Publications
IV. The Arbitration Arena
As a result of pre-dispute arbitration agreements, many clearing firm liability cases are resolved through arbitration. The authors have reviewed a number of recent arbitration awards involving clearing disputes. While those awards rarely analyze the legal standards that control clearing firm liability and avoid fact findings, two observations emerge. First, clearing firm respondents have suffered adverse awards in a number of cases, possibly suggesting that customer claimants may sometimes have better chances against the firms in arbitration than in civil litigation. Second, clearing firms are successfully utilizing pre-hearing dismissal motions to educate panels on the legal principles governing the firms' activities. Summaries of several noteworthy cases follow:
- Porter v. GRF Capital, et al., (NASD Case No. 94-02218): Claims of unauthorized trading, suitability and conversion were asserted against the introducing broker and its officers, the registered representative and the clearing firm. The arbitrators granted the clearing firm's prehearing motion to dismiss even though the claimant maintained that it had not received a disclosure notice from the firm pursuant to NYSE Rule 382.
- Hemmy v. PruBache, et al., (NASD Case No. 93-04729): Claimants alleged failure to disclose, negligence, unsuitability and fraud, contending that Prudential held an undisclosed dual agency as both buyer and seller in the disputed transactions. Prudential responded that it acted solely as a clearing broker. At the conclusion of the hearing, Prudential moved to dismiss the claim, asserting lack of fiduciary obligation. The panel granted the motion.
- Masood v. Prudential Securities Incorporated, (NASD Case No. 95-04922): Claimant was awarded recovery against clearing firm on allegations of negligence and contract breach even though clearing firm maintained that its duties were wholly ministerial.
- Feltyberger v. Gruntal & Co., et al., (NASD Case No. 93-00903): Claimants claimed unsuitable and excessive trading on improper margin along with fraud and negligence. The clearing firm was found liable and ordered to pay attorney's fees. The award indicates that there was a circumvention of the traditional buffer separating clearing firms from introducing brokers.
- Mussman v. Stratton Oakmont, et al., (NASD Case No. 94-04825): Claimant alleged misrepresentation, unauthorized and excessive trading, failure to supervise and market price manipulation. Claimant specifically alleged that the clearing firm supported its introducing broker's fraudulent activities by continuing the clearing function with full knowledge of the fraudulent practices. In reply, the clearing firm argued that it performed clearly administrative functions as delineated in its disclosure letter to the customer issued pursuant to NYSE Rule 382(c) and through the customer agreement. The panel apportioned part of its actual damage and attorney's fees award against the clearing firm.
- Greenebaum v. Bear, Stearns & Co., et al, (NASD Case No. 95-04099): Claimants contended that the respondents misrepresented commission rates and provided them with unsuitable investment advice. The clearing firm responded that the claimants had executed clearing documents that exculpated it from liability. The parties waived their right to an arbitration hearing after which the panel held both the clearing and introducing brokers liable for a portion of the claimed damages.
- Monetti v. National Financial Services, et al., (NASD Case No. 94-01536): Claimant pursued his brokers and the clearing firm but not the introducing broker on claims of suitability and misrepresentation. The clearing firm was alleged to have exceeded its ministerial duties and assumed greater contact and responsibilities vis-a-vis the introducing firm. A substantial award against the brokers was granted; the clearing broker was dismissed but its counterclaim for debit balances was denied.
- Garland v. Josephthal Lyon and Ross, Inc., et al., (NASD Case No. 94-03448): Claims against registered representative, introducing broker and clearing broker for churning, suitability, unauthorized trading and misrepresentation. Claimants contended that the clearing firm was not per se insulated from liability and was responsible under the doctrine of apparent authority, the Know Your Customer Rule and for contract breach. The clearing firm moved to dismiss, citing detailed legal authority. The award includes a discussion on a clearing firm's liability to a retail client. Ultimately, the claimants dismissed the clearing firm.
- Glass et al. v. Beacon Securities, et al., (NASD Case No. 95-03975): Claimants' arbitration against multiple respondents resulted in a substantial compensatory award and punitive damages, including compensatory liability of the clearing broker. It was contended that the clearing firm negligently failed to protect the customers from the introducing broker's fraud, including forged margin documents.
- Dougherty v. E.A. Larkin Co., et al., (Pacific Exchange No. 96-S064): Customer asserted claims of excessive mark-ups, suitability and fiduciary breach against registered representatives, introducing broker and clearing broker. The award reflects extensive findings and conclusions by the panel regarding a clearing broker's liabilities, particularly as to any claimed duty to counsel the customer or surveil introduced accounts. The panel also noted that requiring a clearing broker to conduct due diligence into the affairs of its introducing broker and the customer would likely result in an irreconcilable conflict of interest and impose unreasonable burdens upon the clearing broker. Consequently, all claims against the clearing broker were dismissed.
Given the broad latitude granted to arbitration panels and the finality of their awards, customers and clearing firms have limited opportunities to challenge adverse determinations. As arbitration practitioners know, successful vacatur motions under Section 10 of the Federal Arbitration Act, 9 U.S.C. § 10, are the exception and generally are unavailable for challenging a panel's factual reasoning. Lloyd Securities, supra, supports this observation. There, Newbridge argued that its situation was akin to that of the clearing firm in Fine v. Bear, Stearns & Co., Inc., 765 F. Supp. 824 (S.D.N.Y. 1991). In Fine, the court upheld the panel's decision that the clearing firm was not liable for the introducing broker's forged signatures on letters of authorization which transferred customer funds to a foreign bank account. The bankruptcy court in Lloyd Securities responded that the two cases were in fact different: " . . . the Fine court was merely reviewing an award of arbitrators, and thus the court's role was limited," Lloyd Securities, supra, at 35. With the current abundance of clearing firm cases in arbitration, it is not surprising that panel members are seeing an active motions practice.