NASD as a forum for claims involving stockbroker misconduct

By KyleM.Kulzer

During the last several years, we have seen unprecedented fluctuation in the equity markets in the United States. This phenomenon, coupled with corporate scandals and questionable accounting practices, has resulted in securities litigation becoming one of the fastest growing areas of practice in the legal community.

One cannot turn on the television set without seeing headlines involving the Securities and Exchange Commission investigating a company or the New York State Attorney General’s Office prosecuting an investment firm for violations of securities laws.

In addition to criminal proceedings, there are also a variety of civil suits working their way through both state and federal courts against well-established brokerage firms for their conduct during the Internet and high-technology boom of the late 1990s.


Despite this flurry of activity, the average investor who feels scorned by their investment firm or stockbroker is often left with the question – what is my remedy? For most investors, his or her only remedy is to file an action with the National Association of Securities Dealers, Inc. (NASD).

Pursuant to federal law, every securities firm is a member of the NASD. The NASD membership consists of over 5,200 brokerage firms and more than 653,000 registered securities representatives. The NASD oversees virtually every aspect of the securities industry, including the adjudication of disputes between investors and their stockbrokers, via its Dispute Resolution program.

Dispute Resolution is the largest securities dispute resolution forum in the world and handles over 90% percent of all securities arbitrations and mediations in the United States. The NASD hears a wide variety of customer claims, ranging from an investor who is unhappy with the investment advice provided by his or her broker, to a brokerage firm’s mishandling of an employee’s stock options. NASD maintains jurisdiction over such claims primarily through mandatory participation by its member firms and registered representatives and binding arbitration clauses contained in account creation forms signed by customers.

The number of arbitration filings with NASD has grown swiftly over the last decade, from 3,617 in 1990 to nearly 9,000 claims in 2003. This trend shows no signs of easing and it is estimated that over 10,000 NASD arbitrations will be filed by the end of 2004.

Attorneys must be mindful that significant aggregate losses do not in themselves equate to liability on behalf of the brokerage firm or the broker. In fact, you would be hard pressed to find someone who didn’t lose money during the bear market over the last three years, and there is certainly no shortage of people who are dissatisfied with the way their broker managed their investment accounts. When evaluating claims, it is necessary to conduct a thorough analysis of all available documentation, including account creation forms, account statements and trade confirmations. It is also necessary to solidly understand the different theories of liability typically used to prosecute securities claims in order to successfully evaluate a case.

While each case varies, telltale signs of broker misconduct include: brokers who engaged in any highly speculative option trading or who had their clients utilize a margin account, especial-

ly if done so without the consent of the customer; brokers whose investment strategy was clearly at odds with the investor’s investment objectives; brokers who placed a disproportionate amount of a customer’s assets in a single market sector or in a high risk equity; and brokers who made excessive trades in order to reap higher commission fees.

Even if there are signs that a broker acted inappropriately, however, the stock market is intrinsically risky and your client must be able to clearly demonstrate why a broker or brokerage firm is liable for a customer’s losses before an arbitration claim should be filed with NASD.

Once the decision has been made to move forward with a claim, the NASD Code of Arbitration Procedure (NASD Code) sets forth all the rules and regulations which govern the arbitration. The first step in the process is for the claimant to file what is commonly referred to as a Statement of Claim. The Statement of Claim, much like a complaint in a civil action, sets forth a detailed narrative of the facts of the case and the legal counts of liability.

The NASD Code does not specify a particular format so the Statement of Claim often varies with each attorney. At a minimum, the Statement of Claim should set forth a detailed description of the brokerage firm or broker’s conduct and the statutes and/or rules and regulations that were allegedly violated.

Typical causes of actions alleged in a Statement of Claim often contain one or more of the following counts: churning or excessive trading; violations of the NASD and NYSE suitability rules; violation of section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 promulgated thereunder; violation of New Jersey Uniform Securities Act; professional negligence; breach of

fiduciary duty; failure to supervise; and breach of contract.

In addition to the Statement of Claim, you must also file a Claim Information Sheet, which contains an array of important information such as the customer’s account numbers, the brokerage firm’s CRD number, and a computation of the alleged damages. Once the Statement of Claim and Claim Information Sheet are submitted to NASD, it is assigned to a case manager who then serves it on the named respondents.

After service, a respondent has 45 days in which to file an answer. Shortly thereafter, NASD begins the process for selecting an arbitration panel. For claims of $50,000 or less, NASD will only assign one arbitrator to the case. For claims above $50,000, NASD typically allots three arbitrators.

Both the claimant and respondent receive an initial arbitrator selection form, which contains a list of 20 or so arbitrators from the more than 7,000 arbitrators currently registered with NASD. The arbitrators are divided into “public” (those who have never worked in the securities industry) and “industry” (those who have worked for a brokerage firm or in a securities related position).

The arbitrator selection form often contains arbitrators with a diverse cross-section of professionals from all walks of life and includes a detailed listing of the arbitrator’s education, training courses, employment history and recent arbitration rewards. Both parties have the option of striking any arbitrator from the list and that party will automatically be removed from the panel selection process. Thereafter, claimant and respondent rank the remaining arbitrators in numerical order. Once NASD receives the ranking forms from both parties, the case manager attempts to select a mutually agreed upon panel. The final step in the process is to select an arbitration chair, who typically is an attorney due to his or her familiarity with the NASD procedural rules and regulations.

After a panel is complete, a pre-hearing conference takes place in which the parties agree to discovery dates, motions dates, and the arbitration date. To facilitate discovery, NASD has implemented the NASD Discovery Guide, which attempts to minimize discovery disruptions and standardize the discovery process.

For example, the NASD Discovery Guide sets forth a list of ^ documents for both the claimant and respondent that NASD considers presumptively discoverable. On the claimant’s side, a person must produce his or her tax returns; financial statements; notes; diaries or calendars relating to the customer’s accounts; documents showing action taken by the customer to limit losses in the transactions at issue; resumes and even a listing of the claimant’s educational history.

On the respondent’s side, a brokerage firm must produce all account statements for the customer’s accounts; all correspondence between the customer and the brokerage firm and/or the broker, all sections of the brokerage firm’s compliance manuals relating to the claims alleged in the Statement of Claim; and all recordings of telephone calls or conversations about the customer’s accounts. NASD discovery also differs dramatically from discovery in typical litigation in that it does not allow for depositions or interrogatories. Overall, both claimant and respondent are limited in what type of information they can request during the discovery process.

Once discovery has concluded, the final step in the process is the actual arbitration. The arbitration is typically held in the city closest to the claimant and normally takes anywhere from 3 to 5 days. Each party is allowed to present witnesses, including experts, as well as any documentation they may have to support their claim. After each side presents their case, the arbitrators adjourn to decide the case and typically enter a finding within a few weeks. If an award is entered, the respondent has 30 days to pay or NASD may initiate proceedings to suspend the respondent’s license.

If a brokerage firm or broker is no longer in existence or has gone out of business, it can be very difficult to collect an award since NASD’s only enforcement power is to suspend a member’s securities license. If a respondent is no longer conducting business, the threat of suspension has little effect and typically will not prompt payment. If a claimant

finds himself or herself in this precarious position, they may want to try to enforce the award pursuant to either federal or state laws.

For example, NASD awards have been successfully enforced via the Federal Arbitration Act, which allows for arbitration awards to be converted into court judgments. Based on the foregoing, it is very important to investigate the broker and brokerage firm before filing a Statement of Claim. Over 80% of all unpaid awards relate to brokers or brokerage firms that were out of business or filed had filed for bankruptcy.

Lastly, it is not unusual to settle a case prior to arbitration. In fact, more than half all filed arbitrations end with a settlement between the parties prior to the arbitration date. In 2001, approximately 3,600 cases were resolved, but only 1,365 of the cases actually went to arbitration. Of that amount, 725 of cases resulted in the arbitrators awarding damages to claimant.