What practitioners have known for a long time: The Financial Industry Regulatory Authority’s Arbitration forum is unfair to investors. However, at least this time, there is empirical evidence to back up these claims of unfairness.
Some History of Investor Unfairness
By way of background, since 1987 and the Supreme Court’s holding in Shearson v. McMahon, investors that are subject to stockbroker misconduct or fraud, or the sale of defective financial products cannot bring their claims in state or federal court, but instead must submit these claims to arbitration before FINRA to be decided by a panel of three arbitrators, whom until at least recently, included at least one person with ties to the securities industry.
In 1992, just five years after McMahon, the United States General Accounting Office (“GAO”) conducted a study regarding the fairness of securities arbitration (the “1992 GAO Study”), and issued a report entitled, Securities Arbitration, How Investors Fare. The 1992 GAO Study examined results in arbitrations over an eighteen-month period from January 1989 to June 1990. It concluded, among other things, that abouwwt 60% of investors who submitted claims to industry-sponsored arbitration forums, such as the NASD and NYSE, received an award in some amount, and that the amount awarded averaged about 60% of the amount claimed.
Since 1992, the win rates for customers have fallen as low 37% in 2007 and were approximately 42% in 2013. Claimants’ percentage recovered has also sharply declined. According to a March 2014 article entitled So You Think You Know The Worst FINRA Arbitration Venues?, written by a prominent law firm that represents the securities industry, the most favorable states for respondents are Hawaii, West Virginia, Mississippi, Rhode Island, Iowa, Washington, Nevada, Alabama, Connecticut and Georgia because each have low win rates (e.g. 86% zero rate in Hawaii) and when claimants win, arbitration panels in those states award claimants between 1%-10% of the alleged damages.
Public Investors Bar Association Study
Yesterday, the Public Investors Bar Association released a study that analyzes the background information provided by FINRA to the parties for over 5,000 FINRA arbitrators. It also recounts the history of FINRA’s ongoing lack of transparency with respect to arbitrator recruitment and disclosure process. To support its conclusions, PIABA obtained the opinion of a prominent, tenured professor, Dr. Akshay Rao, to examine the reliability of FINRA’s arbitration disclosure process. Dr. Rao concluded that FINRA’s arbitrator disclosure process is “illusory” and fails to elicit meaningful and reliable information about arbitrators’ bias and conflicts of interest. In addition, PIABA used the background information described above to analyze the demographics of FINRA’s arbitrator roster. This study determined that contrary to FINRA’s public statements that its arbitrator roster is diverse, FINRA’s undisclosed targeted arbitrator recruiting practices have resulted in a non-diverse pool that does not match the demographics of the average investor.
According to the study, although FINRA claims that its arb pool is diverse, PIABA’s analysis showed that the pool is 80% men / 20% women. The average age of the arbitrator in the public pool is 69 years old with over 12% of arbitrators being over 80 years old. In other words, the pool is homogenous.
One expert, Akshay Rao, a tenured professor at the University of Minnesota. Prof. Rao found that the arbitrator application and the entire arbitrator disclosure process flawed at every stage and that it failed to elicit meaningful or reliable information concerning bias. His opinion is in the report. He also concluded that finra’s arbitrator disclosure process gives the brokerage industry an unfair advantage over investors.
Professor Constantine Katsoris, Fordham Law Professor and longtime SICA member, wrote the foreword to the report. In it, he explained that Finra has become less transparent in recent years and advocated for a truly independent board to oversee FINRA’s arbitration system.
Investor Choice Act Introduced
Congress Representative Keith Ellison introduced the Investor Choice Act of 2013, which would give investors the unilateral choice to arbitrate their claims or bring them to court. Following the release of the PIABA study, PIABA held a legislative briefing on Capitol Hill for congressional staffers and was able to team up with Public Citizen, NASAA and AAJ to increase visibility of the issues raised by the report.
The Media Frenzy
Meantime, the media from New York to Guam have gone crazy reporting what most of us know is old news: Reuters, Financial Advisor Magazine, USA Business Daily, Reuters, USA Today, Wall Street Journal, ThinkAdvisor/Investment Advisor Magazine, National Law Journal/Legal Times, Investment News, ADR Prof blog, AARP Bulletin Today, Law360.
Guiliano Law Group
The Guiliano Law Group, P.C. Practice limited to the representation of investors in claims against stockbrokers and investment professionals for fraud, the sale of unsuitable investments, breach of fiduciary duty, failure to supervise. National Practice. Contingent Fee. Free Consultation. If you have suffered losses a the result of misconduct by your stockbroker or investment professional, contact us for a free confidential evaluation at (877) SEC-ATTY.
