Monday, May 17, 2010
Today I appeared as part of a panel of experts on securities arbitration before the SEC Investor Advisory Committee. The Committee appears to be considering seriously a recommendation to eliminate mandatory securities arbitration. As an investor advocate (particularly for small retail investors), I believe that securities arbitration is a better, fairer process for most investors than litigation. Accepting that, it presents the question: if arbitration is better for most investors, and the industry wants arbitration, then won't parties agree to it post-dispute anyway? The answer is not necessarily.
Scholars who have studied consumer and employment arbitration note that the incentives to support arbitration change when the system becomes voluntary. Similarly, brokerage firms have cost advantages attributable to mandatory arbitration that may be lost in a voluntary system. Once a dispute has arisen, each side will have a view about its claim will fare better in court or in arbitration. As a result, they are unlikely to agree, post-dispute, on a choice of forum.
Suppose, for example, a $25,000 claim for breach of the suitability rule. The investor is likely to want arbitration, while the firm has strategic advantages to insist on court -- it won't be cost-efficient to litigate this claim, and there is no private cause of action for breach of an SRO rule. Conversely, if a disabled investor has a $5 million claim for fraudulent misrepresentations, the investor's attorney will want to take the case to a jury, with all the attendant publicity, while the firm would prefer arbitration.
As a result, the number of claims going to arbitration will decrease. There is some empirical evidence in other types of arbitration (employment and consumer) that post-dispute arbitration agreements are rare. The incentives on the part of the firm to support arbitration decrease. In addition, the resources devoted to maintain a fair and efficient arbitration forum -- which, on the part of FINRA, are considerable, would likely decrease.
The complication in the securities arbitration area is that FINRA Rule 12200 provides that a customer can always require the firm to arbitrate its claim. FINRA takes the position that it is essential for investor protection that FINRA maintain Rule 12200 if Congress and the SEC decide to limit or prohibit mandatory arbitration. However, in that event, we can expect that the securities industry would campaign to eliminate Rule 12200 as one-sided and unfair to the industry.