Martindale-Hubbell
State Bar of Georgia
PIAMBA
Atlanta Bar Association

Defeating the Ratification Defense

Ratification is a common defense raised by securities brokers (meaning the brokerage firm and the individual broker). In the context of a FINRA arbitration, ratification means that the investor has done something to communicate to the broker, by words or conduct, that the investor accepts and approves of the transactions or conduct at issue after finding out about them. Most commonly, the transactions or conduct involve unauthorized trading, churning or both of them. Ratification is often raised in tandem with the defenses of waiver and estoppel, which are essentially the same thing. The likelihood of being confronted with such legal defenses in a securities arbitration makes it wise to consult with an experienced Georgia FINRA lawyer regarding any securities arbitration matter.

As with all such defenses, the burden of proof is on the broker. In addition, courts have recognized a number of exceptions to the ratification rule. Three such exceptions are set out in the case of Kurke v. Oscar Gruss and Son, Inc., 454 F.3d 350 (D.C. Cir. 2006). The Kurke case involved a provision in a margin agreement stating that "statements of my account shall be conclusive if not objected to in writing" within a specified period after transmittal. Kurke’s account was churned and unauthorized trades occurred. Kurke complained (but not in writing) about the unauthorized trades and was told by the broker and his manager that the trades could not be undone, but not to worry because they would soon increase in value and more than cover the losses.

Kurke filed an arbitration claim with the National Association of Securities Dealer (“NASD”), now known as the Financial Industry Regulatory Authority (“FINRA”), seeking $1,600,000 in compensatory damages and $2,000,000 in punitive damages as well as attorney’s fees. The arbitration panel issued an award in favor of Kurke in the amount of $706,000 plus 5% interest, but denied his claims for attorney’s fees and punitive damages. The NASD award was confirmed by a district court. The broker appealed the district court’s decision arguing that, although churning and unauthorized trading admittedly occurred, in light of the written objection requirement in the margin agreement, Kurke’s failure to object in writing amounted to a ratification of the unauthorized trading and churning, and therefore the NASD award should be reversed. In an opinion written by Judge Merrick Garland, the D.C. Circuit Court of Appeals disagreed based on three exceptions to the ratification rule.

The three exceptions cited by Judge Garland are as follows. First, a disparity in sophistication between the broker and its customer will defeat the ratification defense. For example, if the customer lacks the skill and experience to understand account statements provided by the broker, which arguably put the investor on notice of unauthorized trading or churning, courts have generally declined to accept the broker’s ratification defense. Second, assurances or deceptive acts by the broker that lull the customer into a false sense of complacency, thus forestalling the filing of the required written objection, will defeat the ratification defense. Third, failure by the broker to advise the customer of his right to reject unauthorized trades will defeat the ratification defense.

The Court of Appeals in Kurke found that all three exceptions applied to defeat the ratification defense. First, while Kurke was an experienced investor, the court found that many of the transactions were beyond what Kurke could understand. Second, there was evidence of lulling comments; specifically, that the broker would fix the problem, that he could turn this around and that Kurke should trust him. Third, there was evidence that the broker told Kurke that the unauthorized trades could not be reversed. Accordingly, the court of appeals affirmed the district court’s confirmation of the NASD’s award in favor of Kurke.

More ammunition against the ratification defense can be found in a number of other court decisions. Consulting with an experienced Georgia FINRA attorney can help investors marshal appropriate arguments to defeat the ratification defense. For example, numerous court decisions have held that there can be no ratification of unauthorized trading by an investor’s acquiescence, silence or failure to repudiate unless the investor has full and complete knowledge of all the material facts relating to the unauthorized transaction(s). Ratification can occur only when it is clear from the circumstances that the investor intended to adopt the unauthorized trade, and knowledge of all the material facts (including the right to reject unauthorized trades) is a precondition to ratification. It is not enough for the broker to show that investor should have known about the unauthorized trading. Rather, it must be shown that the investor actually did know about the unauthorized trading and further manifested a clear intent to ratify.

Finally, there is good authority that an investor’s receipt of transaction confirmations for specific trades does not put the investor on notice that the overall account was excessively traded or unsuitable. See Hecht v. Harris, Upham Co., 430 F.2d 1202, 1210 (9th Cir. 1970).

Sam Brannan is an experienced FINRA lawyer serving clients in Georgia and nationwide. If you have questions or concerns about your investment, we would be happy to consult with you at no charge. Call us at (404) 907-4642 for a free consultation.