While the broker that actually sold the investment may be the sole party in an action (usually where the investor has filed without aid of counsel) most actions include the brokerage firm as well. The question that usually is asked by arbitrators is what part the firm played in the review of the brokers actions and what liability might they incur. I submit that the supervisory requirements of a firm is at least 50% responsible for the actions of the broker. The crux of this statement comes from the very limited information imparted to a broker in licensing preparation courses for the various security exams and the fact that, until 1995, there was no continuing education necessary in the securities business. The brunt of the education- and hence capabilities- in order to be knowledgeable with customers falls on the B/D firms when they accept the broker in the firm.

In the instructional courses I have taught over the years- Series 4, 6, 7, 22, 24, 26, 27, 52, 62, 63, among others, some are for preparation for registered representative licenses to conduct sales and others are for principals licenses which are needed to oversee that actions of such brokers. The licensing courses provide information necessary to pass the exam but are woefully inadequate to address the concerns of most investors/customers. There is incidental instruction on either diversification or suitability- perhaps fifteen minutes total over a two or three day class. (This is not only what I do but the same as other instructors from various firms throughout the U.S.) While the principal courses (26, 24, 8, and 4) are intended to provide additional instruction on certain areas, the coverage of the two preceding subjects is essentially the same- nothing. Yet these are the two most critical issues that are or should be addressed in most arbitrations.

It is my contention that, irrespective of the lack of instruction or rules regarding these areas, the supervisors and firm are unquestionably responsible for most actions of a broker since they, unquestionably, accepted the responsibility upon the broker's employment. Further, if they do not provide or require more courses to cover these and other pertinent problem areas, then they are then even more liable for this inaction. Therefore, for most arbitrations where the supervision was a critical issue, I believe that a firm may be responsible for from 50% to perhaps even 75% of the damages that may be levied. One must also remember that if the supervisor had stopped the illegal activity from day 1, then further inappropriate actions by the broker may have never occurred. There therefore may have been only one isolated incidence to dispute- and that may have been rectified directly by the client and firm and have never required legal action or the use of the arbitration system at all.


This is an issue confronts almost all arbitrators and one that unquestionably causes some anxiety regarding the final (assumed) judgment against a broker. Arbitrators must consider whether the investor's actions- or perhaps even more importantly their inactions- were cause for an offset of the initial award that the arbitrators were considering assessing.

Some attorneys argue that as long as a wrong has been committed, there should be no mitigation whatsoever but a penalty severe enough to stop the injustice from ever being committed again. While I certainly can understand the need to stop illegal or unethical activity, I cannot condone activity by the investor that might have exacerbated the loss due to their inaction in keeping losses to a minimum after an arbitration is filed. I further submit that, even though brokers have a fiduciary or quasi-fiduciary responsibility to clients, there is first and foremost a fiduciary responsibility an investor has is to him/herself in using a reasonable amount of due diligence in determining whether the investment advisor had adequate qualifications to perform the tasks intended or undertaken and that the investments seemed acceptable. (This is an area that requires extensive review and analysis in literally all arbitrations since there is NO Carte Blanche rules establishing guidelines for each investor/broker/firm/investment. The age, education, experience, background of each party as well as the investments selected requires a myriad of interrelating issues to consider. But it is these questions that must be investigated by arbitrators before a final ruling.)  Unfortunately, there is literally no commentary by the media or other source expounding on the issue that a broker has never been taught the fundamentals of investing. That clearly limits the ability of the consumer to recognize what "competency" actually is

Nonetheless, my contention has been that defendants may prove an offset for damages if there is investor inaction that could have prevented part of the loss. Usually it involves holding a declining security far longer than a prudent or reasonable man would consider once the arbitration is filed. In some situations, it is shown that once an investor determines he has purchased an inappropriate investment that has already lost considerable sums, he has a tendency to hold on to the investment either 1. to try to regain some monies back or 2. to show a further loss that would supposedly further convince the arbitrators of the poor investment. I feel that once the plaintiff has determined the problem, he should conduct himself in a prudent manner in keeping subsequent losses to a minimum. He should engage at least a competent investment adviser to determine the best course of action in regards to the investment itself. He should concurrently contact the NASD or other SRO and seek competent legal counsel.

Once again, however, the real world implications need attention. Investors utilize their advisors as the singular source of expert advice since that is why they hired them in the first place. If something goes awry, consumers tend to act emotionally- not objectively- and have a fear of regret should they sell a losing position. Khanemann and Tversky have clearly identified the issue for years and the emotion of investors is now fully addressed by the likes of Barber and O'Dean. Lastly, even if the consumer sought out further expertise, what do they look for? A designation of CFP? CFA? What if their current adviser held the "title" of SEnior Vice President?   

There is a concern for investors who supposedly or apparently never read any of the monthly brokerage statements. It is not meant to imply that investors would always understand such statements, but investors should at least had made the attempt to review these statements to see if there is any APPARENT problems. The term "apparent" is rather nebulous since unsophisticated investors have little understanding of security applications, suitability, risk, etc. and may rarely grasp what may be transpiring.

Neither defense is rarely a full offset of damages since the broker and firm are supposed to have greater knowledge and capability in formulating any actions. The firm has a fiduciary obligation to be sure their agents understand the investments being sold since they are fully aware that licensing training provides nil insight for any investment at all.

Investors unquestionably need to do more research on the products- and particularly their brokers- and accept some responsibility for doing absolutely nothing. Blindly and solely relying on a broker they never met (cold calls) to invest considerable sums- and particularly retirement funds- is illogical. Forum staff also state (privately) that investors need to take more responsibility for their action.

All that said, overriding all this commentary is the clear element of marketing that "runs the world". People perceive a level of competency and trust that is inherent in every ad for almost all types of investment and insurance products. Even where the investors do due diligence, it is debatable that they could find the independent info. I therefore weigh the action of investors with the mandatory fiduciary duty of the agents and firms as carrying the bulk of responsibility for the final decision.

Punitive Damages

Damages are meant to compensate a plaintiff for losses due to activities by the broker and/or firm. In most cases, arbitrators do exactly that- though as stated above, there may be an offsetting amount due to the investor's inaction (never reading a statement). But the justification for punitive damages is riddled by arguments from industry attorneys that arbitrators lack the authority to make such awards. And even if so, on what basis are the punitive damages to be based? Merely as additional compensation or do they actually represent some greater motive? Probably the issue that needs to be expanded by plaintiffs is the use of punitive damages to stop the action from ever happening again. In such cases and particularly with large major houses, the award would have to be considerable and perhaps bear no resemblance to the basic award. I'm not suggesting that that this tact be used in arbitrations but merely presenting it for consideration in those cases where extreme unconscionable behavior was evident.

New York rules- There currently exists a law in New York which does not allow punitive damages to be awarded in arbitration issues. Attorneys in other states may imply that their arbitration case falls under the New York state rule due to the account form signed by the client or simply that punitive damages may not be awarded by arbitrators in any case.

Arbitrators do quite obviously award punitive damages, but the issue in regards to New York state needs further clarification.


In making final decisions, arbitrators must consider innumerable factors- the actions and intent of the parties, when the investments were made, etc., etc. Quite obviously therefore, the decisionmaking process requires compromises and estimations. They rarely involve lengthy scientific calculations- but some arbitrators feel a compunction to prepare an extensive analysis and show a final award in dollars and cents- perhaps to relay to the parties that considerable forethought went into the deliberations. However, such calculations are usually unwarranted and tend to show a lack of understanding of statistics.

To put the comments in perspective, assume you were multiplying $968,332, rounded to the nearest million, by .006675. Then end result can not have any higher degree of accuracy than the least accurate figure. So while the answer for the above is $1,000,000 x .006675 is $6,675, it really is more accurately displayed as $7,000 due to the previous rounding. Arbitrators would do well to understand the above and avoid and lengthy process of calculations that are estimations to begin with. Formulate the overall damages and that should be sufficient.

Joint and Several

Awards made against both the firm and broker have, apparently in most cases, simply been lumped together and filed accordingly. The assumption is that the parties will determine who is to pay the damages and that any split of the liability is done separately. If one accepts my position that the brokerage houses themselves are more liable for many infractions due to their supervisory and control position, then the awards should be deliberately broken out to display the percentage allocated to each party. As such, perhaps 25% of an award is to be paid by the broker and 75% by the B/D firm. The award recognizes the separation of responsibility. However, to assure full payment in case of broker default, the judgment may be made joint and several with the B/D firm.

By the same token, if it was to be shown that the broker was more responsible for the infraction, then the award should show that percentage orientation. And perhaps the arbitrators might suggest only a several award so that the ultimate liability is made clear.

SEC FINES: (1999) For all the rhetoric that the SEC expends regarding how well it protects consumers, it still collects ONLY 50% of all the fines it levies. Over $2.5 billion remains uncollected from the past 13 years. A lot of that is due to small cap investments.

SEC’s Office of Investor Education and Assistance (2001): The number of online trading complaints that investors filed with the SEC surged from 259 in the SEC’s fiscal year1997, which ended September 30, to 1,114 in fiscal1998 and then continued to soar to 3,313 during fiscal1999 and 4,258 during fiscal 2000.

Arbitrations/SIPC and more (WSJ): (2001) Susan Wyderko, director of the Securities and Exchange Commission's Office of Investor Education and Assistance suggested for people who wanted to avoid problems- you want to know "how the investment fits within your portfolio and your desire for risk." How I ask? If you don't know what diversification is by the numbers (and since your broker doesn't know either), there is literally no way you can determine the risk within a portfolio. You are unqualified. But so is your broker since they have not been taught the fundamentals of investing either.  As such, you cannot determine suitability. I would almost bet that Wyderko does not know any of these statistics either. Betcha.

As further commentary- your "desire" for risk may be totally contrary to what you should be doing. But her comments reflect how the industry looks at you as a consumer. A great big money pit where knowledge and ethics are extraneous.

SIPC's $500,000 "protection"  covers only losses due to theft and proven unauthorized trading. Fraud, excessive trading and manipulation of stock prices don't qualify.

Want to try arbitration? (2001) Just 55% of cases heard by arbitrators are decided in favor of investors, according to NASD Dispute Resolution Inc., an arbitration forum operated by the National Association of Securities Dealers. "Just because an investor has lost money doesn't mean the broker has done something wrong," says NASD Dispute Resolution President Linda Fienberg. Ms. Fienberg notes that 70% of arbitration claims are settled before a decision is reached.

When a case isn't clear-cut, arbitrators often "split the baby," giving the broker, say, 60% of the responsibility for any losses and the investor the other 40%. Punitive damages are handed out infrequently. Unless the panel awards attorneys' fees, your lawyer will typically collect about one-third to 40% of any award or settlement.

Even if you do win, will you get paid? A GAO study of arbitration awards handed out in 1998 found that 52% of arbitration awards weren't paid, and 12% weren't fully paid. It's now up to 13% since a lot of the small firms simply go out of business.

Big Case: (WSJ 2001) Merrill Lynch & Co. settled a high-profile arbitration case brought by a former client who claimed he was misled by a bullish stock call by technology-stock analyst. The stock was plummeting but the owner was encouraged to hold on because the analyst kept saying it was a "buy". Guy lost $500,000. Got $400,000 back in a settlement.

Securities arbitration: Punitive damages are awarded in just 2% to 4% of all securities arbitration cases

Arbitrations. (2201) Historically, only 46% of investors ever get any money back and that is just 36 cents on the dollar. Only a third of winners ever get paid in full. It typically takes 14 months for a claim above $25,000 to work its way through the system.

ARBITRATIONS: (2002) Cases filed in 2001 with the NASD Dispute Resolution arbitration forum increased 24 percent from 2000 filings, an increase of almost 1,400 cases, in year-end statistics. Some of the most common allegations made in these claims were negligence, misrepresentation, unsuitable recommendations, and failure to supervise.

Lawsuits: (WSJ) -- Last year was a record-shattering year for securities litigation, with 483 outpacing the 201 filed in 2000 and the 207 filed in 1999.

The PricewaterhouseCoopers LLP report says the suits break down into two broad categories; the majority, 308, concern the allocation of shares in initial public offerings, while the remaining 175 stem from alleged accounting abuses.

In the first five months of this year, more than 60% of the 95 suits filed involve accounting issues.

The IPO-allocation suits are directed against technology, telecom and biotech companies, as well as the securities firms that brought them to market. In most cases, they involve allegations of "laddering" -- a common practice during the bubble. In such cases, certain investors promised to buy additional shares of new issues at progressively higher prices, kicking back a percentage of the profits they made on the hottest issues by rewarding the brokerage firms with additional business.

The other cases revolve around questionable accounting practices, particularly improper revenue recognition or artificially inflated revenue. For example, companies, particularly software companies, recognized revenue even though the product never left the warehouse or when it was defective and sure to be returned, according to the suits."

Of course, if you bought IPO's- actually any individual securities, you were clearly aware of these improprieties, weren't you? I repeat, if you do not know diversification by the numbers, you are out to lunch as an investor.

Arbitrations: (2003) Arbitration suits filed by investors against brokers were up 25 percent in the first four months of this year, versus the same period last year. In 2002, some 7,704 suits were filed, up 38 percent from 2000. Securities regulators are also investigating the mutual fund marketing practices of brokers and their firms.  

Securities arbitration: (2003) There were nearly 1,250 arbitration cases involving mutual-fund sales last year, compared with just 121 in 1999. Current pace is for more than 1,850 by year's end.

Arbitiration:  (2009)While it is undoubtedly true that NASD has instituted procedures to achieve improved procedural fairness in securities arbitration, it is equally clear that its rules fall short of achieving substantive fairness. Part III found only a few selected areas in which the NASD has opted for a substantive rule of decision. The overriding impact of this NASD tradition of encouraging results that are “fair and equitable,” with no guiding standards, is that the system is not substantively fair.
Particularly telling is the NASD position that its arbitration panels are to act like juries rather than judges.144 Juries as decision makers require guidance on the rules of decision. Judges play an important role in jury trials instructing the jury panel on the rules of decision and providing structurally essential clarity on the precise questions that should be answered by the jury. A jury, or a NASD panel of arbitrators, that is unguided in its task is incapable of achieving a substantively fair result. And even with the best of judicial guidance the American jury is not lauded for decisions that are systematically consistent and principled.
The NASD’s unwillingness to require true expert panels may explain its reliance on a jury model. But the price of a pure jury model of arbitration is a set of non-experts incapable of achieving any kind of principled decision. An expert panel comprised of at least two securities lawyers, for example, would be able to apply fixed rules of law. The present situation, in which the NASD fails to systematically train its lay panels on substantive law, creates the sort of chaotic and sporadic use of law that gives rise to unpredictable and arbitrary awards----exactly the sort of decisions criticized by the legal philosophers summarized in Part II.
The irony of the NASD’s reliance on equity as a sort of rule of decision is that equity is best applied by experts. Arbitrator expertise is a crucial core ingredient of arbitration and essential to a fair result. A knowledgeable expert arbitrator can achieve equity by crafting a norm that fills a gap in the formal rules but is consistent with positive law.146 A juror arbitrator, the model presently used by the NASD, is incapable of using nuance or accurate policies when attempting to base an award on equity. By creating the juor model and eschewing panel expertise the NASD has essentially abandoned the greatest advantage of arbitration, that of arbitrator expertise.

As applied to securities arbitration, the disputants need a fixed rule of decision to fairly prepare their case in an efficient and usable manner to enable efficacious arbitrator action. The securities arbitration panel needs a settled rule of decision to aid it in entering a predictable and consistent award. While it is true that NASD references the rule of law in selective arenas, on the whole NASD arbitrations are characterized by only sporadic and inconsistent use of a fixed rules to guide arbitrator decisions. NASD arbitration panels “are a law unto themselves,” routinely deciding cases “according to their own views of justice.” The lack of discursive, written awards with findings contributes to the problem of an elusive, moving target in NASD arbitration.

The continued cliche that securities arbitrators rely on equity as a rule of decision does nothing to solve the problem of an elusive target. Equity is so vague and ambiguous that it fails to guide parties. Equity also provides little guidance in the hands of a nonexpert panel incapable of crafting an equitable result that employs the polices underpinning substantive rules.

* In fiscal 2006 only 1.3% of all federal civil cases went to trial. In great contrast, 21% of NASD cases went to hearing in 2006.  While most NASD cases still settle, the NASD settlement rate cannot compare to the more transparent, higher rate of the federal courts. 

* A broker owes a duty of care to a customer. While their relationship is contractual, the interactions between a professional (the broker) and a securities buyer, often unsophisticated and lacking investment knowledge, are far from those of equals. They are not part of the same community and seem a questionable fit for individuals capable of forging trade customs. There well may be trade customs for brokers but whether these can be imposed upon securities buyers, certainly a distinct subculture, is problematic.

The failure of NASD to invest in achieving panel expertise makes little sense—expertise is an unquestioned advantage of arbitration that distinguishes it from other forms of dispute resolution. Expert securities arbitrators would 
be capable of applying the relevant securities law and thereby lower the costs of customer-broker disputes by implementing a culture of substantive fairness. 

EFM: To the authors at Lewis and Clark Law School- Excellent!!!!

The problem of fairness goes further. Arbitrators do not know the fundamentals of investing. Fair enough for the lay arbitrators. But the fundamentals of investing have never been taught to brokers, supervisors, attorneys et al. The NASD has never demanded this in licensing or in any other venue. One must know diversification (by the numbers) in order to understand risk. And one must understand risk in order to get to suitability.

Alpha, beta, correlation (mind numbing), standard deviation, Monte Carlo, risk, diversification, asset allocation and on and on are not required knowledge in any licensing exam. I never yet met a securities attorney who knew diversification- and only a couple that cared. Arbitrations are generally based on interpretations that do not have much to do with real life application. 

I do not see this changing in my lifetime.