Customer arbitration claims can expose brokers and their firms to substantial liability.
Arbitration claims can trigger enforcement action by the Financial Industry Regulatory
Authority (FINRA) as well, and this can lead to fines, suspensions, and even permanent
loss of registration. In some cases, customer complaints can also lead to scrutiny from
the U.S. Securities and Exchange Commission (SEC)—and, depending on the
allegations at issue, civil or criminal prosecution could be on the table.
As a result, for brokers and brokerage firms, executing a successful defense in FINRA
arbitration and mediation can be about much more than just dealing with the customer’s
allegations. In many cases, a broader defense strategy will be necessary for FINRA
dispute resolution. Brokers and brokerage firms must execute their arbitration defenses
while giving due consideration to all of the potential implications; and, while they must
focus on mitigating their liability in the instant arbitration action, they must also be
careful to avoid oversights that could lead to exposure in subsequent administrative,
civil, or criminal enforcement proceedings.
“FINRA arbitration claims can expose brokers and their firms to substantial liability. They
can also present risks for FINRA enforcement action—and even SEC scrutiny—in many
cases. When developing their arbitration defense strategies, brokers and brokerage
firms need to keep these risks in mind, and they must work closely with their counsel to
ensure that they are giving due consideration to all relevant concerns.” – Dr. Nick
Oberheiden, Founding Attorney of Oberheiden P.C.
With this in mind, here is an overview of some key strategic considerations for
defending against customer claims in FINRA arbitration:

1. Conducting an Internal and Attorney-Client

Privileged Risk Assessment
As with any type of dispute resolution proceeding, when facing a customer complaint in
FINRA arbitration, the process of developing an effective defense strategy starts with
conducting an internal risk assessment. Conducting this risk assessment with the
oversight of outside counsel ensures that any unfavorable findings will be protected by
the attorney-client privilege (subject to discovery rules that apply to pre-existing
materials). This internal risk assessment is truly a fact-finding mission—the goal is not
to focus on building a defense at this stage. Rather, the goal is to ensure that the
defense team has a firm grasp of all of the relevant facts so that it can make informed
decisions.

2. Thoroughly Evaluating the Factual Accuracy of the
Customer’s Allegations

After gaining a clear understanding of the facts at hand, then the defense team can
focus on evaluating the factual accuracy of the customer’s allegations. If the customer is
alleging excessive trading or “churning,” do the timing, volume, and nature of the
transactions executed on the customer’s behalf support these allegations? If the
customer is alleging excessive fees, were the fees fully disclosed, and were they
applied to the customer’s account appropriately? While these are just two of numerous
possible examples, they illustrate how the facts can play a central role in building an
effective FINRA arbitration defense strategy.

3. Thoroughly Evaluating the Legal Merit of the
Customer’s Allegations

Of course, in addition to evaluating the factual accuracy of the customer’s allegations,
building an effective defense strategy requires a thorough legal analysis as well. Even if
the customer’s allegations are true, do they support a claim for damages under FINRA’s
Rules, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, or
other applicable law? As in civil securities fraud litigation, in FINRA arbitration the
burden of proof rests with the customer. If the customer cannot prove each element of a
claim in the customer’s complaint, then the claim should fail. By raising issues with the
legal sufficiency of the allegations in a customer’s complaint, brokers and brokerage
firms can avoid liability in FINRA arbitration in many cases.

4. Assessing the Risk of FINRA and/or SEC
Enforcement Action

Regardless of whether a customer’s allegations justify a claim for damages in FINRA
arbitration, targeted brokers and brokerage firms should also assess their risk of facing
FINRA and/or SEC enforcement action. In some cases, issues that don’t necessarily
warrant arbitration awards in arbitration mediation can still justify FINRA enforcement
action—and a customer’s complaint may tip off FINRA investigators that scrutiny is
warranted.
Of course, substantiated customer claims can trigger FINRA enforcement action as
well, and serious allegations can also lead to SEC scrutiny. Allegations of negligence
can lead to civil enforcement action, while allegations of intentional fraud can present
risks for criminal charges.

5. Carefully Selecting the Arbitrator (or Arbitrators)
Who Will Hear the Case

In FINRA arbitration, both parties get to play a role in selecting the arbitrator, or person
hearing, (or arbitrators on the arbitration panel) the case. While this is often viewed as a
formality, it presents a strategic opportunity that brokers, brokerage firms, and their
counsel should not overlook. By researching potential arbitrators and making an
informed decision about the arbitrator (or arbitrators) they nominate, brokers, brokerage
firms, and their counsel can often avoid unnecessary issues while also setting the stage
for a fair and unbiased arbitration hearing.

6. Leveraging the Discovery Process

While the FINRA arbitration process involves limited discovery compared to securities
fraud litigation, discovery in FINRA arbitration is not insignificant, and brokers and
brokerage firms can—and should—use the discovery process to their advantage. This
includes (but is not limited to): (i) setting appropriate limits on the scope of discovery
during the initial pre-hearing conference; (ii) ensuring that they only disclose records
and communications they are required to disclose under the discovery rules put in
place; and, (iii) using the discovery process to obtain as much information from the
customer as possible.
In some cases, taking discovery from the customer can bring FINRA arbitration to a
swift end. If the customer has been withholding information, if the customer didn’t
realize (or forgot) that he or she received a disclosure, or if the customer’s records or
communications reveal that he or she was fully aware of the facts surrounding the
transactions at issue, all of these can potentially justify a motion to dismiss.

7. Preparing Thoroughly for the Arbitration Hearing

If it isn’t possible to get a customer’s complaint dismissed during the pre-hearing
process (and if settling at this stage isn’t in the broker’s or brokerage firm’s best
interests), then the next step is to prepare thoroughly for the arbitration hearing.
Thorough preparation can itself be a highly effective defense strategy, as overwhelming
an underprepared plaintiff’s lawyer can quickly shift the power balance in the defense’s
favor. In any case, FINRA arbitrators expect both parties to be prepared to present their
respective cases in chief and to know the processes and rules in FINRA
arbitration—and either party’s lack of preparation will quickly be exposed.

8. Being Careful Not to Expose Facts that Could Lead
to Enforcement Action

When defending against customer claims in FINRA arbitration, it is imperative that
brokers and brokerage firms avoid exposing facts that could lead to administrative, civil,
or criminal enforcement action. For example, let’s imagine a scenario in which a
customer alleges that a broker intentionally withheld information about an investment
product in order to generate a sale and earn a commission.

If the broker attempts to defend against the customer’s allegations by claiming that the
failure to disclose material information was inadvertent (which may or may not serve as
a viable defense), admitting to a negligent disclosure violation could effectively seal the
broker’s fate in a subsequent administrative or civil enforcement proceeding (in which
proof of intent isn’t necessary to establish a violation). Again, when facing customer
complaints in arbitration, brokers and brokerage firms cannot ignore the very real
possibility that these complaints could lead to FINRA or SEC scrutiny.

9. Considering Settlement When Warranted

Entering into settlement negotiations is an appropriate defense strategy when
warranted. If a customer is likely to be able to substantiate his or her allegations during
the FINRA arbitration process, then negotiating a confidential settlement could be the
most advantageous and least costly approach. Brokers and brokerage firms sometimes
make mistakes, and FINRA’s Rules and the federal securities laws provide that
investors are entitled to financial compensation for these mistakes in many cases.
When avoiding liability entirely is unlikely, entering into a settlement that mitigates the
broker’s or brokerage firm’s liability while also avoiding unnecessary publicity will often
make sense.

10. Evaluating the Viability and Benefits of an Appeal
Under the FAA (When Necessary)

Finally, if a FINRA arbitration hearing does not go as expected (or if a broker or
brokerage firm is willing to take its chances instead and receives an unfavorable result),
it will generally be worth evaluating the viability and benefits of filing an appeal under
the Federal Arbitration Act (FAA).  While the grounds for appealing arbitrators’ decisions
are limited, when grounds exist, filing an appeal can be essential for avoiding
unnecessary and unwarranted liability. In many cases, appeals will spur settlement
negotiations as well; and, in these scenarios, brokers and brokerage firms can work with
their counsel to assess whether it is most cost-effective to negotiate a settlement or go
through with prosecuting an appeal in federal court.