SEC gave investors half a loaf in arb panel ruling

The SEC deserves a pat on the back for eliminating the requirement that a securities industry representative sit on Finra arbitration panels. Still, its obligation to assure that investors get a fair shake in disputes with their brokers remains unfulfilled.

If it were truly serious about increasing investor protection, the Securities and Exchange Commission would exercise its authority under the Dodd-Frank financial reform law to banish mandatory-arbitration clauses in brokerage contracts. Only then would precedent-setting disputes between brokers and investors be resolved in the full light of the judicial system rather than in the shadows of arbitration.

Forced arbitration should be abolished and investors’ Seventh Amendment rights to a trial by jury upheld as an option for resolving cases where amounts in dispute exceed $100,000. If arbitration, as the brokerage industry contends, is fast, fair and cheap, then the industry should feel confident that investors will voluntarily choose it over going to court.

Nevertheless, the SEC’s decision Jan. 31 to approve a rule change proposed by the Financial Industry Regulatory Authority Inc. to allow investors involved in arbitration proceedings to request a panel composed entirely of people with no recent ties to the securities industry is a step in the right direction.

Until this month, the three-person panels consisted of two public arbitrators and one arbitrator with ties to the industry.

The brokerage industry has long argued that the presence of an industry arbitrator is good for investors.

Non-public arbitrators, the argument goes, understand industry norms and can speak up when a broker or a firm violates them. They also serve to explain complex terms and concepts to their public counterparts.

That argument overlooks the fact that arbitration panels can — and should — use expert witnesses to help them understand complex matters. Second, non-public arbitrators proffering advice act as expert witnesses but aren’t subject to cross-examination by attorneys on the other side of the table.

By Finra’s own account, investors whose cases are heard by all-public panels fare better than those whose cases were heard by panels that included an industry arbitrator.

Consider, for example, the results of a 27-month pilot program testing the all-public arbitration panel concept.

Finra arbitration panels made awards in 30 of the cases filed through the pilot, during which Finra gave certain investors the choice of replacing the industry arbitrator with a public panelist. Of those, 22 cases were heard by an all-public panel, while eight were heard by a panel that included an industry arbitrator.

Investors won in 67% of the cases that were heard by an all-public panel, compared with 50% of the cases in which the panel included an industry arbitrator, according to Finra.

“Giving each individual investor the option of an all-public panel will enhance confidence and increase the perception of fairness in the Finra arbitration process,” Finra chief executive Richard Ketchum said in a statement when the self-regulatory organization first proposed the rule change in September.

Unfortunately, the SEC and Finra were more intent on improving the perception of fairness than improving actual fairness.

How else can one explain their decision to require investors to elect all-public panels rather than making it the default? Or their mandate that investors elect to proceed with the all-public option within just 35 days of filing their statement of claim?

Even after investors elect the all-public option, Finra intends to send those investors a list of 10 non-public arbitrators and require them to strike each one from their list of those who potentially could hear their case. Failure to strike just one from the list will result in the inclusion of a non-public arbitrator on their panel.

Indeed, it is hard to believe that Finra and the SEC are serious about improving the fairness of the process amid steps and procedures that seem intended to trick investors into allowing non-public arbitrators to take part in their hearings.

Related Topics: Securities and Exchange Commission