American business entered its Teflon era on a spring day 25 years ago.
Lawyer Madelaine Eppenstein had taken the morning off from work for a parent-teacher event at her 5-year-old's elementary school on June 8, 1987, when she was summoned to the principal's office for an urgent call. Her husband and law partner, Theodore Eppenstein, told her they lost the Supreme Court case he had argued two months before on behalf of a couple trying to sue their stockbroker for fraud.
“I felt like I got punched in the face,” she told me in an interview late last month.
If Eppenstein was punched, the investing public was mauled. The case known as Shearson v. McMahon would wind up locking investors out of U.S. courts any time they tried to sue a broker. A tiny clause in customer agreements turned out to be Wall Street's magic formula to keep its transgressions out of sight. The agreement that Eugene and Julia McMahon signed said that any dispute between them and their broker at Shearson/American Express Inc. -- a trusted fellow parishioner at their church --“shall be settled by arbitration” in a Wall Street forum. Investors since then have either had to agree to similar terms, or forget about having a securities account.
“If you get screwed,” Theodore Eppenstein says, “now you have no place to go.”
Looking for Luxuries
No place to go, that is, if you're looking for luxuries like publicly filed documents, juries that hear the facts and judges that preside over open proceedings.
The McMahon decision was damaging enough for the impact it had on individual brokerage customers, who tell their stories about fraud, misrepresentation and churning behind closed doors where the public -- including reporters -- isn't welcome. Perhaps worse is what happens when a powerful industry gets accustomed to keeping its squabbles quiet: Wrongdoers are inclined to relax, sending ethics to ever-lower lows.
“It means that all sorts of scams against individuals, however large, are very unlikely to come to the attention of the media and the public,” says F. Paul Bland Jr., a senior attorney at the public-interest law firm Public Justice in Washington.
Wall Street may have been first to catch on to the benefits of mandatory arbitration, but Bland worries that the closed-door trials are spreading to industries from retailing to homebuilding. “The silence and secrecy that surrounds arbitration is extremely harmful to the country,” he says.
These days, employers -- Manpower Inc. and Nordstrom Inc. among them -- require new hires to give up their rights to court before a fresh-faced recruit can check in for orientation. And consumers can forget about opening a Netflix account, signing a mobile-phone contract, or putting a loved one into most big-name nursing homes unless they are willing to give up their rights to go to court. Buying a Starbucks gift card? You are agreeing to mandatory arbitration of any fraud or misrepresentation by the company.
The results can be chilling. After watching his father die from sepsis of the blood caused by infections from 13 bedsores in 2005, David W. Kurth of Burlington, Wisconsin, tried to sue the nursing home whose staff he claimed had left his father's wounds covered in excrement and urine for days at a time. Though the death of his father would have been shocking enough, Kurth told a Congressional subcommittee in 2008 that the “most shocking” part of his family's ordeal was this: They wouldn't be able to sue for the alleged neglect because the deceased man's wife had signed admissions documents that had a mandatory- arbitration agreement.
“How can anyone in good conscience argue that it should be perfectly legal to trick frail, elderly, infirm senior citizens experiencing the most stressful time in their lives into waiving their legal rights?” Kurth asked.
Conscience, of course, plays no role when companies demand arbitration. But Supreme Court decisions do. In April 2011, the court dealt a new blow to consumers and employees in a case known as AT&T Mobility v. Concepcion. AT&T had pitched a deal to woo new mobile-phone customers by offering free phones, but it turned out the freebie came with a $30.22 bill for “taxes.” Vincent and Liza Concepcion tried to bring a class-action lawsuit on behalf of all the other consumers who took AT&T's deal. But the court said that when the couple signed the customer agreement, they gave up their right not only to sue, but also to a class action even in arbitration.
In the year since the Concepcion decision, lower courts have trashed dozens of cases in which consumers or employees were trying to sue as a group. The National Labor Relations Board pushed back against the impact the Concepcion decision might have on employment class actions, ruling in January that it's a violation of federal labor law to make workers give up the right to pursue group claims. That decision probably will be challenged in court.
About 25 percent of U.S. employees are covered by mandatory-arbitration clauses, says Alexander J.S. Colvin, an associate professor of labor relations and conflict resolution at Cornell University. He figures the number will grow as a result of the Concepcion case.
If you are wondering just how bad arbitration can be, the examples are many. When I wrote my book about sexual harassment on Wall Street, “Tales From the Boom-Boom Room,” I was aghast at the things brokerage firms could do that would never be allowed in court. In the weeks before one woman's arbitration hearing was set to begin, her former employer hired a psychiatrist who questioned about her sex life and her menstrual cycle. She had alleged that a man in the office had followed her into a stock room and grabbed her breasts. Another woman, who said the same man had accosted her, was directed by the consultant-shrink to sit in a chair in the middle of a room and recite the names of all the U.S. presidents -- in reverse order.
Both women bailed out and settled, having seen enough of arbitration's downside before the hearings even started.
Get There Early
In October, a doctor who was fired from her job by a physicians' group in suburban Philadelphia told the tale of her arbitration to the Senate Judiciary Committee. Deborah Pierce would have preferred to sue the partnership (17 men, one woman at the time) that fired her, but her employment agreement tied her to arbitration run by the American Health Lawyers Association. One morning, she arrived early to her hearing at a law office in Wayne, Pennsylvania, to see one of her former bosses strolling out of the arbitrator's office carrying a cup of coffee. That sort of encounter is known as an ex-parte meeting between a judge and a party to a case. It isn't allowed in court proceedings.
To pay for her case, which included her half of the arbitrator's $117,042 fee, Pierce took out a home-equity loan that she and her husband are still paying off three years later. Her consolation prize: the arbitrator at one point ordered her adversaries to pay her $1,000 in sanctions for destroying documents and delaying the proceedings. And then, he billed her $2,000 for the time he spent deciding whether he should impose the fine. She lost.
It's an open secret in legal circles that arbitrators are more worried about alienating the corporations who give them regular business than they are about one-shot plaintiffs. “Arbitrators who ding a major firm know they're going to be blackballed,” says Timothy J. Dennin, a New York lawyer who represents aggrieved investors.
There are upsides to arbitration, if only the public had a chance to consider it as an alternative to court instead of a mandate. Investors whose losses are too small to be attractive to lawyers, for example, can often navigate securities arbitration more easily than a court case. And arbitration can be faster than court.
“Do some cases fare better in arbitration? Definitely,” says Ryan K. Bakhtiari, the president of the Public Investors Arbitration Bar Association, a group of lawyers who represent investors. He says arbitration should be at the choice of the investor, not mandatory.
The more cases we relegate to arbitration, the more we fail to hold companies accountable for bad behavior.
Frank Partnoy, the author of “Infectious Greed: How Deceit and Risk Corrupted the Financial Markets,” says that even if an arbitrator decides a business is guilty of fraud, a company “can write a check and not worry about creating a dangerous precedent.”
That case by the McMahons never got to arbitration after the Supreme Court said the couple couldn't go to court. Regulatory records for their former broker show they settled for $700,000. Christine Hines, the consumer and civil-justice counsel in Public Citizen's Congress Watch unit, says groups such as hers would simply have no material to work with if bad products and practices were all relegated to private justice.
“There is no way we, as advocates, would know what's going on,” she says.
Twenty-five years after the McMahons lost their fight for a public hearing, it's hard not to conclude that's precisely what business is counting on.
(Susan Antilla, who has written about Wall Street and business for three decades and is the author of “Tales From the Boom-Boom Room,” a book about sexual harassment at financial companies, is a Bloomberg View columnist. The opinions expressed are her own.)