mandatory securities arbitration under review after hearings
by justin kelly,

(3/23/2005) the top democrat on the house financial services committee will take a closer look at whether arbitration in the securities industry should be made voluntary, following a hearing last week where investor advocates detailed a range of concerns about the current mandatory system.

massachusetts rep. barney frank had long been pushing for hearings on the design and administration of the arbitration systems used by securities self-regulatory organizations (sros) such as the national association of securities dealers and the new york stock exchange, and industry officials gathered with academics and investor advocates on capitol hill march 17 to take questions from the committee.

a committee staffer said "good information" was provided during the hearings and lawmakers will need to analyze the testimony before making any decisions on next steps. among other things, frank will explore whether steps should be taken to make the securities arbitration process voluntary for investors, the staffer said.

there has been a dramatic increase in arbitrations filed with nasd over the past few years, growing from under 5,000 in 1998 to over 9,000 in 2004. investor representatives have raised concerns about a lack of investor protections and criticized the nasd system for requiring at least one industry arbitrator on three-member arbitration panels.

rosemary shockman, president of the public investors arbitration bar association, suggested during her testimony that the most important change needed in the system is removing the requirement that one industry arbitrator sit on every panel.

according to shockman, there is no longer justification for the practice because most investors have legal representation that can call their own experts to inform the panel about industry practice, she said.

"elimination of mandatory industry arbitrators would be the number one way to improve mandatory arbitration in customer cases," she said.

daniel r. solin, an attorney in new york city who represents investors, said there is no "rational justification" for requiring that an industry arbitrator sit on every panel. at the very least there should be three unbiased people hearing a dispute, he stressed.

he suggested keeping three-member panels but having them composed of unaffiliated arbitrators, adding that "the need for industry expertise is overemphasized."

fordham university school of law professor constantine n. katsoris said the "perennial complaint" over having one industry arbitrator on a panel could be addressed by doing away with all classifications for arbitrators and providing parties with preemptory challenges to arbitrators.

while arbitration is a good way to resolve disputes it should still be administered by neutral organizations, using neutral arbitrators, solin said adding that any of the large private adr providers could fill the role. there is nothing unique about the securities industry that would prevent such a system from working, he suggested.

solin said arbitration should be voluntary for all investors, allowing them to choose whether to bring their claims in arbitration or in court. if the current system is as fair as advertised, then investors will opt for arbitration but if they perceive a bias, they would be free to seek redress in court, he said.

even if it were voluntary, the majority of cases would still be filed in arbitration because "most attorneys are comfortable with arbitration and its rules" instead of having to deal with the rules of numerous different jurisdictions, katsoris suggested.

the call for voluntary arbitration would not help investors because most claims are too small to be economically viable in litigation, st. john's university school of law professor michael perino said.

perino authored a report commissioned by the securities and exchange commission, which found that undisclosed conflicts of interest do not present a problem in self-regulatory organization arbitrations. the report grew out california's adoption of ethics standards for arbitrators and the sro's decision to stop arbitrating in the state.

according to perino, he told the subcommittee they should not be regulating based on anecdotal evidence. if they want to make rational regulatory policy, it should be based on empirical evidence, he added.

perino said there exists no real empirical evidence to support the argument that the sro's arbitration system is biased in favor of industry to the detriment of investors.

rather, a comprehensive study of the arbitration system conducted by the government accounting office in 1992 and updated since, found no statistical difference in the percentage of claimant wins or money recovered in arbitrations before nasd versus arbitrations administered by the american arbitration association, he said.

solin countered that the system is a "disgraceful process" that is rigged and unfair to investors. there is no other segment of society where a consumer is required to bring a complaint in a system administered by the industry they are suing, he noted.

according to solin, his own empirical study, which is not yet complete, shows that if an investor wins in arbitration he or she will only get a small fraction of what was claimed. the evidence shows that investors get between seven and 30 percent of their claimed amount, he said.

katsoris said the criticism that investor only get 30 to 40 cents on the dollar for claims in arbitration is specious because most people when they file seek as much as possible, whether all their claims are valid or not.

"on balance" the securities industry arbitration system works, katsoris said. but some changes could be made to protect the interests of all parties required to participate in the system, he added.

he acknowledged that complaints come from both industry and investor counsel that administrative appointment of an arbitrator after a panel member drops out is a problem. but this could easily be solved by allowing each side one uncontested challenge striking an arbitrator, he said.

according to katsoris, the securities industry conference on arbitration (sica) already has such a rule in its uniform code of arbitration and the sros could propose adding a similar rule to their respective codes.

linda fienberg, president of nasd dispute resolution, said in testimony before the subcommittee that her organization "ensures the integrity of the arbitration process by doing all we can to see that investors get the money owed to them from arbitration awards, tightening the rules on arbitrator disclosure of conflicts of interest, and removing arbitrators from the roster when they fail to meet nasd procedural requirements."

nasd recently addressed investor concerns by proposing to sec a rule change that would require written awards explaining the basis for an award when requested by an investor. "we believe that this new option will increase investor confidence in the fairness of the nasd arbitration process," she said.

katsoris cautioned, however, that the new rule could be a disaster for nasd because it could lead to more appeals and lengthen the arbitration process.

solin said the hearings were a "major step forward" that shed light on the issue but stressed that there is an urgent need for reform.

according to solin, the republican members seemed convinced before the hearings started that the system is fair, with little need for reform, while the democratic members, with rep. frank in particular, questioning why the system has to be mandatory and why there is a need for industry arbitrators on panels.

congress should not base a decision to overhaul something as important as securities industry arbitration on stories about bad arbitration experiences before the sros, perino stressed.

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