broker arbitration

Broker Arbitration and Mediation

9 min read

Losing money in the stock market never feels good. But what if the cause of it was your broker? More specifically, negligence on their behalf would feel even worse. So, what are your legal options when your broker has been negligent? This is where broker arbitration comes in.

Finra Broker Arbitration

Finra Website

While many disputes are handled in a courtroom, disputes between investors and brokers are typically resolved in another venue: an arbitration forum. Arbitration is resolving disputes between investors and brokers or between brokers. The notable thing about broker arbitration is that it’s overseen by the Financial Industry Regulatory Authority (FINRA). Also, the decisions are final and binding.

5-Second Summary

  • Typically, when a stock trader signs a brokerage-account application, they also sign away their rights to sue the brokerage firm.
  • Stock broker arbitration is a private way for investors to settle disputes with their stockbroker or financial firm without going through the court system. 
  • People pursue arbitration mainly due to claims of a breach of fiduciary duty. Stated differently, it’s legal to say the broker did not act in a customer’s best interest.
  • You can’t appeal arbitration findings; they’re final and binding.
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What Is Stockbroker Misconduct?

Sadly, many types of stockbroker misconduct may lead you to initiate the broker arbitration process. It varies depending on the strategy or product recommended, offered, or sold. The most common type of stockbroker misconduct is misrepresentation. Or when your broker gives you misleading statements regarding the risk of the investment or strategy they’re recommending. 

Types of Stockbroker Misconduct

To illustrate the breadth and depth of stockbroker misconduct, I’ve included a list below:

  1. Unsuitable Investment Recommendations: Unsuitability is what happens when a broker or financial advisor recommends a financial product or strategy that is inappropriate for a particular investor based on their investor profile
  2. Material Misrepresentation or Omission of Material Facts: brokers may try to push you into an unwise investment product by misrepresenting or omitting material facts. The underlying motivation is to sell a product for the commission.
  3. Lack of Proper Diversification: putting all your “eggs” in one basket. Proper diversification is one of the best ways to control risk and avoid excessive losses. If a broker concentrates too much of your portfolio on one type of investment (such as stocks), you face a greater risk of suffering a large loss. 
  4. Excessive Trading (Churning): is a type of misconduct where a broker engages in too many transactions for a given investor or portfolio. They typically do this because each transaction generates a commission for the broker.
  5. Breach of Contract: A stockbroker commits a breach of contract when the broker’s behavior deviates from the investment contract. A breach of an investment contract can constitute a form of securities fraud.
  6. Unauthorized Trading: Unauthorized Trading is pretty much just what it sounds like. It involves purchasing or selling securities by a financial advisor or broker without the client’s prior knowledge or authorization.
  7. Stockbroker Selling Away: Occurs when a financial professional improperly sells or offers an investment opportunity to an investor outside the bounds and supervision of their FINRA member firm
  8. Breach of Fiduciary Duty: Fiduciary duty means that your stockbroker or financial advisor must always act in your best interests. There are many ways this duty can be broken. This can happen through an intentional act or failure to act.

Broker Misconduct Continued

  1. Broker Negligence: Broker negligence generally occurs when a broker fails to recommend “suitable” investments for the customer based on factors such as age, employment status, financial situation and needs, directives as well as investment objectives and risk tolerance level
  2. Outright Fraud: One of the worst and most blatant types of stockbroker fraud is outright theft.
  3. Violation of Blue Sky Laws: These laws, called blue sky laws, also oversee the licensing and reporting requirements placed on broker-dealer firms, individual brokers, and financial advisors. Blue Sky laws tend to favor investors and put the risk of loss on the broker (or other security sellers) for any violation. Technically, this is called strict liability.

What Is the FINRA Arbitration Process?

Once you decide to pursue an arbitration claim against a broker, you file a claim with FINRA. After that claim is filed, FINRA will serve that claim on the broker. A broker typically has 30 days to file an answer upon receipt of that claim. 

Selecting an Arbitrator for the Broker Arbitration Process

Once the broker files an answer, FINRA appoints an arbitrator or arbitrator. All parties involved in the claim can review the arbitrator(s) selected for the case and rank those arbitrators according to their preferences.

FINRA will ask the parties to send them the ranking forms, which are then put into their computer system. Finally, the computer system generates an arbitrator for that case. 

Timeline of the Broker Arbitration Process

Typically, arbitration claims last anywhere from 9 to 12 months, depending on the claim size. But, it is not uncommon for claims to go longer than that, assuming that the parties don’t resolve the case before the final hearing. 

Once the final hearing is heard, FINRA will issue a ruling within 30 days of the final hearing. If found in violation, the broker has 30 days to pay that arbitration award, and if the award is not paid, FINRA could institute enforcement proceedings for the failure to pay.

FINRA Arbitration to Resolve Stock Broker Dispute

The short answer to your question is that you probably signed a contract with an arbitration provision. Nowadays, virtually every customer agreement at a brokerage firm has an arbitration provision at the end of the contract. It’s even in bold, binding, and final, and judges will enforce it; you will be required to go to arbitration. 

In the early 1980s, there were loopholes in ways to get around FINRA. But by 1988, the United States Supreme Court had closed all the loopholes. This made arbitration final and binding on all investors and anybody who signed an arbitration contract, for that matter. 

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Arbitrations vs. Trials

Arbitration does not grant you all the rights you might have in a trial. More specifically, you don’t have a jury trial, you don’t have a trial by your peers, and there is limited discovery in arbitration. For example, there are no depositions.

Limited Grounds for Appeal

Notably, you have limited appeal rights. More specifically, you can’t appeal an arbitration; it’s generally final and binding. Unless, of course, you can prove the following:

  •  Fraud or corruption. 
  • the arbitration didn’t give you a postponement when you deserved it, 
  •  if the arbitrators exhibited evident evidence partially, or,
  •  they refused to follow the law

But, there are benefits to arbitration.

Benefits to Broker Arbitration

For one, you have experienced arbitrators who are knowledgeable about these issues that the general public – the trial of your peers, might not understand and appreciate the nuances. 

Also, it’s much quicker and cheaper than litigation. You can have a decision much quicker in arbitration than you can in the trial court. Also, the expenses are less. 

 Notably, though, arbitration is considered an “equitable forum.” What this means is arbitrators don’t have to apply the law strictly. In arbitration, they might not rule for one side or another. The investor can be partially right or particularly wrong, and arbitrators can split the difference. In the context of broker arbitration, there is much more room to plead a whole range of alleged violations in a FINRA statement of claim.

Final Thoughts

Consumers pursue arbitration because of claims of a breach of fiduciary duty, which is the legal way of saying the broker did not act in a customer’s best interest. Unfortunately, stockbroker misconduct — negligence or even downright fraud — is a real and serious problem that costs investors hundreds of millions annually. 

If you have a problem with your investment broker and cannot resolve the dispute independently, please click here for an overview of the FINRA arbitration process.

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