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Sunday, June 17, 2007

Study on SRO Arbitration of Customers' Disputes

Edward S. O'Neal, Securities Litigation and Consulting Group, and Daniel R. Solin, a securities arbitration attorney representing investors, released their report, Mandatory Arbitration of Securities Disputes: A Statistical Analysis of How Claimants Fare, this week.  The report is available at http://www.smartestinvestmentbook.com or http://www.slcg.com.  Here are the report's major  findings:

The raw win rate for investors in arbitration has dropped from a high of 59 percent in 1999 to 44 percent in 2004. This overall figure includes a lower win rate (39 percent) at the three largest brokerage firms that do business with the largest numbers of investors.

Award percentages reached a high in 1998 of 68 percent and have steadily declined to stabilize at approximately 50 percent in the 2002-2004 time period.

Investors in arbitration were awarded 22 cents on the dollar in 2004 (as a percentage the amount claimed) versus 38 cents on the dollar in 1998.

The larger the award and the brokerage firm involved, the smaller the recovery. Claimants in arbitrations against top 20 brokerage firms face an expected recovery percentage that is approximately 28 percent in claims under $10,000. The expected recovery percentage plunges to approximately 12 percent in claims over $250,000.

Award requests increased significantly over the entire period while average awards remained nearly constant. In 1998, the average award was $56,000 while in 2004 it was $59,000. This 6 percent increase in real awards is dwarfed by the difference in award requests, which rose over 300 percent from $168,000 in 1998 to $540,000 in 2004.

This is a significant research effort that is an important contribution to the literature on the fairness of securities arbitration of customers' disputes.  The authors collected information on NASD and NYSE arbitrations that occurred between January 1995 and December 2004.  Their database consisted of 13,810 arbitration awards, 90% from NASD and the remaining 10% from the NYSE.  Their conclusions about the drop in investors' win rates and the decrease in the percentage recovery are not new information; SRO statistics reveal the same trend.  No previous study, to my knowledge, has focused on correlations between the size of the requested damages and the size of the brokerage firms and the percentage recovery. 

I remain unconvinced, however, that these statistics demonstrate the existence of a serious "repeat player" problem that advantages major brokerage firms.  The problem with any study of awards is that it excludes the great numbers of cases that are settled and do not result in an award.  Thus, we are left with what may ultimately be an unrepresentative sampling.  In addition, any assessment of the fairness of a system without any examination of the merits of the claim and the assessment of damages (an impossible undertaking given the absence of meaningful information in the awards) must necessarily be incomplete.  The authors argue that brokerage firms have an advantage here because they have greater familiarity with the merits of settled claims than do claimants, but most claimants, at least those claimants seeking recovery of large amounts of damages, are represented by experienced claimants' attorneys who are equally knowledgeable about the system.

Finally, the authors' endorsement of the view that SRO arbitration is "a damage containment and control program masquerading as a juridical proceeding" is not supported by their findings and seems overblown.

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Comments

Dear Professor Black,

I read with interest your blog on our study. I appreciate your observations.

I have the following comments for your consideration:

First, there is no data on settlements, so it is impossible to analyze that factor;

Second, common sense tells us that lawyers settle cases taking into account the likely outcome at the hearing. I can tell you that I have been generally familiar with this data for quite some time, as are other experienced Claimants' lawyers and all competent mediators. Therefore, we are obligated to advise our clients to settle cases for a fraction of their out-of-pocket losses because we know all too well that this is probably the best they will do at the hearings.

I do not understand how defenders of this system justify their position by referring to this (unknown) body of settlements under these circumstances.

Finally, our data is not at all "incomplete". We looked at almost 14,000 cases over a ten year period. We excluded no investor cases for which we could find an award. You are correct that we can't assess the merits of these cases or determine whether or not the damages claimed were overstated. All we can say with great confidence is that the chances of any meaningful recovery by an investor against any large brokerage firm is statistically very small.

To us, that is troubling.

Posted by: Dan Solin | Jun 17, 2007 10:39:06 AM

Dear Professor Black,

I read with interest your blog on our study. I appreciate your observations.

I have the following comments for your consideration:

First, there is no data on settlements, so it is impossible to analyze that factor;

Second, common sense tells us that lawyers settle cases taking into account the likely outcome at the hearing. I can tell you that I have been generally familiar with this data for quite some time, as are other experienced Claimants' lawyers and all competent mediators. Therefore, we are obligated to advise our clients to settle cases for a fraction of their out-of-pocket losses because we know all too well that this is probably the best they will do at the hearings.

I do not understand how defenders of this system justify their position by referring to this (unknown) body of settlements under these circumstances.

Finally, our data is not at all "incomplete". We looked at almost 14,000 cases over a ten year period. We excluded no investor cases for which we could find an award. You are correct that we can't assess the merits of these cases or determine whether or not the damages claimed were overstated. All we can say with great confidence is that the chances of any meaningful recovery by an investor against any large brokerage firm is statistically very small.

To us, that is troubling.

Posted by: Dan Solin | Jun 17, 2007 10:40:05 AM

If one could get an honest study of NASD mediators, it would show that they uniformly advise claimants that if they go to hearing and "win" they will still only receive about 30% of their losses and that a 50% recovery is a home run. It is therefore necessary to settle almost all cases, regardless of merit, for less than 30% of NOP. Interest and attorney fees, which are a matter of right in most blue sky states, are considered laughable. The conspiracy of silence by the inside players in NASD arbitration, the NASD Code of Omerta, forbids any honest discussion of how arbitration works and precludes any acurate study of settlements.

Posted by: Barry Estell | Jun 19, 2007 9:11:00 AM

Dear Professor Black: I have trouble understanding your comment re settlements, as there always have been settlements of NASD arbitration cases. Your point may have some merit if the percentage of settled cases has increased dramatically over the past 10 years, as that might indicate that more meritorious cases are being setled. But even if the percentage has increased, it just as likely reflects that claimants' lawyers are settling cases on the cheap because of the low recovery percentages.

Posted by: Leonard Steiner | Jun 20, 2007 6:12:53 PM

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