Securities Arbitration System Works Effectively and Benefits Investors

Legislation under discussion in the U.S. House of Representatives would change the decades-old securities arbitration system for dispute resolution to prohibit arbitration clauses in consumer contracts. While examining any long-standing process or regulation has its merits – and this debate has been raised repeatedly over the years – the securities arbitration system has worked effectively for decades. It is subject to public oversight, regulatory oversight by multiple independent regulators, and its rules of procedure are designed to benefit investors.

Securities arbitration rules, first created in 1972, are based on the belief – true then and still true nearly five decades later – that many customers would prefer to arbitrate and benefit from arbitration. As the U.S. Supreme Court observed in its landmark McMahon decision in 1987, and as many courts have observed since, securities arbitration is overall less expensive, more expedient, and just as fair as court-based litigation, while also closely monitored by the SEC.

While arbitration is not unique to securities brokerage and many industries in and outside of financial services include arbitration clauses, FINRA’s arbitration forum is far different and stands above because it incorporates substantive and procedural protections comparable to court-based litigation, and thereby ensures fair case outcomes for retail customers.

FINRA Rule 12200, in addition to mandating arbitration if demanded by the customer, also mandates arbitration if “required by a written agreement.” The rule thus recognizes that both firms and their customers may be obligated to arbitrate.

Today, nearly all broker-dealer firms include arbitration clauses in customer contracts to:

  • provide clarity and certainty about where disputes will be resolved;
  • secure a lower cost, more expedient, and equally fair forum; and
  • help manage and control dispute resolution costs (and thereby deliver lower cost services than they otherwise could).

Because it is virtually the sole forum for securities dispute resolution, FINRA and its many committees, task forces and study groups – assisted by state regulators, claimants’ lawyers and industry representatives – have continually evaluated and amended the rules that govern the process to make it fairer and more user-friendly for all participants, especially customers.

This commitment to self-improvement, which over the years has addressed issues like punitive damages, pre-hearing discovery, motion practice and panel composition, to name a few, has enabled securities arbitration to nimbly adapt to the ever-changing times in ways the court system has not (and generally cannot).

Today, FINRA’s forum has evolved into the gold standard for customer protections and customers fare well in FINRA arbitration, recovering through settlements or awards in the vast majority of cases.

And overall, the process is fundamentally investor friendly:

  • FINRA serves the claim on the broker that the investor complained about, with a fee structure favoring the investor, saving them time and money.
  • The hearing is sited where the investor lived when the events occurred, with hearing locations in all 50 states.
  • The process includes a motion-to-dismiss rule severely limiting motions made before the claimant rests their case and provides sanctions for frivolous motions.
  • Parties have access to the FINRA discovery guides and codified discovery provisions in the Code of Arbitration Procedure for Customer Disputes.
  • The customer has the option of an all-public panel, and in close calls, if the investor wants an arbitrator removed for bias, they are removed.

FINRA enforces arbitration awards in the investor’s favor, and awards are public in a searchable database, with statistical data on the program also available online. Investors can also opt out of arbitration and instead join a class action.

Despite this success story, the impassioned cries to ban mandatory arbitration continue.  These naysayers, however, fail to appreciate how such a ban might work out.

Banning mandatory arbitration clauses in brokerage contracts would be an immense mistake – because it would ultimately kill securities arbitration, and in turn, end the significant benefits it provides to customers.

Firms must remain free to name a commercially reasonable dispute resolution forum at the outset of their business relationships – before a dispute arises.  Customers, in turn, are entitled to a fair forum in which to adjudicate their disputes; one that provides due process and that can adapt and improve with the changing times.

We must preserve the current enforceability of arbitration clauses in customer contracts.

To learn more, listen to a podcast further discussing the history and merits of the system:

Kevin Carroll is Managing Director and Associate General Counsel at SIFMA