For example, say a client feels that a broker has mismanaged their investment account. They can file a claim with FINRA, the self-regulatory organization for brokers. Ultimately, an arbitration panel will review the case and make a decision. If the panel rules in the client’s favor, the broker may be required to pay damages to the client.
How Arbitration in Investing Works
The investment arbitration process is usually faster and more affordable than a full-blown lawsuit, making it an appealing option for many investors. And depending on your account agreement, arbitration may also be your only option for legal action. “When a customer opens a brokerage account, they normally sign what’s called a pre-dispute arbitration agreement,” Robert Van De Veire, an attorney at Kurta Law, told The Balance via email. “This means that the customer agrees that if they sue their financial advisor, they will sue them in arbitration, rather than by going to court.” During the arbitration process, an arbitration panel hears both sides of the argument, then makes a decision about who’s right or wrong.
Need for Arbitration in Investing
An investor may initiate arbitration if they believe they’ve lost money due to bad financial advice or their broker’s actions. The U.S.Securities Exchange Commission (SEC), FINRA and state regulators impose strict standards of conduct for broker-dealers and registered investment advisors. Financial advisors are mandated to act in the best interest of their clients and required to disclose any conflicts of interest they may have in the form of commissions they earn on investments they recommend to clients. “Financial advisors and brokerage firms who give investors unsuitable (i.e., bad) investment advice can be responsible for reimbursing their customers for any losses in their investment, and potentially more.” Van De Veire went on to say that investors may also have a claim if their financial advisor stole from them or borrowed money from them and failed to pay it back. “In such a case, the brokerage firm may be held responsible for repaying the customer—with interest.” “I often see clients who lost money with a broker who has done the same thing to other clients in the past,” said Van De Veire. So confirming credentials should be a critical part of the vetting process.
What Does the Arbitration Process Look Like?
To kickstart arbitration in investing, an investor should first file a Statement of Claim with FINRA. This statement includes dispute details, such as:
Relevant datesNames of individuals or businesses involvedType of relief requested (i.e. monetary damages, interest, certain performance, etc.)
Once you file the claim, FINRA will then appoint a panel of arbitrators. If the claim is over $100,000, then three arbitrators will sit on the panel. “Two will be public arbitrators who haven’t worked in the securities industry and one will be a non-public arbitrator with strong ties to the securities industry and practical knowledge of its norms and regulations,” Eric L. Pines, Esq., founding attorney of Pines Federal, told The Balance via email. Claims of less than $100,000 will typically have just one arbitrator — who must be a public arbitrator under FINRA Rule 12402. Any claims that are $50,000 or less are considered “simplified arbitrations” and don’t have a formal hearing unless one is requested by the investor. “If an arbitration panel dismisses an arbitration claim because it’s untimely, then the investor can pursue claims in civil court. However, civil statutes of limitations are shorter than six years and vary from state to state,” said Pines.
Arbitration vs. Litigation
Arbitration in investing is similar to a lawsuit — but there are some key differences. “Arbitration also has less ‘discovery’ — the part of the case where both sides demand that the other side produce evidence in the form of documents and deposition testimony,” Van De Veire said. “Because of this more limited discovery, arbitrations tend to move much quicker and reach a settlement or final decision faster.” Van De Veire said most FINRA arbitrations are resolved in less than two years, whereas court cases can last four or five years or even longer. Lastly, arbitration decisions are final — they can’t be appealed. However, you can appeal most court cases at least once. According to Van De Veire, the appeal process can add another year or two to the length of a lawsuit.
What it Means for Individual Investors
Arbitration offers recourse to investors against the actions of their brokers. It offers a quicker and potentially cheaper way to resolve disputes by taking them before a panel of arbitrators versus approaching the courts for long, drawn-out litigation. Arbitration can apply to many other financial matters outside of investing. For instance, you may also see arbitration clauses in your cell phone plan, credit card terms and conditions, and even your employee contract. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
