Discovery and the means to obtain relevant evidence in arbitration is very important. It is so important because it one of the only basis for seeking to vacate or upset an arbitration award based upon the panel’s refusal to hear pertinent evidence.
Discovery is important, however often the securities industry goes to great lengths to conceal or hide pertinent evidence.
Cases are won and lost, or more accurately settled, as a result of discovery.
Brokerage firm lawyers will generally, employ every device and ingenuity to avoid the production of highly relevant documents, hidden gems that can be found on inter-office e-mails, responses to exception reports, regulatory submissions, and sometimes documents contained in a broker’s employment files.
These lawyers also, typically, want unbridled discovery into every aspect of a claimant’s personal financial life, commonly referred to as a “financial colonoscopy,” in support the two most traditional defenses: “The You Should Have Know Better than to Trust Us” or “The You Could Afford to Lose the Money Anyway” defenses.
Documents relating to customer’s wealth which the brokerage firm seeks to obtain in support of these defenses are generally irrelevant because the broker did not have this information at the time of recommendation.
A registered representative is obligated to make his recommendation only on the basis of concrete information about the client’s financial situation and a representative must make recommendations only on the basis of the concrete information that the customer did supply and not on the basis of guesswork as to the value of other possible assets.
Moreover, subsequent changes in a customer’s financial condition are of no relevance to the suitability of a recommendation at an earlier time.
Perhaps more importantly, wealthy investors are allowed to be conservative, and in any event, particularly in defective product cases, a customer’s wealth or sophistication does not absolve the broker for failing to conduct due diligence or have conducted a product specific suitability analysis. Even the most sophisticated investor deserves proper recommendations.
The fact that a customer may be wealthy does not provide a basis for recommending risky investments. Suitability is determined by the appropriateness of the investment for the investor, not simply by whether the salesman believes that the investor can afford to lose the money.
Generally, depending on the issues in any particular case, customers are expected to produce certain documents, including all written communications between them and their broker, all documents relating to any other securities accounts, together with their tax returns for a period of at least three years before they opened their account. Customers are also expected to provide detailed information relating to their business interests, education, and financial condition.
Among other things, brokerage firms were and are expected to produce all documents relating to your account, including new account forms, customer statements, confirmations, and communications between you and your broker. Records of complaints or disciplinary action against your broker should also be made available together with information and documents relating to the brokerage firm’s supervision of your individual broker, the broker’s training, and in most cases, the brokers basis of compensation should also be produced by the brokerage firm.
In connection with the recommendation of any particular security, the broker or brokerage firm also ought to be obligated to produce documents relating to the basis of any such recommendation.
Accordingly, in November 1999, FINRA, then the NASD adopted a specific Discovery Guide setting forth those documents and information that are discoverable in customer cases.
However, within the last 10 years, the Discovery Guide, was attempted to be amended at least three times. The securities industry, understandably, has sought to limit its scope with respect to the documents that it has to produce and increase the burden on customers, requiring the production of documents relating to almost every aspect of their personal financial life.
While the Discovery Guide, which was expected to decrease the controversies surrounding discovery, is “guide,” for use in customer cases and is “not intended to remove flexibility from Arbitrators or the parties in a given case.” Executive Summary at 1, often the securities industry objects to the production of documents and information contemplated by the Guide, but then argues that the documents customers are contemplated to produce, must be produced in every case.
In May 2011, FINRA published the newest version of the Discovery Guide, and replaced the prior fourteen Lists with just two Lists of presumptively discoverable documents: one for firms/associated persons to produce and one for customers to produce.
Documents the Firm/Associated Persons Shall Produce in All Customer Cases
Item 1: Account record information for the customer parties, documents concerning the
customer parties’ risk tolerance and agreements with the customer parties.
Item 2: Correspondence sent to the customer parties or received by the firm/associated
persons, and advertising materials sent to customers of the firm.
Item 3: Documents evidencing any investment or trading strategies used or recommended in the customer parties’ accounts.
Item 4: For claims alleging unauthorized trading, all documents the firm/associated persons relied upon to establish that the customer parties authorized the transactions at issue, all documents relating to the customer parties’ authorization of the transactions and all order tickets for the transactions.
Item 5: Materials the firm and/or associated persons prepared or used and/or provided to the customer parties relating to the transactions or products at issue, and worksheets or notes indicating that the associated persons reviewed or read such documents.
Item 6: Notes the firm/associated persons made relating to the customer parties and/or the customer parties’ claims, accounts, transactions or products or types of products at issue.
Item 7: Notes or memoranda evidencing supervisory, compliance or managerial review of the customer parties’ accounts or transactions, or of the associated persons assigned to the customer parties’ accounts; and correspondence between the customer parties and firm/associated persons relating to the customer parties’ claims, accounts, transactions or products or types of products at issue bearing indications of managerial, compliance or supervisory review.
Item 8: Recordings, telephone logs and notes of telephone calls or conversations about the transactions at issue that occurred between the associated persons and the customer parties, and/or between the firm and the associated persons.
Item 9: Writings reflecting communications between the associated persons assigned to the customer parties’ accounts at issue and members of the firm’s compliance department relating to the securities/products at issue and/or the customer parties’ claims, accounts or transactions.
Item 10: Forms RE-3, U4 and U5 and Disclosure Reporting Pages for the associated persons assigned to the customer parties’ accounts at issue, customer complaints identified in the forms, and customer complaints filed against the associated persons.
Item 11: Sections of the firm’s manuals relating to the claims alleged, including separate or supplemental manuals governing the duties and responsibilities of the associated persons and supervisors, bulletins the firm issued and the table of contents/index to the manuals/bulletins.
Item 12: Analyses and reconciliations of the customer parties’ accounts, including those relating to reviews of the customer parties’ claims, accounts, transactions or the product or types of products at issue.
Item 13: Exception reports, supervisory activity reviews, concentration reports, active account runs and similar documents produced to review for activity in the customer parties’ accounts related to the allegations. For claims alleging failure to supervise, the firm/associated persons must produce the documents listed in this Item that were produced to review for activity in customer accounts handled by associated persons and related to the allegations.
Item 14: Portions of internal audit reports for the branch in which the customer parties maintained accounts that concern associated persons or the accounts or transactions at issue and discussed alleged improper behavior in the branch against other individuals similar to the improper conduct alleged.
Item 15: Records of disciplinary action taken against associated persons by any regulator or employer for all sales practice violations or conduct similar to the conduct alleged.
Item 16: Investigations, charges, or findings by any regulator and the firm/associated persons’ responses.
Item 17: Portions of examination reports or similar reports following an examination or inspection conducted by any regulator that focused on the associated persons or the customer parties’ claims, accounts or transactions, or the product or types of products, or that discussed alleged improper behavior in the branch against other individuals similar to the conduct alleged.
Item 18: Documents related to the case that the firm/associated persons received by subpoena or by document request directed to third parties.
Item 19: For the transactions at issue, documentation showing the compensation, gross and net, to the associated persons.
Item 20: For claims related to solicited trading activity, a record of all compensation, including, but not limited to, monthly commission runs for the associated persons.
Item 21: A record of all agreements pertaining to the relationship between the associated persons and the firm, summarizing the associated persons’ compensation arrangement or plan with the firm.
Item 22: For allegations regarding an insurance product that includes a death benefit, information concerning the customer parties’ insurance holdings and recommendations, if any, regarding insurance products.
Documents the Customer Parties Shall Produce in All Customer Cases
Item 1: Customer party federal income tax returns, limited to pages 1 and 2 of Form 1040; Schedules A, B, D and E; and the IRS worksheets related to these schedules, redacted to delete the customer parties’ Social Security numbers. Customer parties may redact information relating to medical and dental expenses and names of charities on Schedule A unless the information is related to allegations in the Statement of Claim.
Item 2: Financial statements, including statements within a loan application, or similar statements of the customer parties’ assets, liabilities and/or net worth.
Item 3: Documents the customer parties received from the firm/associated persons and from entities in which the customer parties invested through the firm/associated persons, including account opening documents and/or forms, prospectuses, research reports, annual and periodic reports, and correspondence.
Item 4: Account statements for each non-party securities firm where the customer parties maintained an account.
Item 5: Documents, including agreements and forms, relating to accounts at the firm or transactions with the firm.
Item 6: Account analyses and reconciliations prepared by or for the customer parties relating to the customer parties’ accounts at the firm or transactions with the firm.
Item 7: Notes, including entries in diaries or calendars, relating to the accounts at the firm or the transactions at issue.
Item 8: Recordings and notes or logs of telephone calls or conversations about the customer parties’ accounts or transactions at issue that occurred between the associated persons and the customer parties, and telephone records evidencing telephone contact between the customer parties and the firm/associated persons.
Item 9: Correspondence the customer parties sent or received relating to the accounts or transactions at issue.
Item 10: Previously prepared written statements by persons with knowledge of the facts and circumstances related to the accounts or transactions at issue.
Item 11: Complaints/Statements of Claim and answers filed in civil actions involving securities and securities arbitration proceedings in which the customer parties have been a party, and all final decisions or awards or non-confidential settlements entered in these matters. If a person is a party to a confidential settlement agreement that by its terms does not preclude identification of the existence of the agreement, the party shall identify the documents comprising the agreement.
Item 12: Documents showing the customer parties’ ownership in or control over any business entity. If the customer parties are trustees, documents showing the accounts over which the customer parties have trading authority.
Item 13: Documents the customer parties received, including documents found through the customer parties’ own efforts, relating to the investments at issue.
Item 14: For claims alleging unauthorized trading, documents the customer parties relied upon to show that they did not know about or consent to the transactions at issue.
Item 15: Materials the customer parties received or obtained relating to the claims, transactions or products at issue, and materials received relating to other investment opportunities.
Item 16: Customer parties’ resumes.
Item 17: Existing descriptions of the customer parties’ educational and employment background if not set forth in resumes.
Item 18: Documents related to the case that the customer parties received by subpoena or by document request directed to third parties.
Item 19: To the extent that an insurance product that provides a death benefit is included
in the Statement of Claim, information received from an insurance sales agent or securities broker relating to such insurance.
Discovery, or the parties’ quest to obtain important documents and information that are relevant to any claim or defense, in FINRA securities arbitrations, are different than what one might generally expect in a court proceeding.
In FINRA securities arbitrations, depositions, or the taking of testimony under oath in the presence of a court reporter prior to a final hearing or trial, is not permitted, unless with the permission of the arbitration panel, it is undertaken to preserve the testimony of an ill or dying witness that may otherwise be unavailable at the time of hearing.
Producing Broker and Brokerage Communication Documents
Typically, public customers are required to produce all documents or communications with their broker or brokerage firms, all documents relating to their account(s), their resume, along with their complete federal and state tax returns and statements from other brokerage firms for a period of three years prior to events or transactions at issue giving rise to their claim.
Although an oversimplification, the brokerage firm, generally, is also required to produce certain documents including the broker’s compensation records, disclosable complaints against the broker, and other documents supporting the recommendation of a security to a particular customer.
Respondents, i.e. the brokerage firms and their lawyers, frequently object to the production of those documents and information set forth in the FINRA Discovery Guide, as burdensome, irrelevant or oppressive notwithstanding that the documents sought are business records which are required to be created and maintained in accordance with the record keeping provisions of the federal securities laws. Yet these same entities often relentlessly seek discovery relating to every aspect of a public customer’s personal and financial life.
In November 2003, the NASD (now FINRA) announced that it had become increasingly aware of instances in which parties are not complying with their duty to cooperate in the exchange of documents requested by parties or listed on applicable Document Production Lists within the specified time.
According to FINRA, it will not tolerate abuses of the discovery process, and is issued this Notice to Members to: (1) remind members and associated persons of that duty; and (2) notify them that NASD Dispute Resolution will continue to monitor compliance with its discovery rules, and will refer perceived abuses to NASD Regulatory Policy and Oversight for disciplinary review.
On July 19, 2004, FINRA announced that it had censured and fined Citigroup Global Markets, Inc., formerly Salomon Smith Barney, Merrill Lynch, Pierce, Fenner & Smith Incorporated, and Morgan Stanley DW Inc. $250,000 each for failing to comply with their discovery obligations.
Unfortunately, such discovery tactics continue by many major brokerage firms, as they affirmatively seek to conceal their wrongful conduct, sales mission, and quest for profits, historically, with respect to private partnership sales, tainted analysts’ recommendations, (and the over zealous and often unsuitable retail recommendation of high tech companies to these activities), and most recently, auction rate securities, structured products, and the packaging of preferred shares.
In any event, documents, as opposed to testimonial evidence, are, in substantial part, a more reliable form of evidence that is generally: tangible, unbiased, contemporaneous, or created at our about the time of the events in question, and can be enlarged for any arbitration hearing.
The Brokerage Firms Write the Evidence
Documents created by a brokerage firm, specifically documents provided to the customer by brokerage firms, are written by the brokerage firms, and as such, through an avalanche of disclosure and duty-shifting, are designed to absolve them from all forms of liability. In substantial part, at least on the surface, these are the only documents that are freely produced, without controversy, in discovery in FINRA Securities Arbitrations.
Conversely, in defense of all claims, almost without exception, brokerage firms will attempt to transmogrify every case into a suitability case in that it was not the broker’s duty to disclose risk, or the customers’ expressed investment objective with respect to risk, (i.e. conservative or aggressive), but whether the customer has the financial ability to withstand risk.
Accordingly, in Discovery in FINRA Securities Arbitrations, the brokerage firm will seek intrusive discovery with respect to every aspect of the customer’s financial life, education and employment in an effort show the customer understood risk, could afford to accept risk, and therefore, are immune from fraud by their agents.
Accordingly, many cases are won, or lost, in FINRA Securities Arbitrations based upon the parties’ ability to obtain important discovery.
Guiliano Law Firm
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For more information concerning common claims against stockbrokers and investment professionals, please visit us at stockbrokerfraud.com.