Resolving Client Disputes

“I think there’s a misconception that a panelist with industry experience may be unfair from the plaintiff’s perspective,” Riefberg says. “Many times, the people with industry experience end up being more harsh on people who do things improperly. People in the financial industry don’t like to see other industry people step out of line, and they really want to penalize them for it.”

At it stands today, almost 85% of arbitrations are heard before panels of all-public arbitrators. While that seems like a win for investors, it has had some unintended consequences. Without a knowledgeable industry representative on a panel, both claimants and respondents spend more to retain expert witnesses.

“I like having the option,” Hyndman says. “When I’m dealing with a client on the smaller side of the industry or a claim where I’m dealing with conduct which anyone knows shouldn’t fly, having someone from the industry on my arbitration panel can be nice.”

Finra has around 6,400 arbitrators in its pool. That might not be enough, Robbins says. “Some arbitrators sit on so many cases, when you get the list of potential arbitrators and you see their pending cases you have to wonder if you’re going to get the right damages or decisions in the case,” Robbins says.

Berry says Finra wants to add another 650 to the roster this year, in part to combat the perceived lack of diversity in the pool. According to the Public Investors Arbitration Bar Association, Finra’s arbitrators are overwhelmingly white, male and elderly.

“This is a huge priority for us,” Berry says. “We’ve increased the staffing dedicated to recruitment and have more than 100 organizations focusing on diversity that we are targeting for our recruitment.”

Typically, defense lawyers in a court would file motions to dismiss cases before they are even heard (a way to avoid expensive discovery for a frivolous lawsuit). But dismissals in arbitration are nearly unheard of: One Finra critic has likened arbitration to a “roach motel”—once a brokerage enters arbitration, it can be difficult to get out. Companies can even be sanctioned for these motions if arbitrators believe they are filed in bad faith.

“Frivolous claims are still dismissed,” Robbins says. “It happens all the time. But now they have to wait until the claimant has put on their case.”

As a result, regardless of the legitimacy of the case in front of them, the brokerages must incur the legal fees and retainers for the discovery period and evidentiary hearings. In the independent advisor world, they can end up paying the legal costs.

“I don’t think advisors have any idea of how expensive it can be if you get sued and go to court or to arbitration,” Evensky says. “If you have a big case, just getting prepared and defending it can be an order of magnitude of $100,000 to $200,000.”

Some attorneys believe that gives claimants an advantage to coerce a settlement. “It makes it too costly to fight it,” Robbins says. “There are surcharges, legal fees. It’s not really the specter of losing the case. This is a business decision. Since you have to wait until the accuser has put on the case, frequently the claimant calls the broker as a witness, so you have to prepare the broker.”

Still, a brokerage with deep pockets can always deploy its resources to fight a case for almost an eternity. Evensky served as an expert witness on behalf of Joseph Rothman, a wealthy retired real estate developer, and his wife, who claimed Merrill Lynch took advantage of them by making a $32 million investment in variable annuities on which Merrill and its broker earned about $2.5 million in commissions. A similar $32 million investment in a group of 10 load funds would have generated commissions of only about $300,000.