The Problem of Unpaid Securities Arbitration Awards

The big players in the securities industry have deep pockets and can afford to settle or pay securities arbitration awards when the lose.  But a recent report shows that there a plenty of small brokers who either can't or won't meet their obligation to pay customers harmed by their misconduct.  Unlike other licensed professionals brokers are not required to carry insurance and their firms may have surprisingly little cash or other assets available to satisfy claims.

A recent report by the Public Investors Arbitration Bar Association (PIABA) reveals that nearly $1 out of every $4 awarded to customers in arbitration went unpaid in 2013  The report describes the scope of the problem, provides context, and reviews and recommends solutions.  Brokers who fail to pay are barred from the industry, but the PIABA report suggests that regulators should not tolerate the status quo.  The problem has been around too long and hurts too many investors.  It concludes:

 “Allowing one in three awards to go unpaid is unconscionable.  FINRA’s cures:  barring from the industry those who fail to pay awards, and notifying claimants that they can pursue actions in court against former FINRA members, have failed to cure, or put a meaningful dent in, the problem.  Steps must therefore be taken to put forth a new division of FINRA to craft and administer a National Recovery Pool.”

Per PIABA, a small per-broker fee would quickly generate a large fund, which could be used to reimburse investors unable to collect on their awards.

FINRA has issued figures suggesting that the problem is not quite so grave.  According to a Wall Street Journal article, FINRA's figures put the prevalence of unpaid awards at about 15%.   FINRA continues to "study" the problem.  That is little solace to investors who obtain an award, often at significant legal expense and cost, but find that the award is noncollectable.

Expelled Stockbrokers vs. Disbarred Lawyers

Earlier this year, USA Today reported that FINRA suspended a record number of brokers in 2015, but the FINRA chairman, Richard Ketchum, responsible for the crackdown is retiring. 

A review of FINRA statistics, including data on investor protection, shows that FINRA got results more or less on par with 2014.  In 2015, 492 brokers were barred from Wall Street. That compares with 481 brokers barred in 2014, only eleven fewer.  In 2015 FINRA levied fines of $93.9 million.  That compares with $134 million in fines in 2014.  The numbers of firms expelled from 2010 to 2014 varied between 14 and 30.

Just to be fair to registered representatives -- and because there are bad apples in any profession -- I took a look at how many lawyers have been disbarred for the sake of comparison.

In 2011, according data reported in an American Bar Association (ABA) article, 652 lawyers were involuntarily disbarred nationwide, up from 503 in 2010. By comparison, 329 brokers were expelled in 2011 up from 288 brokers in 2010.  The Boston Globe reported that in 2011 there were about 1.22 million lawyers in the United States, which matches ABA data.  This compares with about 630,000 brokers in 2011, according to FINRA data. 

The conclusion from this very unscientific survey, looking at 2011 only, lawyers were suspended at about the same rate as stockbrokers! No further comment.

e-Mediation!

Anyone who has done much securities arbitration work knows about FINRA's mediation program, and of course mediation can be arranged directly by the parties without involving FINRA.

But what about mediation of discovery disputes?  This emerging field invokes mediation for use in discovery of electronically stored information, sometimes referred to as e-Mediation.  The potential benefits include reducing motion practice and fights over discovery, particularly over electronically stored information.  That can save time and money.  Such mediation can be issue based, not time-based to control costs. 

An e-Mediation process to  is worth a look and could benefit all sides (and the court or arbitration panel) under the right circumstances.

FINRA Dispute Resolution Statistics

I'm sharing a few observations on FINRA's dispute resolution statistics (through October, 2015), which are worth a look here: 

• 80% of cases mediated through FINRA in recent years are settled;
• 15% fewer customer cases were filed in 2015 as compared to 2014;
• the average time to hearing is 17.6 months, but about half that time in simplified decisions (for smaller cases);
• breach of fiduciary duty is the #1 type of controversy in each year form 2011-2015;
• municipal bond funds have been the #1 security in customer disputes (thanks in large part, no doubt to Puerto Rican bonds) in 2014-2015, but prior to that time municipal bond funds were nowhere close to the top of the list;
• a steady 18-19% of cases have been decided by hearing from 2011-2015;
• recent statistics (2015) show that customers win about half the time, but FINRA does not report more information that might shed light on why some customers win and others do not (such, as, whether the customer appeared with or without an attorney -- presumably the win rate is much lower for customers representing themselves).

New Hampshire Adopts Uniform Securities Act - Effective January 1, 2016

On July 27, 2014 New Hampshire’s Governor signed into law a new Uniform Securities Act. The new Act repeals and replaces New Hampshire’s current Uniform Securities Act which is based on the 1956 model securities act. The new Act is based on the Uniform Securities Act of 2002, drafted by the Uniform Law Commission of the American Bar Association, which is a model statute designed to guide each state in drafting its state securities law.

The new Act goes into effect on January 1, 2016 and is intended to simplify and facilitate capital-raising by small-and medium-sized companies, better align securities offering rules with regulatory interests, update and clarify securities compliance requirements, and preserve and enhance investor protections. It is also expected to eliminate any disincentives for companies to operate in New Hampshire and bring consistency between New Hampshire securities law and the securities law of many other states.

A link to the new Securities Act is here.

FINRA Proposes Update to Temper Expungement and Elder Abuse

FINRA’s Board of Governors recently voted to move ahead with two key initiatives for broker-dealers. One initiative would amend codes of arbitration to make it tougher for brokers to erase black marks from their public record. The proposal, which will be submitted to the SEC for approval, would incorporate existing guidance and best practices into the rules. The guidance reminds arbitrators that expungement is “an extraordinary remedy that should be recommended only under appropriate circumstances” and that “customer dispute information should be expunged only when it has no meaningful investor protection or regulatory value.” Ultimately, FINRA is trying to strike the right balance between transparency and eliminating information in a report about a broker that is either unfair or false.

The other initiative is meant to enhance protection for senior investors. The rule would require firms to obtain the name and contact information of a trusted person for the customer's account and allow firms to freeze funds in accounts of investors 65 and older when there is “reasonable belief” of financial exploitation. The proposal does not indicate precisely what constitutes a “reasonable belief” of exploitation.

Non-Traded Real Estate Investment Trusts (REITS): Danger for Retail Investors!

Are some investments so risky that they are virtually always unsuitable -- they should never be recommended -- to typical retail investors, regardless of risk tolerance?   Yes.  The purpose of this post is not to generate a list, but to focus on one particular investment that seems to fall into this category: non-traded real estate investment trusts (REITS).

According to a recent article, Fiduciary Duty and Non-Traded REITS by Craig McCann, non-traded REITS performed about as well over the past 25 years as "investing in short and intermediate term U.S. Treasury securities"  but, unlike U.S. Treasury securities non-traded REITS are illiquid and much more risky.  Not only that, non-traded REITS underperformed their traded REIT cousins.  McCann writes, "Investors in the 41 non-traded REITs that became traded REITS or were cashed out suffered $24.25 billion in underperformance."  "Non-traded REITS underperform traded REITS by approximately 6.8 percent annually."

What else is of concern about non-traded REITS? Investors pay a substantial up front fee, averaging 13.2%  This compares with mutual funds, which charge fees topping out at about 5%. 

McCann found that institutional investors tend to stay away from non-traded REITS.  He writes, "institutional investors almost never own material stakes in non-traded REITS." For retail (and institutional) investors interested in real estate there are ready alternatives, including a wide variety of mutual funds.

Non-traded REITS face the triple-whammy of being illiquid, expensive and performing poorly.  According to McCann, "Brokers and investment advisors may have a good-faith basis for recommending that a client make a focused real estate investment, but they cannot justify a recommendation to purchase a non-traded REIT."