Resolving Client Disputes

“The problem was his friend was very wealthy and could afford to lose 50% of a million. For him, it was pretty much all of his money,” Evensky recalls. “But the position of the [brokerage was that] all the managers were good and honest. That’s just what happened—and he picked them. When there’s suitability, that’s not an unreasonable conclusion.”

Had the plaintiff gone to a fiduciary advisor, however, the case could well have gone the other way. From a fiduciary’s viewpoint, the brokerage obviously failed to diversify the client’s portfolio.

Evensky says it’s often that clients expect high performance and the investments fail to deliver. In one case in federal court, he testified on behalf of Northern Trust when the big trust company was sued by a group of physicians.

“The complaint was [that] they failed to take any steps to limit or offset the decline in the value of the plaintiffs’ portfolio,” Evensky says. But when one examined the investment policy that the physicians and their trustees developed with Northern Trust, all the parties agreed to a very heavy equity allocation. “The losses were very consistent with what the market was.”

The SEC is currently reviewing whether mandatory arbitration is appropriate for both RIAs and brokerages under the Dodd-Frank Act. Finra is scrutinizing the arbitration process as well. Rick Berry, a Finra executive vice president who oversees the agency’s securities arbitration, organized the Dispute Resolution Task Force in 2014 to review the process and recommend reforms. The task force consists of 13 members representing industry firms, investors, attorneys and arbitrators. Much of its work reviews the most common complaints from brokerages and consumers.

One of the topics the group addresses is the fitness of contractual clauses that prevent clients from suing their brokers. In the mandatory arbitration clauses, investors and employees waive their Sixth Amendment right to a jury trial. In 2014, 3,822 arbitration cases were filed with Finra by consumers. The vast majority alleged negligence, breach of contract, misrepresentation or unsuitability and breach of fiduciary duty.

Finra believes whether these clauses should be mandatory is an issue for elected officials and political appointees. “Finra doesn’t require anybody to arbitrate. That’s a matter of contract between firms and investors,” Berry says. “It has always been our position that the issue of mandatory arbitration is something better left to Congress and/or the SEC.”

Finra rules already mandate that brokerages be bound to arbitration if the client requests it, so a mandatory arbitration clause turns that requirement into a two-way street. (RIAs are not forced into arbitration in customer disputes unless they have dual registration with the SEC and Finra.)

By mandating arbitration, brokerages are ironically allowing investors to bring cases that would not otherwise be heard. In a sense, brokerages are supporting and mandating a process that ensures they are held accountable for the professional standards they have created for themselves, says Jeremy Hyndman, principal at Los Angeles-based Investor Defense Law.

“As much as brokerages complain about the process, they still like mandatory arbitration clauses,” Hyndman says. “It’s disingenuous for them to complain since they are the ones requiring us to be there. It ends up saving them money, too.”

There can be advantages for consumers who go to court instead. Frequently, a jury’s decision produces a binary, winner-take-all outcome, while arbitrators are prone to “split the baby,” in legal parlance. Also, juries can be swayed by factors that arbitrators would dismiss. For instance, a jury might be more likely to find for a local plaintiff against a big money center bank.

Evensky testified on behalf of an out-of-town bank that was being sued by a senior executive of a public company who failed to diversify out of his company stock. “They told him he had significant unsystematic risk, and he should liquidate,” Evensky recalls. “He kept saying no, I’m going to wait until [the stock] gets back to a certain price. It wasn’t a poor, little, naïve guy.”

Yet in the end, the plaintiff prevailed. “I don’t know how they came up with their decision,” Evensky says. “All I could conclude was that it was someone local versus a big out-of-town bank. It made no sense to me whatsoever.”