those hearing session fees to the investors.  Sometimes these can really add up, especially when a case goes to hearing.

For instance, Wells Fargo recently defeated claims brought by customers seeking $5,000,000 in damages in an American Arbitration Association arbitration (not FINRA).  The Panel in that case (AAA No. 01-20-0015-7450, as reported by Capital Forensics in its weekly Arb Reporter) issued an award requiring the Claimants to bear responsibility for “the compensation and expenses of the arbitrators totaling $195,233.28.”  Interestingly, the award states that the Claimants voluntarily dismissed their claims against two Wells Fargo affiliates, but the Panel still required Claimants to reimburse those two affiliates for the portion of fees and expenses those affiliates incurred in the arbitration.

In other words, in both of these cases, if the investors thought they would file an arbitration and could always just dismiss it, “no harm no foul,” they were sorely mistaken.  Perhaps it is just coincidence that two separate arbitration panels instructed two different sets of Claimants to reimburse defendants thousands of dollars in expenses even after the Claimants decided to voluntarily dismiss their claims.  But the message should be clear: filing an arbitration claim may be every investor’s right, but it also comes with real risks.  Counsel and their clients should make sure they have done their homework prior to filing a claim, and should strap together something more than a cookie cutter complaint to file.  On the flip side, if a broker-dealer is faced with a truly frivolous claim, there can be some potential silver-lining to fighting it – with the right set of facts and the right panel.

[1] Infinity gave us permission to discuss its case on this blog.

[2] Revised Code of Washington 4.84.185 and Nevada Revised Statutes 18.010(2)(b).

[3] There are other bases for awarding a respondent its attorneys’ fees even if the arbitration panel does not find the claim to be frivolous.  For example, a contract may exist that states the prevailing party is entitled to his/her attorneys’ fees, or if both the Claimant and Respondent request fees in their pleadings then the Panel may award them to either party – even if the claims are not so meritless that they are considered frivolous.