WealthManagement Magazine

Turnstile Justice

If justice is indeed a blind date, she sure isn't a cheap one. Especially not in the investment business where individual parties have to pay some costs up front, and can even get hit with a large bill smack dab in the middle of a hearing.This policy, plus a recently proposed increase in arbitration fees, has got some critics of the industry-run justice system up in arms.Among those complaining the

If justice is indeed a blind date, she sure isn't a cheap one. Especially not in the investment business where individual parties have to pay some costs up front, and can even get hit with a large bill smack dab in the middle of a hearing.

This policy, plus a recently proposed increase in arbitration fees, has got some critics of the industry-run justice system up in arms.

Among those complaining the loudest is Diane Nygaard, an Overland Park, Kan., lawyer and president of the Public Investors Arbitration Bar Association (PIABA), a group of lawyers who represent investors. "PIABA strongly opposes any effort made to increase the expenditure by investors who've been defrauded in order to get access to the only forum in which they are allowed," Nygaard says. "No court charges the kind of fees the NASD does."

Mitchell Perlstein, a Boca Raton, Fla., lawyer who sued the NASD in July claiming fees already were too high (see "Due Process Denied?" Page 83), says the proposed fee hikes just make things worse. "We believe that the fees are at such a high level today that they act to prevent investors from bringing [arbitration claims] against the broker/ dealers," he says.

Perlstein says one of his investor clients has put up almost $3,000 in filing fees and hearing deposits for a $50,000 claim against Monarch Financial, a New York brokerage. And that was before the first scheduled arbitration hearing in January.

Lawyers say public courts, which are paid for largely with taxpayer dollars, charge less than NASDR-run arbitration hearings. Also, court plaintiffs don't have to make a large down payment to cover the costs associated with a trial.

For someone who's suffered losses through fraudulent investments, or been wrongfully terminated from their job, paying up front for justice can sometimes be difficult. Brokers suing firms site several cases in which they've been hit with thousands of dollars in fees in the middle of an arbitration.

T. Sheridan O'Keefe, an independent rep in Minneapolis, says he recently got hit with an $8,000 bill he says he might not be able to pay because of financial difficulties that occurred after he left Piper Jaffray in 1991. He alleges wrongful termination against the firm and is suing for $6 million.

O'Keefe's bill came late last year after he'd gone through several sessions; his case is set to resume in April.

"If I don't pay the forum fees, am I still allowed to finish my case?" O'Keefe wonders. "They now want a copy of my balance sheet."

(O'Keefe is president of the National Association of Investment Professionals [NAIP]. The editor in chief of RR magazine is an NAIP board member. O'Keefe also writes a monthly column for this magazine.)

Piper Jaffray could not be reached for comment.

Meanwhile, last January, in the middle of another wrongful termination case, broker/claimant Paul Svigos of Chicago got a bill for $21,150, and respondent Merrill Lynch, his former employer, received an invoice for $22,650 as a "deposit" for anticipated forum fees, according to transcripts from the case.

Cliff Palefsky, a San Francisco plaintiffs' attorney, says he knows of cases in which brokers had to pay $30,000 or more in fees just to have cases heard. "This is all part of the outrage," Palefsky claims.

Arbitrators can, however, take into account a claimant's financial circumstances when assessing forum fees.

On the other side, many industry lawyers argue that despite the proposed fee increases and prepayment policies, arbitration is still much less expensive than going to court.

"At first it might appear [arbitration] fees are an impediment," says Bradley Schram, of Hertz Schram & Saretsky, a law firm in Bloomfield Hills, Mich., which frequently represents brokerage firms. But if investors and brokers "go through the civil process and an attorney is paid by the hour, it would be, on balance, a much longer process."

And few dispute that many claims heard in arbitration would be thrown out in court on technical grounds.

But then claimants may lose out on potential awards, too. Seven-figure arbitration awards in wrongful termination cases, for example, are rare--and could become almost a thing of the past if the NASDR's proposed cap on punitive damages is approved by the SEC. The proposal would limit punitive damages to $750,000 or two times compensatory damages, whichever is less, and then allow for punitives only if existing state law permits such awards.

"Employees who think that they've been severely wronged often prefer a jury trial where they often expect to get big awards, including punitive damage awards," says Gary Benton, a securities attorney with Coudert Bros., an international law firm in San Francisco.

And if a plaintiff in civil court wins a case, the other side often has to pick up the plaintiff's legal tab. In industry arbitrations, panels often split the costs down the middle; and it's not uncommon to see parties challenge a panel's award of attorneys' fees since arbitration law is unclear as to whether arbitrators can grant legal costs.

Meanwhile, the NASD argues that its fee structure is necessary for cases to be heard. "If the NASD is limited to a small administrative fee, as plaintiffs suggest, the NASD's ability to provide the arbitration forum will be severely impacted," according to a memorandum of law in support of the NASD's motion to dismiss the class-action lawsuit filed by Perlstein.

And the NASDR argues that it needs to increase fees to make arbitration become a self-funding operation. In 1996, it cost the NASDR $11.3 million to provide arbitration services above the amount of the fees paid by participants. The SRO estimated the gap would have been $7.1 million in 1997 even with the higher fees, and projects a $7.4 million shortfall this year.

The NASDR says it has no intention of keeping customers, brokers or anyone else out of arbitration by raising fees. "NASD Regulation is proposing filing fees designed to cover as much of the actual costs of the arbitration process from filing up to the pre-hearing conference as is possible without erecting barriers to entry to arbitration," says the organization's Oct. 28 filing with the SEC.

And the SRO is attempting to switch arbitration costs to the firms that wind up in arbitration the most. Without naming names, the NASDR pointed out that 88 out of 5,500 member firms accounted for more than half of all arbitration cases in 1996. Each firm had more than $100 million in revenue. By contrast, firms with less than $500,000 in revenue accounted for less than 3% of the cases filed. Public investors paid about 23% of the fees the NASDR received from arbitration, or $3.5 million compared to $11.8 million paid by member firms for the 12 months ended Aug. 31.

Additional money to close the arbitration cost gap will come from the industry. "There will not be any further increases in fees charged to public investors in the foreseeable future," the NASD's filing states. The fees for public investors and "associated persons," that is, brokers, are the same.

But the plaintiffs' bar is crying foul. "When you look at a situation where somebody has a $50,000 claim and they can run into a couple thousand dollars in fees," Perlstein asks, "how much money are they willing to risk?"

The NASDR has proposed raising the cost of getting one's day in arbitration.

In a 57-page proposal filed last year with the SEC, the NASDR is seeking to raise by about 50% the filing fees and hearing-session deposits paid by customers, brokers and firms for claims that ask for $1 million or less.

The NASDR expects the increases will raise arbitration revenue to $26.7 million in 1998, up from $22.7 million in 1997, according to the SEC filing. At press time, the fees were scheduled to increase sometime last month pending SEC approval.

The NASDR argues the money is needed to cover operating costs and points out that brokerage firms will have to cough up the biggest chunk of the $4 million in increased fees.

The filing fee for a customer who claims he or she lost $50,000 to $100,000 will jump to $300 from $200 under the NASDR's proposal. The deposit to cover the cost of arbitrators for the same case could go to $1,125 from $750 for each session with three arbitrators, and to $450 from $300 per session for one arbitrator. Only part of the increase will go to pay higher "honoraria" for the panelists.

The money can add up quickly and is "a huge barrier for anybody with a moderate size claim or anybody who has been wiped out," says James Beckley III, a Wheaton, Ill., attorney.

Details about the proposed fee increases can be found by going to RR's Web site at rrmag.com. Go to the "Hot Topics" section, look for this same story and click on the link at the end.

People shouldn't have to pay for services of a judge.

That's the argument being made by Boca Raton, Fla., attorney Mitchell Perlstein, who filed a class-action suit against the NASD and the NASDR July 7 in U.S. District Court for the District of Columbia, which claims that the high cost of arbitration--specifically forum fees--is essentially a requirement that a plaintiff pay for the services of a "judge" (arbitrator). Mitchell argues that this is a denial of due process. The suit asks for a jury trial, and requests that the NASD and the NASDR be "enjoined and restrained from charging any investor claimant appearing before its arbitration forum, pursuant to an Arbitration Clause in a Customer Agreement, for any fees other than reasonable administrative fees in nature to those charged to Plaintiffs in court."

The NASD has moved to dismiss the claim. A hearing on that motion is pending.

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