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The Argument Over Arbitration

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Dallas attorney David Dyer spends about two months each year in arbitration hearings, representing brokers and institutions. That doesn’t count the additional hours that he logs in hearing rooms as an NASD arbitrator. Dyer, a partner at Dallas-based Secore & Waller, has been doing this for 15 years, and lately he has been struck by what a colossal waste of time and money the process often seems. Now, he’s one of many arbitration veterans who say there has to be a better way.

While arbitrations are supposed to be cheaper and more expeditious than trials in civil court, Dyer and others say that these advantages have diminished in recent years, and that all too often the proceedings just look like outtakes from The Gong Show. Dyer recalls one recent arbitration in which his client was alleging that he had been fired on trumped-up charges so the firm could steal his clients. “The claimant testified another broker in the office had harassed him by throwing a Coke can at him,” Dyer recollects. When the Coke-thrower was called to testify, one of the arbitrators began a lengthy interrogation about whether he had played baseball in high school. While the proceedings ground to a halt, says Dyer, the chairman “let this ridiculous line of questioning proceed” for half an hour. Meanwhile, the industry arbitrator on the case, he says, showed up looking like he was still drunk from the night before. “One day I was sure he woke up in his car,” says Dyer. “It’s just an incredible crapshoot on these panels.”

Dyer is not alone in this dim view. “The quality of the panels has continued to decline,” says Anthony Paduano, partner with New York City-based Paduano & Weintraub, who usually represents the industry in arbitration. “When I bring in counsel from member firms, they go crazy because the quality of the panels is so poor. They’re not smart. They’re not prepared. That happens all of the time.”

A Kangaroo Court?

Critics complain that not only are arbitrators often incompetent, but panel chairmen, who are expected to keep proceedings in line, also don’t exercise restraint. Sometimes they literally fall asleep on the job. In addition, critics say the arbitrator pool is too small and biased in favor of the firms. It’s not that public customers do not win cases – they won awards in 43 percent of NASD arbitration cases decided in 2005, which is down from historical averages of about 50 percent; it’s just that customers don’t win much money.

What’s more, arbitration has become increasingly litigious, with attorneys resorting to delaying tactics, drawing out the discovery process with subpoenas, submitting lengthy depositions, requesting extensions and filing repeated motions. A case that used to take a year to resolve is now taking 18 months to two years, say attorneys, and the average arbitration costs about $12,000, close to double what it was a few years ago, according to some estimates.

What the arbitration system needs, say its critics (brokers, broker/dealer counsels and securities lawyers alike), is a wider, more knowledgeable and better-paid pool of arbitrators, staff monitors to oversee proceedings and more guideposts and rules to keep cases from spiraling out of control. Some also advocate a bigger role for mediation, which typically takes 100 days or less from start to finish, costs about a third as much as arbitration and results in settlements close to 80 percent of the time, according to NASD statistics. Others question whether arbitration should be mandatory at all, as it is now.

One American Express broker who spent 18 months in arbitration says she would have preferred a full trial with a jury, even though she won an award in her arbitration against the firm. The arbitrators on her case were never prepared, sought numerous extensions on the discovery process, kept losing faxes and delaying hearing dates, she says. The panel chairman, a 78-year-old man with very poor hearing, had absolutely no control over the screaming attorneys, she adds. In the end, she lost time from work and spent more on legal fees than she won in the final award.

Some attorneys blame the increased litigiousness on brokerage firms. With in-house legal counsel busier than ever in today’s increasingly complex regulatory environment, firms have begun hiring third-party attorneys to deal with arbitrations. “The industry has sublet a huge amount of their case load to large law firms,” says Theodore Eppenstein, a partner with Eppenstein & Eppenstein and a member of the Securities Industry Conference on Arbitration, who testified before Congress on arbitration last year. “They come in with the litigation mentality because they’re used to trying cases in court. They come in with motion after motion to try to delay and wear down the other side. That’s the strategy,” he says.

The Shape of Reform

Responding to years of complaints from parties on all sides of the arbitration system, the NASD and the New York Stock Exchange are testing new ways to streamline the arbitration process and upgrade arbitrator ranks. Together the two self-regulatory organizations (SROs) oversee close to 95 percent of all securities arbitration cases, though the NASD handles over 10 times more case volume than the NYSE. Last year, 6,074 cases were filed with the NASD, and 464 were filed with the NYSE. That’s partly because NASD’s membership is about 10 times larger than that of the NYSE, but also because it has been more responsive to complaints, attorneys say.

The SEC is currently reviewing a new NASD arbitration code, which is widely expected to take effect this year and includes new rules governing motions, subpoenas and arbitrator selection. Under the new code, motions will only be allowed under “extraordinary circumstances”; only arbitrators, not attorneys, will be permitted to issue subpoenas, while all parties will be able to receive copies of subpoenas issued; and the number of arbitrators any one party can strike from a short list of arbitrators will be limited. These reforms are aimed at reducing the amount of time spent in arbitration and making the process of selecting arbitrators more fair.

Another part of the proposed NASD code addresses concerns about hearing chairmen. Today, the NASD offers chairperson training, but does not require arbitrators to take the course or pass the test before they serve as chairs. The parties pick their chair themselves. Under the proposed rule, the NASD will require panel chairs to take the chairperson training course, which lasts eight to nine hours and costs $100. In addition, arbitrators who are attorneys admitted to a state bar will have to serve on at least two cases that went through a hearing to an award before becoming a chairperson; arbitrators who are not attorneys will have to serve on at least three cases that went to an award. The NASD has also proposed a controversial measure that would require arbitrators to write a “reasoned award” – in other words, to explain their decision. Today, there is no explanation given in order to expedite the process. But some worry that this will make it easier for parties to appeal a decision in the courts. Today, it is very difficult to appeal an arbitration award.

Other measures are being tested out. Last August the NASD began a pilot program in its western and southeast regions aimed at speeding up the discovery process, one of the most time-consuming phases of arbitration. The NASD has also been working to expand the rolls of arbitrators over the past several years – last year alone, it approved over 1,200 new arbitrators, and these individuals are far more competent than past arbitrators, says David Robbins, who chairs the NASD neutral roster committee that approves new arbitrators. “Arbitrator competence is the single most important issue facing securities arbitration,” says Robbins. “And these new arbitrators have led lives of achievement.”

Wait and See

Some attorneys still have their doubts. New arbitrators often don’t get picked, because they don’t have a history of awards that lawyers can check to get a sense of their leanings. Older arbitrators who make a living serving on arbitration cases often cap awards, fearing that they will be struck from the list by firms if they appear to be too zealous about awarding large sums to investors or brokers, says Jacob Zamansky, an arbitration attorney with Zamansky & Associates. “If I have sat on numerous cases, I’m going to be afraid to issue a large award against a big brokerage firm,” he says, because these firms appear over and over again in arbitration hearings.

The NYSE says it’s waiting to see how some new NASD rules pan out. “We are reviewing our entire code of arbitration to see where it needs to be fine-tuned,” says Daniel Beyda, chief administration officer for NYSE Regulation. “We’re going to watch and see how it goes on their end before we take action.”

In response to complaints about delays in its arbitration process, the NYSE says that it has made great strides in the past year at limiting the amount of time it takes to select arbitrators to five months. It has also drafted a rule concerning subpoenas very similar to the one the NASD wrote – the SEC is also reviewing the NYSE proposal. But it’s taking a wait-and-see attitude towards discovery arbitrators and increased training, as well as other rules included in the NASD code.

Still, the NYSE does have some advantages. Because it sees fewer cases, it’s able to provide better supervision of the panels by arbitration counsel. “The NYSE sends its arbitration counsel to monitor a lot of hearings,” says Paduano. “As a result, their panelists don’t goof off.”

The NYSE has also gotten more aggressive about eliminating any pro-industry bias from its arbitrator pool. Every arbitration panel includes one industry arbitrator and two “public” – or non-industry – arbitrators, but some claim that the public pool is contaminated, because under current rules, any individual whose business or firm receives up to 10 percent of its earnings from the securities industry can serve as a public arbitrator. (For larger firms, 10 percent equals quite a lot, they say.) An NYSE rule amendment, now pending at the SEC, would require that public arbitrators have absolutely no ties to the securities industry, including ties based on firm or family relationships. In December 2005, NASD established a task force to further review its classes of arbitrators, but it has not yet issued any amendments.

The Cost of Quality

In the meantime, there is a real Catch-22 in the arbitration debate, because while everyone complains about the quality of arbitrators, they also complain about rising costs. “Do you get what you pay for? Yeah, unfortunately, sometimes,” says Robbins, who is also a partner at Kaufmann Feiner Yamin Gildin & Robbins and has been defending brokers and investors in arbitrations for the past 30 years. “They’re not paid much, and, as a result, a lot of them don’t work that hard. How do you improve the system? Pay them more.” But higher pay would probably mean higher costs. The NASD says it’s planning to raise pay, but it doesn’t want to start hiring professional arbitrators, such as those used by the American Arbitration Association to mediate construction disputes. That would “increase the expenses for all parties,” says Linda Fienberg, president of NASD Dispute Resolution.

Some say mediation is a better alternative. Last year, of 6,000 arbitration cases filed with the NASD, about 900 of them were settled via NASD mediation. Mediation usually takes three months at most, and costs as little as one-third the cost of an arbitration, says Joe Meyer, a financial advisor and an NASD-approved mediator with Meyer & Associates, an RIA in Ormond Beach, Fla. The NASD pays the mediator an hourly rate – anywhere from $150 to $250 an hour – which is then shared by the parties. Typically, the mediator sits in on the actual mediation for no more than a day, or eight hours, Meyers says.

Beyond cost, one advantage is that the parties control the outcome, whereas in arbitration, the panel is in control of the proceedings. In addition, if mediation fails, the parties can go on to arbitration having evaluated the strengths and weaknesses of their respective positions, says Meyer. So why haven’t more individuals turned to mediation? Meyer says too few of them understand what it entails. The NASD is trying to educate the public – a few years ago it began hosting an annual mediation week, where it offers a reduced rate to parties who participate in mediation.

Still, some think that, despite its flaws, the current arbitration system is pretty good. “Arbitration should be voluntary, but I would still elect it 9.5 times out of 10,” says Phil Aidikoff, a California attorney and former president of the Public Investors Arbitration Bar Association. “If it’s set up properly, it’s more efficient. I can accept cases on behalf of customers with lower dollar thresholds. When you talk about going into federal court, you may be pricing yourself out of helping people.”


2006 (through March)




Total Cases Filed 1,393 6,074 8,201 8,945
Cases closed 2,084 9,043 9.209 7,278
Cases decided by arbitrators 387 2,122 2,423 2,077
Cases settled directly between parties 974 3,940 3,700 2,616
Cases settled via mediation 231 910 1,201 1,182
Cases withdrawn 197 806 677 647

Source: NASD