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Monday, June 11, 2007

Mandated Arbitration is the Only “Choice” for Investors

Finally Ira Hammerman, general counsel of the Securities Industry and Financial Markets Association (SIFMA), and I agree on something. “Arbitration is not perfect,” Hammerman said in a recent report, “but it is a more efficient way for customers to voice their claims.”

Hammerman and I recently appeared on a North American Securities Administrators Association (NASAA) panel together and this is almost assuredly where our shared opinions on securities industry regulations end. The ability to find common ground on arbitration reform will be put to the test this week when the House Committee on the Judiciary will hold fast-tracked hearings tomorrow to expose how the process has morphed into a protective shield for Wall Street against investors ripped off by their brokers.

The hearings will be held one day prior to the full release of an influential study showing that investors recovered only about 34 percent of claims based on a review of 14,000 arbitration cases filed with the NASD and NYSE from 1995 through 2004. More alarming is the fact that Wall Street’s three largest brokers – Merrill Lynch, Citigroup and Morgan Stanley – only paid damages in 38 percent of cases filed against them, according to the study compiled by a Wake Forest professor and securities arbitration attorney.

The reasons for the disparity are simple and well known. The main reason investors do not fare well in mandated arbitration is that it is required that one of the three arbitration panelist must be an industry representative. Immediately, the chips are stacked against the investors. It’s akin to getting up to bat with one strike against you.

Furthermore, many times the so-called “public arbitrators” are former financial services employees, thus they are not truly representative of the public at large, as is mandated. The NASD and NYSE have frankly done a poor job recruiting a pool of arbitrators that is truly representative of American investors. The pool of available arbitrators at the NASD and NYSE is neither deep, nor does it reflect the diversity of backgrounds which we see in our jury pools around the country. To be blunt, arbitration panels are composed largely of older white men and lack proper representation by women, African-Americans, Latinos or Asian-Americans.

There are plenty of other reasons for reform, but we still must tread carefully and consider only ideas that are in the investor’s best interest. Senate Judiciary Committee Chairman Patrick Leahy (D-Vt.) and fellow committee member Russell Feingold (D-Wis) recently sent a letter to the SEC arguing that investors should have a greater choice in resolving legal disputes with brokerage firms; they argue that investors should be able to choose the court system.

Though their interest in reforming securities arbitration is commendable, this part of their thinking is flawed. Less experienced attorneys may encourage their clients to pursue Wall Street firms in court where they will no doubt be devoured. Making matters worse, long drawn out litigation is extremely expensive. It will be difficult for an investor who has lost his or her life savings to find an attorney willing to absorb the costs of a long protracted case. More likely the attorney will have to bill by the hour.

The arbitration process on the other hand, is designed to be an expedient and low cost forum of dispute resolution, and many attorneys take cases based on a contingency fee so their interests are completely aligned with an investor’s. But we still must fix the system.

Rest assured the industry and its lobbyist will fight tooth-and-nail against reforms by any means necessary. They will argue that recent studies, including the one mentioned above, don’t account for settlements. This position is so flawed its silly and regulators should not be boastful of such matters. The number of settlements is actually driven by the fact that the disparity of the existing system forces investors into unsubstantial settlements.

Investors, advocates, regulators and attorneys actually have more common ground on the issue of arbitration reform that some seam to think. If we work together to fix the system, and limit the number of large expensive court cases, everyone wins and Wall Street will continue to be the cash machine it always has been.


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