Securities Law Prof Blog

FINRA Dispute Resolution Expands Discovery Pilot Program

FINRA Dispute Resolution expanded its voluntary discovery arbitrator pilot, which it first launched in its Southeast and Western Regional hearing locations in 2005, to address concerns about discovery in arbitration. FINRA has also added non-public arbitrators to the pilot for certain intra-industry cases. Under the pilot, the Director of Arbitration appoints a single discovery arbitrator to resolve all discovery disputes before the hearing. The discovery arbitrators do not serve on the panels that decide the cases; they only decide the parties' discovery disputes. Parties participating in the pilot have described it as cost effective with arbitrators providing consistent decisions on discovery issues.

If parties wish to participate in the pilot, they must sign a stipulation and be represented by counsel.

FINRA Releases Report Card on Securities Arbitration

Editor's Note to FINRA's Arbitration Policy Task Force Report—A Report Card:

In 1994, NASD, now the Financial Industry Regulatory Authority (FINRA), assembled a group of outside experts, led by former Securities and Exchange Commission Chairman David S. Ruder, to conduct a thorough examination of the nature of securities arbitration and recommend a roadmap for the future. It was the first comprehensive assessment of securities arbitration since the Supreme Court decisions in the late 1980s that held predispute arbitration agreements enforceable.

The task force report, Securities Arbitration Reform, recommended comprehensive proposals to revamp securities arbitration. The recommendations in the report formed the framework that currently guides FINRA's dispute resolution policy and rulemaking. FINRA has implemented nearly every key recommendation and has worked extensively to preserve and respect the basic elements of a fair and efficient dispute resolution system. FINRA's Arbitration Policy Task Force Report—A Report Card traces the actions taken in response to those recommendations.

What is the Problem with Securities Arbitration?

Critics of the securities arbitration process frequently express concerns about bias -- the fact that in a three-person panel one arbitrator will be a member of the securities industry and the fact that public arbitrators may have ties to the industry.  See Gretchen Morgenson's article in today's New York Times for an expression of these concerns.  However, in my opinion, a more serious concern goes to the competence of arbitration panels, or, more charitably, whether it is reasonable to expect individuals who serve as occasional arbitrators for minimal pay, to perform the functions of a judge.  A recent 2d Circuit opinion, Porzig v. Dresdner, Kleinwort, Benson, North America, LLC, provides a good illustration.  In this arbitration, the panel found that "age was a factor" in the termination of Porzig's employment by Dresdner.  Despite the fact that the federal statute requires an award of attorney's fees and costs to a prevailing plaintiff in an age discrimination claim, as Porzig's attorney advised the panel, the panel originally denied both to Porzig.  The federal district court concluded that denial of attorney's fees and costs was in manifest disregard of the law and remanded the case to the arbitration panel to award attorney's fees and assess costs against Dresdner, not Porzig.  On remand, Porzig's attorney submitted detailed information of his services, the time spent, and the rate charged, documenting $250,000 in attorney's fees and another $12,000 in costs.  Porzig's attorney also provided the panel with clear legal authority supporting his costs.  Dresdner's attorneys submitted an opposing affidavit, arguing that Porzig's contingency fee agreement with his attorney should set the maximum amount of the attorney's fee; that an award of attorney's fees may be unnecessary to achieve the statutory purpose; and that Porzig's fee application should be substantially reduced, if not denied in its entirety.  After requiring submission of Porzig's contingency fee agreement, the panel awarded $75,000 in attorney's fees and another $8,5000 in costs, an amount approximately the same as the amount of the award Porzig's attorney retained as his contingency fee and costs.  The panel also ordered Porzig's attorney to remit to his client the amount of the award that he retained as his contingency fee and costs.

Porzig again sought vacatur and modification of the award, and, in vacating the modified award, the Second Circuit clearly expressly its annoyance at the behavior of both Dresdner's counsel and the arbitration panel.  The court comes close to accusing Dresdner's counsel of misstating the applicable law to the panel; the law is clear that the prevailing party in an age discrimination case is entitled to attorney's fees, not limited by the amount of any agreed contingency fee, and that amount includes time spent in litigating the fee.  The court emphasizes that vacatur of an award for manifest disregard is rarely granted, and that the law does not require arbitrators to give reasons.  However, in the absence of any explanation, the award of an amount approximating the amount of the contingency fee demonstrated that the panel acted in manifest disregard of the law, particularly in this case, when the award had been partially vacated and the case remanded to the panel for the purpose of calculating attorney's fees and costs.  The court clearly expected the arbitration panel to pay closer attention to the district court's instructions.

The opinion nicely illustrates a common problem facing arbitrators -- what are they to do when each side presents legal arguments that are (as is frequently the case when material issues are disputed) completely opposed to each other?  NASD Regulation (and presumably now Finra as well) instructed arbitrators that they were not to conduct independent research on any legal issue, but rely on parties to brief them on the law, and, of course, arbitrators, unlike judges, do not have support staff to research the law for them.  How are arbitrators, particularly those without legal training, supposed to assess strengths and weaknesses of the proponents' legal assertions?

The Second Circuit also deals with another issue that has been much debated in recent years -- whether an arbitration panel has any authority over the attorneys who represent parties to an arbitration.  The Second Circuit held that the arbitration panel had no authority to order Porzig's attorney to return his contingency fee to Porzig.  While the opinion specifically prohibits interference with the attorney-client relationship, it may have broader applicability.  The recent debate focused on whether the SRO rules could authorize panels to impose sanctions on attorneys for discovery or other violations; NASD Regulation withdrew the rule when many (including me) filed comment letters challenging the SRO's power to sanction private party's attorneys.      

Thanks to Jill Gross, for calling this case to my attention.

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.

SEC Approves New NASD Arbitration Code for Customer Disputes

Today, after a long wait, the SEC approved the NASD's rewrite of the Code of Arbitration.  A complete re-write of the Code to make it more user-friendly, there are now three separate codes -- one for customer disputes, one for industry disputes, and one for mediations (which had been approved by the SEC earlier).  Among the substantive changes are: broader authority for arbitrators to impose sanctions; enhanced qualifications for Arbitrator Chairs; changes in discovery procedures; and improved arbitrator selection provisions.  See the SEC's press release and its Order; see also the NASD's press release.

Percentage of Customers' Wins in NASD Securities Arbitration Down Again

The 2005 statistics show that a customer "wins"  (i.e., the customer recovers something) 43% of the time in NASD securities arbitration.  This continues a downward trend since the 2001 high of 54%. Results of Customer Claimant Arbitration Award Cases