Skip to main content

Aggrieved Investors Face the Big Fight; Contentious Brokerage Arbitration Renews a Debate

Los Angeles Times

When Nancy Penoyer-Blau filed an arbitration claim against her brokerage firm 19 months ago, she expected a simple process with a quick resolution.

What the Woodland Hills woman got instead was the sort of elaborate and contentious showdown that has become the norm in arbitration proceedings.

“It was far more litigious than I had expected,” said Penoyer-Blau, who claimed to have lost hundreds of thousands of dollars because of an unscrupulous broker. “It was very much like a court case as opposed to just going in and telling my story.”

When brokerage firms gained the right 16 years ago to force customers into arbitration, they portrayed it as an informal — almost relaxed — alternative to overburdened state and federal courts.

No more.

The investors who are filing record numbers of arbitration claims today are confronted by an increasingly rancorous system in which brokerages spar with them over everything from which documents must be produced to when hearings can be scheduled, experts say.

By many accounts, wrangling by the firms has grown steadily nastier as investors continue to feel the fallout of a three-year bear market and Wall Street’s various scandals.

The NASD, the regulatory organization that oversees 90% of securities arbitrations, is looking into the matter. Within the next two weeks, the organization will begin officially monitoring cases for signs of foot-dragging by brokerage firms.

The rising level of acrimony has renewed a long-simmering debate about how arbitration works and whether the process is fair to investors.

Despite wide agreement that arbitration has improved in recent years thanks to NASD reforms, some investor attorneys say it remains tilted in favor of brokerage firms.

They criticize the process as too secretive, and say that arbitrators, for reasons ranging from demographics to the structure of the system,are more likely to side with brokerage firms.

“A rational person has to conclude that this system favors the brokerage houses,” said Jeff Riffer, a partner at Jeffer Mangels Butler & Marmaro in Century City.

The NASD and Wall Street firms strongly dispute that notion.

“The NASD wants to ensure that investors get a fair, efficient, less costly process” than going to court, said Linda Fienberg, president of NASD Dispute Resolution.

A Crucial Process

There is no debate that arbitration is crucial to small investors, especially as many of them try to recoup losses that they blame on either bad advice from brokers or on dishonest recommendations from stock analysts.

A landmark Supreme Court ruling in 1987 allowed brokerage firms to require customers to submit complaints to arbitration rather than filing suit in court, a requirement that virtually all firms make customers agree to when they open accounts.

The significance of arbitration was underscored this month when a federal judge in New York threw out three class-action lawsuits over the conduct of Merrill Lynch & Co. stock analysts. Similar suits against other firms also may be tossed, leaving arbitration as the primary outlet for aggrieved investors.

Through June, investors had filed 4,654 new cases with the NASD, a 25% jump from last year’s pace. Some 350 cases have been brought in recent months alleging analyst conflicts of interest and several thousand more are expected to pour in.

According to NASD statistics, investors win monetary awards in 55% of cases. But that figure encompasses the many cases in which investors receive far less than they have claimed in losses.

California investors have had to grapple with an additional issue over the last year. The NASD and New York Stock Exchange are involved in a dispute with California over the state’s financial-disclosure requirements for arbitrators, which are tougher than the NASD and NYSE rules.

The spat, which has held up arbitration hearings, remains unresolved, but many investors are waiving their rights to the California standards and proceeding with their cases. Much of the discord engulfing the arbitration system involves disputes over the discovery process, with plaintiffs accusing firms of not turning over required documents as part of an overall stonewalling effort.

Despite NASD guidelines broadly outlining the documents that firms must hand over, critics say firms routinely delay or refuse to produce records.

She filed a claim in December 2001 against Newport Beach-based Roth Capital Partners for $875,000, alleging that her broker put her into risky technology stocks and private placements even though she was in her 60s and needed more conservative investments.

Terry Ross, the lawyer for Roth Capital, said the firm quickly handed over pertinent documents, but thought some of the requests were not relevant to the case.

An Award, Finally

The arbitration panel finally awarded Penoyer-Blau $270,639 plus interest last month.

Investor attorneys and some arbitrators say firms seek to delay cases through the filing of excessive motions and other maneuvers. The goal, critics say, is to wear down investor resolve in hopes that they will drop cases or settle for lesser sums.

The average arbitration case now takes 14.2 months to resolve, according to the NASD, up from 12.7 months in 2001.

“From the time the claim is filed, there are just motions and discovery requests filed week after week after week,” said Stuart Buchalter, an arbitrator and defense lawyer at Buchalter Nemer Fields & Younger in Los Angeles. “It’s part of the wear-them-down” strategy.

In two recent arbitration cases, Merrill Lynch was sanctioned a total of $17,591 by NASD arbitrators for failing to turn over documents.

Bill Halldin, a Merrill spokesman, said the firm produced tens of thousands of documents, adding that the information being sought “was not central to the cases.”

“We don’t believe either of these sanctions was warranted,” Halldin said.

Another tactic used by brokerages, critics say, is to try to schedule hearings as far in the future as possible.

Farid Shalabi, an Arcadia resident who owns a supermarket chain, brought a claim against Merrill Lynch and one of its brokers in November 2001.

On the hearing day in April, one of the three panelists didn’t show up,

Shalabi said, and Merrill attorneys suggested the hearing be rescheduled 13 months later. Shalabi’s attorney, Alton Burkhalter, protested and another arbitrator was chosen.

“Merrill Lynch tried to use that as an opportunity to greatly delay the proceeding,” Burkhalter said. “It was just gamesmanship.”

Merrill spokesman Mark Herr denied the charge. “We have an obligation to mount the best case and the best defense we can,” he said, “and the standard for that does not include seeking approval from plaintiff’s counsel.”

Investor lawyers also complain that brokerage attorneys are seeking subpoenas much more often than in the past.

The firms seek a variety of financial records, such as details of accounts at other brokerages. The firms sometimes subpoena documents from outside sources that aren’t pertinent to a case, such as records from an employer.

The firms sometimes turn up useful information, he said. If not, they figure they may intimidate investors.

Fighting Aggressively

Defense lawyers say they never try to delay cases and that they seek only necessary documents. But they stress that many investors who bet heavily on tech stocks are trying to blame brokerages for their losses, and say they must send the message that firms will fight those cases aggressively.

“Bear markets bring claims out of the woodwork,” Ross said. “There is a bandwagon effect that we must watch out for before we just roll over and write a check.”

The current sparring over arbitration includes complaints that have long been debated between Wall Street and its critics.

Critics, for example, say arbitrator pools can be biased against investors, particularly “industry” panelists.

Although the expertise of a brokerage employee may have been needed in the early days of arbitration, critics say, public arbitrators have a far broader understanding of market issues today. Thus, industry representatives often are little more than automatic votes for brokerage firms, they say.

“In a jury trial, you don’t have anyone who is an ‘industry’ juror,” Riffer said.

The NASD’s Fienberg responded that industry arbitrators usually vote in unison with their two peers, and that industry panelists are sometimes the most angered by wrongdoing in their profession.

Critics say that even public arbitrators tend to be middle-aged businessmen, who often show an affinity for the brokerage firms. They also argue that longtime arbitrators can become desensitized to investor complaints.

“When you hear the same complaints over and over again, it is inevitable that a degree of cynicism is going to creep into the process,” said Robert S. Mann, a Century City lawyer.

The NASD has made a big effort to recruit women, who now comprise 17% of the 7,000-person arbitrator pool, and minorities, who make up 7%, Fienberg said.

One common criticism is that arbitrators are afraid to issue big judgments against firms for fear that the brokerages would veto them from future panels.

“You can’t come down hard on the industry, or you don’t get picked for panels,” said Skip Raring, a Costa Mesa investor attorney.

But even investor attorneys concede that major improvements have been made to arbitration in recent years.

The NASD enacted rules in the late 1990s requiring arbitrators to undergo training and testing. It also began allowing plaintiffs and defendants to pick arbitrators themselves rather than have panelists selected by computer.


How arbitration process works

Most disputes between Wall Street firms and their customers are handled through arbitration. Here are some facts about the process.

  • Cases involving less than $25,000 go through “simplified” arbitration, in which investors submit paperwork to a single arbitrator, who issues a written decision without holding a hearing.
  • In disputes involving sums up to $50,000, an arbitrator conducts a hearing, unless a three-member panel is requested.
  • Claims topping $50,000 automatically go to a panel, often for hearings that last several days.
  • Each panel has one member representing the brokerage industry and two members representing the public.
  • There is extensive document discovery but no depositions.
  • Half of all NASD arbitration cases are settled, with one-third of the remaining cases decided by arbitrators. Most other cases are withdrawn or lapse.
  • Investors pay upfront fees ranging from $50 to $1,800, depending on damages claimed.