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With the increasing globalization of capital market and emergence of securitization of asset, banking loans and security products are becoming entangled with each other, leading to increasing number of security disputes or disputes related to securities. Many financial arbitrations are concerned with security disputes or financial disputes related to securities. According to the U.S. Securities Act and decisions made by the Federal Supreme Court, securities could be defined in a broad way to include any notes, stocks, financial bills, certificates, corporate bonds, debentures, certificates of interest or participation in profit-sharing agreements, collateral-trust certificate, transferable shares, investment contract, voting-trust certificates, certificates of deposits for a security, and a fractional undivided interest in gas, oil, or other mineral rights, temporary certificates, receipts, certificates or rights of warranty, pledge or subscriptions. A decision made by the U.S. Supreme Court also added financial derivatives(namely financial futures in China) to the list of securities. Article two of the Security Law of China provides for that the law applies to the issuing and trading of stocks, corporate bonds and other securities accredited by the State Council according to law within the territory of China.”
In practice, securities market, capital market and financial market are frequently used by insiders, supervisors and scholars in an undifferentiated way. The three terms mean the same in this paper.
This paper focuses on relevant cases and arbitrations made by the financial supervisory bodies in the U.S., and compares them with Chinese practices. The United States is a financial power with more financial arbitration cases being witnessed, and relevant problems may be encountered in other countries. The U.S. experience may guide other countries in resolving securities disputes. Similar to their American counterparts, the Chinese courts usually shun litigations about securities disputes. China is at a starting phase in terms of securities arbitration, thus making the American practice and experience a valuable lesson for the country’s theoretical research and practical arbitrary efforts.
I. Necessity of securities arbitration
Financial arbitration is becoming increasingly complex, transnational and important, but about lawsuits involving securities disputes, both American and Chinese courts tend to be potent and shun their responsibilities. A. Cross-jurisdictional dilemma
Financial disputes might be resolved by courts in different jurisdictions in totally different manner, the result of which may easily bedazzle any party concerned. The Bankruptcy of Lehman Brothers is a case to this point. The structured financial trading contract usually will include a flip clause, according to which, holders of certificates of collateral bond have priorities in reclaiming the collaterals. The British high court ruled in favor of holders of collateral bond certificates in the Lehman Brothers bankruptcy case, but an American bankruptcy court had invalidated the flip clause before that ruling was made. On July 2, 2011, the British Supreme Court ruled that the flip clause was valid. However, the claim received no echoes or responses from their American counterparts, neither the federal court of appeal nor the Supreme Court ruled in this regard. In future cases, uncertainties will stay and resolution of relevant disputes may last longer.
Arbitration may function here to avoid possible jurisdictional discrepancies. In a precedent of 1987, the U.S. Supreme Court said that arbitration may reduce uncertainties in international contract, freeing the parties involved from possible troubles of submitting their case to rival or unfamiliar tribunals.
B. American courts’ tendency to avoid conflicts
The U.S. Supreme Court has set up barriers for investors to claim their losses through litigations. In a 2005 decision, the court reaffirmed that in accordance with the precedents, investors must provide following evidences when bring a civil lawsuit for claiming losses: a. significantly fraudulent statement or omission; b. intentional violation of law; c. concerning purchasing or selling securities; d. reliance; e. economic losses; f. causation between significantly fraudulent statement and losses. In 2004, the Supreme Court ruled again that the price dropping tendency of natural gas would not be categorized as significant information, thus such relevant fraudulent information did not constitute as grounds for investors claiming losses. In 2007, the court ruled that anti-monopoly law did not apply to securities industry, though there were also phenomena like forcible buying or selling, excessively high commissions, and tiein sales in the industry. Justices making the decision further explained that the disputable industry was under sound supervision of the U.S. Securities and Exchanges Commission. However, the fact is far below their expectations, under the “sound” supervision of SEC, the capital market collapses and financial crisis occurs. In 2004, the SEC tried to impose more stringent control on hedge fund and introduced relevant register rules. However, the regulation was vetoed by the court, and the SEC lost a lawsuit in Federal Court o Appeal. Afterwards, the SEC gave up appeals and suspended the new rules. In the year of 2008, a decision made by the Supreme Court made it more difficult for investors to claim a loss, in which joint liability was termed as scheme liability, and the schemer who falsify information for the issuers was called secondary actor, and the plaintiff must prove that his buying of financial derivatives was a direct result of listening to the opinions of the schemer.
C. Chinese courts’ tendency to avoid securities disputes
Chinese courts show a negative attitude in resolving securities disputes. In 1998, the Supreme People’s Court issued A Notice about Termination of Trial and Enforcement of Economic Disputes over Illegal Stock Trading on OTC market, and A Notice about Termination of Trial and Enforcement of Disputes Covered by a Debt Clear-up Chain of Bond Washing Brokerages. In 2001, the court issued A Notice about Suspension of Accepting Lawsuits Involving Civil Securities Compensation Claims, and in 2005, A Response by the Supreme People’s Court to Questions about Whether or not the People’s Courts will Accept Cases Involving Disputes Between Companies of Financial Asset Management and State-owned Commercial Banks over Contracts of Policyoriented Financial Asset Transfers. The Supreme Court stressed over and over its basic position in securities lawsuits, namely it would not accept such securities cases in the future; it would suspend on-going trials of such cases; it would not enforce legal decisions already made.
The Supreme People’s Court also designed a so-called“pre-positioned proceeding” for initiating a civil tort lawsuit caused by falsified statement, requiring that the falsified statement must a. be confirmed by a decision for punishment made by China Securities Regulatory Commission and its dispatched investigators; or b. be confirmed by a criminal judgment of the people’s court. The Supreme People’s Court, for specifying the above two requirements, issued A Notice about Relevant Questions Concerning Acceptance of Civil Tort Cases Involving Falsified Statement and A Number of Regulations about Questions Concerning Acceptance of Civil Tort Cases Involving Falsified Statement.
Criminal conviction has a higher threshold than civil judgment, and it is obviously not a favorable move for investors’ to safeguard and protect their rights when the Supreme Court is requiring that an acceptance of civil compensation lawsuit should be decided by whether or not it satisfies a criminal conviction. An indictment or conviction in criminal case will be determined by “whether or not the corpus delicti have been fully investigated”, or “whether or not evidences are accurate and sufficient”, whereas in a civil litigation, evidences presented to the court will play an overwhelming role in deciding the final winning party. Administrative penalty may lead to administrative litigation, though it is hard to tell whether a civil lawsuit will require a heavier burden of proof as compared with an administrative litigation. The administrative institutions can determined if an administrative penalty is imposed. Equally, the procuratorate agencies can use their discretion in deciding whether to press a criminal charge. In other words, even if losses have been sustained by the investors as a result of falsified information, they cannot press for a claim of losses when the administrative agency or procuratorate agency chooses inaction. Chinese judges are racking their brains to avoid civil securities disputes. It is a pity that they are not doing it for protecting the public good. Profession Huang Tao made excellent comments hitting the nail on the head:
Within the Chinese framework of political and economic system, division of powers between different branches of authority does not follow a “check-and-balance” principle but could be described as “a rigid separation of power domains”. In China’s financial industry, supervisory bodies are often confused with competent authorities in charge of a certain sector, a tendency that may lead to a hidden rule: any affairs(including financial legal disputes) must be first classified as a subject matter to a certain competent authority that is supposed to be responsible for dealing with this matter as its political task and must shoulder the outcome, no matter it is good or bad (the competent authority is just like a parent who is supposed to discipline his own child).
Beginning 1950s, Han Xuzhi, then Chief Judge of the Shanghai Municipality Court made concise and excellent remarks about adjudication work of the court, “before the founding of the P.R.C., the society was in a lawless state; after the liberation, we have judicial organs in place but lack rule of law.” Today, in the realm of financial disputes on capital market in both China and U.S., the U.S. has established a well-functioned legal framework, but lack competent authorities; while in China, we have neither well-functioned legal framework nor competent authorities.
Of course, we should not deny the dilemma faced by the courts that are more reluctant to accept securities disputes. It is widely acknowledged, though not publicly, that stock market and capital market (stock market in a broader sense) resemble the character of a gambling house. For example, the credit default swap transactions frequently seen during the financial crisis would be decided by a lot of accidental factors: if the debtor defaults, then the selling party must pay an agreed sum of money to the buyers according to the swap contract; if no default is found, the selling party may gain all fees paid by the buyer. It is not within the courts’ competence to rule in gambling disputes, nor do we see any such legal precedent across the world. Even if in jurisdictions where gambling has been legalized, relevant disputes would be solved outside courtrooms.
Chinese and American judges show similar attitude toward securities lawsuit. The former was more or less restrained by the system and relied upon relevant judicial interpretations of the Supreme People’s Court; the latter must follow the precedents of U.S. Federal Supreme Court and would dismiss securities cases under many circumstances. The situation will not be fundamentally changed in the foreseeable future. However, securities disputes must find their way out, otherwise social harmony will be sacrificed. The U.S. experience shows that an alternative dispute resolution, or arbitration, should be employed in order to resolve financial disputes. II. Feasibility of securities arbitration
From 1953 to 1987, an arbitration clause agreed upon in advance of a dispute will not be supported by the court according to precedents of the U.S. Supreme Court. Since 1987, such an arbitration provision has been explicitly allowed and supported. Arbitration agencies have been set up by the securities self-regulators in the U.S., resolving a huge number of securities disputes between financial institutions as well as between financial institutions and investors.
A. Applicability of arbitration clause
The primary question for arbitration is the validity of arbitration agreement. Arbitration in modern sense has a history of two hundred years. An Arbitration Law become effective in U.S. in the year of 1925, however, since then the applicability of it has been a controversial question. Securities arbitration would usually not be supported by the American courts, and as early as in the year of 1947, an American judge openly admitted that the court would frown on the arbitration.
A pre-dispute arbitration clause in a securities contract in the U.S. may read rougly as follows:
Any dispute arising out of or in connection with this contract shall be referred to and finally resolved by arbitration under rules of National Association of American Dealers or the Board of Directors of NYSE.
In Wilko v. Swan, a decision made by the Supreme Court in the year of 1953, a pre-dispute arbitration clause was found invalid on the ground that an arbitration would not satisfy and guarantee legal rights provided by article 12 (2) of the Securities Act that specifically stipulated that any contract or agreement should not give up abiding by the Act itself.
In Shearson/American Express v. McMahon of 1987, the Supreme Court overruled the Wilko decision, giving full effect to the arbitration clause signed in advance of securities dispute. According to such an arbitration clause, disputes between parties in connection with the Securities Exchange Act and Racketeer Influenced and Corrupt Organization should be referred to arbitration for resolution. The U.S. Supreme Court raised a new theory: “abiding by” mentioned in the Securities Exchange Act was “substantial abiding by”, which had no binding on procedures of case acceptance followed by the federal court; arbitration clause was an agreement on relevant procedures, irrelevant to a substantial observance of the Securities Exchange Act. Following the precedent of Shearson/American Express v. McMahon, the Supreme Court upheld this holding in Rodriguez de Quijas v. Shearson/American Express Inc. again in 1989, affirming the validity of pre-dispute arbitration clause in connection with the Securities Law. In a recent decision made by the Supreme Court in earlier 2012, an arbitration clause used in credit card contract was sustained. Although the decision does not directly involve securities arbitration, it manifests an attitude or trend of the U.S. Supreme Court, which is that after the financial crisis, American court will adhere to a position that supports predispute arbitration clause.
B. Arbitration by financial supervisory
Many securities disputes are arbitrated within selfregulatory organizations, among those the Financial Industry Regulatory Authority receives most of the arbitration cases. The FINRA was set up in July 2007, and was a huge organization with 3000 employees and annual cost reaching 500 million US dollars. The FINRA is a self-regulatory organization and arbitration is one of the services they offer.
Large financial institutions like Goldman Sachs will frequently be challenged as a respondent to arbitration conducted by the FINRA, which is considered an acceptable alternative dispute resolution means with more simplified discovery procedure compared with being sued to the court. According to the U.S. Federal Rules of Civil Procedure, the courtroom discovery procedures include deposition, written interrogatories, requests for admissions and requests for production. Comparatively speaking, arbitration requires far less from witnesses and testimonies, so does the arbitration rules with the FINRA that has introduced a document production list in its Discovery Guide for customer cases, though, without specific requirement for witness and testimony. However, according to the FINRA rules, parties may decline to produce documents required on the list on the ground of excessive cost and burden. Arbitrator should bear in mind the realistic situation of parties in rendering a decision, mulling over the following factors: relevance of the documents required; if it is feasible to narrow scope of time period and content of the list; if the same information is contained in other document, etc.
Financial institutions may avoid class actions initiated by investors by signing an arbitration agreement with the investing public. For financial institutions, class actions are just like nightmares, which would usually damage the reputation of the institutions and bring about negative influence, what’s more, losing a case may simply mean huge amount of compensation and covering the counsel fees for the winning party. Motivated by economic interests, a large number of lawyers are willing to claim their fees after winning the case, or they may even go out to find potential customers to initiate securities fraud claims. Only by initiating class actions, medium and small investors will have the chance to make full use of discovery procedures to collect evidence from financial institutions on a large scale. If suing the financial institution independently, they may find that costs and expenses brought about by the discovery procedures are well beyond their capabilities. Arbitration agreement will free financial institutions from possible troubles brought about by the class actions. The U.S. Supreme Court indicated in a decision of 2010 that arbitration agreement may exclude possibilities of parties to initiate class actions. The decision is not about financial dispute arbitration, though, it might be inferred that the Supreme Court is ready to support arbitration agreement in financial disputes. Arbitration may be a preferred way of seeking remedies for investors too. As mentioned above, Supreme Court has raised threshold for individuals to bring lawsuit to the court in a successive of decisions. Investors are facing more barriers to seek remedies by litigation, and have to turn to arbitration. Arbitration is in its essence a compromise: under many circumstances, claimants may get certain amount of compensation, not much though, it is better than nothing. As the arbitration verdicts attached below show, arbitration fees are nothing to financial institutions like Goldman Sachs and affordable to ordinary investors. In an arbitration case Adam C. Singer v. Goldman Sachs, the respondent demanded a postponement for producing documents required, the purpose of which was obviously to drag on the hearing. If it were a civil litigation, financial institutions will appear more active to produce more trouble for investors. Judges will usually allow a party’s requirement for postponement, and litigation fees may become unaffordable.
C. Arbitration verdict
Arbitrators will not offer any ground for the final award in the arbitration verdict, which is a feature of U.S. financial arbitration. According to the U.S. laws, there is no required form for a written arbitration verdict as long as the final decision is reached and arbitrators sign on it. The grounds for reaching the final verdict and how the arbitrators reach that final decision would not be required by law. usually, a written arbitration verdict may include following contents: the nature of the dispute, parties involved, major facts, legal disputes and the verdict.
The FINRA produced an arbitration verdict with less than three thousand words to resolve the disputes between Goldman Sachs and its clients. (See the attached file) China International Economic and Trade Arbitration Commission produced a written verdict with twenty thousand words, longer and more detailed than a court verdict. In fact, an arbitration verdict should be shorter and simplified, emphasizing more the result or award, whereas a court verdict should emphasize its reasoning. However, a long and well legally worded arbitration verdict reflects, on the one hand, the high standard of China’s arbitrators, on the other hand, a lack of soundness in China’s rule of law: the court is not willing to accept securities dispute and arbitrators have to play a role that is not supposed to belong to them.
Different from the civil judgment, arbitration verdict is final. A simplified arbitration verdict will cater to the needs of both parties because the claimant will usually care only about the award and financial institutions are expecting to put a cap on the award money. The FINRA has obviously achieved the above goals in the Goldman Sachs dispute: compensation or award would usually be limited to a certain affordable range as long as there is no punitive damage involved. III. Conclusion
Arbitration is both an alternative dispute resolution and an industry. It is also an important mark of financial centers. The Netherlands is going ahead of the rest in seizing the business opportunity by setting up, in January 2012, a special financial arbitration tribunal. The Holland government is taking ambitious steps, trying to build the tribunal into a world leading arbitration authority.
During the past one century, financial disputes have been mainly resolved by “white judges in London and Manhattan.” Today, the world’s economic order is undergoing huge changes, and China should become a center of global financial dispute resolution. Judges home and abroad are usually unwilling to take financial dispute cases, which may constitute as a good opportunity for the growth of China’s financial arbitration. The gap between Chinese arbitrators and their international peers can more easily be bridged as compared with the gap between Chinese and western judges. So it is quite possible that China’s financial arbitration could reach the standard of western countries or even overpass them. Due to China’s important position in international securities, capital and financial market, our arbitration agencies may demand a larger share in this business. Although the arbitration industry in the U.S. is well developed, disputes with excessively large amount of money or disputes between financial institutions will be resolved by arbitrators outside the self-regulatory organizations. For example, there is no arbitration agreement in place in disputes over certificates of collateral bond in bankruptcy case of Lehman Brothers.
Appendix:
AWARD
FINRA Dispute Resolution
In the Matter of the Arbitration Between:
Name of Claimant
Adam C. Singer, as Trustee
for the Adam C. Singer 2004 Trust UA DTD 20FEB04
vs. Case Number: 09-01485
Hearing Site: Dallas, Texas
Name of Respondent
Goldman, Sachs and Company
NATURE OF THE DISPUTE
Customer vs. Member
REPRESENTATION OF PARTIES
Adam C. Singer, as Trustee for the Adam C. Singer 2004 Trust UA DTD 20FEB04
("Claimant" or "Singer") was represented by Scott A. Shanes, Esq., Strasburger & Price,LLP, Frisco, Texas.
Goldman, Sachs and Company ("Respondent" or"Goldman Sachs") was represented by Sharon J . Shumway, Esq., Carrington Coleman Sloman & Blumenthal, Dallas, Texas.
CASE INFORMATION
The Statement of Claim was filed on or about March 17, 2009. The Submission Agreement of Claimant, Adam C. Singer, As Trustee for the Adam C. Singer 2004 Trust UA DTD 20FEB04, was signed on or about April 6, 2009. On or about April 2, 2009,Claimant filed a Brief in Support of the Original Statement of Claim. The Amended Statement of Claim was filed on or about April 8, 2010. The Statement of Answer was filed by Respondent, Goldman, Sachs and Company, on or about June 18, 2009. The Submission Agreement of Respondent, Goldman, Sachs and Company, was signed on or about June 23,2009. The Answer to the Amended Statement of Claim was filed on or about May 7, 2010.
CASE SUMMARY
Claimant asserted the following causes of action: breach of fiduciary duty; material misrepresentations; omissions; fair dealing; negligent misrepresentation; gross negligence;common law fraud; respondeat superior; violation of federal securities laws; and violation of Texas Securities Act. The causes of action related to the recommendation and purchase of Vermont Student Loan Auction Rate Securities (“SLARS VT”). Claimant alleged that Goldman Sachs failed to disclose material information regarding the SLARS VT before Singer purchased the securities in his account and that Goldman Sachs misrepresented and omitted material information about the maximum rate of the SLARS VT. Claimant alleged that Goldman Sachs was aware of his investment strategy to purchase periodic auction reset securities (“PARS”) with high maximum rates in the event of a failed auctions.
Claimant alleged that before he bought the SLARS VT, Goldman Sachs had internal information that there were PARS with maximum rate waivers allowing them to realize high interest rates but then when those waivers expired, the rates would reset to much lower percentages. Claimant asserted that although Goldman Sachs was aware of this information, it failed to inform him.
Unless specifically admitted in its Answer, Respondent denied the allegations made in the Statement of Claim and asserted affirmative defenses including the following: Claimant failed to state a claim upon which relief can be granted; Claimant waived and is estopped from asserting the claims made by him; Claimant ratified the transactions complained of;Claimant’s own conduct is responsible for the loss complained of; Goldman Sachs did not know, and in the exercise of reasonable care could not have known, of the existence of the alleged misrepresentations and omissions by reason on which liability is alleged to exits;Claimant did not justifiably rely on any alleged misrepresentations and omissions; Claimant failed to mitigate his damages; and Claimant’s recovery of damages is barred or must be reduced by his proportionate fault.
RELIEF REQUESTED
Claimant requested an award in the amount of:
Actual/Compensatory Damages $ 452,884.93 Exemplary/Punitive Damages Unspecified
Interest Unspecified
Attorneys’ Fees Unspecified
Other Costs Unspecified
Other Non-Monetary Relief Rescission
At the hearing. Claimant requested:
Theory 1 (Benefit of Origin): $171,397.65 in actual/ compensatory damages + interest at the rate of 18% from September 1, 2010 until sold at par or redeemed $143,336.66 in attorneys’ fees = $314,734.31.
Theory 2 (Texas Securities Act): rescission of SLARS VT $450,000 + legal interest under Vermont law $29,791.06 + attorneys’ fees $143,36.66 = $623,127.72.
Respondent requested that the claims asserted against it be denied in their entirety and that it be awarded its costs and attorneys’ fees.
OTHER ISSUES CONSIDERED & DECIDED
The Arbitrators acknowledge that they have each read the pleadings and other materials filed by the parties.
On or about April 2, 2010, Claimant filed a Motion for Leave to File Amended Statement of Claim. On or about April 6, 2010, Respondent filed a Response to Claimant’s Motion for Leave to Amend. On or about April 8, 2010, the Panel granted Claimant’s Motion for Leave to File Amended Statement of Claim. The Panel granted Respondent until April 16,2010 to file an Answer to the Amended Statement of Claim.
On or about October 8, 2010, the Panel issued an Order requesting post-hearing submissions from the parties. On or about November 4, 2010, FINRA forwarded the parties’ posthearing submission to the Panel.
On December 20, 2010, Respondent submitted a Request to Re-Open the Record. On or about December 21, Claimant filed an Opposition to the Motion. On or about December 22, 2010, Respondent filed a Reply in Support of the Motion. On January 25, 2011, FINRA sent to the parties the Panel’s additional questions it wanted answered from Respondent prior to determining whether it would entertain Respondent’s Motion to Re-Open the Record. On January 27, 2011, Respondent submitted its answers to the Panel’s additional questions. On or about January 31, 2011, the Panel issued an Order:
The Panel agrees to reopen the record only to receive Respondent’s December submission and Claimant’s reply, if any. The Panel will NOT consider any further requests or an additional hearing session with the parties. Claimant has until February 4, 2011 to submit a reply brief On February 8, 2011, FINRA forwarded to the Panel Respondent’s Motion to ReOpen,dated December 20, 2010 and Claimant’s Reply, dated February 4, 2011.
In practice, securities market, capital market and financial market are frequently used by insiders, supervisors and scholars in an undifferentiated way. The three terms mean the same in this paper.
This paper focuses on relevant cases and arbitrations made by the financial supervisory bodies in the U.S., and compares them with Chinese practices. The United States is a financial power with more financial arbitration cases being witnessed, and relevant problems may be encountered in other countries. The U.S. experience may guide other countries in resolving securities disputes. Similar to their American counterparts, the Chinese courts usually shun litigations about securities disputes. China is at a starting phase in terms of securities arbitration, thus making the American practice and experience a valuable lesson for the country’s theoretical research and practical arbitrary efforts.
I. Necessity of securities arbitration
Financial arbitration is becoming increasingly complex, transnational and important, but about lawsuits involving securities disputes, both American and Chinese courts tend to be potent and shun their responsibilities. A. Cross-jurisdictional dilemma
Financial disputes might be resolved by courts in different jurisdictions in totally different manner, the result of which may easily bedazzle any party concerned. The Bankruptcy of Lehman Brothers is a case to this point. The structured financial trading contract usually will include a flip clause, according to which, holders of certificates of collateral bond have priorities in reclaiming the collaterals. The British high court ruled in favor of holders of collateral bond certificates in the Lehman Brothers bankruptcy case, but an American bankruptcy court had invalidated the flip clause before that ruling was made. On July 2, 2011, the British Supreme Court ruled that the flip clause was valid. However, the claim received no echoes or responses from their American counterparts, neither the federal court of appeal nor the Supreme Court ruled in this regard. In future cases, uncertainties will stay and resolution of relevant disputes may last longer.
Arbitration may function here to avoid possible jurisdictional discrepancies. In a precedent of 1987, the U.S. Supreme Court said that arbitration may reduce uncertainties in international contract, freeing the parties involved from possible troubles of submitting their case to rival or unfamiliar tribunals.
B. American courts’ tendency to avoid conflicts
The U.S. Supreme Court has set up barriers for investors to claim their losses through litigations. In a 2005 decision, the court reaffirmed that in accordance with the precedents, investors must provide following evidences when bring a civil lawsuit for claiming losses: a. significantly fraudulent statement or omission; b. intentional violation of law; c. concerning purchasing or selling securities; d. reliance; e. economic losses; f. causation between significantly fraudulent statement and losses. In 2004, the Supreme Court ruled again that the price dropping tendency of natural gas would not be categorized as significant information, thus such relevant fraudulent information did not constitute as grounds for investors claiming losses. In 2007, the court ruled that anti-monopoly law did not apply to securities industry, though there were also phenomena like forcible buying or selling, excessively high commissions, and tiein sales in the industry. Justices making the decision further explained that the disputable industry was under sound supervision of the U.S. Securities and Exchanges Commission. However, the fact is far below their expectations, under the “sound” supervision of SEC, the capital market collapses and financial crisis occurs. In 2004, the SEC tried to impose more stringent control on hedge fund and introduced relevant register rules. However, the regulation was vetoed by the court, and the SEC lost a lawsuit in Federal Court o Appeal. Afterwards, the SEC gave up appeals and suspended the new rules. In the year of 2008, a decision made by the Supreme Court made it more difficult for investors to claim a loss, in which joint liability was termed as scheme liability, and the schemer who falsify information for the issuers was called secondary actor, and the plaintiff must prove that his buying of financial derivatives was a direct result of listening to the opinions of the schemer.
C. Chinese courts’ tendency to avoid securities disputes
Chinese courts show a negative attitude in resolving securities disputes. In 1998, the Supreme People’s Court issued A Notice about Termination of Trial and Enforcement of Economic Disputes over Illegal Stock Trading on OTC market, and A Notice about Termination of Trial and Enforcement of Disputes Covered by a Debt Clear-up Chain of Bond Washing Brokerages. In 2001, the court issued A Notice about Suspension of Accepting Lawsuits Involving Civil Securities Compensation Claims, and in 2005, A Response by the Supreme People’s Court to Questions about Whether or not the People’s Courts will Accept Cases Involving Disputes Between Companies of Financial Asset Management and State-owned Commercial Banks over Contracts of Policyoriented Financial Asset Transfers. The Supreme Court stressed over and over its basic position in securities lawsuits, namely it would not accept such securities cases in the future; it would suspend on-going trials of such cases; it would not enforce legal decisions already made.
The Supreme People’s Court also designed a so-called“pre-positioned proceeding” for initiating a civil tort lawsuit caused by falsified statement, requiring that the falsified statement must a. be confirmed by a decision for punishment made by China Securities Regulatory Commission and its dispatched investigators; or b. be confirmed by a criminal judgment of the people’s court. The Supreme People’s Court, for specifying the above two requirements, issued A Notice about Relevant Questions Concerning Acceptance of Civil Tort Cases Involving Falsified Statement and A Number of Regulations about Questions Concerning Acceptance of Civil Tort Cases Involving Falsified Statement.
Criminal conviction has a higher threshold than civil judgment, and it is obviously not a favorable move for investors’ to safeguard and protect their rights when the Supreme Court is requiring that an acceptance of civil compensation lawsuit should be decided by whether or not it satisfies a criminal conviction. An indictment or conviction in criminal case will be determined by “whether or not the corpus delicti have been fully investigated”, or “whether or not evidences are accurate and sufficient”, whereas in a civil litigation, evidences presented to the court will play an overwhelming role in deciding the final winning party. Administrative penalty may lead to administrative litigation, though it is hard to tell whether a civil lawsuit will require a heavier burden of proof as compared with an administrative litigation. The administrative institutions can determined if an administrative penalty is imposed. Equally, the procuratorate agencies can use their discretion in deciding whether to press a criminal charge. In other words, even if losses have been sustained by the investors as a result of falsified information, they cannot press for a claim of losses when the administrative agency or procuratorate agency chooses inaction. Chinese judges are racking their brains to avoid civil securities disputes. It is a pity that they are not doing it for protecting the public good. Profession Huang Tao made excellent comments hitting the nail on the head:
Within the Chinese framework of political and economic system, division of powers between different branches of authority does not follow a “check-and-balance” principle but could be described as “a rigid separation of power domains”. In China’s financial industry, supervisory bodies are often confused with competent authorities in charge of a certain sector, a tendency that may lead to a hidden rule: any affairs(including financial legal disputes) must be first classified as a subject matter to a certain competent authority that is supposed to be responsible for dealing with this matter as its political task and must shoulder the outcome, no matter it is good or bad (the competent authority is just like a parent who is supposed to discipline his own child).
Beginning 1950s, Han Xuzhi, then Chief Judge of the Shanghai Municipality Court made concise and excellent remarks about adjudication work of the court, “before the founding of the P.R.C., the society was in a lawless state; after the liberation, we have judicial organs in place but lack rule of law.” Today, in the realm of financial disputes on capital market in both China and U.S., the U.S. has established a well-functioned legal framework, but lack competent authorities; while in China, we have neither well-functioned legal framework nor competent authorities.
Of course, we should not deny the dilemma faced by the courts that are more reluctant to accept securities disputes. It is widely acknowledged, though not publicly, that stock market and capital market (stock market in a broader sense) resemble the character of a gambling house. For example, the credit default swap transactions frequently seen during the financial crisis would be decided by a lot of accidental factors: if the debtor defaults, then the selling party must pay an agreed sum of money to the buyers according to the swap contract; if no default is found, the selling party may gain all fees paid by the buyer. It is not within the courts’ competence to rule in gambling disputes, nor do we see any such legal precedent across the world. Even if in jurisdictions where gambling has been legalized, relevant disputes would be solved outside courtrooms.
Chinese and American judges show similar attitude toward securities lawsuit. The former was more or less restrained by the system and relied upon relevant judicial interpretations of the Supreme People’s Court; the latter must follow the precedents of U.S. Federal Supreme Court and would dismiss securities cases under many circumstances. The situation will not be fundamentally changed in the foreseeable future. However, securities disputes must find their way out, otherwise social harmony will be sacrificed. The U.S. experience shows that an alternative dispute resolution, or arbitration, should be employed in order to resolve financial disputes. II. Feasibility of securities arbitration
From 1953 to 1987, an arbitration clause agreed upon in advance of a dispute will not be supported by the court according to precedents of the U.S. Supreme Court. Since 1987, such an arbitration provision has been explicitly allowed and supported. Arbitration agencies have been set up by the securities self-regulators in the U.S., resolving a huge number of securities disputes between financial institutions as well as between financial institutions and investors.
A. Applicability of arbitration clause
The primary question for arbitration is the validity of arbitration agreement. Arbitration in modern sense has a history of two hundred years. An Arbitration Law become effective in U.S. in the year of 1925, however, since then the applicability of it has been a controversial question. Securities arbitration would usually not be supported by the American courts, and as early as in the year of 1947, an American judge openly admitted that the court would frown on the arbitration.
A pre-dispute arbitration clause in a securities contract in the U.S. may read rougly as follows:
Any dispute arising out of or in connection with this contract shall be referred to and finally resolved by arbitration under rules of National Association of American Dealers or the Board of Directors of NYSE.
In Wilko v. Swan, a decision made by the Supreme Court in the year of 1953, a pre-dispute arbitration clause was found invalid on the ground that an arbitration would not satisfy and guarantee legal rights provided by article 12 (2) of the Securities Act that specifically stipulated that any contract or agreement should not give up abiding by the Act itself.
In Shearson/American Express v. McMahon of 1987, the Supreme Court overruled the Wilko decision, giving full effect to the arbitration clause signed in advance of securities dispute. According to such an arbitration clause, disputes between parties in connection with the Securities Exchange Act and Racketeer Influenced and Corrupt Organization should be referred to arbitration for resolution. The U.S. Supreme Court raised a new theory: “abiding by” mentioned in the Securities Exchange Act was “substantial abiding by”, which had no binding on procedures of case acceptance followed by the federal court; arbitration clause was an agreement on relevant procedures, irrelevant to a substantial observance of the Securities Exchange Act. Following the precedent of Shearson/American Express v. McMahon, the Supreme Court upheld this holding in Rodriguez de Quijas v. Shearson/American Express Inc. again in 1989, affirming the validity of pre-dispute arbitration clause in connection with the Securities Law. In a recent decision made by the Supreme Court in earlier 2012, an arbitration clause used in credit card contract was sustained. Although the decision does not directly involve securities arbitration, it manifests an attitude or trend of the U.S. Supreme Court, which is that after the financial crisis, American court will adhere to a position that supports predispute arbitration clause.
B. Arbitration by financial supervisory
Many securities disputes are arbitrated within selfregulatory organizations, among those the Financial Industry Regulatory Authority receives most of the arbitration cases. The FINRA was set up in July 2007, and was a huge organization with 3000 employees and annual cost reaching 500 million US dollars. The FINRA is a self-regulatory organization and arbitration is one of the services they offer.
Large financial institutions like Goldman Sachs will frequently be challenged as a respondent to arbitration conducted by the FINRA, which is considered an acceptable alternative dispute resolution means with more simplified discovery procedure compared with being sued to the court. According to the U.S. Federal Rules of Civil Procedure, the courtroom discovery procedures include deposition, written interrogatories, requests for admissions and requests for production. Comparatively speaking, arbitration requires far less from witnesses and testimonies, so does the arbitration rules with the FINRA that has introduced a document production list in its Discovery Guide for customer cases, though, without specific requirement for witness and testimony. However, according to the FINRA rules, parties may decline to produce documents required on the list on the ground of excessive cost and burden. Arbitrator should bear in mind the realistic situation of parties in rendering a decision, mulling over the following factors: relevance of the documents required; if it is feasible to narrow scope of time period and content of the list; if the same information is contained in other document, etc.
Financial institutions may avoid class actions initiated by investors by signing an arbitration agreement with the investing public. For financial institutions, class actions are just like nightmares, which would usually damage the reputation of the institutions and bring about negative influence, what’s more, losing a case may simply mean huge amount of compensation and covering the counsel fees for the winning party. Motivated by economic interests, a large number of lawyers are willing to claim their fees after winning the case, or they may even go out to find potential customers to initiate securities fraud claims. Only by initiating class actions, medium and small investors will have the chance to make full use of discovery procedures to collect evidence from financial institutions on a large scale. If suing the financial institution independently, they may find that costs and expenses brought about by the discovery procedures are well beyond their capabilities. Arbitration agreement will free financial institutions from possible troubles brought about by the class actions. The U.S. Supreme Court indicated in a decision of 2010 that arbitration agreement may exclude possibilities of parties to initiate class actions. The decision is not about financial dispute arbitration, though, it might be inferred that the Supreme Court is ready to support arbitration agreement in financial disputes. Arbitration may be a preferred way of seeking remedies for investors too. As mentioned above, Supreme Court has raised threshold for individuals to bring lawsuit to the court in a successive of decisions. Investors are facing more barriers to seek remedies by litigation, and have to turn to arbitration. Arbitration is in its essence a compromise: under many circumstances, claimants may get certain amount of compensation, not much though, it is better than nothing. As the arbitration verdicts attached below show, arbitration fees are nothing to financial institutions like Goldman Sachs and affordable to ordinary investors. In an arbitration case Adam C. Singer v. Goldman Sachs, the respondent demanded a postponement for producing documents required, the purpose of which was obviously to drag on the hearing. If it were a civil litigation, financial institutions will appear more active to produce more trouble for investors. Judges will usually allow a party’s requirement for postponement, and litigation fees may become unaffordable.
C. Arbitration verdict
Arbitrators will not offer any ground for the final award in the arbitration verdict, which is a feature of U.S. financial arbitration. According to the U.S. laws, there is no required form for a written arbitration verdict as long as the final decision is reached and arbitrators sign on it. The grounds for reaching the final verdict and how the arbitrators reach that final decision would not be required by law. usually, a written arbitration verdict may include following contents: the nature of the dispute, parties involved, major facts, legal disputes and the verdict.
The FINRA produced an arbitration verdict with less than three thousand words to resolve the disputes between Goldman Sachs and its clients. (See the attached file) China International Economic and Trade Arbitration Commission produced a written verdict with twenty thousand words, longer and more detailed than a court verdict. In fact, an arbitration verdict should be shorter and simplified, emphasizing more the result or award, whereas a court verdict should emphasize its reasoning. However, a long and well legally worded arbitration verdict reflects, on the one hand, the high standard of China’s arbitrators, on the other hand, a lack of soundness in China’s rule of law: the court is not willing to accept securities dispute and arbitrators have to play a role that is not supposed to belong to them.
Different from the civil judgment, arbitration verdict is final. A simplified arbitration verdict will cater to the needs of both parties because the claimant will usually care only about the award and financial institutions are expecting to put a cap on the award money. The FINRA has obviously achieved the above goals in the Goldman Sachs dispute: compensation or award would usually be limited to a certain affordable range as long as there is no punitive damage involved. III. Conclusion
Arbitration is both an alternative dispute resolution and an industry. It is also an important mark of financial centers. The Netherlands is going ahead of the rest in seizing the business opportunity by setting up, in January 2012, a special financial arbitration tribunal. The Holland government is taking ambitious steps, trying to build the tribunal into a world leading arbitration authority.
During the past one century, financial disputes have been mainly resolved by “white judges in London and Manhattan.” Today, the world’s economic order is undergoing huge changes, and China should become a center of global financial dispute resolution. Judges home and abroad are usually unwilling to take financial dispute cases, which may constitute as a good opportunity for the growth of China’s financial arbitration. The gap between Chinese arbitrators and their international peers can more easily be bridged as compared with the gap between Chinese and western judges. So it is quite possible that China’s financial arbitration could reach the standard of western countries or even overpass them. Due to China’s important position in international securities, capital and financial market, our arbitration agencies may demand a larger share in this business. Although the arbitration industry in the U.S. is well developed, disputes with excessively large amount of money or disputes between financial institutions will be resolved by arbitrators outside the self-regulatory organizations. For example, there is no arbitration agreement in place in disputes over certificates of collateral bond in bankruptcy case of Lehman Brothers.
Appendix:
AWARD
FINRA Dispute Resolution
In the Matter of the Arbitration Between:
Name of Claimant
Adam C. Singer, as Trustee
for the Adam C. Singer 2004 Trust UA DTD 20FEB04
vs. Case Number: 09-01485
Hearing Site: Dallas, Texas
Name of Respondent
Goldman, Sachs and Company
NATURE OF THE DISPUTE
Customer vs. Member
REPRESENTATION OF PARTIES
Adam C. Singer, as Trustee for the Adam C. Singer 2004 Trust UA DTD 20FEB04
("Claimant" or "Singer") was represented by Scott A. Shanes, Esq., Strasburger & Price,LLP, Frisco, Texas.
Goldman, Sachs and Company ("Respondent" or"Goldman Sachs") was represented by Sharon J . Shumway, Esq., Carrington Coleman Sloman & Blumenthal, Dallas, Texas.
CASE INFORMATION
The Statement of Claim was filed on or about March 17, 2009. The Submission Agreement of Claimant, Adam C. Singer, As Trustee for the Adam C. Singer 2004 Trust UA DTD 20FEB04, was signed on or about April 6, 2009. On or about April 2, 2009,Claimant filed a Brief in Support of the Original Statement of Claim. The Amended Statement of Claim was filed on or about April 8, 2010. The Statement of Answer was filed by Respondent, Goldman, Sachs and Company, on or about June 18, 2009. The Submission Agreement of Respondent, Goldman, Sachs and Company, was signed on or about June 23,2009. The Answer to the Amended Statement of Claim was filed on or about May 7, 2010.
CASE SUMMARY
Claimant asserted the following causes of action: breach of fiduciary duty; material misrepresentations; omissions; fair dealing; negligent misrepresentation; gross negligence;common law fraud; respondeat superior; violation of federal securities laws; and violation of Texas Securities Act. The causes of action related to the recommendation and purchase of Vermont Student Loan Auction Rate Securities (“SLARS VT”). Claimant alleged that Goldman Sachs failed to disclose material information regarding the SLARS VT before Singer purchased the securities in his account and that Goldman Sachs misrepresented and omitted material information about the maximum rate of the SLARS VT. Claimant alleged that Goldman Sachs was aware of his investment strategy to purchase periodic auction reset securities (“PARS”) with high maximum rates in the event of a failed auctions.
Claimant alleged that before he bought the SLARS VT, Goldman Sachs had internal information that there were PARS with maximum rate waivers allowing them to realize high interest rates but then when those waivers expired, the rates would reset to much lower percentages. Claimant asserted that although Goldman Sachs was aware of this information, it failed to inform him.
Unless specifically admitted in its Answer, Respondent denied the allegations made in the Statement of Claim and asserted affirmative defenses including the following: Claimant failed to state a claim upon which relief can be granted; Claimant waived and is estopped from asserting the claims made by him; Claimant ratified the transactions complained of;Claimant’s own conduct is responsible for the loss complained of; Goldman Sachs did not know, and in the exercise of reasonable care could not have known, of the existence of the alleged misrepresentations and omissions by reason on which liability is alleged to exits;Claimant did not justifiably rely on any alleged misrepresentations and omissions; Claimant failed to mitigate his damages; and Claimant’s recovery of damages is barred or must be reduced by his proportionate fault.
RELIEF REQUESTED
Claimant requested an award in the amount of:
Actual/Compensatory Damages $ 452,884.93 Exemplary/Punitive Damages Unspecified
Interest Unspecified
Attorneys’ Fees Unspecified
Other Costs Unspecified
Other Non-Monetary Relief Rescission
At the hearing. Claimant requested:
Theory 1 (Benefit of Origin): $171,397.65 in actual/ compensatory damages + interest at the rate of 18% from September 1, 2010 until sold at par or redeemed $143,336.66 in attorneys’ fees = $314,734.31.
Theory 2 (Texas Securities Act): rescission of SLARS VT $450,000 + legal interest under Vermont law $29,791.06 + attorneys’ fees $143,36.66 = $623,127.72.
Respondent requested that the claims asserted against it be denied in their entirety and that it be awarded its costs and attorneys’ fees.
OTHER ISSUES CONSIDERED & DECIDED
The Arbitrators acknowledge that they have each read the pleadings and other materials filed by the parties.
On or about April 2, 2010, Claimant filed a Motion for Leave to File Amended Statement of Claim. On or about April 6, 2010, Respondent filed a Response to Claimant’s Motion for Leave to Amend. On or about April 8, 2010, the Panel granted Claimant’s Motion for Leave to File Amended Statement of Claim. The Panel granted Respondent until April 16,2010 to file an Answer to the Amended Statement of Claim.
On or about October 8, 2010, the Panel issued an Order requesting post-hearing submissions from the parties. On or about November 4, 2010, FINRA forwarded the parties’ posthearing submission to the Panel.
On December 20, 2010, Respondent submitted a Request to Re-Open the Record. On or about December 21, Claimant filed an Opposition to the Motion. On or about December 22, 2010, Respondent filed a Reply in Support of the Motion. On January 25, 2011, FINRA sent to the parties the Panel’s additional questions it wanted answered from Respondent prior to determining whether it would entertain Respondent’s Motion to Re-Open the Record. On January 27, 2011, Respondent submitted its answers to the Panel’s additional questions. On or about January 31, 2011, the Panel issued an Order:
The Panel agrees to reopen the record only to receive Respondent’s December submission and Claimant’s reply, if any. The Panel will NOT consider any further requests or an additional hearing session with the parties. Claimant has until February 4, 2011 to submit a reply brief On February 8, 2011, FINRA forwarded to the Panel Respondent’s Motion to ReOpen,dated December 20, 2010 and Claimant’s Reply, dated February 4, 2011.