At the conclusion of an arbitration hearing, claimants request that the panel award some measure of damages that the claimant proved at trial. Claimants may also ask for other damages such as attorneys’ fees, punitive damages, and expenses in his or her closing statement. The information below details the most common measures of damages and also provides some authority for other types of relief frequently requested by claimants.
Trading losses are the amount of principal losses in an account. Any interest or dividends created by the funds at issue in the litigation are not used to offset the actual losses in the account. The calculation is simply the purchase price minus the sales price. In situations where the security is still held by the customer, one would use the purchase price minus the value of the security at the time of filing the statement of claim or at the time of the final evidentiary hearing.
Example 1: An elderly woman sued her broker to recover her lost retirement savings that were invested in a complex variable annuity. The annuity exposed the woman to substantial market risk and, as a result, she lost $150,000 of her $200,000 account value. Because of contingent deferred sales charges incurred at the time of selling out of the unsuitable variable annuity, the woman had to pay an additional $9,000 in penalties for early withdrawal. At the time of the sale, the annuity had generated approximately $14,000 in interest income over the life of the product. At the final hearing, the customer’s attorneys asked the panel to award the customer full trading losses of $150,000 plus the $9,000 in withdrawal penalties.
Example 2: Under the same fact pattern in example 1, the elderly woman never sold her variable annuity because she could not afford to incur the $9,000 contingent deferred sales charge. At the time her attorneys fi led the statement of claim her account value had declined an additional $3,000. As a result of these additional losses, her attorneys asked the panel to award damages of $153,000.
It is important to note that many brokerage firms argue that damages should be calculated based on net out-of-pocket losses (see explanation below) even though the monthly statements that are sent to clients actually show trading losses.
FINRA’s Arbitrator’s Manual includes discussion about calculating damages. For example, with regard to compensatory actual damages, the Arbitrator’s Manual states:
(Arbitrator’s Training Manual)
The recovery of compensatory damages is the primary reason a party brings a claim. An award of compensatory damages may include the party’s actual dollar loss and any other damages. Claimants will generally state a figure in the statement of claim of what they consider to be actual damages. Claim- ants have a duty to prove those damages. All claims for damages should be supported by evidence. The arbitrators may consider the concept of mitigation, where appropriate.
In cases where the losses are not sufficient to hire an expert, use of the firm’s own monthly statements that were sent to the customer can help establish damages. Frequently, the losses shown on these statements are trading losses and not out-of-pocket losses. It will make the respondents’ argument regarding the use of net out-of-pocket losses a bit disingenuous when their own calculations for the clients are based on trading losses.
Net Out-Of-Pocket Losses
Net out-of-pocket losses are the losses sustained in an account or specific security offset by any dividends or interest income produced by the account or security. Net out-of-pocket damage calculations are frequently used by experts to calculate losses in an account. They essentially give the respondent the benefit of any income generated by the underlying products. Many claimants argue that the respondent should not receive the benefit of the generated income because a primary goal of many investments is to generate income or dividends.
The law in one circuit is clear that the respondent is not entitled to any set-off from any profits. In Kane v. Shearson, 916 Fed.2d 643 (11th Cir. 1990), the Eleventh Circuit ruled that the broker-dealer is not permitted to argue that the respondent should be permitted to “net” prior gains in any account of claimants against later losses. In Kane, a customer sued a broker and the broker-dealer for RICO violations, violations of the Securities Act of 1933, the Securities Exchange Act of 1934, violations of Florida’s chapter 517, common-law fraud, negligence, and breach of fiduciary duty. The facts in Kane reflect that the broker recommended that the customer purchase shares of March Resources and the customer followed the broker’s advice. The broker then recommended that the customer sell his shares of March Resources and the customer followed the broker’s advice and realized a profit. Three days later, the broker recommended that the customer purchase shares of March Resources stock and the customer invested $196,399. The customer ultimately sold his shares and realized a loss of $137,796 in the second purchase of March Resources. The arbitration panel found that the broker and the broker-dealer violated section 12(2) of the 1933 Act, section 10(b) of the 1934 Act, and the state securities laws, and that the broker and broker-dealer were negligent and breached their fiduciary duty. The panel awarded the customer $28,322.
The customer appealed the award to the district court and the broker and broker-dealer cross-appealed. The district court held that there had been no violation of federal law but affirmed the decision on the Florida securities law claim as well as the common law negligence and breach- of-fiduciary duty claims. Furthermore, the district court held that the customer should recover the entire $137,797 loss from the second sale of March Resources stock and granted prejudgment interest as well.
On appeal to the Eleventh Circuit, the broker and the broker-dealer argued that they should be entitled to offset the losses against gains previously made in the account. The Eleventh Circuit rejected any request for “netting” and held:
Kane [customer] is correct when he states that there is no sup- port to be found under federal or Florida law for the “netting” theory Shearson [broker-dealer] argues for here. What is found, under both federal and Florida law, is the intent to have securities antifraud provisions enforced stringently to deter fraud. As the district judge noted, “If the . . . methodology espoused by [Shearson] were adopted, it could serve as a license for broker- dealers to defraud their customers with impunity up to the point where losses equaled prior gains.
Net Out-of-Pocket Losses (Arbitrator’s Guide)
The calculation of a claimant’s net out-of-pocket losses varies depending on whether the panel finds the wrongful conduct involves one or more specific trades or the management of an entire account. For specific trades, net out-of-pocket loss is the purchase price of the security plus commissions minus the total of the value of the security on the relevant date plus dividends or interest received. For wrongful conduct involving an entire account, net out- of-pocket losses are calculated by taking the beginning account value, plus money and securities deposited, minus money and securities withdrawn, less account value on the relevant date. Arbitrators should look to the parties for instructions on these issues.