By Howard S. Suskin, partner at Jenner and Block, Chicago, hsuskin@jenner.com

Arbitrations also increasingly are involving complex and substantial matters. Several arbitrations filed before the NASD in recent years have sought damages exceeding $1 billion. In 1994, one matter alone requested damages over $5 billion. On average, arbitration hearings before the NASD run a total of five sessions.

Given the proliferation of securities arbitrations, attorneys should understand the reasons that more and more of their clients are finding themselves in arbitrations and to be in a position to explain to their clients how securities arbitrations are conducted. This article gives a basic primer on these topics.

Why Are More Matters Going To Arbitration?

The marked growth in the number of securities arbitrations filed since the early 1980s is attributable in large part to the United States Supreme Court's 1987 decision in Shearson/American Express, Inc. v. McMahon, which upheld the enforceability of agreements to arbitrate investors' claims arising under section 10(b) of the Securities Exchange Act of 1934.⁽²⁾  Two years later, in Rodriguez de Quijas v. Shearson/American Express, the Supreme Court held that agreements to arbitrate investors' claims arising under the Securities Act of 1933 likewise are enforceable.⁽³⁾

Since those rulings, nearly all securities brokerage firms routinely have included arbitration clauses in the account opening forms required to be signed by their customers. These clauses typically require arbitration of all disputes between the customer and the brokerage firm before one or more specified SRO arbitration forums, usually the NASD or the NYSE.

Significantly, even in circumstances where customers can choose whether to pursue claims in court or in arbitration forums, many are being advised by their attorneys to select arbitration.⁽⁴⁾  Securities customers' growing preference for arbitration has several explanations.

First, despite early concerns that SRO arbitration forums might be biased in favor of securities industry members, many customers and their attorneys now perceive that SRO arbitrations provide fair forums for adjudicating customer/broker disputes. That perception is supported by statistics showing that, over the last several years, customers bringing claims in NASD arbitrations were awarded some relief in roughly 50% of the cases.⁽⁵⁾

Second, customers and their attorneys are finding that SRO securities arbitrations often are considerably more expeditious than court proceedings. Since 1985, the average turn-around time of cases before the NASD has ranged between nine and twelve months. That pace is significantly faster than what would be available in many federal and state courts throughout the country.

Third, arbitrations generally are much less expensive than full-blown litigation, a consideration that customers with modest claims find particularly attractive. There are several reasons that the cost to arbitrate is less than the cost to litigate: arbitration forums rarely permit depositions; arbitrations involve relatively little motion practice; arbitrations usually allow only limited pre-hearing or post-hearing briefing; and the grounds for appealing from an adverse arbitration award are very narrow.

Fourth, recent court rulings, including a 1995 U.S. Supreme Court holding, have made clear that securities arbitrators are permitted to award punitive damages.⁽⁶⁾  Previously, the uncertainty as to whether arbitrators were empowered to award punitive damages dissuaded customers from bringing their claims in an arbitration forum.

Fifth, a significant advantage of arbitrations from the customer's perspective is that arbitrators generally are reluctant to dismiss claims based on legal defenses such as the statute of limitations prior to a full hearing on the merits of the dispute. Consequently, a customer whose claim otherwise might be vulnerable to a motion to dismiss in court on grounds that the claim is time-barred can more readily overcome traditional pre-trial hurdles and receive a hearing on the merits by bringing the claim in arbitration. Relatedly, in arbitrations, customers generally do not need to be concerned with formal pleading requirements such as alleging fraud with particularity, as Federal Rule of Civil Procedure 9(b) or analogous state rules would require in court. Thus, customers filing arbitration claims can formulate a general statement of claim, propound document requests or requests for information upon the respondents, and then fill in the specific details and support for their allegations as additional evidence is adduced through discovery.

Sixth, yet another advantage of arbitrations from the customer's perspective is that a statement of claim is not subject to the provisions of Rule 11 of the Federal Rules of Civil Procedure or other similar state law sanctions that might be levied against claims that are ultimately determined to have been not well-grounded. Thus, the downside risk to pursuing a claim in arbitration is reduced somewhat from what it might otherwise be in court, although an arbitrator nonetheless may have discretion to assess costs against a non-prevailing party.

Tips For Succeeding In Arbitrations

Given the increased likelihood that attorneys in the securities field will find themselves handling arbitrations and advising their clients in arbitration forums, attorneys should familiarize themselves and their clients with some of the basic differences between handling a litigated matter and handling an arbitrated matter. The two situations are not quite interchangeable, and require unique approaches and considerations.

Reading the Rules

An important first step before embarking on an arbitration is to obtain the formal rules of procedure applicable to the proposed arbitration forum. Each SRO has promulgated its own formal arbitration rules, which set forth the particular procedures under which the arbitration forum will operate. Attorneys should read those rules carefully. They detail, among other things, the time deadlines to which the parties to the arbitration are subject, and the consequences (including default) if the arbitration forum's procedures or deadlines are not obeyed. Additionally, attorneys should obtain a copy of the SRO's Arbitrator's Manual, which contains the instructions that are furnished to members of the arbitration panel on how to conduct the arbitration hearing. Reading the Arbitrator's Manual can furnish important insight about the arbitrator's perspective regarding the arbitration process.

Most SROs also publish helpful brochures explaining in laymen's terms how the arbitration process operates. Sharing those brochures with clients can help prepare clients for what to expect during the arbitration process.

Drafting The Statement Of Claim or Answer

A claimant typically initiates a securities arbitration by filing a statement of claim. Generally, the statement of claim includes a recitation of the basis upon which the claimant is entitled to arbitration (e.g., an arbitration clause in a customer agreement or some other binding agreement to arbitrate), the factual background of the dispute, the legal causes of action upon which the claim is based, and a statement summarizing the relief that is sought.

Oftentimes, claimants' attorneys will draft the statement of claim in much the same way that they would draft a complaint to be filed in court, containing numbered paragraphs and a prayer for relief. However, that might not always be the best approach to take in arbitration. In securities arbitrations involving public customers, for example, at least one member of the arbitration panel will be from the securities industry and likely will not be trained as an attorney. Such a panelist may not comprehend -- or might be bored by -- a complaint of the type customarily filed in court. A preferred alternative might be to present the claimant's version of the events in the form of a factual brief, explaining in a clear and narrative manner the story behind the dispute. Where available, attaching key exhibits to the statement of claim also is advisable.

A similar approach may be applicable as well with respect to drafting the respondent's answer and any related counterclaim. Many respondent's attorneys, when confronted by a statement of claim with numbered paragraphs and legal jargon, respond in kind. But the respondent's attorney need not simply respond to a statement of claim's numbered paragraphs with an "admit" or "denied." Writing a discursive explanation of the respondent's position can be a more effective way of presenting the respondent's defenses. Again, attaching key exhibits for the defense also should be considered.

The statement of claim and answer are very important. Generally, those papers, together with any appended exhibits, are the only materials that the arbitrators will read before the hearing. The statement of claim and answer therefore make an important first impression on the arbitrators, and should not be treated lightly. Attorneys should urge their clients to furnish as complete a background as possible, together with all relevant documents, to assist preparation of the statement of claim or answer.

Pre-Hearing Discovery

Although pre-hearing discovery rules in arbitrations are considerably less comprehensive than those in federal or state codes of civil procedure, claimants and respondents in arbitration do have the opportunity to obtain discovery prior to the hearing. The discovery available in arbitrations consists of requests for production of documents and requests for information akin to interrogatories. Unlike court proceedings, arbitration rules of procedure usually do not authorize depositions.

A claimant/customer generally will propound a wide range of discovery requests upon a broker/respondent. Those requests usually seek information and documents relating to the specific transactions or investments at issue, as well as requests designed to elicit information about the broker's background and general compliance procedures. Among the typical subject matters included in discovery requests propounded on behalf of customer/claimants are: all communications between the customer and broker, including the customer's account opening documents, periodic statements, confirmation slips, margin calls, sales literature, activity letters or other correspondence; any internal brokerage firm documents relating to the customer's transaction, including research reports or due diligence files relating to the broker's investigation of the securities at issue; information relating to the commissions or other compensation received by the broker; communications with third parties relating to the transaction; prior disciplinary or enforcement actions against the broker or other litigation involving the broker, including information contained on the broker's Forms U-4 and U-5; the brokerage firm's compliance manual, supervisory manual, and other internal firm procedures and policy manuals; the identities of fact witnesses; and information concerning expert witness.

On behalf of a respondent brokerage firm, it is common to propound discovery requests that not only seek information concerning communications with the broker and the transaction at issue, but also inquire about the customer's overall investment sophistication. Often, the broker will request the customer to produce information concerning the customer's: investment experience both before and after the transactions at issue; net worth; tax returns; check registers; other investment accounts; and sources of and access to information concerning investments, including subscriptions to financial publications or memberships in investment clubs.

If either side fails to comply with discovery requests to the other side's satisfaction, the arbitration forums provide mechanisms for pre-hearing conferences, which may be conducted by the arbitration forum's personnel or by one or more members of the arbitration panel, either in person or by telephone. Additionally, arbitration forums usually require that, even absent any formal discovery requests, the parties must exchange documents that the parties intend to introduce into evidence and must disclose the identities of witnesses in advance of the arbitration hearing. Failure to make these prehearing disclosures may lead the arbitrators to bar documents or testimony from presentment at the hearing.

Both sides to an arbitration also have the ability to obtain discovery from non-parties through document subpoenas. Such subpoenas to non-parties often are served, for example, by respondent brokerage firms seeking information about the claimant/customer's investment activity elsewhere. If the subpoenas are not complied with, the requesting party can seek relief from the arbitrators and, if non-compliance persists, the party seeking the discovery can attempt to obtain enforcement of an arbitrator's order through court intervention under the Federal Arbitration Act or the Uniform Arbitration Act as adopted by the forum state.

The Arbitration Hearing

Clients should be forewarned that the arbitration hearing likely will be conducted somewhat informally, without adhering to the rules of evidence and with the parties and the arbitrators participating in the hearing while seated around a conference table. Nonetheless, the arbitration hearing will bear some similarities to the format that would be encountered in court. The arbitrators will hear opening statements from both sides. The claimant introduces its exhibits and has its witness testify, with an opportunity for the respondent to cross-examine. After the claimant rests, the respondent may introduce any additional exhibits and witnesses, with an opportunity for cross-examination by the claimant. The arbitrators may ask questions of the witnesses as well. At the end, both sides may present closing arguments. If the parties request, and if the case is sufficiently complex, the arbitrators may entertain post-hearing briefs, although this is more the exception than the rule.

In formulating an effective presentation at the arbitration hearing, attorneys and their clients need to consider the unique perspective of the arbitrators, and how that perspective might differ from that of a judge or a jury. At least one of the members of an SRO securities arbitration panel involving a customer/broker dispute likely will have some expertise in securities transactions, but may lack the formal legal training and substantive legal knowledge of a judge. Such arbitrators probably will have a solid understanding of the technical aspects of the securities transaction at issue, but may need to be informed about the legal underpinnings of the parties' claims and defenses. Other panel members may be relatively well-versed as to securities law issues, but may be unfamiliar with the way in which securities transactions and customer relationships actually are handled in the "real world." As in planning presentations to lay jurors in court, attorneys conducting arbitrations should be sensitive to whether all the arbitrators are comprehending the presentation and whether the presentation is being communicated as clearly as possible. Attorneys should consider using demonstrative exhibits and charts, as well as expert witnesses, if doing so would assist in clarifying any points.

Clients should be advised not to expect a ruling immediately upon the conclusion of the arbitration hearing. Arbitrators generally issue their rulings within 30 to 60 days after the record is closed. Clients also should be advised not to expect a lengthy opinion or any explanation in the ruling as to the basis for the arbitrators' decision. Generally, the arbitrators' ruling simply will indicate the prevailing party, the amount of any damages to be awarded, and an allocation among the parties of the costs of the arbitration.

Lastly, clients should be forewarned that the opportunity for appeal is very narrow, and generally must involve an allegation of an undisclosed conflict of interest on the part of the arbitrators or other arbitral misconduct. If the arbitration award is not complied with, the prevailing party may seek to confirm the award in court and enforce the award under the Federal Arbitration Act or the forum state's uniform arbitration act.

Conclusion

With arbitrations increasingly becoming a fact of life in the securities field, practitioners and their clients would be well-advised to have a basic understanding of how the arbitration process operates. Arbitrations have unique characteristics that differ from those of court proceedings. Understanding those differences is an important first step in maximizing one's chances for a successful arbitration outcome.

Footnotes

1. In 1994, over 85% of all SRO securities arbitrations were filed with the NASD. The second most popular SRO arbitration forum was the New York Stock Exchange, which receivedslightly under 11% of all arbitrations that were filed in 1994. The remaining SRO securities arbitrations were filed before such forums as the American Stock Exchange and the Chicago Board Options Exchange.

2.  482 U.S. 220 (1987).

3.  490 U.S. 477 (1989).

4.  Even absent arbitration agreements, customers generally can require securities brokers to arbitrate disputes arising in connection with the broker's business. By virtue of a broker's membership in an SRO, such as the NASD or the NYSE, a broker is required to arbitrate claims at the customers' demand.
See e.g., NASD Code of Arbitration Procedure Section 12; NYSE Arbitration Rule 600.

5.  In 1991, NASD arbitrators issued awards in favor of customers in 55.4% of the cases that were decided. The percentage of awards in favor of customers was 53.6% in 1992, 50.7% in 1993, 48.2% in 1994, and 50% during the first nine months of 1995.

6. See Mastrobuono v. Shearson/American Express, Inc., 115 S.Ct. 1212 (1995).