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STOCK ISSUES

Margin Liquidations ...

Margin sellout cases are difficult but not impossible to win. One reason they are difficult is because margin limits and sellouts are not designed for the benefit of the client but rather are designed to protect the market and the brokerage firm. However, if the house or its broker can be shown to have misrepresented the margin rules or committed error in the application of those rules, the presumption in favor of the house in a sellout is swept away and the stage is set for some manner of client recovery. This happens more often than you might think, underscoring the need for the expert in such cases to diligently review the facts and to note and communicate to the attorney any possible infractions of the house in handling the matter.

A second factor that makes these cases challenging is the need for a credible and well-verified damage calculation. Often, after a sharp change in market prices (and particularly in cases involving futures or options or other situations in which the leverage can be very great), the market reverses after the margin call and subsequent sellout. This presents the client with an opportunity to claim that, "but for" an allegedly erroneous sellout, the client would have made a substantial amount of money.

With futures or options, the obvious way to compute damages is often to look at the price of those positions at maturity. However, this approach becomes suspect if the time to maturity is long or if intervening market volatility would have resulted in a subsequent margin call in which the client's account would have been liquidated with certainty. In those cases where the client's account would have not survived intact until maturity, an earlier cut-off date to damages, when some profit might have existed, is needed.

In cases where no intervening volatility is present to cause a subsequent liquidation but where the maturity date is significantly removed (i.e., more than a limited number of days from the sellout), it may still be better to present a damage theory with as few days as possible. When more than one viable sellout date exists, it is wise to present an arbitration panel with each viable option and its damages (usually there are only a couple of such choices) and let the panel decide which theory it prefers. If a brokerage firm appears to have acted arbitrarily, even if it had the legal right to do so under the margin agreement, it is possible that an arbitration panel, which sits in equity, may be inclined to make some kind of award. The panel could thus choose the second best damage argument (which could still be considerable) to balance out the equities.

Finally, we all know that damages are not supposed to be speculative. However, in one case before a jury in Federal Court in Boston, Judge Rya Zobel was heard to deliver a lecture to a defense attorney on this point, saying in part "Most damages theories have an element of speculation. The question is: Is it reasonable speculation?" So that is the test. If assumptions have to be made, are they reasonable?

As President and Senior Consultant of Market Consulting Corporation I have participated as an expert in at least six cases related to margining and relevant industry standards and practice, including those involved in selling out accounts. I have also served as an industry consultant to Options Clearing Corporation concerning margin setting practices and portfolio risk analysis and have helped develop margin rules, including those for options. I am also familiar with portfolio margining from an early point in its development and am aware of regulatory concerns related to its employment. Almost all cases I have been retained on have required damage analysis.

I have also served as both a chairperson and panelist for NASD (now FINRA) and the American Arbitration Association among other arbitration forums of which I have been a member.

In margin cases, as in other cases for which an expert is necessary, the best time for selecting an expert is before a panel is selected. Due diligence regarding arbitrator selection is the most important factor relating to the outcome of your case over which you have direct control (albeit a factor shared with your opponents with their own rationale for ranking arbitrators). During the selection process, it may be useful to have additional input to develop information for consideration beyond what FINRA supplies. Some specifics you may wish to consider if you are a claimant:

1. The selection of an all-public arbitrator panel consisting solely of attorneys is a proper start. Going further, background material on arbitrators in your kind of case in all arbitration forums is desirable (experienced securities arbitrators are often active in a number of forums including FINRA, AAA, JAMS and NFA). Also, try to get panelists who have shown a serious attention to the details of securities dispute resolution as evidenced by previous cases as opposed to senior generalists who, in my experience as NASD/FINRA and AAA arbitrator/panel chairperson, are numerous.
2. An expert who is retained early can often suggest if your client has a secondary complaint relating to some regulatory i's undotted and t's uncrossed, or other more serious regulatory issues. For example, even if your client has wealth, experience, and seeming sophistication — did the opposing brokerage firm cover all the bases in qualifying the client and in how they subsequently supervised the broker? This is relevant to supplemental discovery requests which come almost immediately after panel selection and hence further suggest a need to get expert opinion early. With SEC Regulation BI (Best Interest) now in force, this is particularly important.

If you are a respondent, you may already have a well-developed approach to arbitrator selection as well as access to data to facilitate it. Hiring an expert early may not be of such importance unless the case has novel aspects for which the experience of a seasoned expert may be important in charting a defense.

However, as you know, there is ordinarily no meaningful appeal to a bad arbitration decision. Accordingly, whether you are handling the case of a claimant or a respondent, a serious approach to beginning a case properly is important. In either case the FINRA-supplied information on arbitrators for you to rank will usually not supply sufficient detail on proposed panelists nor can sufficient discovery be obtained without appeal to your panel.