SC Lawyer, Nov. 2003, #2. When the bulls make way for the bears - civil liability under federal and state securities laws and the common law.

AuthorBy Gerald D. Jowers Jr.

South Carolina Lawyer


SC Lawyer, Nov. 2003, #2.

When the bulls make way for the bears - civil liability under federal and state securities laws and the common law

South Carolina LawyerNovember. 2003When the bulls make way for the bears - civil liability under federal and state securities laws and the common lawBy Gerald D. Jowers Jr.Who hasn't lost money in the stock market? Just a few years ago it seemed no one could. The mid-1990s saw enormous growth across the entire market, most notably in the technology sector. Internet startups and IPOs were the news of the day and everyone, it seemed, was getting in on the action. The champions of the "new economy," the Wall Street analysts, the media and the public cheered as the markets reached unprecedented levels and ignored those who warned that prices were unsustainable.

On January 14, 2000, the Dow Jones Industrial Average reached its all time high at 11,723. The NASDAQ, fueled in large part by the technology sector, reached 5,048.62 on March 10, 2000. However, in 2002 the bulls made way for the bears and "irrational exuberance" gave way to sobering reality. At market close on October 9, 2002, the Dow Jones was at 7,286.27, 37.8 percent down from its peak. That same day, the NASDAQ closed at 1,114.11, 77.9 percent less than its high. Today, the Dow has returned to the 9000 level, yet the NASDAQ is still below 2000.

In the aftermath of the 2002 decline, investors are closely scrutinizing their portfolios wondering where things went wrong. The bursting of the technology bubble and the recent Wall Street scandals draw attention not only to the fundamental risk involved in stocks, but also to the fact that, in some cases, the individual investor is headed for financial disaster from the outset.

While everyone knows the stock market has risk, fewer know that the securities laws impose legal duties on brokers and provide rights to investors. It must be recognized that most brokers are ethical and want to do what is best for their customer; however, the brokerage industry is a business of inherent conflicts of interest. Brokers are compensated by commission. Promotions are largely dependant on a broker's revenue, and firms provide incentives to brokers to sell certain investment products. Inevitably, there will be those whose professional ethics give way to self-interest. This article provides an introduction to the state and federal securities laws, two common forms of broker misconduct and investors' available remedies.

Disputes must be arbitrated

In virtually every case, investor disputes with brokerage firms must be arbitrated. In 1987, the U.S. Supreme Court handed down Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 237 (1987), holding that claims based on the federal securities laws and other federal statutes may properly be decided in arbitration. Soon after McMahon, the Court held in Rodriguez de Quijas v. Shearson/ American Express, Inc., 490 U.S. 477, 481-82 (1989), that predispute arbitration clauses in standard brokerage contracts are enforceable. Thus an investor who is a party to such an agreement is precluded from bringing her dispute in court. Naturally, the brokerage industry responded by including predispute arbitration clauses in its standard account opening agreements. The result has been that so long as the contract is valid, the investor must submit all disputes to binding arbitration.

Securities arbitrations are most commonly conducted by the securities industry self-regulatory organizations (SROs). SROs are private organizations to which Congress, through the securities laws, has delegated authority to make and enforce rules governing their members' conduct. The largest SROs are the National Association of Securities Dealers (NASD) and the New York Stock Exchange (NYSE). Each of these organizations sponsors its own arbitration forums to which disputes involving their members may be submitted.

The choice of arbitration forum is usually left to the investor. However, the choice of forum may be limited to the SROs in which the brokerage firm is a member or by a forum selection clause in the contract. Of course, in some cases a claimant's choice of arbitration forum may be made for strategic reasons, as there are some differences between them.

The advantages of arbitration over litigation in most contexts are well recognized. Arbitration is less expensive and disputes are resolved faster. In the securities context, arbitration begins with the filing of a Statement of Claim, and from that point the case is typically resolved in less than one year. The swift resolution and reduced expense is due, in large part, to limitations placed on the two time consuming and expensive features of litigation - discovery and motion practice. Another advantage of arbitration is the finality of the award. Arbitration awards may be overturned by the courts only on very limited grounds. See Upshur Coals Corp. v. United Mine Workers of Am., Dist. 31, 933 F.2d 225, 228-29 (4th Cir. 1991); Remmey v. Painewebber, Inc., 32 F.3d 143 (4th Cir. 1994). Additionally, SRO rules require prompt payment of awards by members and impose severe penalties for nonpayment.

Securities arbitration is not without its disadvantages. Because arbitration is less expensive and disputes are resolved quickly, defendants are less likely to settle. Another disadvantage is that while arbitrators are expected to be guided by the law, unlike the judiciary, they are not bound by existing precedent. As a result, there is some degree of uncertainty and a potential for inconsistent results. Lastly, there is a perception of bias because securities arbitrations are sponsored by the industry.

Information on securities arbitration law and procedure is abundant. The Web sites of the NASD and the NYSE contain a wealth of information for both the practitioner and the investor. Additionally, a number of books on the subject are available. First among them is Securities Arbitration Procedure...

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