FINRA Flooded With Arbitration Claims
The Financial Industry Regulatory Authority (FINRA) is seeing a sharp rise in the number of arbitration claims filed by irate investors seeking compensation from the securities industry for steep losses during the market downturn.
FINRA, the non-governmental regulator of the U.S. brokerage industry, says the number of new arbitration case filings jumped to 1,065 during the first two months of 2009 versus 561 in the year-earlier period--a 90% increase. That surge continues the upward trend that began last year following a three-year stretch of declining arbitration case filings from 2004 through 2007. There were 4,982 cases filed in 2008, a 54% jump over the prior year.
The agency says the main types of arbitration cases filed in 2008 involved mutual funds, common stocks, annuities, corporate bonds, options, limited partnerships and certificates of deposit. In addition, there were a sizable number of cases dealing with auction-rate securities, along with collateralized debt and mortgage obligations. The most common complaints against securities firms in these cases included breach of fiduciary duty, misrepresentation, breach of contract, negligence, omission of facts, unsuitability and failure to supervise.
Increased arbitration hearings are a byproduct of down markets--the last great surge in cases occurred in 2003 and 2004 after the tech bubble burst. "When markets go down, it's sort of like people go through the three phases of grieving," says Marc Dobin, director of the financial services department at LaBovick & LaBovick in Palm Beach Gardens, Fla. "The first phase is disbelief, followed by mourning and then analysis, or blame-placing."
Dobin says the growing arbitration workload also stems from three other factors: There are more lawyers doing securities-related work, they advertise more aggressively and consumers are better educated about their rights. People realize that investments can lose money, he says, but now they can also question whether they should have been in an investment in the first place.
"It's the financial advisor's responsibility to match the investment with the investor," says Dobin, who represents both investors and broker-dealers in arbitration cases. "They have to make recommendations that are suitable to a client's investment objectives and financial situation."
Typically, arbitration cases involve a three-member panel consisting of one person from the securities industry and two non-industry members. But an independent study published last year found there was a presumption of industry bias on the panels because the one industry member could influence the other two panelists in favor of the broker.
In response, FINRA late last year launched a two-year pilot program that lets investors choose three "public" panelists rather than the traditional panel with the one industry member. Eleven broker-dealer firms have elected to participate in the program, and they run the gamut of industry giants including Citigroup, Morgan Stanley, LPL Financial and Fidelity Brokerage.
These firms have agreed to participate in a set number of cases to be overseen by the all-public panels during the next two years. The number ranges from 40 cases each year for Citigroup to 10 cases each year for Fidelity.
Some people feel the pilot program is unnecessary, if not a detriment to the arbitration process. "There have been thousands of awards, and there hasn't been found any significant rate of dissent by industry arbitrators," says S. Lawrence Polk, a partner at the Atlanta office of Sutherland Asbill & Brennan, who represents broker-dealers in securities arbitration cases.
Dobin, who represents both sides, says he believes industry panel members are helpful because they know the industry and understand its nuances. And he doesn't believe industry panelists prejudice cases toward brokerage defendants. "Oftentimes, it's the opposite because industry arbitrators see it as a chance to help clean up the industry," he says.
According to FINRA, arbitration resulted in awards in 24% of cases last year. That's up from 21% in 2007, but down from 33% in 2003.
Here's a bit of good news gleaned from last year's carnage in the financial markets--mutual fund investors experienced a smaller tax bite than in 2007. Cold comfort, for sure, but every little bit helps considering mutual fund investors, like most others, experienced the worst one-year return in decades.
According to Lipper, the mutual fund research company, equity funds on average sank 39.54% last year, the biggest drop since Lipper began tracking funds in 1959, and significantly worse than the previous lowlight year of 1974, when equity funds dropped 24.35%. And even if taxable and tax-exempt funds did "better," they still lost an average of 7.62% and 7.46%, respectively.
But these large shortfalls helped reduce the tax drag on mutual funds. Estimated taxes paid by mutual funds in 2008 fell 53% from the record amount in 2007. Lipper calculates that buy-and-hold taxable mutual fund investors last year forked over $15.8 billion in taxes to Uncle Sam, which roughly tracks the ten-year average. That's still a hefty tax bill, considering how the funds performed. "Personally, I think $15.8 billion is an atrocity," says Lipper senior research analyst Tom Roseen.
And depending on the asset class, some investors fared better than others. Equity funds, for example, saw hefty declines in both short-term and long-term capital gains--84% and 79%, respectively--from the prior year.