Skip to main content

SEC Green-Lights ‘Historic’ Arbitration Rule


In what is being hailed as an historic change to the securities arbitration process, the SEC has approved a rule that allows investors to choose only public arbitrators to hear and decide their claims against brokers.

Previously, in cases with three arbitrators (those involving claims over $100,000), the panels have been made up of two public arbitrators and one “non-public” arbitrator – somebody with a connection to the securities industry. Finra proposed the rule in October after a 27-month pilot program that allowed certain investors the option of having only public arbitrators hear their cases.

Under the new rule, investors can still choose to have a non-public arbitrator on the panel.

“For us, this is really pretty historic,” says Linda Fienberg, president of the Financial Industry Regulatory Authority’s dispute resolution program. “It’s the most historic of the rule changes we have done since I got to Finra in 1996.”

Some, but not all, investor advocates have criticized the arbitration process for being unfair. They note that many investors at least perceive arbitrators as being biased, largely because Finra, which manages the arbitration forum, is sponsored by the brokerage industry.

Finra says it believes giving investors the ability to have an all-public arbitration panel “will increase public confidence in the fairness of our dispute resolution process,” according to a press release announcing the SEC’s approval of the rule.

Fienberg says that “non-public,” or industry-affiliated, arbitrators can include registered individuals or attorneys or accountants who represent the industry. Public arbitrators can be anyone with five years of financial or business experience and can cover such professions as high school teachers, journalists, engineers and doctors.

Investors participating in the pilot program chose the option of all-public arbitrators about 60% of the time. Investors also frequently opted to use a non-public arbitrator, but the ability to choose between the two options improved their perception of the process, Finra says.

Among the 20 awards issued by all-public panels under the pilot program, investors were awarded damages in 13 of 19 cases, or 68%. The parties settled the remaining case.

Of all the cases that were decided by arbitrators in 2010, 47% awarded damages to investors, up from 43% in 2005.

“So far the data show that customers are prevailing more often with an all-public panel, but there just aren’t enough awards to have any significance yet,” says Fienberg.

Only 22% of investor claims were decided by arbitrators last year. About 60% were settled and the rest were withdrawn or resolved in other ways.

Ryan Bakhtiari, who represents investors in arbitration claims and is a partner at Aidikoff, Uhl & Bakhtiari, says the new rule is a big step toward leveling the playing field for investors in securities arbitration.

He likens the inclusion of non-public arbitrators on securities arbitration panels to doctors’ deciding medical malpractice claims.

“Today, customers have a choice,” says Bakhtiari. “It’s a big structural change.”

While Bakhtiari praised Finra for the change, he says that the self-regulatory organization needs to go a step further and tighten the definition of “public arbitrator.” There are “too many industry types that are creeping their way into the public pool,” he says. “There are loopholes that need to be closed.”

There are currently 3,521 public arbitrators and 2,808 non-public arbitrators, according to Finra’s website. Finra added arbitrators across the board in recent years, in part because it anticipated making the option of an all-public panel permanent after the pilot program, says Fienberg.

Finra pays public and non-public arbitrators an honorarium of $200 per hearing session.

Finra also faced a shortage of arbitrators in the South in the wake of hundreds of claims filed against brokers by investors in several Morgan Keegan bond funds.

“We have more than enough arbitrators even if all of the investors were to choose an all-public panel,” says Fienberg.

Results of the pilot program suggest that one potential drawback of having an all-public panel is the arbitrators take longer to decide claims. Pilot program cases with all-public panels took about two months longer to wrap up than the claims decided by panels with one non-public arbitrator (this includes both those cases that were part of the pilot program and those that were not).

Some in the industry are concerned about arbitrators’ level of knowledge.

“My view is that arbitration panels are better informed about the securities industry if there is an industry arbitrator, and having an industry arbitrator doesn’t create any lack of fairness because that person is only one of three arbitrators on a panel and cannot control the outcome,” says Hardy Callcott, partner at Bingham, in an e-mail response to questions.

Industry observers also note the possible connection between the SEC’s speedy approval of Finra’s proposed rule and the Dodd-Frank mandate that the SEC conduct a review of securities arbitration. The law gives the SEC the power to prohibit mandatory pre-dispute arbitration clauses in agreements between brokers and clients. Nearly all broker-dealers currently require their customers to sign a mandatory arbitration clause, meaning those customers must settle disputes through Finra rather than in court.

There is no deadline on the SEC’s review of securities arbitration.

Jill Gross, professor of law at Pace University School of Law, says the SEC review meant Finra could not justify a non-public arbitrator on all three-arbitrator panel cases.

“I predict that the SEC’s Dodd-Frank study of Finra arbitration will now conclude that this latest reform enhances the fairness of the forum,” writes Gross in a law blog post. “As a result, the SEC will refrain from prohibiting mandatory securities arbitration.”

Fienberg says the new rule has been a long-term goal for Finra and has nothing to do with the SEC’s review of securities arbitration.

The new rule applies to all investor cases requiring a three-arbitrator panel in which arbitration lists have not been sent as of Jan. 31.