August 22, 2010
I submit this comment on FINRAs proposal to amend its Discovery Guide
(SR-FINRA-2010-035). I cannot support the proposal.
I am opposed to the concept of a guide to discovery in arbitration. I have been representing investors in securities arbitration since I left the SEC staff in 1980. I therefore have more than 30 years of experience in this area, some of the experience even pre-dating mandatory arbitration.
In the "early days" of arbitration, before the McMahon decision and shortly afterward, investors and their counsel had to fight for every document. This fight was usually conducted in court, most often federal court, before judges accustomed to dealing with Rule 26 relevancy issues. Once arbitrators began dealing with discovery issues, the playing field began to tilt toward the securities industry. In an effort to appear to be "fair" and "even-handed", the NASD (now FINRA) adopted a discovery guide calling for both brokerage firms and public customers to produce certain documents in discovery that the NASD deemed to be "presumptively relevant" and discoverable. The basic fallacy in this concept is that customers' documents are as relevant as brokerage firms' documents. In fact, they are not.
The regulatory system imposed by the Securities Exchange Act of 1934 and particularly the record-maintenance and retention rules adopted thereunder results in the creation of hundreds of documents relating to each brokerage account maintained by a brokerage firm. These documents were specifically created by the securities industry to evidence execution, custody, pricing, commission, order entry, margin extension, disclosure, supervision and other data deemed to be important by the Commission in its rule-making capacity. Each of these documents relates specifically to the customer, the customer's account, and the orders placed and executed in that customer's account. Yet under the current FINRA discovery guide, only a fraction of these documents are "presumptively discoverable". Moreover it has become common practice for brokerage firms to object to producing even those limited documents listed in the FINRA discovery guide on the basis that such documents are purportedly "not relevant".
On the other hand, the FINRA discovery guide lists numerous categories of documents to be produced by investors which are truly of questionable relevance. For example, the discovery guide requires customers to produce their income tax returns in virtually every arbitration, regardless of the claims made in the arbitration. Few documents are as sensitive or intrusive as a citizen's income tax return, yet any public customer considering making a claim against a broker-dealer must be advised that his tax returns will probably be ordered to be produced to the brokerage firm. Yet tax returns are totally irrelevant to the average customer/broker dispute. If a claim is based upon the exercise of discretion in a customer's account without a trading authorization, what relevance does the customer's income tax return have? If the customer's claim is based upon his account being churned, what relevance does the customer's income tax return have? In churning cases, the broker's tax return probably has more relevance by revealing the broker's financial condition than does the customer's tax return, yet I am aware of no case where an arbitration panel has ordered the production of a broker's tax return. The only type of case where an argument can even be conceivably made as to the relevance of a customer's tax return is a case based upon "unsuitability". Yet even in these cases, the customer's investment objective is the crucial suitability factor regardless of the customer's wealth. Even wealthy investors can have conservative investment objectives which must be honored by their brokers.
The adoption of a discovery guide by FINRA and the "horse-trading" that went into the creation of that document and every revision of the guide since its creation has done little to benefit the public customer and much to benefit the securities industry. It would be better to start from scratch and require both parties to tailor their discovery requests to the specific issues of each case, to appoint experienced arbitrators (perhaps retired judges) to rule on these discovery requests, and to abandon any attempt to create a blanket list of documents that are "presumptively discoverable". There is no "discovery guide" in the Federal Rules of Civil Procedure, and there should be none in arbitration.
Steven J. Gard
Member FL, GA, MO bars
Certified by The Florida Bar in Business Litigation
August 22, 2010