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Battle over mandatory arbitration heats up

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By Dan Jamieson

November 5, 2007 6:01 am ET

The issue of mandatory arbitration is heating up.

A House subcommittee held hearings late last month on the Arbitration Fairness Act of 2007, which would abolish pre-dispute arbitration agreements that are used by the financial industry and a variety of other industries.

A companion bill has been introduced in the Senate.

Both critics and supporters of mandatory pre-dispute arbitration contracts, which are used in the securities industry for both customer and employment claims, cited various studies to support their arguments.

Citing statistics from the Financial Industry Regulatory Authority Inc. of Washington and New York, Theodore Eppenstein, a senior partner with Eppenstein & Eppenstein, a New York law firm that represents investors, testified that industry customers last year lost 58% of the time in FINRA arbitrations.

Investor win rates have "declined precipitously" since 1987 when the U.S. Supreme Court upheld a pre-dispute contract used by Shearson/American Express Inc. of New York, he said.

Mr. Eppenstein was the plaintiff's attorney in that case, known as the McMahon decision.

He cited a study this year by Daniel Solin, a securities arbitration claimants' counsel in Bonita Springs, Fla., and Edward O'Neal, a Fairfax, Va.-based expert witness for plaintiffs, showing that even when investors get any award — which statistically counts as a win — it may be less than they lost or not cover their costs.

"We've now had 20 years to see how bad" industry arbitration is, Mr. Eppenstein said in an interview. "The industry forum is now seen as a stacked deck."

Before the hearing of the House Judiciary subcommittee on commercial and administrative law, the Securities Industry and Financial Markets Association of New York and Washington released a white paper that it said showed the benefits of arbitration.

SIFMA's white paper shows that the percentage of securities arbitration claimants who recover, either by award or settlement, has held steady in recent years. In 2006 the recovery rate was 66%, SIFMA said, citing FINRA data that includes intraindustry cases.

The paper said 25% of all arbitrations involve claims of less than $10,000, and another 25% involve claims of less than $50,000 — small claims that are too costly to litigate in court, the trade group said.

Without pre-dispute agreements, "most disputes would end up in the lengthier, costlier litigation forum" of court, SIFMA said in submitted testimony at the hearing last week. The "obvious benefit of the speedy resolution [in arbitration] is that successful plaintiffs obtain the relief they seek ... more quickly, and all parties are able to move on."

Pre-dispute agreements are necessary, SIFMA added, because parties are unlikely to arbitrate after a dispute has arisen.

The bills in Congress would affect many industries that use pre-dispute agreements, including credit card companies, telecommunications providers and the medical field, in addition to Wall Street.

At the Oct. 25 hearing, Public Citizen, a Washington-based consumer group, trotted out a detailed report it released in September based on an eight-month investigation of 34,000 cases of binding mandatory arbitration used by credit card companies. The report said that in 19,000 cases studied, consumers "lost a shocking 94% of the time," Laura MacCleery, director of Public Citizen's Congress Watch division, said in testimony.

Fully 90% of the cases "were handled by a small cadre of 28 arbitrators," she said.

Public Citizen got its data thanks to a California law that requires arbitration providers to post basic data on case outcomes.

"All states should have disclosure regimes like California," Ms. MacCleery said in an interview. "There should also be a public record of hearings when parties agree to it."

Secrecy is one of the "structural inadequacies" in mandatory-arbitration systems that need to be fixed, Ms. MacCleery said.

Most of the arbitrations evaluated by Public Citizen were default collection actions, countered Peter Rutledge, associate professor of law at the Columbus School of Law at The Catholic University of America in Washington, who also testified.

These are "relatively straightforward arbitrations commenced by a bank when someone does not pay their credit card bill," he told Congress.

Mr. Rutledge urged lawmakers "not to let the anecdotes drive the debate."

Richard Naimark, senior vice president of the American Arbitration Association of New York, a leading private provider of arbitration services, told the hearing that mandatory-arbitration clauses are the only means of ensuring that consumers or employees have "meaningful access to justice in most cases."

Additional protections for em-ployees and consumers can be achieved by requiring due-process safeguards, he said.

Dan Jamieson can be reached at djamieson@crain.com.

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