Class Actions vs. Individual Securities Arbitration Claims


Class Actions Versus Individual Securities Arbitration Claims

The purpose of this article is to analyze whether joining a class action or bringing an individual FINRA arbitration claim makes the most sense for investors.

Please note that, while this article accurately describes applicable law on the subject covered at the time of its writing, the law continues to develop with the passage of time. Accordingly, before relying upon this article, care should be taken to verify that the law described herein has not changed.

I. The Decision to Act.

Unfortunately, given the economic climate of the past few years, more and more investors have been placed in unsuitable investments, not fully informed of the risk(s) associated with their investments, or actually and purposefully defrauded by their brokerage firms and/or financial advisors. Once the investor becomes aware that in some way he or she has been harmed, the investor has a threshold decision to make – do they take action at all?

Some investors feel like there is a sense of shame in having to resort to some type of legal proceeding. Perhaps they feel like they share in the responsibility. Perhaps they are embarrassed because the individuals with whom they invested are involved in the same social or religious circles. Or perhaps they just feel like any type of formal proceeding would be too costly – both in terms of time and finances. While these are all valid concerns, an attorney with securities experience can minimize any potential negative impact a legal proceeding can have on an investor.

Once an investor has decided to act, however, there are two choices: (1) join a class action lawsuit with other investors that have had the same problem with an investment, FINRA member firm, associated person/registered representative, etc. if a class action indeed exists; or (2) file an individual arbitration claim with FINRA, explained in Section III of this article. Investors typically are stripped of the option of bringing an individual civil lawsuit against brokerage firms and associated persons/registered representatives because of arbitration provisions present in agreements between customers and brokerage firms. See Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220 (1987) (arbitration provisions in agreements between brokerage firms and customers are valid and enforceable).

II. What Is a Class Action Lawsuit?

A class action lawsuit is a lawsuit that involves sometimes thousands of plaintiffs with a similar complaint. Many people are familiar with examples of class action lawsuits brought by patients who were all harmed by a certain pharmaceutical drug, for example. In the securities context, for example, class actions are brought by investors who invested in the same security and were harmed. A recent example of such a class action is a class action pending in California federal court against Charles Schwab, where the plaintiffs allege that Charles Schwab failed to disclose the risks to investors associated with its YieldPlus fund, touting it as a very safe investment when, in fact, it was subject to great risk.

III. What Is a FINRA Arbitration?

FINRA is the acronym for the Financial Industry Regulatory Authority, formerly known as the National Association of Securities Dealers, or NASD. FINRA regulates securities firms, as well as securities professionals, in the United States. FINRA has authority over 4,580 brokerage firms, 162,850 branch offices and 630,695 registered securities representatives. See our related article, “How Does the FINRA Arbitration Process Work for Investor Claimants?

IV. Factors to Consider in Deciding Between Joining a Class Action and Bringing an Individual FINRA Arbitration.

A. Size of Loss. The first factor for investors to consider in determining whether to join a class action or bring an independent arbitration claim is the size of the financial loss. Investors with smaller losses tend to join class action lawsuits because the attorney’s fees and costs associated with joining a class action are typically less than those associated with bringing an individual FINRA arbitration action. Mitchell & Associates, P.C. welcomes investors with all levels of losses to make an appointment to discuss their options.

For investor with larger losses, individual securities arbitrations can yield a much better return on those losses, even taking into consideration such arbitration-related expenses as filing and session fees, attorney’s fees, expert witness fees, etc. The chance of a large investor receiving 100% of his or her losses in a class action are basically non-existent; while in a FINRA arbitration, it can happen, depending on the strength of the case. Additionally, while awards of attorney’s fees, costs, etc. in FINRA are made in few cases, federal securities statutes, which likely govern in many class actions, expressly prohibit recovery of attorney’s fees, costs and interest.

B. Recovery Goals. The second factor for investors to consider in determining whether to join a class action or bring an independent arbitration claim is what level of recovery would be acceptable to them.

1. Recovery through a Class Action. In 2002, Cornerstone Research issued a report stating that the average recovery for securities class action plaintiffs in federal and state court was 3.825% of plaintiffs’ losses. Of that 3.825%, not all was cash recovery – that percentage took into account the value of stock options and warrants as well. Id.

Another study, also conducted by Cornerstone Research, revealed that, in over 1000 class action settlements between 1996 and 2008, plaintiffs recovered only 3% of their damages. A more recent Cornerstone Research study, again involving only securities class action settlements, found that in 2009, plaintiffs recovered only 2.3% of the their damages.

Also in 2009, NERA Economic Consulting performed a study of securities class action cases and found that the plaintiffs recovered only approximately 2.5% of their damages through class action settlements. Id. In a recent class action settlement involving the brokerage firm Ameriprise, investors recovered approximately 10% of their damages, depending on legal fees.

2. Recovery through an Individual Arbitration. In 1992, the U.S. General Account Office (GAO) completed a study indicating that investors who pursued their arbitration awards received a 61% recovery of their losses, and in 30% of the arbitrations studied, investors recovered 100% of their losses. The GAO also found that investors who retained counsel to represent them in arbitrations were 1.6 times as likely to be awarded more than 60% of their losses. Id.

Edward S. O’Neal, Ph.D. and Daniel R. Solin, Esq. examined almost 14,000 securities arbitration awards from 1995 through 2004, and found that when an investor sued his or her brokerage firm, they recovered 12% of their damages, not including legal fees. Of interest is that the larger the damages were, the smaller the return, and the larger the brokerage firm was, the smaller the return. Id. The 1992 GAO study reflects the same phenomenon.

However, in a study done by the law firm of Klayman & Toskes, P.A., investor recovery from arbitration actions between 1998 and 2003 ranged from 53% to 61% of their losses.

In sum, the above studies clearly indicate that investors will likely recover more of their investment losses if they pursue an independent arbitration claim as opposed to joining a class action. Investors should keep this in mind when evaluating the criticism frequently leveled against individual arbitrations that FINRA is biased in favor of securities industry respondents. Mitchell & Associates, P.C. has successfully secured its clients much high returns on their losses both through settlements in FINRA arbitrations and through panel awards following FINRA arbitration hearings.

C. Timeline. The third factor for investors to consider in determining whether to join a class action or bring an independent arbitration claim is how anxious they are to see their claim resolved. The 2008 Cornerstone Research study found it took approximately three to three-and-a-half years for the class actions to settle. It can take as long, or longer, for class actions to actually go to trial.

FINRA arbitrations, on the other hand, typically progress much quicker. During a FINRA initial prehearing conference (held once all the parties have been brought into the action and a panel has been appointed), a hearing date is usually set within nine months. After the arbitration hearing, the FINRA rules state a panel should try to issue an award within thirty (30) days after the end of the hearing. See FINRA Rule 12904. Therefore, FINRA arbitration actions are generally complete within a year – possible sooner for investors who are elderly.

D. Case-Specific Facts. The fourth factor for investors to consider in determining whether to join a class action or bring an independent arbitration claim is how strong their case is from an objective, factual perspective. In an individual securities arbitration, the panel will go deeper into the facts of a particular investor’s situation to determine the outcome. In a class action, investors are grouped together and particular investors who might have stronger cases factually are lumped in with other investors who may have weaker cases – and this can have an impact on the eventual settlement or trial decision. For example, if an investor in a class action was placed in the investment at issue in violation of the securities industry’s suitability guidelines, a class action plaintiff usually cannot pursue a suitability claim because it is so fact-intensive. Investors are encouraged to contact Mitchell & Associates, P.C. for an objective evaluation of the strengths and weaknesses of their individual case.

E. Desired Level of Involvement. The fifth factor individual investors need to evaluate is how involved they want to be in a legal action to recover their investment losses. An investor in a class action will likely have less responsibilities and obligations with respect to the action, which may be seen as an advantage. However, with that advantage comes the potential disadvantage that the investor must give up control over the proceedings. Unless an investor is a lead plaintiff in a class action, class action members typically do not have a say in what attorney(s) represents them and what strategies that attorney(s) pursues. Additionally, if the majority of investors in a securities class action votes to settle the matter for much less than what an investor in the minority believes he or she is owed, that minority investor will likely be stuck with the settlement, whether the investor likes it or not. In an individual FINRA arbitration, the individual investor, along with his or her attorney of preference is in control of case management and strategy.

V. Remember to "Opt Out"!

If you are considering bringing an individual arbitration claim, and receive a notice of a class action involving similar claims, you must quickly determine whether you want to become a member of the class action or pursue your own arbitration claim. If you do not return the paperwork to the administrators of a class action to “opt out” by the set deadline, which is usually fairly tight, you will be automatically considered part of a class action and will no longer have the right to initiate your own arbitration action with FINRA. Again, using the class action against Charles Schwab regarding its YieldPlus fund as an example, if investors did not formally opt out by January 14, 2011, their only remedy will now come from the pending class action. Investors with questions about class action notices they receive should seek the advice of an independent attorney, rather than the attorney who represents the lead plaintiff(s) in the class action.
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