April 4, 2014 / 8:26 PM / 5 years ago

COMPLY-Wall St. tactic for fighting investor claims seen as double standard

April 4 (Reuters) - 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 jury.

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 was unfair.


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 closed-door proceeding.

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.


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)

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