Understanding the Critical Role of Documentation in Resolving Brokerage Disputes

By Mark J. Astarita, Esq.

Arbitration has become the preferred method for resolving customer disputes within the brokerage industry since the pivotal United States Supreme Court decision in MacMahon v. Shearson American Express. Today, nearly every brokerage firm in the country includes a pre-dispute arbitration clause in their agreements, obligating the firm, broker, and customer to resolve all account-related disputes through arbitration.

Arbitration has proven to be an efficient and widely used method for dealing with these disputes, offering numerous benefits and some risks. However, the success of arbitration heavily relies on proper documentation, which is often the most critical element in resolving disputes. This article will explore the various aspects of documentation and its importance in the arbitration process.

Common Claims Against Brokers

When disputes arise between customers and brokers, the claims typically involve churning, unauthorized trading, unsuitability, misrepresentation, breach of fiduciary duty, and breach of contract. These claims require substantial evidence, often derived from proper documentation, to be effectively addressed during arbitration.

The Importance of Documentation in Brokerage Disputes

Brokers and customers often underestimate documentation’s significance in the arbitration process. The reality is that documentation is the cornerstone of any brokerage dispute. Most disputes revolve around what was said during various interactions—whether it was a broker discussing an investment or a customer outlining their financial objectives.

While it’s not necessary to document every word exchanged between a customer and their broker, implementing a few straightforward procedures can significantly strengthen a broker’s defense against unwarranted claims. These procedures are not time-consuming and can be crucial in resolving disputes.

Account Documentation

One of the most essential forms of documentation is the Account Documentation. Every brokerage firm requires specific documentation from a new client, which should be updated regularly as the relationship progresses. The significance of these documents cannot be overstated, as they serve as vital evidence during arbitration, often outweighing verbal testimony.

The New Account Form is particularly critical. Unfortunately, many brokers and customers do not pay enough attention to this document. The New Account Form is fundamental in a wide range of customer disputes, as it contains essential information about the customer’s financial and investment background, which forms the basis for the broker’s recommendations and the firm’s compliance reviews.

To avoid disputes, brokers should ensure that the New Account Form is completed accurately and reviewed annually with the customer. Accurate information on the form is critical. Updating the form and having the customer sign off on the update is equally important.

Maintaining Accurate and Up-to-Date Documentation

Both brokers and customers must keep the New Account Form up to date. Changes in a customer’s investment objectives or financial status should be promptly recorded, either on the original form or by completing an amended form. Failing to do so can lead to significant issues in the broker-customer relationship, as mismatches between investment objectives and trading activity may occur.

Regularly updating account documentation ensures that the broker’s recommendations remain suitable for the customer’s current financial situation. For example, a customer who initially opened an account at age 35 may have different financial goals by age 40. Annual reviews of account information can prevent potential disputes by aligning the customer’s objectives with their investment activities.

Clear Communication and Record-keeping

Most communications between brokers and their clients are oral, which can lead to misunderstandings or disputes over what was said during these conversations. Brokers should strive to communicate clearly and confirm any significant conversations in writing. Written confirmations can prevent disputes from arising, as they provide clear evidence of what was discussed.

For instance, if a customer decides to deviate from a broker’s recommendation in a way that increases their potential risk of loss, the broker should document and confirm the conversation in writing. This practice helps establish a clear record of the customer’s instructions and the broker’s advice, which can be invaluable during arbitration.

The Role of Tape Recordings and Telephone Records

Tape recordings and telephone records can be powerful tools in resolving disputes, as they provide indisputable evidence of what was said during specific conversations. However, brokers must be aware of the legal and ethical implications of recording conversations. In some states, recording a conversation without the consent of all parties involved is illegal.

If brokers choose to record conversations, they should inform the other party and ensure that all recordings are carefully stored. Similarly, maintaining telephone records, such as monthly telephone bills or internal computer records of calls, can provide compelling evidence in disputes over whether a conversation occurred.

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Personal Notes and Paper Trails

Brokers should maintain a “paper trail” of their activities by keeping detailed notes of appointments and client conversations. Contemporaneous notes are highly effective in resolving complaints that may arise years later. A well-maintained notebook or diary can provide a chronological record of events, which can be crucial in reconstructing a particular conversation or series of events during arbitration.

Using a hardbound notebook to record daily activities may require discipline, but the benefits are substantial. These notes can be valuable evidence, significantly when memories fade.

Other Preventative Measures

Beyond documentation, brokers can take several other preventative measures to avoid disputes. For instance, brokers or their sales assistants should follow up with customers when initial monthly statements are issued to ensure they have been received and understood. This practice not only prevents misunderstandings but also keeps the lines of communication open between brokers and customers.

On the other hand, customers should immediately inform their brokers if they do not receive account statements. Brokers generally assume that customers are receiving and reviewing their statements, so they need to be alerted if there are any issues.

Confirmation slips, which confirm the execution of orders, should never be ignored. These slips are legally binding in many states and may serve as critical evidence in arbitration. Customers and brokers alike must take these documents seriously to avoid potential disputes.

Effective Communication: Delivering Bad News

Delivering bad news is never easy, but it is a necessary part of a broker’s job. Brokers must inform their customers of any investment downturns or unexpected news related to their accounts. Failing to communicate bad news can turn a simple market loss into a full-blown complaint. Customers may become suspicious and believe they have been defrauded if their broker does not return calls or provide timely updates.

Summary

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While no document or set of procedures can entirely prevent disputes between customers and brokers, following the suggestions outlined in this article can significantly reduce the likelihood of disputes arising. Proper documentation and clear communication are key to resolving disputes effectively and may even prevent them from escalating to the point of requiring arbitration. By taking these steps, brokers and customers can ensure a smoother, more transparent relationship.