The Expert's Examiner

Broker-dealers who engage with customers as “introducing broker-dealers” don’t perform the “back office” tasks needed to clear and settle transactions. Rather, they depend on specialized clearing broker-dealers to perform those functions for the introducing BDs, relying on information provided by the latter. Traditionally, clearing firms have enjoyed a low liability rate, when sued by customers of the introducing BDs, in part, because they generally have no direct communications with the customer and because they rely on information provided by the introducing BD. In this survey, we investigate if the clearing broker-dealer (“CBD”) liability rate has changed since 2001 in claims made against them, compared with the rates for non-CBD respondents in the same set of Awards and compared with the customer win rate in Customer-Member Awards generally.

Methodology

This survey covers the calendar years 2001 through 2018, broken out into three-year periods. We provide the same set of statistics for each period and for the entire period. We limit our universe to Customer-Member Awards (those brought by customers against brokerages, excluding Small Claims cases, which currently are limited to a maximum $50,000 damage request). We also exclude stipulated Awards, those issued by consent after all of the parties settle. Our focus is on Awards issued in cases brought against CBDs (which we will call “Claims v. CBD Awards” for short). We determine the total number of such Awards, the number of those in which CBDs were held liable, and the liability rate for CBDs, expressed as the percentage of Claims vs. CBD Awards in which the CBDs were held liable (which we will call “Successful Claims v. CBD Awards”). By way of comparison, we likewise determine the number of claims v. CBD Awards in which CBDs were not liable but non-CBD respondents were, together with the liability rate in those cases. Finally, as a further comparison, we determine the win rate in non-stipulated Customer-Member Awards regardless of whether they were brought against CBDs or not. We present our findings in the Chart below:

How Often Are Clearing Firms Sued?

Before addressing liability rates, it is worth pointing out that, when viewed against the entire set of Customer-Member Awards in the survey period, the incidence of Claims v. CBD Awards is very small (313/12,257). The numbers have also declined over the years and in three distinct six-year phases: the figures for 2007-12 were almost half those of 2001-06, but twice those in 2013-18. These numbers do not actually reflect a decline in the likelihood of CBDs facing off with disappointed customers in arbitration. Rather, they track a declining trend in Customer-Member cases overall that occurred in the same six-year increments (7,650; 2,987; 1,620). In fact, the drop-off in the latter was even sharper between 2001-06 and 2007-12, falling by about 60%, and the later drop-off between 2007-12 and 2013-18 was comparable to Claims vs. CBD Awards.

Clearing Firm Liability

CBD liability is significantly more stable, although we do discern a slight decline in liability rates between 2001-06 and 2007-12. The liability rate fluctuates erratically between 2013-15 and 2016-18, but we interpret this as statistical “noise” due to the relatively small sample in those final two periods. The liability figure for 2013-18 is actually 12% (6/49), comparable to the two preceding periods in the Chart. Claims vs. CBD Awards in which only non-CBD respondents paid damages saw an equally moderate drop in liability rates from 2007-09 to 2010-12, and a fluctuation in the next two periods -- similar to the one we saw in the number of Claims vs. CBD Awards -- but which, when combined, produced a more moderate liability rate of 31% (15/49), comparable to 2010-12’s figure. Generally speaking, only 16% of customers in Claims vs. CBD Awards win damages against CBDs, while non-CBD respondents in those same cases are tagged with liability 37% of the time, even when the CBD respondent is not. Overall, CBD respondents are shielded from liability, at 16%, far more than the "average" respondent in all Customer-Member Awards, who, for the length of the full survey period, incurred liability 47% of the time.

(ed: *Our survey counts all non-stipulated Customer-Member Awards in which CBDs were named, even when the CBD settled out. In this way, we hope, we maintained an “apples to apples” comparison of the liability rates for CBDs with those in which only non-CBD respondents were held liable, since some of those also settled out. However, as a result of this choice, the customer win rates for CBD Awards is usually (but not always) greater than those for Customer-Member Awards in general. **SAC h/t to Harry A. Jacobowitz, a research lawyer of thirty years and SAC's former Award Database manager. Mr. Jacobowitz now serves in a consulting capacity to SAC and is available to perform customized Award searches -- such as the one performed for this article -- for SAC subscribers and others. He can be reached at harryjacobowitz@optimum.net or by calling SAC.) (SAC Ref. No. 2019-27-02)