How to prepare for NASD arbitration

One of the most useful ways for the registered representative to envision the [arbitration] process is to realize that it is a marathon and not a sprint. The NASD has an objective to have arbitration proceedings closed within a year of their initiation. However, this is not always accomplished.

NASD arbitrations do not happen at warp speed but rather unfold over time. In the days just leading up to and during the actual hearings, the intensity is phenomenally high. However, there are often prolonged periods of time when the case seems to be lying dormant and requires little actual budgeted weekly time.

When you receive either a letter of demand (a claim of losses or damages and an attempt to negotiate a settlement of those demands) or a statement of claim (explains in legal language why an investor believes he is owed monetary damages), among the first reactions may be shock, followed by anger and indignation.

These documents typically are written in a bold, flamboyant style, often using colorful, if not inflammatory, language in describing the representative’s behavior. This is coming from someone whose interests you genuinely tried to serve. Your professional behavior is being described in a legal document with phrases such as “contumacious disregard,” “wild and frenzied trading pattern” and “seized control of the investment portfolio,” among others.

There are four actions that you must take immediately:

1. Inform the relevant broker-dealer firm’s compliance department.

2. Inform the relevant office of supervisory jurisdiction or branch manager.

3. Notify the errors-and-omissions carrier.

4. Begin a file that documents every development and every action taken.

Cases can be filed up to six years after the time period in question. By the time you receive either a demand letter or statement of claim, there may be multiple broker-dealer firms involved. The primary firm will be the firm you were with during the period described. This firm’s E&O insurer will fund the legal effort. In the event you have been with multiple broker-dealer firms, it is prudent to inform any that might be affected.

If a letter of demand was received, the broker-dealer firm will usually inform you that it will handle the issue until further notice and instruct you not to communicate further with the client. This is almost always the correct course of action. However, there are some examples in which reps believed that they knew the client well enough to be able to defuse the situation by calling them directly. In some cases, this has resulted in demands’ being dropped. However, it is clearly a risky course of action.

It is a prudent course of action to communicate on a regular basis with the compliance department to track the progress of the case. This could be monthly for the first few months, then bimonthly, until it has been resolved or elevated into an arbitration case. If a statement of claim is received, the broker-dealer firm usually will have been notified by the [Financial Industry Regulatory Authority Inc.] of [New York and] Washington in the same manner as you have been notified — by mail. In this case, the broker-dealer firm will contact the E&O carrier, who will select legal representation.

Whether it is a letter of demand or statement of claim, it is important self-protective action to inform the E&O carrier personally about what has happened. If a statement of claim has been received, this action will duplicate the effort of the accountable broker-dealer firm’s compliance department, which is fine.

If a letter of demand has been received, contacting the E&O carrier may be the action that saves the rep tens or even hundred of thousands of dollars of legal expenses and exposure. E&O policies contain numerous provisions, which are written in a legalistic language and often glanced over, at the most, by many reps. Some of these provisions relate to the timeliness of informing the carrier of a claim or potential claim. If the carrier is not notified within a certain time period of the claim, or potential claim, coverage may not apply, and the rep will be exposed for the costs of the legal defense and any award or settlement.

The third important action is to begin a filing system for the case and fastidiously document every development and action taken. You are on a war footing and at a high level of preparedness regarding this issue until it is resolved. In an arbitration hearing, every little step that is taken can have far-reaching consequences.

Documentation is the lifeblood of the process. Document the calls you made and what was communicated. Follow up with e-mails, as appropriate. For really important information, it is a good idea to take the next step and actually prepare a written letter and mail it to the appropriate parties. This is especially true with regard to the communications — with the broker-dealer firm and the E&O carrier.

If organization and detail have never been your strengths, now is the time to be more organized, more diligent, more detailed, more fanatical than ever before. This is like tax audit time. Let the shock of the proceedings and the negative possible consequences motivate you to perform at your absolute best, starting with the first moment and continuing through the resolution of the case.

It is surprising to realize that not all broker-dealer firms have a formal, written procedure for reps on how to prepare the case files for their attorney. It is arguable that the items are common sense, but it is worth listing them here.

All documents involving the client. This will include a number of signed documents, including pros-pectus receipts and new-account forms.

Any hard copy notes that involve this client.

Printouts of all trades and confirms conducted on behalf of the client.

Printouts of any electronic files involving this client. This may include records and notes of calls that were taken by the staff or the rep. If you print out anything from an electronic file that does not contain a date, you should date-stamp it.

Any documentation or printouts of electronic files that might have been supplied to you by your broker-dealer.

Client account statements (monthly or quarterly) from relevant statements.

The other two steps that come in early in the process are:

Signing the Uniform Submission Agreement, which binds both parties to the process and in which they agree to abide by the decision.

Paying the E&O insurer for the deductible of your coverage in a timely manner.

For writing your narrative, this information should be copied at least twice, three-hole punched and put into a large three-ring binder. At this point, the best organization is chronological. So this binder would start off with the initial documentation, likely including an investor questionnaire, followed by new-account forms. It is helpful to use tabs to separate the documentation, usually by time periods.

You will find it helpful and calming to put the material together in this sequence.

You will want to speak with your attorney as you perform this due diligence. Offer to write the attorney a memorandum that explains the relationship between you and the client at a fairly high level of detail. Virtually any attorney would be very pleased that you offered to do this.

Most representatives who are in securities arbitrations do not provide such detail. You are immediately separating yourself out as a client who is focused, determined, innocent and willing to do whatever is necessary to provide your attorney with everything they need to provide you with an outstanding defense.

Assuming your attorney would like you to do this, approach this exercise with the utmost seriousness. Unless a better scheme suggests itself, write it in chronological sequence. Include any information or insight that will help the attorney better understand what happened.

Going back over the records is like watching a movie of your relationship with this client. With the wisdom of perspective, you will undoubtedly be able to provide details, insight and little bits of information that will paint a vivid picture. Did your client have some important family issues that might have affected their actions? Did the client experience any significant personal changes or challenges during the time you worked with them? What is the client’s personality? By providing this type of information, you are not only giving your attorney the best information to assess the case, you are also starting them off in preparing to cross-examine your former client.

You should be brutally honest with your attorney. Even if you are basically innocent of the charges, it is unrealistic to expect that subjecting any professional relationship to this level of scrutiny will result in a “fairy tale” story of perfection. There will inevitably be some gray areas. You discover a note or file or form that you realize the other side can use against you. You recall moments where you took actions about which you had little more than 51% conviction. With the wisdom of 20/20 hindsight, there are a few things you would have done differently.

It is extremely important, for both yourself and your attorney, that you scrutinize the client relationship very intensely, with an eye toward anything that might be construed as supportive of the claimant’s case and damaging to yours. This is especially challenging when you consider that there may come a point at which your attorney may literally hold your fate in this case in their hands. In most cases, your attorney will be required to communicate to the E&O carrier any settlement offers. The latter may have the option (under the terms of the coverage) to accept the offer. If that moment comes, and your attorney believes in your case and your chances to prevail in a hearing, they may be able to convince the carrier to refuse the offer and allow the case to go forward.

It may be tempting to think that it might be a good idea to either ignore or gloss over any deficiencies that you might have, in order that your attorney will be favorably impressed. This is a formula for total disaster. It is a near certainty that whatever you are trying to hide will come up at some point, either from your own attorney’s questioning of you or during the hearing.

Reprinted by permission of the publisher, John Wiley & Sons Inc., from “NASD Arbitration Solution: Five Black Belt Principles to Protect and Grow Your Financial Services Practice.” Copyright (c) 2007 by Thomas J. Hine and John K. Brubaker. All rights reserved.

Related Topics: Practice Management