Pursuing a Claim Against a Stock Broker

May 2009

Ira Starr

With the debacle in the financial markets during the past year, there has been a predictably sharp interest in the number of questions regarding securities-related issues. It should be no surprise that the steady disclosure of regulatory lapses, mind-boggling salaries and bonuses and ever-increasing losses in savings and retirement plans, has led more and more people to question the good faith of the stock broker who handled their account or the good faith of the managers of the companies in which they were induced to invest. In addition, many financially wounded investors are motivated by a desire to recover assets by whatever means.

This discussion will only focus on stock broker performance. The issue of the performance, etc. of corporate managers and directors will be left for a future article. There are myriad ways in which a stockbroker handles an account improperly (or illegally). The most common situations involve: churning (i.e. excessive trading); unauthorized trading; failure to recommend investments which are suitable for the client’s stated goals, needs and objectives; failure to adequately disclose risk factors; direct misrepresentation of factual information; high pressure sales tactics; and outright theft or defalcation of assets in the customer’s account.

The inquiry into whether there has been an actionable wrong, begins with a preliminary analysis of the account statements and confirmations, as well as the various documents executed by the customer during the course of the relationship with the particular broker. This enables us to ascertain whether the documentation supports the claim of the customer. For example, if the new account form contains a customer profile, signed by the customer, in which the customer expresses a clear preference for government and municipal bonds and the broker has been recommending highly speculative volatile securities, there is a good chance that the customer’s claim of wrongdoing will be upheld. By the same token, if the profile shows an interest in speculation or writing uncovered options, the customer’s complaint about the broker’s failure to recommend safe securities will likely fall on deaf ears. After the preliminary documentary analysis is complete, it is customary to conduct an in-depth interview of the potential client to develop the factual elements of the client’s relationship with the broker. This interview is designed to both develop the client’s case and to ascertain any weaknesses or discrepancies between the customer’s version and the documentation.

The next step is for us to determine whether we should take the case. In analyzing the merits of the potential client’s case, we take into consideration that in virtually all actions by a customer against a brokerage firm the only choice of a trial forum is arbitration, either through the American Arbitration Association or through FINRA (the self-regulatory arm of the securities industry). Arbitration is a mixed blessing — it is theoretically faster and cheaper than courtroom litigation and the arbitrators are generally more experienced in securities matters than most judges. However, there is severely limited discovery (i.e. no depositions or full-scale interrogatories are permitted), therefore the claimant’s attorneys have to do a lot of independent digging and investigating. In addition, the typical arbitration panel at FINRA (where most broker cases are arbitrated) has one industry representative on the typical three person panel, so there is some built-in bias.

Finally, since arbitrator panels are not required to issue findings of fact or conclusions of law, one of the few grounds to effectively appeal an arbitration award (i.e. manifest disregard of the law) is not available. As a result, we have to plan that the arbitration hearing is the only “bite at the apple”.

One of the practical realities of brokerage litigation is that the customer/client who has lost significant monies is very reluctant to invest significant new money to initiate the litigation. The customer/client wants the case handled strictly on a straight contingency basis, while the lawyer is aware that the typical arbitration matter which is fully litigated will generate approximately $75,000 of time charges, expert fees and other out-of-pocket disbursements. Therefore, the experienced lawyer will: (a) only take matters in which the losses are substantial; and (b) require a meaningful up-front retainer to cover some of the out-of-pocket expenses and time charges. This retainer approach leads to a “hybrid” fee arrangement in which the lawyer charges a reduced contingency fee (typically 30% as opposed to the standard 40% of recovery on a pure contingency) and the up-front retainer is applied against the ultimate total fee earned.