Little-discussed provision in Dodd-Frank empowers the commission to put an end to mandatory arbitration
A little-known provision within the Dodd-Frank Act gives the Securities and Exchange Commission the power to remove mandatory arbitration language from client-broker agreements. If the SEC strips out the language, it would expose broker-dealers to huge costs, experts said.
“This would mean more litigation and more jury trials for broker-dealers,” said Lee Pickard, former director of trading and markets at the Securities and Exchange Commission and a partner at Pickard & Djinis LLP.
Currently, if an investor has a problem with a broker, the investor's only recourse is to have the complaint heard by an arbitration panel put together by the Financial Industry Regulatory Authority Inc. But if the SEC nixes mandatory arbitration, investors could choose instead to hire lawyers to pursue private lawsuits. And unlike scores of other sections in Dodd-Frank that require the SEC to study an issue before making changes, this provision states that the commission can put out a rule for comment at any time.
Such a move would catch a lot of brokers unaware, said TD Ameritrade Trust Co. president Skip Schweiss, who oversees adviser advocacy issues for the firm. In his talks with advisers, the rescinding of mandatory arbitration is the one Dodd-Frank issue that surprises brokers the most. “I see a lot of eyes widen when I talk about this one,” he said.
At the moment, the SEC is collecting comments on all aspects of the Dodd-Frank legislation, including the arbitration provision, said SEC spokesman John Heine. The agency doesn't have a timetable for deciding whether to submit an arbitration rule for comment.
Nancy Condon, a Finra spokeswoman, declined to comment.
Critics of the current rule said that removing mandatory arbitration would be better for investors. They point out that if the SEC does pass a rule change, it doesn't mean that investors will be stymied from pursuing arbitration. Under Finra rules all investors have the right to seek out arbitration; a change in the rule by the SEC would just give investors the choice between arbitration and litigation, experts said.
Some industry participants also noted that a rule change would create a more transparent decision-making process for brokerage firms.
Arbitration panels don't have to disclose how they came to decisions, while courts do, said Pat Huddleton, a former enforcement branch chief at the SEC and chief executive of Investor's Watchdog. “With arbitration panels, you win or lose and there is no application of law and facts because every arbitration panel is different,” Mr. Huddleton said. “Opening the courthouse back to investors is the right thing to do because it would help investors in the long run and the industry by knocking down frivolous claims and giving everyone an understanding of what brokers are allowed to do through court decisions.”
But court cases cost money and the cost of litigation may actually prevent some investors from going to court, said Elliott Curzon, a partner at Dechert LLP. “My guess is that if this happens, it will drive bigger cases to go to court because the perception is that plaintiff's lawyers feel they have a better chance of winning bigger judgments in court,” Mr. Curzon said. Smaller cases would probably still get worked out through Finra arbitration panels.
Advocates of mandatory arbitration believe the current setup is sufficient. “The arbitration process works fairly well and investors haven't been at a disservice by it,” Mr. Pickard said.
Raymond James Financial Inc. executives also back mandatory arbitration.
“Raymond James believes the Finra arbitration process as currently structured offers a forum for customer disputes which is both efficient and equitable,” Anthea Penrose, wrote in an e-mail.
Surprisingly, not all brokers are opposed to the rule. “It used to be that arbitration hearings were cheaper and faster than going to court, but it seems that these proceedings have gotten longer and the costs borne by the broker-dealer community have increased,” said Neal E. Nakagiri, president and chief executive of NPB Financial Group LLC. “Today the costs between arbitration or litigation are roughly equivalent.”
This isn't the first time that the issue of mandatory arbitration has come up. In 1987, the Supreme Court ruled in favor of the use of mandatory arbitration. “This is something that has been percolating for ages,” Mr. Curzon said. “So it was pretty surprising to see it in the Dodd-Frank bill.”
Finra, for its part, seems to be doing what it can to pre-empt the SEC rulemaking process. On Sept. 28, following a two-year pilot program, the industry self-regulator announced a proposal by which investors who file claims against brokerage firms would be able to request public arbitration panels without industry representatives. Currently, arbitration panels comprise two public arbitrators and one industry representative.
Said Mr. Huddleton: “I think the timing of this proposal is too good to be coincidental.”
