All-Public Arbitration Panels
Is There Fairness Without Representation
by Warren A. Forest
Virtually all security industry disputes are decided through an arbitration process rather than through litigation. Instead of having a judge hear a grievance and render a decision, customers and firms elect to have arbitrators listen to their dispute and grant an award to one party or the other.
Historically, most arbitration panels are composed of three members. Two of the panelists are “public” arbitrators meaning that they derive no income from, and have no direct ties to the security industry.
The third panel member is an “industry” arbitrator, and this person is tied to, and derives a significant portion of their income from the securities industry. More importantly, the industry arbitrator is familiar with industry rules, laws and regulation, and can lend considerable insight into often complicated issues that arise during the course of an arbitration hearing.
Unanimous decisions are strongly encouraged in arbitration proceedings. However, a majority decision will prevail, and is enough to render an arbitration award.
On February 1, 2011, FINRA announced that the SEC approved its proposed rule change to allow customers in all FINRA arbitrations the option to have an all-public arbitration panel. The amended rule will apply to all customer cases in which a list of potential arbitrators has not yet been sent to the parties.
According to Mr. Frank Ketchum, FINRA Chairman and Chief Executive Officer, “this change will give investors an additional choice in selecting their arbitrators when they file claims. We believe that giving investors the ability to have an all-public panel will increase public confidence in the fairness of our dispute resolution process.”
FINRA sought the rule change shortly after the arbitration results were tabulated for 2007, which was the worst year for investors that had their disputes decided by arbitration over the last six years. Securities firms prevailed in their cases nearly 60% of the time in 2007. Coincidentally, during the pilot program that soon ensued, customers chose all public panels nearly 60% of the time.
There are over five thousand arbitration cases filed every year. Yet, the pilot program to effect this rule change included the participation of only fourteen member firms, which is less than half-a-percent of the firms involved in an arbitration in any given year.
In the subsequent years, investors increasingly prevailed. In 2009, customers won almost 45% of their cases, and in 2010 the odds of a customer winning an arbitration case was just shy of 50%. FINRA was still concerned about perceptions, and claimed that “investors regularly accepted a non-public (industry) arbitrator, but the ability to have an all-public panel will increase public
confidence in the fairness of our dispute resolution process.”
Securities arbitration has a long history in the United States. Disputes between member firms, and between member firms and registered persons, must be decided through arbitration.
Grievances between member firms and customers can be resolved through arbitration as long as both parties use a pre-dispute
arbitration agreement where both sides voluntarily agree to arbitrate any dispute before any dispute actually arises. The use and validity of Pre-dispute Arbitration Agreements was upheld by the United States Supreme Court in Shearson v. MacMahon, 482 U.S. 220 (1987).
Arbitration is a preferred method for dispute resolution because it is typically faster, simpler and less expensive than litigation, most certainly for the claimants. Since almost all customer cases are handled on a contingency basis, the customer usually pays nothing until their case is decided.
The downside to arbitration is that you only get one shot at having your case heard. Since arbitration is binding, the grounds for
vacating an award are extremely few, therefore, virtually all awards rendered are final, and cannot be appealed.
The vast majority of customer initiated disputes against member firms involve only a few allegations. These allegations are suitability, excessive transactions, excessive commissions, negligence, and failures to supervise.
While the allegations are the same, customers historically make these allegations only when there is a monetary loss. In falling markets, arbitration cases soar, in rising markets they diminish. It becomes even more important during times of increasing arbitration cases that panels be as knowledgeable and informed as possible.
Arbitration is a forum of equity not a court of law. In recognition of this, the perception of equity is equally important as is the actuality of equity. That is why there have historically been two public arbitrators instead of two industry arbitrators on three member arbitration panels.
Security arbitrations often involve complex issues that an industry panelist can shed light on and explain to the public members of the panel. Without this important input, the process, let alone the perception of the process can be critically flawed.
While it is still extremely early to determine the outcome of this amendment on all of the parties involved, member firms, and customers alike, should be extremely wary of the change. Arbitration cases that are not adequately heard and understood by panels will have an adverse effect on all participants involved.
Member firms have never had equal representation on arbitration panels. To deny them of any representation at all has at least the perception of defeating any chance of equity for them. Since arbitration is a voluntary process, firms may want to consider litigation in lieu of arbitration until the perception of equity is restored for them.
Posted by: editor March 22, 2011