| April 4
April 4 Securities brokerages have long required
retail investors to bring their complaints to the arbitration
forum run by the Financial Industry Regulatory Authority.
But recent cases show that Wall Street embraces an entirely
different strategy when dealing with certain investment banking
customers: it demands they go to court.
A federal appeals court on Friday heard arguments about
whether Goldman Sachs Group Inc and Citigroup Inc,
both facing claims from clients who issued auction rate
securities before the 2008 financial crisis, can force them to
resolve those disputes in court instead of by FINRA arbitration.
While the case involves institutional investors, the
outcome in that and similar cases could ultimately impact retail
investors by allowing brokerages to include restrictions in
their account opening agreements that would give up rights they
have under FINRA's arbitration rules, some lawyers say.
The arguments are the latest in a string of such cases
playing out around the United States. All involve similar facts:
investment firms and issuers signed agreements to resolve future
legal disputes in court.
Compare that with the industry-wide practice for individuals
who buy and sell securities through brokerages. When those
customers open their accounts, they sign contracts that waive
their right to go to court and require them to bring disputes to
the FINRA arbitration system.
Consumer and investor advocates have long been fighting
so-called forced arbitration clauses, which became an industry
practice on Wall Street in 1987 when the U.S. Supreme Court
approved the measure.
"Why the double standard?" said Constantine Katsoris, a
professor at Fordham University School of Law in New York and
long-time arbitrator. Big banks with brokerage units seem to be
playing legal arbitrage - they've figured out it is to their
advantage to face big institutional clients in court but retail
investors in arbitration where they don't have to worry about a
These cases, if they go in the banks' favor, could allow
industry lawyers to chip away at FINRA's ability to enforce the
arbitration rules in place to protect retail investors, some
attorneys say. That is because these cases, including one
decided in favor of Goldman last week, make it clear that
private parties can contract away specific rights that they have
under FINRA arbitration rules.
For example, a brokerage firm could someday require new
clients to sign contracts waiving their right to seek punitive
damages in the event of future legal disputes, said George
Friedman, an arbitration consultant in Teaneck, New Jersey.
"It all comes together as being dangerous," said Friedman,
who is also a former director of FINRA's arbitration unit.
A FINRA spokeswoman declined to comment. Spokespeople for
Goldman and Citigroup declined to comment on the cases or
whether the industry's treatment of different types of customers
FIGHTING TOOTH AND NAIL
Friday's arguments follow a March 31 win by Goldman Sachs in
a similar dispute against Reno, Nevada. The U.S. Court of
Appeals for the 9th Circuit ruled that the parties would have to
duke out their battle in court, instead of FINRA arbitration.
"They force everyone including an 80-year-old widow into
arbitration, but when an institution wants to arbitrate with
them they fight it tooth and nail," said Joseph Peiffer, a
lawyer in New Orleans who represented the city. He is
considering whether to appeal to the U.S. Supreme Court.
Firms have their own motives for trying to keep
institutional investment banking cases in court while insisting
on FINRA arbitration for retail brokerage customers, said
Jeffrey Riffer, a securities lawyer in Los Angeles.
Tales of individual investors who lost money could be
especially compelling to juries in a proceeding that would play
out publicly, said Riffer. The results may not only be costly
but could trigger bad publicity, Riffer said. Arbitration
proceedings, in contrast, give brokerages the advantage of a
Investment banks gain certain advantages by dealing with
their customers in court. They include being able to drag out
the proceedings, Riffer said. Ongoing litigation about the
narrow issue of where to decide issuers' auction rate
complaints, six years after the market collapsed, shows how long
it can take to resolve one piece of a lawsuit.
The Goldman case, and others like it, date back to the
middle of last decade when firms pushed auction rate securities
as an instrument for institutional clients who wanted to issue
debt. Interest rates were supposed to reset periodically through
regular auctions of the securities. That and other steps were
supposed to protect issuers against having to make rising
interest payments to investors who bought the securities.
But the market collapsed in 2008, leading to skyrocketing
payments for issuers. They were sometimes stuck having to pay
interest as high as 20 percent on bonds they had issued with the
banks' help. Issuers subsequently turned around and sued the
investment banks to recoup their expenses.
SOME INVESTORS WIN BIG WITH FINRA ARBITRATION
FINRA has become an attractive venue for some financial
crisis-era plaintiffs with big cases because the process is
typically faster than going to court. The outcome is also harder
to reverse on appeal.
Some of those cases ended with huge rulings against
brokerage firms by FINRA arbitration panels. Among them: a
$406.6 million award in favor of STMicroelectronics NV in 2009
and against a unit of Credit Suisse Group AG over auction rate
securities. The institutional client in that case was an
investor, not an issuer, so the case was heard in arbitration
instead of court.
Nonetheless, the magnitude of that outcome and others swayed
investment firms to turn to courts in order to keep certain
cases away from FINRA panels, lawyers say.
Federal courts have been divided about whether cases such as
Goldman's should proceed in court or FINRA arbitration because
of confusing language the firms used in their agreements. The
split could increase the likelihood that the U.S. Supreme Court
will ultimately weigh in, lawyers say.
(Reporting by Suzanne Barlyn; Additional reporting by Nate
Raymond and Alison Frankel; Editing by Phil Berlowitz)