An Uptick in Customer Arbitration?
Daniel Hetzel
When there is a downturn in the markets, claims against broker/dealers (B/Ds) and investment advisers tend to increase. For example, 8,945 arbitrations were filed in 2003 in response to the declining markets associated with the “tech wreck.” As markets recovered, claims lessened and reached a low of 3,238 in 2007. In 2009, however, 7,137 arbitrations were filed, in the aftermath of the Great Recession. Once again, as markets recovered, claims progressively declined, to a low of 3,757 last year.
The Dow Jones peaked at 29,569 this February 20—dropping to a low of 18,213 on March 23 due to fears over the novel coronavirus. Although the market has recovered some, certain investors will have lost money, as a result of this general market decline. Markets are also likely to remain volatile for the foreseeable future—which creates the potential for additional losses. This precipitous decline in equities markets, coupled with the fact that many investors may have suddenly lost their job or small business, provides fertile ground for attorneys from the Public Investors Arbitration Bar Association (PIABA) to solicit customer claims. March saw a 14% increase in arbitration filings. But this recent jump may be unrelated to COVID-19, as it can take six to 12 months for a claim to actually get filed.
Understand the Risks
To understand what types of claims will likely be filed against broker/dealer and investment adviser firms, it’s instructive to visit PIABA attorneys’ websites. For example, these attorneys are now arguing that the recent decline in equities markets was somehow “foreseeable,” such that representatives and advisers should have moved their clients out of the market and into “safer” investments. With the benefit of 20/20 hindsight, they are also identifying sectors of the economy that have been hit hard by the COVID-19 crisis and are encouraging customers with alleged over-concentrations in these sectors—e.g., hospitality or senior housing—to come forward.
PIABA attorneys are also soliciting claims for losses in oil and gas investments—in fact, portraying the recent decline in fossil fuel prices as a separate “financial crisis,” which pre-dated the pandemic and has been exacerbated by it. Further, these attorneys are targeting claims for illiquid investments, including nontraded real estate investment trusts (REITs) and different types of annuities. Finally, they are soliciting claims for: 1) the use of margin in customer accounts; 2) failure to execute claims based on firms not being able to process securities transactions in a timely manner; 3) losses in the accounts of elderly customers; and 4) claims for failure to supervise reps and/or the activity in customer accounts.
Mitigating the Risks
To mitigate the risk of arbitration claims being filed, firms and advisers need to recognize that certain customers may have lost money, or may have at least experienced temporary declines in their portfolio, and these customers may be emotional. These emotions may also be driven by external factors such as the loss of a job, loss of a small business or an unexpected illness. Firms and advisers should be proactive and identify which customers have lost the most money and then contact them first. Firms and advisers should also try to identify and contact customers with large positions in illiquid investments, oil and gas investments or other sectors of the economy affected by the pandemic.
Firms or advisers should call customers whose accounts have the largest losses and talk to the customers about these losses. Although the call may not be easy, it will be appreciated. It’s much better for a customer to find out about losses in this way as opposed to reading the account statements themselves and feeling like no one from the firm cared enough to call. Registered representatives and financial advisers then need to talk to these customers about what has changed in their lives since the COVID-19 crisis and what they want to do going forward.
The risk/reward landscape has changed dramatically since early March, and customers face difficult decisions about what to do with their investment portfolios. However, the first, and easiest, step in this process is to talk to the customer—be it an individual, a plan or a trust—and document any changes to their investment objectives, risk tolerance, financial situation and other “suitability factors.” Then find out what the customer wants to do and what the customer thinks, for example, will happen in financial markets and in the broader economy in the aftermath of COVID-19. Having these conversations at this point not only helps to prevent the risk of client claims being filed, but may also provide valuable evidence in defense of claims that do get filed. Firms and advisers need to be careful in having these conversations and not, for example, make any unwitting admissions of liability.
Daniel Hetzel is a partner in the financial services and regulatory practice group at Kaufman Dolowich & Voluck, a civil defense litigation law firm that represents and advises insurers, self-insured businesses and professionals in a wide range of matters.