Wall Street loves arbitration. And no wonder: For decades, securities firms have benefited from a system that is frequently criticized for being arbitrary and unjust to investors. Customers put up with it because they have no choice if they want a brokerage account. Regulators have left the system's flaws largely uncorrected. With investor claims hitting records, however, the time has come for fundamental changes in the way investor disputes are handled.
It's not just a question of fairness. It's also an issue that goes to the heart of the relationship between Wall Street and the public. At a minimum, regulators such as the NASD, which administers the most widely used arbitration system, need to enforce their rules evenhandedly and stringently. They must crack down on improper conduct by attorneys for brokerage firms -- and scour decisions for evidence of bias that favors the Street.
But instead regulators meet accusations of improprieties with a shrug. A good example is the NASD's laissez-faire attitude toward brokerage lawyers who complicate cases by filing frivolous pretrial motions. Linda D. Fienberg, president of the NASD Dispute Resolution, concedes that "right now, the arbitration code does not explicitly provide" for prehearing motions by parties to arbitrations. So why doesn't the NASD stop them? Parties who engage in such tactics should be consistently and severely sanctioned.
Since the arbitration process denies investors their right to a hearing by a jury of their peers, the pool of arbitrators needs to be greatly expanded to include men and women from a wide cross-section of the general population's demographic and occupational background. Charles W. Austin Jr., a Richmond (Va.) securities lawyer and president of the Public Investors Arbitration Bar Assn., says he believes that the three-person panels should be opened up to blue-collar workers. Asks Austin: "Why can't Joe Everyman become an arbitrator?"
The godlike powers of arbitration panels need to be curbed. It's not enough simply to require arbitrators to set forth the reasons for their decisions. That will make them more prone to appeal, which could hurt investors since brokerages could then tie up arbitration awards in court. The solution is to allow a right of appeal -- but only for investors. Would that be unfair to brokerage firms? Only if you disregard the fact that arbitration is imposed on investors. If the Street doesn't want to fix the system, it should stop shoving arbitration down investors' throats.
Years ago, arbitration was optional, and investors could bring claims to court. It may well be time to give investors back their right to sue brokers -- if they wish. The court system is surely flawed, but at least it is accountable to the public. Securities arbitration, with its opaque and nonappealable rulings, is accountable to nobody.
By Gary Weiss