Recovered for Investors
At the conclusion of an arbitration hearing, claimants request that the panel award some measure of damages that the claimant proved at trial. Claimants may also ask for other damages such as attorneys’ fees, punitive damages, and expenses in his or her closing statement. The information below details the most common measures of damages and also provides some authority for other types of relief frequently requested by claimants.
Trading losses are the amount of principal losses in an account. Any interest or dividends created by the funds at issue in the litigation are not used to offset the actual losses in the account. The calculation is simply the purchase price minus the sales price. In situations where the security is still held by the customer, one would use the purchase price minus the value of the security at the time of filing the statement of claim or at the time of the final evidentiary hearing.
Example 1: An elderly woman sued her broker to recover her lost retirement savings that were invested in a complex variable annuity. The annuity exposed the woman to substantial market risk and, as a result, she lost $150,000 of her $200,000 account value. Because of contingent deferred sales charges incurred at the time of selling out of the unsuitable variable annuity, the woman had to pay an additional $9,000 in penalties for early withdrawal. At the time of the sale, the annuity had generated approximately $14,000 in interest income over the life of the product. At the final hearing, the customer’s attorneys asked the panel to award the customer full trading losses of $150,000 plus the $9,000 in withdrawal penalties.
Example 2: Under the same fact pattern in example 1, the elderly woman never sold her variable annuity because she could not afford to incur the $9,000 contingent deferred sales charge. At the time her attorneys fi led the statement of claim her account value had declined an additional $3,000. As a result of these additional losses, her attorneys asked the panel to award damages of $153,000.
It is important to note that many brokerage firms argue that damages should be calculated based on net out-of-pocket losses (see explanation below) even though the monthly statements that are sent to clients actually show trading losses.
FINRA’s Arbitrator’s Manual includes discussion about calculating damages. For example, with regard to compensatory actual damages, the Arbitrator’s Manual states:
The recovery of compensatory damages is the primary reason a party brings a claim. An award of compensatory damages may include the party’s actual dollar loss and any other damages. Claimants will generally state a figure in the statement of claim of what they consider to be actual damages. Claim- ants have a duty to prove those damages. All claims for damages should be supported by evidence. The arbitrators may consider the concept of mitigation, where appropriate.
In cases where the losses are not sufficient to hire an expert, use of the firm’s own monthly statements that were sent to the customer can help establish damages. Frequently, the losses shown on these statements are trading losses and not out-of-pocket losses. It will make the respondents’ argument regarding the use of net out-of-pocket losses a bit disingenuous when their own calculations for the clients are based on trading losses.
Net out-of-pocket losses are the losses sustained in an account or specific security offset by any dividends or interest income produced by the account or security. Net out-of-pocket damage calculations are frequently used by experts to calculate losses in an account. They essentially give the respondent the benefit of any income generated by the underlying products. Many claimants argue that the respondent should not receive the benefit of the generated income because a primary goal of many investments is to generate income or dividends.
The law in one circuit is clear that the respondent is not entitled to any set-off from any profits. In Kane v. Shearson, 916 Fed.2d 643 (11th Cir. 1990), the Eleventh Circuit ruled that the broker-dealer is not permitted to argue that the respondent should be permitted to “net” prior gains in any account of claimants against later losses. In Kane, a customer sued a broker and the broker-dealer for RICO violations, violations of the Securities Act of 1933, the Securities Exchange Act of 1934, violations of Florida’s chapter 517, common-law fraud, negligence, and breach of fiduciary duty. The facts in Kane reflect that the broker recommended that the customer purchase shares of March Resources and the customer followed the broker’s advice. The broker then recommended that the customer sell his shares of March Resources and the customer followed the broker’s advice and realized a profit. Three days later, the broker recommended that the customer purchase shares of March Resources stock and the customer invested $196,399. The customer ultimately sold his shares and realized a loss of $137,796 in the second purchase of March Resources. The arbitration panel found that the broker and the broker-dealer violated section 12(2) of the 1933 Act, section 10(b) of the 1934 Act, and the state securities laws, and that the broker and broker-dealer were negligent and breached their fiduciary duty. The panel awarded the customer $28,322.
The customer appealed the award to the district court and the broker and broker-dealer cross-appealed. The district court held that there had been no violation of federal law but affirmed the decision on the Florida securities law claim as well as the common law negligence and breach- of-fiduciary duty claims. Furthermore, the district court held that the customer should recover the entire $137,797 loss from the second sale of March Resources stock and granted prejudgment interest as well.
On appeal to the Eleventh Circuit, the broker and the broker-dealer argued that they should be entitled to offset the losses against gains previously made in the account. The Eleventh Circuit rejected any request for “netting” and held:
Kane [customer] is correct when he states that there is no sup- port to be found under federal or Florida law for the “netting” theory Shearson [broker-dealer] argues for here. What is found, under both federal and Florida law, is the intent to have securities antifraud provisions enforced stringently to deter fraud. As the district judge noted, “If the . . . methodology espoused by [Shearson] were adopted, it could serve as a license for broker- dealers to defraud their customers with impunity up to the point where losses equaled prior gains.
The calculation of a claimant’s net out-of-pocket losses varies depending on whether the panel finds the wrongful conduct involves one or more specific trades or the management of an entire account. For specific trades, net out-of-pocket loss is the purchase price of the security plus commissions minus the total of the value of the security on the relevant date plus dividends or interest received. For wrongful conduct involving an entire account, net out- of-pocket losses are calculated by taking the beginning account value, plus money and securities deposited, minus money and securities withdrawn, less account value on the relevant date. Arbitrators should look to the parties for instructions on these issues.
In addition, some claimants may argue that to award “full compensatory damages” it is necessary to look beyond a claimant’s net out-of-pocket loss. These “special” or consequential damages might include:
Well-managed account damage calculations are used to show the opportunity costs of having the customer’s funds in an account that was improperly managed. This type of analysis is used to show either how much the customer would have made or how much less the customer would have lost had the account been properly managed. Some damages experts use “market-adjusted” damage calculations to show what the customer’s funds would have made had they been allocated to a variety of investment options. For instance, an expert might use a customer’s $100,000 investment and hypothetically invest those funds during the same time period that they were invested with the respondent. The hypothetical model may place the funds in a range of investments with varying risk/return characteristics. Market indices are often used to help compare market performance to the performance or underperformance of the investments at issue in the litigation. Some of the most popular indices include S&P 500 Composite Index, NASDAQ Composite, Dow Jones Industrial Average, Barclays Capital U.S. Aggregate Index, Bar- clays Capital Intermediate Aggregate Bond Index, Russell 2000 Index, and Thomson U.S. Corporate High Yield Index. Of course, the bench- mark used should correspond to the client’s risk tolerance and investment objective so that the analysis remains fair and consistent with the client’s investment goals during the period at issue in the litigation.
Rescission typically is governed by principles of equity or by statute. Rescission is simply the unmaking or cancelation of a contract between parties. The purpose of this remedy is to put the wronged individual back into the situation that existed prior to the wrongful conduct. The customer usually must give back the security, and the firm must return the purchase price to the investor. Some states also force the wrongdoer to pay the investor a statutory rate of interest on the purchase price from the date of purchase to the present. If the investor no longer owns the security, some state statutes provide a formula based on the value of the security at the time it was sold.
Disgorgement is an equitable remedy that forces a wrongdoer to give up any profits obtained by unethical or illegal means. Disgorgement is not intended to punish the wrongdoer, but rather it is a tool to prevent unjust enrichment. In the context of securities arbitration, disgorgement is frequently requested when a stockbroker churns an account in order to generate more commissions. In that case, the broker or firm arguably should not be able to simply return a customer’s principal, while keeping all of the commissions generated by his or her own wrongdoing.
Example: A customer invested $100,000 with a broker. The broker invested the money in suitable securities and the account made money. Six months into the relationship with the customer, the broker began to buy and sell securities in high volume. The account value declined by $3,000, but the broker generated $9,000 in commissions by churning the account. The customer learned of the excessive commissions and, although she had relatively small losses in the account, decided to file a claim to get back the $3,000 plus the $9,000 in commissions.
As the name implies, punitive damages are intended to punish the wrongdoer and deter potential wrongdoers. They are damages that go beyond compensatory damages and attempt to send a signal to wrong- doers that it may be financially harmful to allow certain types of bad behavior to occur. Punitive damages are rare and are typically awarded only in cases where the defendant’s conduct was intentional, malicious, fraudulent, or reckless.
Example: A broker solicited the purchase of a speculative product by telling the customer that the security would pay her 12 percent annually, that her principal was guaranteed, that the security was as safe as a certificate of deposit, and that the broker sold his retired mother the same product. The broker had a history of making this same sales pitch to a number of other clients and had actually been reprimanded by his supervisor for misrepresenting the product. Once the customer realized that the product was not guaranteed and that it would not pay her 12 percent annually, she sued for fraud. The arbitration panel found that the broker had intentionally defrauded the customer and, based on his other similar past conduct and supervisor’s reprimand, it awarded the customer three times her actual damages.
The legal authority giving arbitration panels the power to award punitive damages in an arbitration is found in Mastrobuono v. Shearson Lehman Hutton, 514 U.S. 52, 115 S. Ct. 1212, 131 L. Ed. 2d 76 (1995), which held that punitive damages are permitted in arbitrations under the Federal Arbitration Act.
Punitive Damages—(Arbitrator’s Manual) Arbitrators may consider punitive damages as a remedy. Generally, in court proceedings, punitive damages consist of compensation in excess of actual damages and are awarded as a form of punishment against the wrongdoer. If punitive damages are awarded, the decision of the arbitrators should clearly specify what portion of the award is intended as punitive damages, and the arbitrators should consider referring to the authority on which they relied.
Punitive Damages—(Arbitrator’s Guide) Upon a party’s request, arbitrators may consider punitive damages as a remedy if a respondent has engaged in serious misconduct that meets the standards for such an award.
Punitive damages are not intended to right a wrong, but they are intended to punish the wrongdoer and to deter future wrongdoing. The standards for awarding punitive damages vary from state to state. While most states permit punitive damages only for conduct that is malicious or intentional, some states permit punitive damages for reckless indifference to the rights of others or for gross negligence.
If punitive damages are awarded, the arbitrators should clearly specify what portion of the award is intended as punitive damages. In addition, arbitrators should include in the award the basis for awarding punitive damages. If the panel needs additional information to determine the basis for awarding punitive damages, it should ask the parties to brief the issue to help determine whether both factual and legal bases exist for such an award.
A claimant who requests punitive damages in arbitration should provide in the prehearing brief and in the closing argument the reasoning of the Mastrobuono decision and any other similar decisions from the state or federal courts in the jurisdiction where the arbitration is being held.
Attorneys’ fees are intended to compensate the successful party for having to pay an attorney to protect its interests. Whether attorneys’ fees may be awarded in arbitration is usually determined by state statute. Many state securities statutes provide for attorneys’ fees as an optional, and in some cases a mandatory, remedy for the prevailing party.
Example: Alabama Code Section 8-6-19: Civil Liabilities of Sellers
(a) Any person who:
(1) Sells or offers to sell a security in violation of any provision of this article or of any rule or order imposed under this article or of any condition imposed under this article, or
(2) Sells or offers to sell a security by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, the buyer not knowing of the untruth or omission, and who does not sustain the burden of proof that he did not know and in the exercise of reasonable care could not have known of the untruth or omission, is liable to the person buying the security from him who may bring an action to recover the consideration paid for the security, together with interest at ___ percent per year from the date of payment, court costs and reasonable attorneys’ fees, less the amount of any income received on the security, upon the tender of the security, or for damages if he no longer owns the security. Damages are the amount that would be recoverable upon a tender less the value of the security when the buyer disposed of it and interest at six percent per year from the date of disposition. (Emphasis added.)
Attorney’s fees are frequently requested in arbitration. Arbitrators have the authority to consider awarding attorneys’ fees, but the procedure varies from state to state. It is appropriate for the arbitrators to request the parties to brief this issue.
The authority for granting attorneys’ fees must be included in the award. If the arbitrators have doubts regarding their authority to award such fees, they should ask the parties to brief the issue. There are three situations when parties may pursue attorneys’ fees:
Arbitrators must award reasonable attorneys’ fees to claimants who prevail under certain statutes, including Title VII actions for discrimination based on race, color, religion, sex, or national origin. If the panel determines that a party has a right to reimbursement for attorneys’ fees, that party must prove the amount to the satisfaction of the panel.
Any party requesting attorneys’ fees should be prepared to provide the panel with a detailed breakdown of the work completed, time spent, and hourly rate. In contingency fee cases, the attorney should consider tracking time or providing an explanation of how the contingency fee contract with the client works.
Some SROs subsidize the arbitration forums they sponsor. In order to defray part of the costs, the arbitrators are empowered to assess forum fees as set forth in the rules. When a party fi les a claim, counterclaim, third-party claim, or cross-claim, that party is required to remit a nonrefundable fi ling fee in addition to a hearing session deposit based upon the fee schedule in the Uniform Code. The Director may temporarily waive the fee or deposit. The total fee is determined by the number of hearing sessions. The arbitrator(s) may assess in the final award a fee waived by the Director. When it is clear that multiple hearing sessions are required, the arbitrator(s) should consider requiring the parties to deposit interim forum fees for additional hearing sessions that have been held or are scheduled.
Forum fees may be assessed for prehearing conferences conducted with the parties and an arbitrator. Should a case settle or withdraw subsequent to the commencement of the first hearing session, including a prehearing conference with an arbitrator, the arbitrator(s) may assess forum fees and costs. The assessment should be based on hearing sessions held or scheduled within eight business days after the sponsoring organization receives notice that the matter has been settled or withdrawn.
The arbitrators may also assess an adjournment fee when a party’s request for a postponement has been granted, thereby necessitating rescheduling the hearing. For all of these issues, the arbitrator(s) should refer to the schedule of fees.
In addition to administrative expenses, the parties may request that the arbitrators direct reimbursement for certain expenses such as
It is within the panel’s discretion to decide which party, if any, shall pay these fees and expenses. The panel may use the same basis it did in determining compensatory damages.
Arbitration is frequently touted as a cheaper alternative to court, but that does not mean that the arbitration process is without expense. Filing fees, hearing session fees for prehearing conferences and final evidentiary hearings, copy costs, binder costs, exhibit costs, and expert witness costs all add up very quickly. Parties often ask that the panel award them all of their expenses if they are successful on the merits.
The panel has the discretion to assess forum fees among the parties. In deciding how to allocate the forum fees, arbitrators may consider the following factors:
Occasionally, parties may request that the arbitrators direct reimbursement for expenses of a witness and the costs associated with producing documents. When reviewing witness fees, arbitrators should follow the rule in the applicable jurisdiction. If necessary, the panel should ask the parties to brief the issue. Usually, each party is responsible for producing and copying documents that they intend to use. According to FINRA Rule 12513 the party requesting the production of documents shall bear all reasonable costs of production, unless the panel directs otherwise. On larger cases, a party might ask that the requesting party come to the location of the documents and copy what is needed. If the parties cannot agree on who should bear such fees, the panel must find a reasonable solution. After reaching a decision, the panel should memorialize it in an order or the award.
The parties may request that the arbitrators direct reimbursement for other expenses, such as
FINRA may also alert the panel to outstanding administrative costs such as
A panel may assess each of these fees and costs in its award applying equitable principles.