A new regulation that would allow investors to choose an all-public arbitration panel in disputes with brokers is being hailed as a step toward making the process fairer — and criticized as a half-step toward giving investors the option of litigation.
The Securities and Exchange Commission
last week approved a rule proposed by the Financial Industry Regulatory Authority Inc. that would allow investors involved in Finra arbitration proceedings to request a panel composed entirely of people with no recent ties to the securities industry. Usually, the three-person person boards consist of two public arbitrators and one from the industry.
The SEC action follows a 27-month pilot program during which Finra gave certain investors the choice of replacing the industry arbitrator with a public panelist. The rule change, announced last week, does not affect disputes among brokerage firms or between brokers and their firms.
(Weigh in on some recent regulatory developments affecting advisers.)
The SEC move, however, still does not provide the investor latitude that some reformers seek.
“I'm really afraid that this is what we're going to have to settle for, rather than access to the courthouse,” said Pat Huddleston, chief executive of Investor's Watchdog LLC.
Settling broker-investor disputes through the judicial system is especially important now that the SEC is on the verge of promulgating a regulation that would impose a universal fiduciary duty on personalized investment advice, according to Mr. Huddleston.
He explained that arbitration cases leave a scant paper trail in their wake, while civil cases form a body of law as they work their way through the appellate process.
“Litigation becomes a way to enforce the law,” said Mr. Huddleston, a former enforcement chief in the SEC's Atlanta office. “The decisions can inform the industry. [Arbitration decisions] cannot possibly add up to a pattern, because they're not explained.”
The North American Securities Administrators Association Inc., which represents state and provincial regulators and is a longtime champion of arbitration reform, also wants to give investors the option of going to court.
Its president, North Carolina Deputy Securities Administrator David Massey, doesn't oppose Finra arbitration, which he said can be effective.
“Arbitration is getting better and better over time,” Mr. Massey said. “My ax to grind is against the mandatory, cram-down nature of securities arbitration. We're for the investor having a choice.”
For now, though, investor advocates are pleased with the adjustment to the arbitration panel selection process.
“This is a tremendous step in the right direction,” said Peter Mougey, president of the Public Investors Arbitration Bar Association, which represents plaintiff's attorneys.
DODD-FRANK QUESTIONS
PIABA, along with state regulators, has pushed for the all-public option as well as the elimination of mandatory-arbitration agreements in securities sales.
Under the Dodd-Frank financial reform law, the SEC can promulgate a regulation prohibiting mandatory arbitration in brokerage contracts. The agency has not yet indicated that it will exercise that authority.
Finra asked the SEC for the arbitration selection rule change after finding that investors chose all-public panels 60% of the time in the pilot program and that having the option to do so increased their confidence in the process.
The move toward all-public panels is not an effort to dissuade the SEC from eliminating pre-dispute arbitration agreements, according to Finra.
“The all-public arbitration panel pilot was begun over two years ago,” said Nancy Condon, a Finra spokeswoman. “It is unrelated to the mandatory pre-dispute agreement issue, which was a part of the Dodd-Frank legislation passed late last spring.”
Finra's attempts to address concerns about arbitration show political savvy.
“By being responsive, they tend to deflect that criticism,” said Barbara Roper, director of investor protection at the Consumer Federation of America.
Within the broker-dealer community, though, the shift toward all-public panels has been controversial. Many industry arbitrators themselves feel they can be tougher on truly bad actors, because as industry participants, they know how things are supposed to work.
“I absolutely believe that having an industry arbitrator enhances” the ability of a panel to reach the right conclusion, said Lisa Roth, chief executive of Keystone Capital Corp. and past chairman of the National Association of Independent Broker/Dealers Inc.
The results of the Finra pilot program show that investors include industry arbitrators on their panels much of the time. If given the choice, they might often favor arbitration over court proceedings because of its efficiency and cost-effectiveness.
“Absent a mandate, many investors would choose to arbitrate,” Ms. Roper said.
Like other investor advocates, though, she wants to allow investors the option of selecting a court as their forum for adjudication.
“Giving investors the choice of having an all-public-member panel is a good place to start on arbitration reform,” Ms. Roper said.
