Lawyers who represent investors in securities arbitrations hope that a proposed NASD rule—which would give them the option of demanding written explanations from arbitration panels that hear their disputes against brokerage houses—will take effect soon. Meanwhile, a case pending against the former Prudential Securities offers a window to what could happen if investors get what they wish for.
The NASD proposed the rule in March 2005, just as hearings were convened on Capitol Hill to vet complaints about the securities arbitration system. At the time, Linda Fienberg, president of NASD Dispute Resolution, testified, “We believe that this new option will increase investor confidence in the fairness of the NASD arbitration system.”
When the Securities and Exchange Commission asked for comments on the proposed change last summer, it received a boatload of letters opposing it from brokerage firms, among them A.G. Edwards, Charles Schwab and Raymond James. Because the option to get a written explanation is available only to investors—and to registered reps or RIAs who bring a dispute against the industry to arbitration—the brokerage firms claim the new rule would be “inherently unfair” and “prejudicial.” The NASD is reviewing the objections, and arbitration lawyers believe it will make revisions to address the industry’s concerns. (An NASD spokeswoman said only that the agency has yet to make a decision on how to proceed.)
In May, Thomas Ajamie, a well-known plaintiffs’ lawyer from Houston, won an $11.5 million award against Prudential from an arbitration panel at the New York Stock Exchange. The award, with back interest, amounts to $14.5 million. The third largest award handed down by an NYSE panel, it came as a surprise to Ajamie, who had also filed a lawsuit in New York State court seeking to have one of the arbitrators removed for failure to disclose her ties to the securities industry.
But the arbitration award was unusual for yet another reason: The arbitration panel chose to pen a detailed written explanation rather than simply putting a dollar figure to the claim or denying it in a single word, as they so often do. Under NYSE’s rules, like the NASD’s current system, such written explanations are within the sole discretion of the arbitrators. And the panel’s explanation in Sahni v. Prudential Securities makes for strange reading.
“No attempt will be made here to summarize all the testimony and evidence, which frequently proved largely irrelevant, inconclusive or contradictory,” the panel wrote. It called the allegations against the named Prudential officers “false,” and described the investors’ failure to name their individual broker as a defendant or to “offer any explanation why this was not done,” as “one of the unanswered questions” in the case.
“The panel considered this to be highly significant,” according to the decision, because the relationship between Charanjit Sahni and his broker was “deeper and more significant than that of a broker-client.” And they speculated that documents opening the account, crafted by Sahni and his broker, were “perhaps deliberately” intended to duck appropriate supervision by Prudential. In the end, they concluded that Sahni and his broker “were in effect ‘partners’” and that the $23 million loss in his account “should appropriately be shared.”
Citing a lot of this language, Prudential has sought to vacate the monster award, calling it “irrational and in manifest disregard of the law.” When Ajamie filed his July 20 response on behalf of the Sahnis, his brief explained why his clients’ broker had not been named in the arbitration: The broker had filed for personal bankruptcy and his potential liabilities to his former clients had been discharged. “Although contained in the record, the answer was apparently missed by the arbitrators in their reviewing 9,000 pages and 241 exhibits,” Ajamie’s brief points out. The arbitration spanned two-and-a-half years and included 83 hearings and the testimony of 37 witnesses.
Ironically, Ajamie and his clients would have been better off had the arbitrators kept the parties in the dark as to why they rendered their monster award. Now Ajamie is relying on the argument that defense lawyers usually assert: He reminds the court that Prudential mandated his clients to sign a contract agreeing that “arbitration is final and binding on all parties.” This contract—standard industry practice since the U.S. Supreme Court upheld the constitutionality of mandatory arbitration clauses in agreements between customers and brokerage firms—blocks appeal of arbitration awards in all but the narrowest of circumstances.
Ajamie, for his part, believes the proposed NASD rule would be a welcome change from the one-sentence orders that leave his clients in the dark 90 percent of the time. Like other plaintiffs’ lawyers, he complains that arbitrators often issue awards with damages that bear no relationship to the evidence introduced in the case—a phenomenon they believe is driven by a desire to “split the baby” so they will be chosen again to serve on arbitration panels.
“It’s fairly well recognized or understood that arbitrators purposely compromise their awards. Often they’ll come up with a number that seems to bear no rational relationship to the evidence that was put in on damages,” says Jay Salamon of Cleveland’s Hermann Cahn & Schneider, whose firm represents investors. “They are generally extremely frustrated with not knowing why the panel did what they did.” But giving the right to a written decision to defendants, he says, would be “a clear invitation for abuse, because brokerage firms would comb decisions to find a basis for costly appeals.”
For now, Ajamie’s case seems to show that a written explanation will, in fact, cause delay and give opponents the opportunity to make arbitrations, which were meant to be streamlined and simple, more like complicated and costly court cases. And some believe it will ward off arbitrators, who will be paid a paltry $200 extra when asked to write a decision, from signing up to serve on arbitration panels.
Cheryl Moore, a defense lawyer with the Dallas office of Patton Boggs, says complaints about illogical damage awards by lawyers for investors are nonsense. “There’s nothing that says there has to be a rhyme or reason as to why the panel arrives at a certain dollar amount,” says Moore, who also serves as a securities industry representative on arbitration panels. She also worries that the proposed rule, if adopted, will discourage people from serving. “The panel is going to be walking a tightrope any time they give a reasoned opinion,” she says. “That’s why I think you’re going to find some watered-down version of this rule.”