Broker-dealer costs likely to rise if Senate arbitration bill passes

Broker-dealers may face higher costs connected with customer disputes if revised legislation that would do away with mandatory securities arbitration passes both houses of Congress and is signed into law.

Litigating customer and broker complaints could be three or four times as costly to brokerage firms as arbitration, according to a report by an industry group.

At issue is a version of the 2007 Arbitration Fairness Act revised at the end of April by Sen. Russ Feingold, D-Wis. The revision specifically mentions services “relating to securities and other investments,” which were not detailed in the original bill.

Mandatory arbitration for clients of brokerage firms has been a staple of the business for generations. Broker-dealers like the speed and low cost of arbitration through the Financial Industry Regulatory Authority Inc. of New York and Washington; investors for many years have charged that the system is biased in favor of the securities industry.

Brian Smiley, president of the Public Investors Arbitration Bar Association of Norman, Okla., and a partner with Smiley Bishop & Porter LLP of Atlanta, said that successful arbitrations often result in investors receiving 50% or less of their claimed losses, which is less than what they would win in a successful lawsuit.

If mandatory arbitration were banned, investors would have a choice of resolution alternatives.

“If the bill passes, it will change the face of arbitration in the securities business and other industries,” said Richard Ryder, editor of the Securities Arbitration Commentator, of Maplewood, N.J. “It certainly is going to push up costs.”

PRIORITIES UNCLEAR

The likelihood of the bill passing, however, is unclear, observers said. Although congressional lawmakers face a number of issues relating to the financial services business, the depth of lawmakers' desire to tackle this issue isn't clear, industry sources said.

“It's not a matter of votes but whether it will become a priority,” Mr. Ryder said.

“I don't see it happening, yet. It could be put on the back burner” to major issues,” Mr. Ryder said.

“It's going to happen; the only issue is when,” said one industry attorney, who asked not to be identified.

State securities regulators, regarded as a thorn in the side by many in the securities business, favor the revised bill.

Their professional group, the North American Securities Administrators Association Inc. of Washington, gave its “full support” to the revised bill last month.

“We appreciate that the Senate bill now includes a provision to specifically include services relating to securities … and we encourage similar language in its House counterpart to ensure that investors will have a choice between arbitration and the traditional court system,” NASAA president Fred Joseph said in a statement.

“NASAA believes the "take-it-or-leave-it” clause in brokerage contracts is inherently unfair to investors,” added Mr. Joseph, who is Colorado's securities commissioner.

Securities industry trade groups, meanwhile, are mum about the potential impact of the bill on -broker-dealers.

For example, the Financial Services Institute Inc., which represents independent broker-dealers and their advisers, hasn't made the issue one of its priorities this year, said David Bellaire, general counsel and director of government affairs for the Atlanta-based organization.

And the Securities Industry and Financial Markets Association of New York and Washington isn't focusing on the issue from the perspective of the industry but instead is stressing that the proposed bill would potentially increase costs to investors, said Travis Larson, a spokesman.

Regardless, SIFMA acknowledges the potential expense to the industry if the bill passes. In a 2007 white paper produced after the introduction of the Arbitration Fairness Act, the trade group estimated that “a ratio of 3- or 4-to-1, litigation versus arbitration, is fairly reasonable.”

It also noted that “a reasonable expectation is that the cost of an arbitration will not be in excess of half the cost of litigating.”

Litigation in court is simply more expensive and carries other risks than arbitration, said an industry attorney, who asked not to be identified. “It's really expensive to litigate in federal court. And jurors want their pound of flesh,” he said.

E-mail Bruce Kelly at [email protected].