Many advisers who have been involved in arbitration cases are welcoming a move to give investors the option of having all-public arbitration panels.
Many advisers who have been involved in arbitration cases are welcoming a move to give investors the option of having all-public arbitration panels.
But plaintiff's attorneys fear that the pilot program, announced July 24 by the Financial Industry Regulatory Authority Inc., will be used by the securities industry to stall legislation in Congress that would bar mandatory-arbitration clauses in contracts.
"A lot of industry arbitrators seem to be shills for the industry, which is very troubling," said John Duval, managing member of Duval Asset Management LLC in Milan, N.Y.
He is also president of John Duval Associates LLC, a Bronxville, N.Y., firm that specializes in arbitration, and he is an industry arbitrator for Finra of New York and Washington.
"I have even had panelists tell me in deliberations they don't want to award punitive damages or too large of an award, because they won't be chosen for the next panel," said Mr. Duval, whose investment advisory firm manages $2.5 million.
Merrill Lynch & Co. Inc., Citigroup Global Markets Inc. and Morgan Stanley, all of New York; UBS AG of Zurich, Switzerland; Wachovia Securities LLC of St. Louis; and Charles Schwab & Co. Inc. of San Francisco have volunteered to contribute a total of 420 cases over the course of the two-year pilot program that is to start Oct. 6. Claimants in those cases may choose to have three public panelists instead of the current system of having two public arbitrators and one industry arbitrator.
While Mr. Duval supports Finra's initiative, he worries that all-public arbitration panels will be less likely to refer brokers who may have engaged in misconduct to Finra for enforcement.
"It's hard to imagine [such a] panel that witnesses or hears egregious conduct making a referral to discipline" if it doesn't have an industry arbitrator, he said. "They won't know the standards of the industry."
Doing away with industry arbitrators "would be an excellent idea," said Thomas Grzymala, principal of Forensic Analytics LLC in Keswick, Va., which manages $10 million.
He is also a securities litigation and arbitration expert witness.
"In the days of old, we had the industry arbitrator there to explain to the other panel members what was going on," Mr. Grzymala said.
"I don't think any one industry arbitrator really knows much more than the other arbitrators. The securities industry has become far more complex," Mr. Grzymala said, adding that if public arbitrators needed additional expertise, consultants could be brought in.
Moreover, investors should have the choice of taking their cases to court, said Benjamin Tobias, president of Tobias Financial Advisors in Plantation, Fla., which manages $130 million.
Under the current system, most brokerage contracts include mandatory-arbitration clauses in the event of a dispute.
"I saw the results of arbitration," said Mr. Tobias, who was a member of the Washington-based Certified Financial Planner Board of Standards Inc.'s professional-review panel from 1999 to 2003. "Sometimes you just had a question about what the results were."
Mr. Duval agrees. "There are just too many cases where a jury should hear these cases instead of three arbitrators who are worried about being appointed to the next case," he said.
The securities industry isn't alone in grappling with this issue.
On July 30, the House Judiciary Committee approved by a vote of 17-10 a precedent-setting legislation that would bar mandatory-arbitration contracts for residents of nursing homes.
More ambitiously, Congress is also considering legislation that would bar all mandatory-arbitration clauses in consumer contracts. The bill has 102 co-sponsors, and similar legislation has been introduced in the Senate by Sens. Russ Feingold, D-Wis., and Tim Johnson, D-S.D.
But the industry will argue that Finra's pilot program should be allowed to take its course before legislation is enacted, said Larry Schultz, president of the Public Investors Arbitration Bar Association in Norman, Okla.
If the legislation does move forward, "Finra and the brokerage industry would ask that investor arbitrations be carved out," said Mr. Schultz, who is a founding shareholder with the law firm Driggers Schultz & Herbst PC in Troy, Mich.
State securities regulators who support a ban on mandatory-arbitration clauses say that Finra's pilot doesn't go far enough in resolving problems with the securities arbitration system. "Unfortunately, Finra's pilot program is yet another example of glacier movement to resolve immediate investor harm," Massachusetts Secretary of State William Galvin wrote in an e-mail.
DEFENDING STATUS QUO
The securities industry has argued in favor of keeping the arbitration system, saying that it is more efficient and less costly for consumers than having to go to court. The Securities Industry and Financial Markets Association of New York and Washington supports the "creative pilot program, which should provide some instructive and useful data on plaintiffs' views of industry arbitrators and how [they] do or do not affect awards," SIMFA spokesman Travis Larson wrote in an e-mail.
Finra has been working on the pilot proposal since January, said spokesman Herb Perone, and is seeking more brokerage firms of different sizes and locations to participate.
Finra has no position on the pending legislation, he said, noting the Supreme Court ruled that mandatory-arbitration clauses can be used in consumer contracts. About 2,100 investor claims went to arbitration in 2007, and the number is rising this year, Mr. Perone said.
"We view [the pilot program] as a great first step," he said. "Finra could elect to change the arbitration -system," Mr. Perone said. But eliminating industry arbitrators from panels would require a rulemaking and approval from the Securities and Exchange Commission, which would take several years.
"If you look at other industries and their arbitration procedures — malpractice, home improvement and realty — it's either all industry people on the panel or majority industry people on the panel," Mr. Perone said. "Ours is majority public."
E-mail Sara Hansard at shansard@investmentnews.com.
