At present, the stock market appears to be in free-fall, with most major market indices down approximately 25% in the past two weeks. The extent of the current crash and the duration of the recovery will likely depend on the extent and duration of the coronavirus crisis and the oil price trade war between Saudi Arabia and Russia. Absent a quick turnaround, it is likely that there will a spike in FINRA arbitration filings made by disgruntled investors.
Securities arbitration filings run countercyclical to stock market trends. Not surprisingly, arbitration case filings were down from 20011 through 2019 due to the sustained recovery following the 2008 financial crisis. FINRA statistics show that 3,238 cases were filed in 2007, the last full year before 2008’s market meltdown. In 2009, the number of FINRA cases filed more than doubled the 2007 total, with 7,137 filings. By 2010, the markets had turned the corner and began the period of nearly uninterrupted steady growth that ended only recently. During this period, 2010 through 2019, the S&P 500 market index nearly tripled in value. As I write this, the S&P 500 is down 20% year to date.
With history as our guide, one can expect that a prolonged, steep decline in markets will lead to a significant increase in customer case filings, as occurred in 2009 through 2011 when case filings were 50% to 100% higher than during the pre-2008 period. Looking backward, it is also possible to predict the type of claims that will be asserted.
Margin Sell Offs
The first wave of investors to feel the effects of a sustained sell-off are those whose accounts are heavily margined. Investment firms will exercise their near-absolute authority to sell a customer’s assets when a customer’s borrowing limit exceeds regulatory and contractual requirements. When stock markets drop precipitously, margin accounts may be sold out very quickly, with little or no notice to the investor. Investors are typically given little or no time to try to salvage their accounts by depositing additional funds. A margin customer may even be left with a negative account balance, which the firm will likely try to collect.
Execution Claims
Sharp declines often lead to execution problems. Brokers’ phones may be ringing off the hook, and it may be difficult or impossible for firms to field all the calls from panicked customers. Firms’ on-line trading platforms may be inaccessible due to the volume of customers attempting to place sell orders. Investors who are unable to reach their brokers may claim that they were unable to mitigate their losses because their brokers were unavailable or slow to respond.
A related problem occurs when the customer places a sell order, thinking the sale will be made at the current market price, and later finds out that because the markets were collapsing the price he received was much lower than he thought it would be. There may be a dispute between the customer and the firm over the time it took for the firm to place the order and whether it could have been executed sooner.
Suitability Cases
The bedrock duty of a securities broker is to recommend securities that are suitable in light of the customer’s investment objectives and financial circumstances. During a sustained bull market, it is easy for brokers and customers to believe that the stock markets are invincible. After the dust settles, customers may claim that their portfolios were over-concentrated in risky sectors. Market corrections have the greatest effect on the holdings of retired customers who are depending on their savings to fund their living expenses.
Bad Product Claims
In the aftermath of the 2008 financial debacle, investors suffered losses on a variety of derivative-based securities known as “structured products.” Those investment vehicles were often marketed as “safe” or “guaranteed.” but in truth were highly risky products that involved the use of leverage or were tied to sectors or companies that fared poorly during the market meltdown. One can expect that there may be cases involving similar types of bad product claims.
As I conclude this blog post, the securities markets are down 8% to 9% for the day. If such steep declines continue and there is no quick recovery, one can expect that FINRA arbitration filings by unhappy customers will greatly increase.
© Andrew Whiteman 2020
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For over thirty years, Whiteman Law Firm has handled securities litigation and arbitration cases. Click here for more information about our securities law practice. Please contact us for more information.