Most Major US Brokerages Require Investors to Sign Binding Arbitration Agreements
Whether you know it or not, as an investor, when you first open an account with any major broker-dealer in the United States, you will be required to sign a binding arbitration agreement. Once you sign that agreement, hopefully you will never have to think about it again - hopefully, your investments make you a lot of money; and your broker is a stand-up individual.
We should all be so lucky!
Investors May Pursue Recovery for Damages Through FINRA’s Arbitration Process
However, in the event that something goes wrong between you and your financial advisor or brokerage firm, that arbitration document could potentially have a huge impact on your future. That’s because, when you suffer financial injury due to the misconduct or negligence of a broker or broker-dealer, the arbitration agreement stipulates that you may only seek recovery for your damages through the Financial Industry Regulatory Authority (FINRA) arbitration process. In other words, you cannot sue your broker in court, and your case will not be decided by a jury of your peers. Instead, it will be decided by a FINRA arbitrator or panel of arbitrators, most of whom are older, retired financial industry professionals who are very likely not your peers or even particularly sympathetic to your plight. And their decision will be final.
But let’s say you went through all that - you ran the gauntlet of the FINRA arbitration process - and you wrestled away a good result. You were awarded real money for your losses… Congratulations. Except that...
Just Because You Win FINRA Arbitration Doesn’t Mean You’ll Get Your Money Back
Here’s your next problem: Can you collect the money you won?
According to FINRA, around 21% of arbitration awards last year remained uncollected.
And, what happens if the broker you won the award against is now broke or bankrupt? What then?
Now you see why it’s so important to confirm that your broker and/or your broker-dealer carries “bad practice” insurance. Because then, even if the individual broker can’t pay up on your arbitration award, you can go after his insurance carrier for the money you’re owed. Same goes for the brokerage. It’s less common for broker-dealers to go bankrupt; but many of the smaller, fly-by-night brokerages - especially those slapped with large awards and/or large penalties by FINRA - will sometimes elect to enter bankruptcy or dissolve altogether rather than pay what they owe. Fortunately, if they carried insurance at the time they committed the “bad practices” in question which lead to your losses, there’s at least a chance you’ll eventually be able to collect your FINRA-sanctioned award from the insurance carriers.
Broker and brokerages don’t have to carry insurance - and they don’t have to disclose whether they have it or not. Therefore, it’s your responsibility as an investor to confirm that your broker and your broker-dealer carries malpractice insurance. Be sure and do it!