If you have a problem with your investment broker and you cannot resolve the dispute on your own, you probably won’t get your day in court. But you will be heard, most likely in a conference room somewhere, before a panel of arbitrators.
The moment people open a brokerage or investment account, they most likely – and perhaps inadvertently – waived their right to sue. The fine print of most customer agreements almost always contains a clause that says the customer agree to resolve any future disputes through arbitration, largely through the forum operated by the Financial Industry Regulatory Authority, Wall Street’s self-regulatory organization, known as FINRA.
The mandatory nature of these agreements – which are increasingly appearing in other consumer financial products as well and have been repeatedly blessed by the Supreme Court – is a frequent complaint of consumer advocates. And if you try to avoid brokers’ so-called predispute arbitration clause, you may have little choice but to stow your savings in a mattress.
While arbitration has its share of benefits – it’s much quicker and cheaper than litigation – some securities lawyers who represent investors argue that they would get better results before a jury of their peers. But other legal experts point out that many investors wouldn’t have a chance to be heard if it weren’t for arbitration; federal securities laws, along with some states’ laws, are not always investor-friendly.
“From the investor’s perspective, the great advantage of the FINRA model is that arbitrators might be able to find a remedy for investors that is not supported by law,” said Barbara Black, a professor at the University of Cincinnati College of Law.
But it doesn’t always work in investors’ favor, according to securities lawyers. And last month, FINRA acknowledged that its arbitration process, which has come under recent criticism, could be improved when it announced a 12-member task force to look into improving transparency, impartiality and efficiency.
So how do investors fare in arbitration right now? Last year, about 18 percent of customer cases, or 499 claims, were decided in arbitration. Customers received monetary or nonmonetary damages in 42 percent of those cases. But 77 percent of customer cases – including settlements between the parties and arbitration awards – resulted in some sort of monetary or nonmonetary relief (such as canceling a stock purchase and getting money back).
The leading reason consumers pursue arbitration is because of claims of a breach of fiduciary duty, which is the legal way of saying the broker did not act in a customer’s best interest. There were nearly 1,900 of those cases last year, according to FINRA, followed by lesser numbers of cases involving claims of negligence and misrepresentation. Problems involving stock investments were the most frequent, followed by mutual funds and variable annuities.
Investors are often surprised at how the process works. Arbitration is considered an “equitable forum,” for instance, which means arbitrators don’t have to strictly apply the law.
“The court applies the law to the facts and makes a decision,” said Jonathan Morris, chief legal officer at Dynasty Financial, who has served as an arbitrator. “In arbitration, they might not rule all for one side or another. The investor can be partially right and partially at fault and arbitrators can split the difference.”
Depending on the circumstances, the lack of a legal standard can help or hurt your case. Someone like Phil Ashburn, whose case was arbitrated last year, may have done better if his case had been heard by a jury, at least by his lawyer’s estimation, because the laws in his home state, California, are more favorable for investors.
Ashburn, a former phone installation and repair technician, said he pursued his claim after an “adviser” who visited his company offices, and later his kitchen table, urged him to take a company buyout instead of a $1,500-a-month pension. He was 51 at the time, and took the buyout.
The adviser then invested the $355,000 he received into a high-cost variable annuity. He needed income right away, so she recommended that he take advantage of a tax rule allowing penalty-free withdrawals before retirement age. He took out about 9 percent of his money each year.
“She kept stressing the fact that you are never going to go broke,” said Ashburn, now 63 and working as a part-time dog trainer out of his Pleasanton, Calif., home. “And I believed her. It was my ignorance.”
He filed his case in 2009, seven years after he met with the adviser, and went to arbitration early last year. He, along with five of his co-workers, lost, although the opposition had to pay the arbitration fees.
Ashburn said he didn’t feel like he got a fair hearing because the head arbitrator was hard of hearing, while the two other arbitrators struggled to stay awake. He said he also overheard the head arbitrator in the lobby laughing about the facts of the case.
Legal experts say that most arbitrators are well-intentioned, although FINRA’s training program needs to be more rigorous. And FINRA did recently improve the impartiality of the panels: Until 2011, the panel of arbitrators included one industry arbitrator and two “public” arbitrators, with no industry ties. Consumers can now request an all public panel. FINRA also proposed a rule to make it more difficult for people with former industry ties to be listed as a public arbitrator.