Commentary: Securities arbitration: Time to level the playing field

Jim and Dorothy thought their retirement savings was secure in a portfolio managed by one of the nation's largest stock brokerage firms. Suddenly, they find their account is decimated by what appears to have been misconduct by their broker. They are looking for answers, for justice. For Jim and Dorothy, however, this justice may be hard to come by.

In recent years, more investors have been victimized by widespread corporate and securities fraud than at any time in our history. And yet, victims are not permitted to have their cases heard in a neutral, impartial forum. This is an unconscionable situation that must be addressed.

In 1987 the U.S. Supreme Court upheld the use of arbitration requirements by brokerage firms, and effectively ruled that an individual investor cannot sue a broker or brokerage firm in court, but rather must submit the claim to binding arbitration. Given the unfairness of this process, claimants are unwittingly participating in a high-stakes game in which the cards are stacked against them.

Arbitrations are held under the auspices of the National Association of Securities Dealers (NASD) or the New York Stock Exchange. They are generally held before a panel of three arbitrators. Two of the arbitrators are handpicked, trained and monitored by the securities industry forum. The third must be a member of the securities industry.

Needless to say, the typical securities arbitration panel bears no relation to a jury of one's peers and does not even come close to reflecting the diversity and demographics of the general or local population.

This system of stacking the jury has become the norm for securities disputes. The largest financial institutions in the world control their own regulation, discipline and dispute resolution system.

As if this inequity weren't enough, the game is much tougher for the claimant. Fees can run into thousands of dollars. After filing the complaint, the investor must wait well over a year, and in many cases two or three years, for the arbitration hearing.

For somebody who has lost their life's savings, the delay can represent an extreme hardship. And delay is exactly what the brokerage firms want.

Procedural maneuvering, postponements and extensive motion practice (previously unheard of in arbitration), have become standard tactics utilized by the brokerage firms to delay the arbitration process. They also typically respond to discovery requests for information with endless objections, foot-dragging and stone-walling.

Arbitrators rarely do anything to prevent these abuses because the securities arbitration discovery rules lack teeth.

For example, Merrill Lynch, Morgan Stanley and Smith Barney (Citigroup) were recently each fined $250,000 for repeated failures to comply with arbitrator orders to produce documents in discovery - a drop in the bucket for these firms.

Additionally, brokerage firms wield the process as a club to batter individual investors, sending subpoenas to their bank or even to their employer. The claimant's entire life becomes fair game for inquiry, while the broker's disciplinary problems and financial affairs are off limits.

The vast majority of public investors are unaware of this securities industry controlled system for arbitration. Most people who go through the arbitration process find that it not only has the appearance of unfairness, it is unfair.

What can be done? Here are some proposals:

* Eliminate the industry arbitrators.

The rule requiring that one arbitrator on every panel be a member of the securities industry must be eliminated. This is essential in order to have an impartial panel of arbitrators and an appearance of impartiality.

* Establish a fair and qualified arbitrator pool.

There should be a broad-based, community recruitment of unbiased arbitrators. The potential arbitrators should then be trained by a neutral process, not trained by the securities industry.

* Lower the fees.

Investors who may have been defrauded should not have to pay fees any higher than court filing fees. It is unfair for the securities industry to compel investors into this forum and then charge them exorbitant fees for the privilege.

* Reduce the delays.

Arbitration was intended to be a quicker and more efficient process than court. All cases should be scheduled for arbitration hearings within nine months of filing, at the latest.

* Enforce the discovery process.

There must be teeth in the rules for enforcement of the discovery process, so that substantial fines and sanctions for discovery abuse will be the rule, not the rare exception.

Investors who have been defrauded should be entitled to a fair hearing. At both the federal and state levels, it is time for lawmakers to fix this rigged game.

This article was originally published in Massachusetts Lawyers Weekly, another Dolan Media publication.

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