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Law & Order: Client-Broker Disputes

Registered Representative

The last couple of years have been hell on anyone who owns stock. And someone must pay. Rightly or wrongly, that person typically is you. Case in point: the rate of NASD arbitration cases is expected to increase nearly 35 percent in 2002 compared with 2000. That’s a lot of brokers on the hot seat.

Brokers are afraid, very afraid. “I’ve been offering prudent advice to my clients, but I know I’m going to be sued because we are in a bear market and their investments are down double digits,” says a Wachovia broker who asked not to be named.

An increasing number of reps – many of whom had never been even near a complaint before today’s bear market – are finding their fate in the hands of arbitrators. But just who are these modern-day Solomons – the 10,000 or so securities arbitrators that decide Wall Street disputes? They are finance industry professionals, accountants, doctors, teachers and other white-collar workers; a number are retirees; a broker may even find a real peer – another broker – on their jury. Anyone is allowed to be an arbitrator, as long as he pledges to be objective – and as long as neither lawyer uses his right to peremptorily strike the candidate from the list of potential arbitrators.

The profile of an arbitrator most closely matches that of the gentleman courthouse gadfly who likes getting a front-row seat at a real-life legal drama. Instead, he gets to be the star on Law & Order: Stock Market Disputes. Granted, it lacks bloodshed, Jerry Orbach or a judge demanding order in the court, but it is satisfying for the arbitrators.

“I find it intellectually stimulating,” says Frank Jurist (yes, that’s his real name), who retired from accounting 10 years ago and now lives in Floral Park, N.Y. “It’s no great social desire on my part. It’s not to make the world a better place.”

Fred Pieroni of Ridgewood, N.J., a 63-year-old who retired nine years ago from mediating labor disputes on behalf of a school union, compares the job to being a home plate umpire. “I get a great deal of satisfaction in having things resolved,” he says. “The parties need someone to hear it so they can go on with their lives.”

Wall Street’s arbitrators – who prefer to be called “neutrals” – are different than those who handle other business disputes. Almost none are professional arbitrators. For a half-day session, they earn an honorarium of $200. But before their names can even be added to a waiting list, they must take a $100 class sponsored by their regional NASD alternate dispute resolution office.

An arbitration panel typically includes two members of the public and one person from the industry who can explain technicalities and common practice, and the proceedings take the form of informal court hearings. The arbitrators think of themselves as more like judges than jurors, although the job is a bit of both. Like judges, they have to decide pretrial motions, keep lawyers in line and sometimes decide a case all on their own if the case is small enough ($25,000 for the NASD and $10,000 for the New York Stock Exchange).

James Madan, an investment banking consultant and veteran arbitrator from White Plains, says patience is a virtue. “You’ve got to be able to sift through the evidence. You’ve got to be able to analyze,” he says. “The questions have to be pointed, yet they have to be respectful.”

An arbitrator’s main concern is fairness, not following the letter of some legal procedure, says arbitrator Thomas Turley, a Harrison, N.Y., retiree who started in retail sales in the 1970s and then found his way to clearing. So, for example, he says, the rules of evidence are relaxed. The arbitrators can decide to accept evidence that normally would be excluded from a trial, but they must consider its potential limitations. “The stock answer is ‘We’ll take it for what it’s worth,'” he says.

Decisions are rarely overturned. Most of the time the panel quickly comes to an agreement on which side should win the case and then spends time arguing over the size or particulars of a decision.

Fred Shinagel, a retired investment banker who lives in New York and has been an arbitrator for more than a decade, can recall only one case in which he disagreed with the other two panelists. “I rendered a written dissent,” he says. “I felt very strongly about the disagreement. In fact, that case was appealed, and it’s gone through two levels of judgment.”

The NASD and the NYSE each has its own arbitration process; American Stock Exchange disputes go through the American Arbitration Association.

The NASD, which handles 90 percent of all securities industry disputes in the U.S., has been trying to recruit a bigger and more diverse pool of arbitrators for about five years, says Linda Fienberg, president of NASD Dispute Resolution. The organization is especially interested in signing up women, minorities, accountants and educators.

“We have purposely sought a panel that is not professional and not primarily securities lawyers,” says Fienberg. “Most respondents don’t want a judge. They want something that more closely resembles a jury.”

The NASD now has 47 arbitration offices around the country, and it is actively recruiting in Pittsburgh. Classes are held at different locations, depending on demand. For example, the New York office is to hold four classes this year, San Francisco two and Louisville one – if a minimum of nine aspiring securities arbitrators sign up.

Richard Ryder, publisher of Securities Arbitration Commentator, a newsletter in Maplewood, N.J., that tracks arbitration cases, relates that each market had its own arbitration system until the industry got together to codify their procedures in 1980; subsequently, the Securities Industry Conference on Arbitration has kept meeting and refining the process. In 1989, it more broadly defined what experience counts to affiliate someone with the industry. Its ruling resulted in more members of the lay public being added to panels in an effort to quell concerns of plaintiffs’ lawyers, who suggested there was a bias against investors.

Most arbitrators, whether from the public or industry side, bristle at the implication that they favor firms over brokers and the public. Although a 1992 General Accounting Office study on Wall Street’s justice system found “no indication of a pro-industry bias,” some lawyers who represent investors still prefer to go to court. Philip Aidikoff, president of the Public Investors Arbitration Bar Association, would like to see changes go further. For example, though NASD already evaluates its arbitrators and is stepping up its background checks, Aidikoff believes there needs to be additional scrutiny.

In California, tighter background checks, including additional disclosures of business and family ties, now are required of arbitrators handling cases in a variety of industries. Securities cases have been piling up while the NASD and NYSE fight the new rules, but Securities and Exchange Commission Chairman Harvey Pitt has ordered the self-regulatory organizations to empanel arbitrators to start handling the unheard cases. (Registered Rep., October 2002).

Plaintiffs have won about 60 percent of all cases in recent years. Most disputants, however, hammer out their differences before their cases reach the arbitration panel, either on their own or through a more hands-on dispute resolution process called mediation.

One reason is to save time. In the past, when a case was filed, it would get to arbitration in a few months, and the hearings would generally wrap up in a matter of day. Now, it may take a year to reach arbitration, and the proceeding can drag on for months, even years.

In a down market, as in 1987 and again beginning in 2000, arbitration cases skyrocket. NASD expects 7,500 cases to be filed this year, compared with 5,580 two years ago and 6,915 last year.

The arbitration process has come a long way. Until the late 1980s, the pool of arbitrators was so small that the panelists all knew each other and worked repeatedly on case after case, says Aidikoff. Nowadays, even the most active arbitrators only get called a few times a year and, according to a 1995 study, don’t make more than $8,000 a year, says Ryder.

Turley, who worked in sales, research and clearing, remembers when the hearings started a half hour after the closing bell. “It had an interesting effect,” he says. “Half the people wanted to go out for a drink, so it made things move rapidly.”

NYSE vs. NASD Compared

Minimum dispute: NYSE: $10,000. NASD $25,000. (for three arbitrators.)

Setting: NYSE: at exchange or one of 35 cities. Flexible if parties want to go elsewhere. NASD: 47 locations.

Sustenance: NYSE: pleasant lunch at exchange. NASD: take-out with strict expense limits.