Published on:

Unpaid Arbitration Awards: Uninsured and Insufficiently Capitalized Broker Dealers Increasingly Fail to Pay Investor Damages

According to metrics provided by the Financial Industry Regulatory Authority (“FINRA”), $62.1 million of investor awards issued in 2013 went unpaid, due to brokerage houses’ insolvency.  The Public Investors Arbitration Bar Association (“PIABA”) analyzed FINRA arbitration outcomes and found that for every 1 out of 3 cases that yield damages in arbitration, those damages fail to be collected.  Brokerage firms that are insufficiently capitalized, if not outright insolvent, fail to have the resources to pay investors’ damages when sales practice violations or fraud are uncovered.  For investors who feel they may be victims of fraudulent activity, the additional risk of uncollectable damages is increasingly imbedded into their calculation of whether litigation would lead to a win and net financially positive results.

The Center for Financial Services Innovation (“CFSI”) is a wealth management industry support group, with members such as Bank of America, Charles Schwab, Morgan Stanley, and many smaller broker dealers.  CFSI routinely releases marketing statements with direct encouragements for investors to maintain financial health, as well as a safety net and large cushion of savings. CFSI releases metrics on consumer saving habits, showing that a small unexpected expense would cause bankruptcy for a large percentage of Americans.  Yet many CFSI members often fail to ensure that they can cover investor claims themselves.

In 2010, Securities America, was the fifth largest independent brokerage firm in the country with over 1,900 brokers employed.  However, it had a capital reserve requirement of only $250,000.  Given the limited capacity of its insurance, it had hardly any capital on hand to cover additional uninsured claims.  When Securities America sold $400 million worth of private placements which turned out to be Ponzi schemes that subsequently defaulted, it did not have the resources on hand to pay out damages stemming from various awards.  The claims were eventually settled by Securities America’s parent company Ameriprise.  In many instances, low capital reserves and insufficient insurance can be an advantage because it allows for bargaining from a position of weakness.  If engaged in a class action suit, Securities America can threaten to file for bankruptcy and declare themselves insolvent if claimants don’t agree to accept a specific sum of damages.  However, this case illustrates the underlying danger of the broker dealer industry–firms are far more concerned with paying out commissions and keeping the lights on than provisioning for damages owed to investors.

According to FINRA, Newport Coast Securities Inc. (“Newport”) is another recent example of a brokerage firm with irresponsible capital reserves and poor broker oversight.  Newport was a small broker-dealer with 109 registered representatives.  According to FINRA review, over 60% of the brokers at Newport had at least one compliance mark on their record, compared to an industry wide average of approximately 10%.  Newport shut down under the weight of numerous outstanding arbitration claims against it, and sold all assets to another broker-dealer.  These assets, which were select high performing brokers and their books of business, were sold without the proceeds being directed to the outstanding arbitration claims.  After Newport ceased to be an entity, clawing back damages won in past arbitration awards became exceedingly difficult.

Given that FINRA had to approve the sale of Newport’s assets to a new broker-dealer, industry experts such as PIABA question why FINRA didn’t investigate whether those assets should have been used to satisfy outstanding arbitration awards.  Additionally, FINRA has faced doubt as to why it hasn’t enacted regulation requiring more robust insurance for broker dealers and specific coverage for investor arbitration claims.  In 2013, a senior FINRA executive informed the Wall Street Journal that FINRA was considering a requirement for brokerage firms to carry such insurance.  However, only one year later, FINRA informed the media that such measures would be too costly and the risk premiums too high for the market to operate effectively.

According to PIABA, of the $256,749,289 awarded by FINRA in 2013 arbitration claims, $62.1 million was unpaid.  This shortfall represents 24.1% of total FINRA awards in claimants’ favor.  Of the 225 claimants in 2013 who won an award, 75 were not paid.  This figure means that approximately 1 in 3 claimants who go through arbitration and receive a favorable ruling will not be paid, and approximately 1 of every 4 dollars awarded goes unpaid.

The attorneys at Lax & Neville LLP have extensive experience in successfully prosecuting claims on behalf of customers who have suffered losses as a result of investment and securities fraud.  If you are a victim of fraud, please contact Lax & Neville LLP today at (212) 696-1999 to schedule a consultation.