Wall Street Should Stop Playing The BullyMichael Schroeder
Six years ago, the Supreme Court handed down a decision that Wall Street thought was a major victory. Instead of allowing investors to take their broker to court, the high court ruled that investors are bound by the standard brokerage-account contract, which requires complaints to be resolved through arbitration. The industry figured that dealing with such spats out of court would be quicker and cheaper--and reduce the possibility of astronomical awards by jurors sympathetic to individual investors.
But arbitration has turned out to be anything but fast and simple--or cheap for Wall Street. The National Association of Securities Dealers, which handles more than 80% of these disputes, says complaints have soared more than 320% since the 1987 court ruling, to 5,200 cases in 1993--a 23% jump in the last year alone. Both sides now come armed with lawyers and fight over access to documents. Hearings drag on nearly three days on average, more than double their length before 1987. And in about 5% of the cases, firms even have to shell out punitive damages. Between 1989 and last year, the industry ponied up more than $200 million to disgruntled investors. "Something has to be done," declares Deborah Masucci, the NASD's vice-president for arbitration.
LOSING TWICE. Terrified at its growing liability, the industry wants to slap new restrictions on the process--its worst idea since portfolio insurance. The restraints would crimp many customers' ability to recoup losses from all-too-pervasive abuses, from unauthorized trades to putting customers into inappropriately risky investments.
A recent NASD proposal would force an investor who rejects a brokerage settlement offer to pay the firm's attorney fees if the ultimate arbitration award is less than the original settlement offer. The rule would apply to claims exceeding $250,000, about 30% of all cases. Comments to the Securities & Exchange Commission are due on the proposal by Dec. 10, and it's already generated a scathing reaction.
Such a rule, critics say, would put intense pressure on investors to settle. Richard P. Ryder, publisher of the Securities Arbitration Commentator, reviewed 8,000 claims and calculates that brokerages' average legal fees were $46,900. The fear of having to cover huge legal bills "would unfairly coerce investors, who have already lost their life savings in many cases, into accepting a brokerage firm's lowball offer," complains Diane A. Nygaard, an Overland Park (Kan.) investors' attorney.
The other brainstorm--from the Securities Industry Conference on Arbitration--is aimed at smaller claims. SICA wants to bar investors from getting assistance from anyone who isn't a lawyer. That would shut down several nonattorney arbitration firms around the country that are willing to help investors whose claims are too small for lawyers' tastes.
These proposals, in short, would add a new element of unfairness to a system that already tilts toward brokers. For starters, arbitrators usually have industry ties. Making matters worse, brokers have all the records, and defense lawyers often stonewall requests for the information. The process has become dominated by "scorched earth tactics," says J. Boyd Page, an Atlanta attorney. The result: An investor filing a claim can expect on average to undergo about a year of wrangling with the brokerage firm.
William J. Fitzpatrick, general counsel to the Securities Industry Assn., claims investors are not at a disadvantage. He says that from the start they know what they've lost and what would constitute a fair settlement. Even if that's true, the industry's solution is the wrong one. Securities firms already have a serious public-image problem. Consider such recurring headline-making industry scandals as penny-stock scams and widespread abuses involving Prudential Securities Inc.'s $8 billion worth of limited partnerships. New rules that make it harder for customers to feel they can get justice will only aggravate matters.
CHURNING. The industry's proposals simply amount to a more efficient shovel brigade for the elephant parade. Instead, the industry should work on the front end to prevent abuses in the first place. That may require an overhaul of a compensation system that encourages brokers to churn customer accounts to generate commissions. SEC Chairman Arthur Levitt Jr. advocates a pay scheme linked more to the quality of service brokers provide. "I'd like to see brokers compensated more highly for such things as training, longevity, and overall performance of customer accounts," he says.
Wall Streeters got what they wanted six years ago, and it proved disappointing. The SEC might think twice before granting the industry its wishes this time.