[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]



 
                   THE SECURITIES ARBITRATION SYSTEM

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                     CAPITAL MARKETS, INSURANCE AND
                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                             MARCH 17, 2005

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 109-11






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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana          PAUL E. KANJORSKI, Pennsylvania
DEBORAH PRYCE, Ohio                  MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair   JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                GREGORY W. MEEKS, New York
JIM RYUN, Kansas                     BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio           DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois         MICHAEL E. CAPUANO, Massachusetts
WALTER B. JONES, Jr., North          HAROLD E. FORD, Jr., Tennessee
    Carolina                         RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut       WM. LACY CLAY, Missouri
VITO FOSSELLA, New York              STEVE ISRAEL, New York
GARY G. MILLER, California           CAROLYN McCARTHY, New York
PATRICK J. TIBERI, Ohio              JOE BACA, California
MARK R. KENNEDY, Minnesota           JIM MATHESON, Utah
TOM FEENEY, Florida                  STEPHEN F. LYNCH, Massachusetts
JEB HENSARLING, Texas                BRAD MILLER, North Carolina
SCOTT GARRETT, New Jersey            DAVID SCOTT, Georgia
GINNY BROWN-WAITE, Florida           ARTUR DAVIS, Alabama
J. GRESHAM BARRETT, South Carolina   AL GREEN, Texas
KATHERINE HARRIS, Florida            EMANUEL CLEAVER, Missouri
RICK RENZI, Arizona                  MELISSA L. BEAN, Illinois
JIM GERLACH, Pennsylvania            DEBBIE WASSERMAN SCHULTZ, Florida
STEVAN PEARCE, New Mexico            GWEN MOORE, Wisconsin,
RANDY NEUGEBAUER, Texas               
TOM PRICE, Georgia                   BERNARD SANDERS, Vermont
MICHAEL G. FITZPATRICK, 
    Pennsylvania
GEOFF DAVIS, Kentucky
PATRICK T. McHENRY, North Carolina

                 Robert U. Foster, III, Staff Director
  Subcommittee on Capital Markets, Insurance and Government Sponsored 
                              Enterprises

                 RICHARD H. BAKER, Louisiana, Chairman

JIM RYUN, Kansas, Vice Chair         PAUL E. KANJORSKI, Pennsylvania
CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
PAUL E. GILLMOR, Ohio                DARLENE HOOLEY, Oregon
SPENCER BACHUS, Alabama              BRAD SHERMAN, California
MICHAEL N. CASTLE, Delaware          GREGORY W. MEEKS, New York
PETER T. KING, New York              DENNIS MOORE, Kansas
FRANK D. LUCAS, Oklahoma             MICHAEL E. CAPUANO, Massachusetts
DONALD A. MANZULLO, Illinois         HAROLD E. FORD, Jr., Tennessee
EDWARD R. ROYCE, California          RUBEN HINOJOSA, Texas
SUE W. KELLY, New York               JOSEPH CROWLEY, New York
ROBERT W. NEY, Ohio                  STEVE ISRAEL, New York
VITO FOSSELLA, New York,             WM. LACY CLAY, Missouri
JUDY BIGGERT, Illinois               CAROLYN McCARTHY, New York
GARY G. MILLER, California           JOE BACA, California
MARK R. KENNEDY, Minnesota           JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio              STEPHEN F. LYNCH, Massachusetts
J. GRESHAM BARRETT, South Carolina   BRAD MILLER, North Carolina
GINNY BROWN-WAITE, Florida           DAVID SCOTT, Georgia
TOM FEENEY, Florida                  NYDIA M. VELAZQUEZ, New York
JIM GERLACH, Pennsylvania            MELVIN L. WATT, North Carolina
KATHERINE HARRIS, Florida            ARTUR DAVIS, Alabama
JEB HENSARLING, Texas                MELISSA L. BEAN, Illinois
RICK RENZI, Arizona                  DEBBIE WASSERMAN SCHULTZ, Florida
GEOFF DAVIS, Kentucky                BARNEY FRANK, Massachusetts
MICHAEL G. FITZPATRICK, 
    Pennsylvania
MICHAEL G. OXLEY, Ohio




                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    March 17, 2005...............................................     1
Appendix:
    March 17, 2005...............................................    27

                               WITNESSES
                        Thursday, March 17, 2005

Fienberg, Linda D., President, Nasd Dispute Resolution, Inc......     4
Galvin, Hon. William Francis, Secretary of the Commonwealth of 
  Massachusetts..................................................     6
Katsoris, Constantine, Wilkinson Professor of Law, Fordham 
  University School of Law.......................................    13
Kupersmith, Karen, director of Arbitration, New York Stock 
  Exchange, Inc..................................................    12
Lackritz, Marc E., President, Securities Industry Association....    15
Perino, Michael, Professor of Law, St. John's University School 
  of Law.........................................................     8
Shockman, Rosemary, President, Public Investors Arbitration Bar 
  Association....................................................    10
Solin, Daniel R., Esquire........................................    17

                                APPENDIX

Prepared statements:
    Gillmor, Hon. Paul E.........................................    28
    Kanjorski, Hon. Paul E.......................................    29
    Fienberg, Linda D............................................    31
    Galvin, Hon. William Francis.................................    41
    Katsoris, Constantine........................................    47
    Kupersmith, Karen............................................    50
    Lackritz, Marc E.............................................    65
    Perino, Michael..............................................    80
    Shockman, Rosemary...........................................   103
    Solin, Daniel R..............................................   111


                   THE SECURITIES ARBITRATION SYSTEM

                              ----------                              


                        Thursday, March 17, 2005

             U.S. House of Representatives,
        Subcommittee on Capital Markets, Insurance,
               and Government Sponsored Enterprises
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to call, at 2:00 p.m., in 
Room 2128, Rayburn House Office Building, Hon. Richard Baker 
[chairman of the subcommittee] presiding.
    Present: Representatives Baker, Ryun, Kanjorski, Frank, 
Clay, and Scott.
    Mr. Baker. I would like to call this meeting of the Capital 
Markets Subcommittee to order.
    The committee meets today for the purpose of reviewing the 
current securities arbitration system, which has been in place 
and in effect for some number of years, which enables those who 
feel wronged in the treatment of their investment practices may 
seek out remuneration or appropriate remedy by engaging in the 
services of arbitration systems.
    Three out of every four investors who have sought 
arbitration remedy before the NASD have been awarded 
compensation. In a 1997-1999 survey, 93 percent of the NASD 
arbitrants believe their claims were handled appropriately and 
without bias. There have been diligent efforts to improve on 
the payment methodologies, from the amount of unpaid awards in 
2001 of 31 percent, down to the recently achieved number of 14 
percent for the first half of 2004. Regrettably, the unpaid 
awards usually are attributable to brokers who are no longer in 
business.
    I do believe the system offers a timely, efficient and low-
cost remedy for those who seek redress, but it certainly is 
consistent with the committee's overview of market-sector-by-
market-sector to engage in this hearing today, ask stakeholders 
and participants to give us their perspectives, and each of you 
brings to the committee a unique perspective on enhancement, 
remedies, criticisms, compliments, of the current methodology 
and we certainly will welcome your comments.
    By way of explanation, every individual's comments will be 
made part of the official record. We will recognize you in 
regular order for the customary 5 minutes of comment. I am 
certain that as the committee proceeds, members will come in 
and out. I am advised that in about 45 minutes to 1 hour, we 
will expect a series of votes which will interrupt the 
proceedings, but it is our intent to return immediately 
thereafter to conclude the hearing.
    Also by way of announcement, because of prior obligations 
before this hearing was actually scheduled, Mr. Ryun will at 
the appropriate time assume the chair.
    With that, I would like to recognize the ranking member, 
Mr. Frank, for his statement.
    Mr. Frank. Mr. Chairman, thank you for calling this 
hearing. I did request that the Secretary of the Commonwealth 
of Massachusetts, my former legislative colleague and former 
legislative colleague of about half the Massachusetts 
delegation, William Galvin, who has been a very diligent 
advocate of the rights of individual investors in regard to 
this and in many other areas. He is the one who called this 
subject to my attention and thought it was worth this sort of 
an examination. I agree with him and I am glad to do that.
    I also welcome Mr. Daniel Solin who has written on this, 
who is another Massachusetts person.
    I thank you for convening this balanced panel. I think 
there were some very important issues raised as to how this 
process goes forward. This is very much our obligation. We are 
not at a crisis point here, but we are often legitimately 
criticized for waiting until we get to crisis points. I think 
that some concerns have been raised; The Wall Street Journal 
today has a page one article which raises some genuine issues 
that need to be addressed. I hope some of the representatives 
of industry will address some of them as to who is or is not a 
public arbitrator and what qualifies you to be a public 
arbitrator.
    I think what we have found is to the extent that we are 
able to have hearings such as this and to legislate, we are 
helping the financial system. To the extent that we address 
concerns or grievances of individual investors or institutional 
investors in the large have, and give people some sense that we 
are trying to improve that, we enhance the attractiveness of 
investing. This is not an attack, even for those who are 
critical of the system. It is not an attack on the American 
financial system. It is an effort to continue to improve it and 
thereby, among other things, enhance its attractiveness to 
people.
    So this is a relatively new subject for the committee. I 
want to congratulate Secretary Galvin for the initiative he has 
taken in bringing this issue forward. Once, as it often 
happens, people learn that there is going to be this kind of a 
hearing, other people come forward with comments. I think this 
is the beginning of a process which I hope will result in some 
improvements.
    Thank you.
    Mr. Baker. I thank the gentleman for his statement.
    Mr. Ryun?
    Mr. Ryun. Thank you, Mr. Chairman, for scheduling this 
important hearing.
    Arbitration has long been a primary dispute resolution 
process for the securities industry in the United States. By 
providing a faster and cheaper method of resolving disputes 
between investors and brokers than would the court proceedings, 
the arbitration process has been largely successful. The 
success of the arbitration process depends heavily on the 
ability to provide a fair and unbiased proceeding. It is 
especially critical to ensure the arbitrators selected are 
unbiased.
    To accomplish this goal, panels are made up of three 
arbitrators, two that are public and one that is industry. 
While the actual process for selecting arbitrator varies from 
forum to forum, I believe that this is generally done in an 
equitable fashion. I look forward to hearing the comments from 
our witnesses on the various techniques used to ensure the 
fairness. All in all, I believe that arbitration has served the 
industry well.
    Clearly, each member of this panel should remain interested 
in continuing to improve the system by making it even more 
equitable and efficient. The results of the disputes through 
means other than a court proceeding saves time and money for 
all parties involved. There is strong evidence that the system 
already operates in an equitable manner, but we are here today 
to hear testimony from those who know the industry best and who 
can provide us with valuable insight on where improvements 
could and possibly should be saved.
    I encourage my colleagues on this committee, as well as 
witnesses, to come to this dispute, if you will, with an 
attitude of helping to make a great system even better. I 
believe we have an outstanding panel of witnesses. I believe 
that this hearing is going to give us an opportunity to look at 
the state of the industry. I will be especially interested to 
hear comments about recent improvements in the arbitration 
selection process, as well as the positive trends that result 
in fewer unpaid rewards.
    Again, I thank the esteemed panel for coming, for your 
time, for agreeing to be here, and I welcome each of you. I 
look forward to your testimony.
    Mr. Baker. I thank the gentleman.
    Mr. Kanjorski?
    Mr. Kanjorski. Thank you, Mr. Chairman.
    We meet today to discuss the issue of securities 
arbitration. I just left the hearing on steroids in the Reform 
Committee. I was going to suggest we could end up making this a 
lot sexier if we put a testing device in for all financial 
service people. It may get us the attention the other hearing 
gets.
    I greatly appreciate the courtesy that you have extended to 
Congressman Frank, the ranking Democrat on the Financial 
Services Committee, in agreeing to convene this hearing. 
Securities arbitration is an important issue and deserves 
careful examination. The securities industry has long relied on 
arbitration to resolve disputes. As I understand the New York 
Stock Exchange has used arbitration throughout most of its 
history. In addition, more than 125 years ago, the big board 
expanded its arbitration program to include investor 
complaints.
    For many decades, investors had the option of pursuing 
claims against brokers through either litigation or 
arbitration. In 1987, a U.S. Supreme Court ruling determined 
that brokerage firms could compel customers to agree to 
arbitrate claims in an industry-sponsored forum as a condition 
of opening a brokerage account. In such agreements, customers 
would forfeit their right to pursue individual claims in court.
    Since the Supreme Court ruling, the use of mandatory 
arbitration agreements has grown. In my view, there is nothing 
inherently wrong with arbitration per se. It can prove to be a 
more efficient and less expensive dispute resolution mechanism 
than court litigation. However, for arbitration to work well 
and to foster investor trust, it must be fair.
    We have before us a panel with a demonstrated breadth and 
depth of knowledge on arbitration issues. They will be able to 
help us understand how arbitration works and whether there is a 
need for statutory, regulatory or procedural reforms. I look 
forward to learning of their insights, as I approach these 
matters with an open mind.
    As we proceed today, I nevertheless hope that we will 
explore a number of issues. For example some have questioned 
the mandatory nature of securities arbitration. We should 
therefore examine whether investors should once again be 
offered a choice. We should also discuss the inclusion of an 
industry-related arbitrator on arbitration panels, and the 
process of selecting arbitrators. In particular, we should 
focus on the disclosure of potential conflicts.
    One other issue that we are certain to review today 
concerns the transparency of arbitrators's decisions. In the 
past, arbitrators have not had to justify their decisions with 
written rulings. As a result, a customer often had little 
understanding of how the arbitration panel reached its decision 
in a case. To address this concern, the NASD recently proposed 
giving the participants in arbitration proceedings the option, 
prior to the first hearing, to request written explanations of 
decisions for an additional fee. The adoption of this proposed 
reform will help to better transparency and may increase 
investor satisfaction with and confidence in the fairness of 
the arbitration proceedings.
    In closing, Mr. Chairman, I commend you for convening this 
proactive hearing to examine the securities arbitration 
process. I look forward to receiving the testimony of our 
distinguished panel.
    [The prepared statement of Hon. Paul E. Kanjorski can be 
found on page 29 in the appendix.]
    Mr. Ryun. [Presiding.] Thank you very much.
    Since it does not appear that we have any questions within 
the financial industry with regard to steroids, we are going to 
move ahead.
    I would like to begin by introducing our first panelist, 
Ms. Linda Fienberg, president of NASD Dispute Resolution.
    We look forward to your testimony and welcome you. Thank 
you for coming.

    STATEMENT OF LINDA D. FIENBERG, PRESIDENT, NASD DISPUTE 
                        RESOLUTION, INC.

    Ms. Fienberg. Thank you very much, Chairman Ryun, for 
inviting us to participate, and thank you to the members of the 
committee and subcommittee.
    My name is Linda Fienberg and I am president of NASD 
Dispute Resolution. I am very grateful for the opportunity to 
testify about our arbitration system. NASD is a private sector 
regulator of the securities industry. Our foremost mission is 
to protect investors and to ensure market integrity. By federal 
law, any individual or firm that sells securities to the public 
must be regulated by NASD.
    As part of our investor protection mission, NASD operates 
the world's largest forum to help investors, firms and 
individual brokers settle disputes through arbitration or 
mediation. In 2004, we administered more than 9,000 
arbitrations. Roughly three of every four investors who brought 
claims received compensation either in settlements or awards.
    Over the last decade, we have made significant improvements 
to ensure that investors get a fair, expeditious and affordable 
resolution of their disputes. Important steps have included 
party selection of arbitrators; tightening the definition of 
who can serve as a public arbitrator; increasing the number of 
arbitration hearing sites so that there is one in every state, 
we will have 68 sites by the end of this month; and sponsoring 
our expanded mediation program.
    NASD believes that transparency should be the hallmark of 
securities arbitration. Each step of the process should be 
clear for investors. Transparency starts when investors open a 
brokerage account. In most cases, investors sign an agreement 
with their brokerage firm to settle any disputes through 
arbitration rather than litigation. This is a matter of 
contract between the investor and the firm, an arrangement the 
Supreme Court has held permissible under the federal securities 
laws. It is not an NASD requirement, but NASD does require 
firms present plain English agreements that explain to 
investors the process and the differences between arbitration 
and litigation.
    To further transparency, during the arbitration selection 
process, parties receive arbitrator disclosures and information 
on past awards to help them choose their three-member panel. 
NASD allows parties to strike arbitrators they do not want and 
to rank the remaining ones in order of preference. And NASD 
awards are publicly available on our Web site.
    An important step that NASD has taken to improve 
transparency is a rule proposal that we recently sent to the 
SEC that will give investors the power to require arbitrators 
to explain in writing the basis of their decisions. We believe 
this will increase investor confidence in the fairness of the 
process.
    NASD also ensures the integrity of the process by taking 
all steps in our power to ensure that investors get the money 
from their awards, mediations or settlements. Our rules require 
NASD firms and brokers to pay awards within 30 days or face 
removal from the industry. Recent NASD initiatives have 
resulted in a steady decline in the percentage of unpaid awards 
to about 14 percent to 15 percent, but we are not satisfied 
with this. Even one unpaid award is one too many.
    The essential quality of arbitration is fairness. 
Therefore, the quality of the arbitrators is critical. We 
maintain a roster of about 7,000 arbitrators. They are not NASD 
employees. We are committed to have arbitrators who have the 
experience to evaluate disputes fairly. Thus, we review their 
performance on strictly neutral criteria. To assure the quality 
of the arbitration, all new applicants must undergo background 
checks, training and testing. And we continue to train existing 
arbitrators to make sure the roster is filled with highly 
qualified individuals. NASD rules require that arbitrators 
disclose all conflicts of interest. We remove from the roster 
those who do not comply.
    Mr. Chairman, let me briefly discuss an issue that has been 
a subject of some debate. Each arbitration panel consists of 
three individuals, two who are classified as public and one who 
is classified as non-public who has ties to the industry. Some 
critics have charged that non-public arbitrators are biased 
toward the industry. Let me be clear: the overwhelming number 
of awards is unanimous, and our review of them shows absolutely 
no abuse or pattern of non-public arbitrators favoring industry 
parties.
    In conclusion, NASD is committed to review of its 
arbitration program to promote transparency for investors, to 
improve quality, and to ensure the integrity of that process. 
We look forward to working with Congress on this and other 
issues.
    Mr. Chairman, again thank you for the opportunity to 
testify. I would be happy to answer any questions.
    [The prepared statement of Linda D. Fienberg can be found 
on page 31 in the appendix.]
    Mr. Ryun. Ms. Fienberg, thank you very much for your 
testimony.
    Next, we have the Honorable William Galvin, Secretary of 
the Commonwealth of Massachusetts.

     STATEMENT OF WILLIAM FRANCIS GALVIN, SECRETARY OF THE 
                 COMMONWEALTH OF MASSACHUSETTS

    Mr. Galvin. Thank you, Chairman Ryun and Ranking Member 
Frank and all the members of the subcommittee.
    I am Bill Galvin, Secretary of the Commonwealth and chief 
securities regulator in Massachusetts. Thank you for the 
opportunity to be here today to testify about arbitration in 
the securities industry from the point of view of investors on 
Main Street. I can speak to the concerns of small investors 
because they call or visit my office in Massachusetts all the 
time. Small investors, let's not forget, are the lifeblood of 
our securities markets. Without their faith and trust and their 
hard-earned money, our markets could not function.
    Unfortunately, in recent years their faith has been badly 
shaken. They have watched as giant companies, some with 
household names, were looted and run into the ground by corrupt 
management. They have seen respected Wall Street firms hype 
technology stocks using corrupt research reports, research that 
we now know were designed not to paint a true picture of the 
company or its prospects, but to curry favor with a client in 
order to win lucrative investment banking business.
    Corporate scandals and the collapse of the high-tech bubble 
have hurt countless Main Street investors. That is bad enough. 
What is worse in my opinion is the rigged system we now have to 
help harmed investors seek a measure of justice. Every year, 
thousands of investors file complaints against their brokers. 
If these disputes are not settled, they end up in mandatory 
arbitration, a system that I believe is fundamentally flawed 
and stacked against the individual investors.
    The sad thing is, industry-sponsored arbitration is the 
only game in town. When an investor opens a brokerage account, 
in almost all cases he or she must sign away their right to a 
day in court should a dispute arise. Instead, they agree to 
have their claim heard by a panel of three arbitrators, picked 
from a list compiled by the NASD or the NYSE, the so-called 
``industry self-regulators.''
    The term ``arbitration'' as it is used in this proceeding 
is really a misnomer. Most often, the process is not about two 
evenly matched parties to a dispute seeking the middle ground 
and a resolution of their conflict from knowledgeable, 
independent and unbiased fact-finders. Rather, what we have 
here in America today is an industry-sponsored damage 
containment and control program, masquerading as a juridical 
proceeding.
    Of the three arbitrators on the panel, there is one with 
ties to the securities industry and two supposedly without ties 
to the industry. I believe the truth about the independence of 
these other arbitrators will reveal a troubling pattern. I 
invite your review. Is it a fair process? The industry would 
say yes, but let's think about it for a minute. The NASD, the 
industry umbrella group, or the NYSE, gets to decide who is 
qualified to be an arbitrator and who is not. They and only 
they select the pool of arbitrators. There is no state in this 
union that gives to one party to litigation the unilateral 
right to choose the finders of fact or jury that will decide 
their case.
    Would anyone seriously suggest that we apply this approach 
to any other industry? For instance, would anyone here 
seriously suggest that in all future disputes between 
automobile manufacturers and their customers relating to 
defects, that those who purchase an automobile can only bring 
their complaints and claims before a panel selected by GM, Ford 
or Chrysler? I do not think so. Are not the financial futures 
of our citizens entitled to at least as much protection as 
their cars?
    As further proof of this rigged system, I offer one example 
that I happen to be personally familiar with. John J. Mark is a 
former NASD arbitrator from Massachusetts. Mr. Mark was an 
arbitrator with the Commonwealth of Massachusetts for many 
years and an adjunct professor at Harvard University and Boston 
University. As far as I know, he is a man of impeccable 
credentials and yet he was dropped from the NASD pool of 
arbitrators. Why? As he told a meeting of state securities 
regulators last summer, ``The word on the street is, if you 
rule against the brokerage houses, you will be removed from the 
list.''
    To be sure, lately the NASD has been working on this 
arbitration process. About 9 months ago, for example, they 
fined three large Wall Street firms, Merrill Lynch, Morgan 
Stanley, and Smith Barney, $250,000 each for failing to produce 
documents in some 20 arbitration cases between 2002 and 2004. 
That was an overdue step in the right direction. Foot-dragging 
by Wall Street firms involved in disputes with investors must 
be punished, but these fines are so small in light of the 
overall totality of the problem that they hardly operate as a 
deterrent to further stonewalling. Automatic default and treble 
damages on claims would be a far more effective remedy. More 
recently, the NASD, after deliberation, has passed another 
milestone. Arbitrators may be required to put their decisions 
in writing for a fee.
    But no fine or other regulatory tinkering will address the 
more fundamental flaw of the so-called arbitration process, 
namely that is run by the industry and for the industry. The 
system is unfair. Consider the statistics. While the NASD 
asserts that in more than half the cases, arbitration panels 
award money to investors, the number of so-called investor 
victories does not tell the true stories of how investors fare 
in arbitration.
    The NASD cites cases where the arbitrators make any cash 
award as a victory for the investor, but in fact many of those 
awards are for only a fraction of the amount claimed. Under 
this method of reckoning, a claimant who has $5 million in 
losses, but was awarded just $5 in restitution, has received an 
arbitration award. This is a pyrrhic victory at best.
    The arbitration system should be reformed to put the 
investors's interest on the same level as those of Wall Street. 
How can we do that? Given that investors by law today have no 
choice but arbitration, we need to make the system more fair. 
The best way to do that is to take it out of the hands of the 
industry. Put someone besides the self-regulators in charge. 
That is the best solution. In the short term, we need to 
increase the oversight of the arbitration process. The FCC, 
state securities regulators and perhaps even Congress need to 
take a hard look at arbitration.
    State securities regulators have begun this process by 
creating a task force to look at the issues involving 
arbitration. These issues include how arbitrators are selected, 
trends in arbitration awards, and how cumbersome and expensive 
the system is for investors. This is not a small thing. We have 
almost 100 million investors in this country. In recent years, 
we have made reforms to make sure that Main Street investors 
get a better shake in the marketplace. We now need to focus on 
reforming the dispute resolution system. It is the right thing 
to do, the right thing for investors, and the right thing for 
our markets. It is time to act.
    Again, I am grateful for the chance to be here today to 
share some of my thoughts, and I look forward to your 
questions. Thank you.
    [The prepared statement of Hon. William Francis Galvin can 
be found on page 41 in the appendix.]
    Mr. Ryun. Mr. Galvin, thank you very much for your 
testimony.
    I want to encourage the panelists to stay with the 5-minute 
time limit.
    We are next going to hear from Mr. Michael Perino, 
professor of law from St. John's University School of Law. 
Thank you.

   STATEMENT OF MICHAEL PERINO, PROFESSOR OF LAW, ST. JOHN'S 
                    UNIVERSITY SCHOOL OF LAW

    Mr. Perino. Thank you. Mr. Chairman and members of the 
committee, thank you for the invitation to appear before you 
today.
    As you all are well aware, the fairness and adequacy of 
securities arbitration is crucially important because 
arbitration is the primary dispute resolution mechanism for 
customer-broker disputes. To be successful, the system must not 
only be fair and impartial, but investors, the public, the 
judiciary and Congress must believe that it is fair and 
impartial.
    Does securities arbitration satisfy that standard? This 
subcommittee will no doubt hear stories of problems in 
individual cases and calls for substantial overhauls of the 
current system, but a rational regulatory policy cannot be 
based on mere anecdote. Sweeping changes can have significant 
unintended consequences and additional procedural requirements 
can impose significant cost. As the SEC has noted, proposed 
changes ``must balance the need to strengthen investor 
confidence in the arbitration system with the need to maintain 
arbitration as a form of dispute resolution that provides for 
the equitable and efficient administration of justice.''
    Those seeking to revamp the securities arbitration system 
thus should have the burden of identifying through thorough and 
well-documented empirical evidence that actual problems in fact 
exist. In my mind, a compelling case for substantial change has 
yet to be made. In 2002, the SEC asked me to review the 
adequacy of arbitrator conflict disclosure requirements in 
securities arbitrations. In putting together that study, I 
examined the available empirical evidence in detail, which I 
discuss at length in my written statement. I am not going to 
repeat that material here. Of course, I am happy to answer any 
questions you might have about it.
    At bottom, the available empirical evidence on outcomes in 
SRO arbitrations and on investors' perceptions of the 
arbitration process suggests that the current system addresses 
customer disputes fairly and impartially. There are, I believe, 
good reasons why the data do not show a pro-industry bias. The 
NASD and the New York Stock Exchange are likely subject to more 
regulation and greater oversight than any other arbitration 
forum.
    The NASD and the New York Stock Exchange are not mere trade 
organizations, as some have characterized them, but self-
regulatory organizations that have a statutory mandate to 
provide a fair dispute resolution forum. The SEC exercises 
oversight over the SROs, approves all arbitration rules before 
they become effective, and oversees SRO arbitrations through 
its inspection process.
    Congress also plays an important role. In addition to 
holding hearings such as this, members have frequently 
requested the GAO to study the securities arbitration system. 
Although the GAO has recommended changes from time to time, it 
has never found that SRO-sponsored arbitrations were biased in 
favor of securities industry members.
    The securities industry also has a rational self-interest 
in providing a fair dispute resolution system. The 
acceptability of arbitral awards is strongly correlated with 
the parties's perceptions of whether fair and unbiased 
procedures were used to reach an outcome. Systemic procedural 
inequities would likely increase the costs of the arbitration 
system. More dissatisfied parties would attempt to overturn 
arbitration awards and judges would be more likely to grant 
those requests. If the securities industry wants to reap the 
cost savings associated with arbitrations, they must also 
inhibit any pro-industry biases from developing.
    Let me be clear about one final point. Nothing I have said 
here or in my written statement should be taken to mean that we 
can safely ignore securities arbitrations. In my report to the 
SEC, I wrote that given the unquestioned significance of 
securities arbitrations, it is crucial that the SROs resolve 
any lingering concerns about pro-industry bias. Accordingly, I 
recommended that the SROs sponsor additional independent 
studies to further evaluate the impartiality of the arbitration 
process. It is my understanding that such a study is about to 
commence. If that or other studies reveal systemic problems, 
then those problems should and must be addressed. But until 
persuasive evidence of such a problem exists, it would be 
imprudent to substantially alter a system that appears to serve 
investors well.
    Thank you.
    [The prepared statement of Michael Perino can be found on 
page 80 in the appendix.]
    Mr. Ryun. Mr. Perino, thank you very much.
    Our next panelist is Ms. Rosemary Shockman, president of 
Public Investors Arbitration Bar Association.
    Welcome.

  STATEMENT OF ROSEMARY SHOCKMAN, PRESIDENT, PUBLIC INVESTORS 
                  ARBITRATION BAR ASSOCIATION

    Ms. Shockman. Thank you, Mr. Chairman, Ranking Member 
Frank. My name is Rosemary Shockman. I have been representing 
public investors in cases against securities broker-dealers for 
23 years. I am president of the Public Investors Arbitration 
Bar Association. PIABA is an international bar association of 
more than 750 lawyers representing investors in securities 
arbitrations. We are dedicated to creating a level playing 
field for public investors in securities arbitration.
    Let me begin with what we believe is the most important 
issue to help level the playing field for aggrieved investors: 
the elimination of the mandatory industry arbitrator on panels 
hearing cases. As was pointed out earlier, the cases are heard 
by three-member panels. One of the panelists is required to be 
a member of the securities industry. The remaining two are to 
be public, although many times they have also spent part of 
their careers in the securities industry.
    Problem number one with the industry arbitrator is my 
clients come in to me, they see the industry gets to have one 
member on the panel and they do not think it looks fair to 
them. They think it has an appearance of impropriety. Problem 
number two with the industry arbitrator, and I think to 
practitioners this is a greater problem, we have been faced, 
and we have seen in the last few years these broad securities 
problems such as the mutual fund problems that went across the 
industry, and the problems now that we are seeing with variable 
annuity sales.
    The NASD, the SEC, and NYSE have all come out commenting 
about the over-sale of variable annuities on suitable sale to 
retired investors, a half-trillion sold in the last 3 years. 
Yet our clients when they bring these cases are forced to have 
their cases heard with a panel member whose very firm is 
selling the same variable annuities and using the same 
practices. That is a reason to end the industry arbitrator.
    The industry tells us that an industry arbitrator is needed 
so that someone on the panel will have knowledge of the 
securities industry, sort of an expert witness. Long ago, that 
might have been true. Securities arbitration has become so much 
more sophisticated. Both parties are represented by lawyers, 
and typically have expert witnesses. We do not really need to 
have an expert witness on the panel anymore. Congress should 
urge the SEC to move forward to adopt rules eliminating the 
requirement of an industry arbitrator.
    Compounding the problem of the industry arbitrator is the 
existence of public arbitrators who are just too close to 
looking like an industry arbitrator. Instances where public 
arbitrators have worked for years in the securities industry, 
maybe 10, 15 years, where lawyers have worked for long periods 
of time representing broker-dealers, it does start to look to 
the public investor having his or her case heard that this 
panel is stacked against them.
    Last summer, I had a case in which not only did I have an 
industry arbitrator, but two of the people on the public panel 
presented to me for selection had gone from being industry 
arbitrators to public arbitrators the week before. So there are 
some problems here that definitely need to be worked with with 
respect to who is a public arbitrator.
    Discovery abuses, I do commend the NASD for their efforts 
to put forth fines and so on, but here is a packet of just 
recent discovery abuses with Morgan Stanley Dean Witter. It is 
still out there. It is a problem. They look at it as a cost of 
doing business.
    Unpaid arbitration awards, there has been an improvement, 
but part of what is not reflected in those numbers is clients 
who do not get lawyers because the lawyers know that they 
cannot collect at the end of the day. So while the NASD has 
made strides in collecting against people who can pay, we still 
have a problem with small broker-dealers who simply go out of 
business and there is no where to collect. I recently had the 
experience of a widowed mother-in-law of a prominent Member of 
this Congress, who came to me with a very good case. She had 
been defrauded, but there was nowhere to collect the money in 
the end. This was a broker-dealer heading out of business.
    Public investors are shocked to hear that they have to have 
car insurance, that the net capital requirements are so small 
for broker-dealers. Why isn't there some sort of protection in 
an industry where people are handling their life savings?
    Problems at the New York Stock Exchange. Practitioners who 
brought cases there for years are no longer bringing cases 
because of delays in getting arbitrators appointed and in 
getting hearings set, just extraordinary delays. I do want to 
commend Karen Kupersmith and Dan Beta of the Exchange for 
meeting with us and working with us in efforts to try to 
improve that situation. It still exists. Work needs to be done 
there.
    Thank you, and if we can provide any further information, 
we would be happy to do so.
    [The prepared statement of Rosemary Shockman can be found 
on page 103 in the appendix.]
    Mr. Ryun. Thank you for your testimony.
    Our next panelist is Ms. Karen Kupersmith, director of 
Arbitration, New York Stock Exchange.
    Welcome.

  STATEMENT OF KAREN KUPERSMITH, DIRECTOR OF ARBITRATION, NEW 
                   YORK STOCK EXCHANGE, INC.

    Ms. Kupersmith. Thank you very much, Mr. Chairman, 
Congressman Frank and everyone else for permitting me to come 
here today to testify on behalf of the New York Stock Exchange. 
I am Karen Kupersmith. I am the director of Arbitration at the 
New York Stock Exchange. I started working there in 1983, first 
as a staff arbitration attorney and then a senior counsel, a 
manager and finally I was appointed director of Arbitration in 
April, 2004.
    There have been many changes at the New York Stock Exchange 
since I have been there, but one factor has remained constant, 
a factor that I have personally observed and that is the firm 
commitment of the New York Stock Exchange to providing the most 
fair and neutral forum possible for the public investor.
    Arbitration has always been thought of and found to be 
efficient, faster than court, and also far more economical than 
litigation proceedings. At the New York Stock Exchange, in 
fact, in 2004 all cases were closed in less than 15.45 months. 
In court, that number is considerably higher, often 2 1/2 years 
to perhaps even 5 years.
    The New York Stock Exchange is very committed to providing 
this level playing field and has taken many initiatives to show 
this commitment. The most recent of these is a recent rule 
filing with the SEC, the purpose of that filing being to make 
permanent a variation of a pilot program that allows for 
alternate ways of appointing arbitrators. This particular rule 
filing will now give, once approved, the public investor the 
right to select the method of arbitrator appointment, either 
computerized list selection or what we call the traditional 
staff method of appointment.
    At the base of every arbitration program are the 
arbitrators themselves. They are the individuals who hear the 
cases and they are the most important part of the system. The 
New York Stock Exchange is doing everything possible to recruit 
new arbitrators into its pool to enlarge that pool. Currently, 
our 12 staff attorneys are reaching out to all the current 
arbitrators that we have and asking them, do you know of 
somebody who might be interested, who would be a good candidate 
to be an arbitrator? It is very important to us to have people 
from diverse backgrounds to represent the diverse backgrounds 
of the public investors sitting before them.
    I always say, were my mother to be involved in a securities 
arbitration and have a complaint against a brokerage house, I 
would want someone on that panel with a background similar to 
hers.
    We train our arbitrators carefully and continually. There 
is an ongoing requirement that all NYSE arbitrators attend 
training at least once every 4 years. This training focuses on 
disclosures and how important it is that everything be 
disclosed. Any family, personal, professional, social or other 
type of relation, any type of financial or personal interest 
that the arbitrator might have in the outcome of the proceeding 
must be disclosed.
    To help that, we have just started an online portal system 
so our arbitrators can actually go online and input information 
themselves to maintain their profiles in the most current 
fashion possible. We also focus on the fact that arbitrators in 
deciding cases must decide the cases on the facts and the 
testimony before them in that particular matter, and should not 
have any preconceptions when they start the hearing and 
throughout the course of a proceeding.
    We are always reviewing the process of arbitration to make 
it better. Relationships change and so have the corporate 
relationships changed, many as a result of the financial 
modernization legislation, some of which I understand came out 
of this committee. Corporate relationships are far more 
complicated and complex now, so that entities which once had 
nothing to do with the securities industry now may find 
themselves owning broker-dealers. The New York Stock Exchange 
is in the process of reviewing current classifications to make 
sure that all classifications of arbitrators as either public 
or securities arbitrators is correct, and is correct as regards 
these new relationships that have developed.
    I thank you very much for permitting me to be here to 
testify today, and I am glad to answer any questions. Thank 
you.
    [The prepared statement of Karen Kupersmith can be found on 
page 50 in the appendix.]
    Mr. Ryun. Ms. Kupersmith, thank you very much for your 
testimony.
    Let me sort of give you an update on what is happening. The 
Chair has ruled that I am going to, out of respect for all of 
you and your time, I am going to go ahead and miss this 
particular vote because we have time for a lot of other 
discussion on the floor. I want to listen as much as we can to 
what the panel has to say and keep things moving along, if we 
may.
    Next, we have Mr. Constantine ``Gus'' Katsoris, Wilkinson 
Professor of Law, Fordham University School of Law.
    Welcome. We look forward to your testimony.

STATEMENT OF CONSTANTINE KATSORIS, WILKINSON PROFESSOR OF LAW, 
                FORDHAM UNIVERSITY SCHOOL OF LAW

    Mr. Katsoris. Thank you, Mr. Chairman.
    I have participated in the resolution of securities 
disputes for over 35 years as an arbitrator, a mediator, an 
arbitrator trainer, a public member of the Securities Industry 
Conference on Arbitration, also known as SICA, and an adviser 
to the Fordham Law School Arbitration Clinic.
    I could not begin to share all of my experiences in the 5 
minutes allotted me, so I will save my opinions for my 
responses to questions from the panel. I would, however, like 
to tell you how I first got involved in this area. Before 
joining the faculty at Fordham Law School over 40 years ago, I 
was a full-time litigator at a major Wall Street law firm. 
After a few years of teaching and loving every minute of it, I 
realized that I missed litigation.
    Thus, in 1967, I became an arbitrator at the NASD and 
shortly thereafter at the New York Stock Exchange, where I have 
served in many, many, many cases. In 1977 when SICA was first 
created, I was selected as one of its public members where I 
have served ever since. In addition, about 8 years ago at the 
suggestion of then-SEC Chairman Arthur Levitt, I helped 
establish the Securities Arbitration Clinic at Fordham to 
represent injured investors who could not obtain an attorney 
and thus would find it difficult to pursue their claims. I am 
proud to say it is the most popular clinic at Fordham and is 
the first such clinic in the country to obtain punitive damages 
in an SRO arbitration. There are presently about one dozen such 
law school clinics operating today, and collectively they 
constitute a growing force in this area.
    Arbitration in the 1960s when I first began was like the 
horse and buggy days. There was virtually no pre-hearing 
discovery or exchange of information. Not too many people 
complained, however, because basically the system was voluntary 
as far as the public was concerned. In the 1970s, however, the 
SEC was not satisfied with handling of small claims and its 
office of consumer affairs issued a report recommending the 
creation of a non-SRO entity for the handling of such claims. 
In response to this report, SICA was created with an initial 
mandate to establish a procedure for handling small customer 
claims.
    Facilitating the processing of small claims, however, did 
not address the broader issue, namely the basic balkanization 
of the various SRO arbitration programs. In other words, each 
SRO had its own set of rules. Some were written, some existed 
solely on the basis of custom and usage, all of which 
complicated the task of the practitioner in choosing a forum.
    Thus, SICA's next assignment was to establish a uniform 
code of arbitration, which was basically applicable to all SRO 
cases, large as well as small. Nevertheless, SRO arbitrations 
were still basically voluntary because of the then-prevailing 
conventional wisdom that 1934 Act federal securities claims 
were not subject to previous arbitration agreements and thus 
could still go to court.
    As confidence grew in the new code, SRO arbitrations more 
than tripled from 830 in 1980 to over 2,800 in 1986. Yet SRO 
arbitration was still in its infancy until the McMahon case in 
1987, which virtually transformed the process from a voluntary 
procedure to a mandatory one by holding that 1934 Act claims 
were arbitral pursuant to pre-dispute arbitration agreements.
    After the McMahon case, the landscape changed overnight. 
Not only did the number of arbitrations more than double to 
over 6,000 in the year after McMahon than the year before, but 
equally significant was the influx of the larger and more 
complicated cases that previously were being filed in court. At 
this point, the task of ensuring the fairness of SRO 
arbitrations largely fell upon SICA, which incidentally had 
been favorably mentioned in the McMahon case as evidence of the 
changing landscape.
    SICA's independence was essential to the process, and that 
independence was ensured at the outset because its public 
members were beholden to no one. Thereafter, the public members 
got to pick their own successors. Moreover, the SEC with its 
oversight authority over the SROs and as gatekeeper of the 
19(b) process, attends SICA meetings. Indeed, the efforts to 
ensure a level playing field are outlined in SICA's 12 reports 
issued to the SEC over the years, which describe with great 
transparency the evolution in SRO arbitrations. I have a few of 
those reports here which I will gladly give at the end.
    It is not only the affirmative rules that SICA enacted into 
the code of arbitration that is important, but it is also the 
actions that SICA took in preventing from seeing the light of 
day some provisions that could have been injurious to the 
public. For example, a rigid cap on punitive damages where no 
such rule existed in court. Another example, an offer of a ward 
rule that could have limited the damages sought by claimants. 
And there were others.
    Since the adoption of the uniform code, over 100,000 
arbitrations have been filed at the various SROs. Has justice 
been achieved in every one of those 100,000 cases? Certainly 
not, but I do not know of any dispute resolution system that 
has an unblemished record in this regard, and that includes our 
own court system. Admittedly, sometimes awards are excessive, 
sometimes they are inadequate, but that is true no matter what 
resolution system we use.
    Are there improvements that can still be made to the SRO 
process? Of course there are, and the process is ongoing and 
never-ending as new problems and situations arise. For example, 
when it became obvious that third party subpoenas were being 
used in an abusive manner, SICA just a few months ago required 
a 10-day notice period before such subpoenas became effective. 
Another example, when a problem arose as to the administrative 
appointment of arbitrators to fill vacancies, SICA just this 
very week, last Tuesday, granted a peremptory challenge to each 
side as to such appointments.
    My principal concern going forward is we do not backslide 
into a system of balkanization that existed before SICA, where 
practitioners had to contend with the diverse rules of 
procedures of the various states, various courts, and the 
various SROs throughout the country, each of which spoke in a 
different language, reminiscent of the biblical Tower of Babel. 
We saw an example of that when the State of California recently 
sought to impose its own rules as to the qualification of 
arbitrators in SRO proceedings.
    In conclusion, I can express to you that since the mandate 
of McMahon, the system has on balance worked well. We must be 
ever vigilant, however, that the playing field remains level 
and is not tilted one way or the other.
    Thank you, Mr. Chairman.
    [The prepared statement of Constantine Katsoris can be 
found on page 47 in the appendix.]
    Mr. Ryun. Thank you very much for your testimony.
    Our next panelist is Mr. Marc Lackritz, president of the 
Securities Industry Association.
    Thank you for being here.

 STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY 
                          ASSOCIATION

    Mr. Lackritz. Thank you very much, Mr. Chairman and members 
of the committee. We commend you for holding this hearing today 
and welcome the opportunity to discuss the current arbitration 
system, as well as suggestions for improvement.
    Mr. Chairman, public trust is critical to the success of 
our capital markets, the securities industry, and any dispute 
resolution mechanism used by our customers. SRO-sponsored 
securities arbitration is a system that works well. It is a 
fair and efficient means of resolving disputes between 
customers and brokerage firms. We know this from the weight of 
both anecdotal evidence and empirical data. Independent 
organizations such as the General Accounting Office, the 
Securities Industry Conference on Arbitration, and noted 
academic experts, some of whom are here today, have all 
consistently documented the success of securities arbitration.
    Studies conducted over the past 20 years have consistently 
shown that investors receive awards in more than half of all 
cases brought in arbitration. Even this data understates 
investor success since investors collect money in more than 
three-quarters of the cases that they bring to arbitration, 
taking into account cases that are settled by the parties.
    Arbitration continues to be a far more efficient and cost-
effective dispute resolution mechanism than traditional court-
based litigation. Studies have consistently shown that on 
average, disputes are resolved much faster and at a lower cost 
to customers in the SRO-sponsored arbitration than in 
comparable court cases. Successful claimants get the relief 
they want more quickly. The significant reduction in time spent 
litigating means less disruption in the parties' business and 
lives and less money spent on lawyers.
    Faster resolution also makes arbitration fair, since there 
is less difficult with witnesses' inability to recall age-old 
facts and less trouble locating witnesses and documents. That 
is why an independent analysis in 2000 found that 93 percent of 
all parties to securities arbitration consider the system to be 
fair. Aggrieved customers get what they really want: their day 
in court.
    Unlike in court cases, claimants in arbitration are not 
held to technical pleading standards. Unlike in court cases, 
pre-trial discovery in arbitration is focused and limited and 
rarely includes expensive and time consuming taking of 
depositions. Unlike in court cases, the hearings themselves are 
not intimidating technical proceedings bound strictly by the 
rules of evidence, but are designed to be flexible and allow 
the arbitrators to reach the most equitable and just 
conclusions.
    The more streamlined process of arbitration, as compared 
with many procedural and financial obstacles that must be 
overcome by a plaintiff in a court case, means that nearly 
every case brought in arbitration other than those that are 
settled goes to a full merits hearing.
    So the system works, but it will continue to be superior to 
court-based litigation only if we guard against what I would 
call creeping litigiousness that is at the gates. Some of the 
changes that have been proposed, for example requiring written 
explanations of awards by arbitration panels, expanding 
pretrial discovery, broadening the scope of parties's rights to 
appeal from arbitrators' decisions, would undermine what has 
made arbitration an attractive alternative: a streamlined, 
efficient and less-costly means of resolving disputes. I urge 
the committee and the Congress to be very reluctant to endorse 
this type of change to securities arbitration.
    Two criticisms leveled at securities arbitration are the 
inclusion of a so-called industry arbitrator on panels and the 
mandatory nature of arbitration. Both criticisms miss the mark. 
Arbitration panels in most fields, not just securities, include 
those with experience in that field. This is a positive 
development for everyone by providing a level of expertise that 
would not otherwise be available to the panel.
    The ever-growing complexity of financial products and 
services and the technical issues that sometimes arise, as well 
as the disputes among expert witnesses on both sides that often 
occur, make it desirable that one of the three arbitrators be 
well-versed in the regulatory framework under which brokers and 
other financial professionals operate. The painstaking and 
transparent selection process for arbitrators also protects 
against any possible pro-industry bias.
    Criticism of the mandatory nature of securities arbitration 
is also misplaced. Agreeing to arbitrate rather than court-
based litigation, is a choice of forum, not of rights. In fact, 
arbitration can and does impose extraordinary sanctions with 
respect to securities firms such as referring conduct uncovered 
in the proceeding to regulatory authorities or suspending an 
industry member's license for failing to pay an arbitration 
award promptly. Moreover, agreeing in advance to arbitrate all 
disputes is a neutral event that prevents one party when a 
dispute arises from blocking access to arbitration because it 
sees an advantage to dragging the dispute out in court.
    The current system of SRO-sponsored arbitration, like any 
system of justice devised by humans, is not perfect. The NASD, 
the New York Stock Exchange and the securities industry 
continue to work hard to take into account the concerns and 
issues raised by all participants and to adjust the process as 
needed. The facts show that disputes continue to be resolved 
more expeditiously, efficiently and fairly than they would be 
in our already-overburdened court system.
    Thank you for holding this hearing, Mr. Chairman, and for 
inviting me to testify. I would be pleased to answer any 
questions.
    [The prepared statement of Marc E. Lackritz can be found on 
page 65 in the appendix.]
    Mr. Ryun. Mr. Lackritz, thank you very much.
    Our final panelist today is Mr. Daniel Solin, investor, 
attorney and author. In fact, one of his books is very 
intriguing, ``Does Your Broker Owe You Money?"
    We welcome your testimony.

               STATEMENT OF DANIEL SOLIN, ESQUIRE

    Mr. Solin. Thank you very much, Mr. Chairman.
    Thank you, especially, Congressman Frank, for convening 
these hearings. It is a terribly important issue for the 
millions of investors who have been the victims of misconduct 
by their brokers and whose only recourse is the industry-
sponsored arbitration system.
    While it is of course true that these investors sign a 
document in which they agree to mandatory arbitration, make no 
mistake about the reality of what that situation really is. I 
have been representing investors for a number of years. I have 
tried many cases before these tribunals. I have never met a 
single investor who knew that when he signed his or her account 
opening statements, they were consenting to mandatory 
arbitration, much less understood the nature of the mandatory 
arbitration they were consenting to.
    The issue, Mr. Chairman, has nothing to do with the merits 
of arbitration or the merits of the court system. The issue 
properly framed is whether investors in this country are 
entitled to a dispute resolution system which has both the 
appearance and the reality of fairness. The current system does 
not have the appearance of fairness. As Commissioner Galvin and 
Rosemary Shockman so eloquently stated, it is run by the 
industry. This makes no more sense than if Congress mandated 
that all investor disputes should be run by PIABA as the 
administrative arm. No one would regard that as fair or 
reasonable and no investor would perceive that as fair or 
reasonable.
    Second, as somebody who sits and looks in the eyes of these 
tribunals, let me tell you that having an industry member on 
that tribunal is a devastating blow to the perceived, if not 
the actual, fairness of these proceedings. The ostensible 
purpose for having this industry arbitrator is because of his 
supposed expertise. If that is true, you can imagine the 
influence that that person has which is far beyond his one 
vote.
    The fact that in a number of cases, the industry arbitrator 
joins in acquiescing to a favorable verdict for the investor 
does not mean that that industry arbitrator did not do his or 
her best to ensure that that result did not occur. It does not 
mean that that industry arbitrator did not accomplish his or 
her goal of limiting the amount of damages that that tribunal 
would award.
    The impartiality, as Commissioner Galvin and Rosemary 
Shockman stated, of the public arbitrators is highly suspect. 
The only study I have found is a 1994 study by the General 
Accounting Office which said that 89 percent of the panelists 
at that time were white men over the age of 60. There are very, 
very few members of those panels, of the 6,000 or 7,000, who 
are around today. Certainly in 1994, there were very few of 
them who were people of color, who were younger people. This 
tends to be a very conservative industry-oriented group.
    The NASD and the NYSE have broad discretion in appointing 
these people and it is not true, in all candor, that we as 
advocates play a meaningful role in this process. Very often in 
my cases, a week or 2 weeks before the actual hearing, for some 
reason, the arbitrators that we ranked highly drop out and the 
NASD and the NYSE then have the right without any discretion 
whatsoever to appoint whoever they want. We have no role in 
that process.
    Finally, and this is a very significant point, 
psychologically let me tell you that it is a valuable perk for 
people to sit on these tribunals. They love sitting in 
judgment. This is part of their life. Many of them are retired. 
This is a very important part of who they are. And these people 
know that if they issue a big award against the brokerage 
industry, they are not going to be reappointed to sit on 
panels. It becomes a self-selecting group.
    There is no evidence that this system is fair. The evidence 
that Mr. Perino is talking about and that the industry 
representatives are talking about is very flawed statistical 
evidence, as I indicate in my report. We are in the process of 
doing an exhaustive analysis that I hope will shed some light 
on it, but it is very difficult to prove that a whole system is 
unfair.
    What should be done here is very clear. We should have a 
system of arbitration run by a completely impartial tribunal, 
like the American Arbitration Association or any private 
dispute regulation group. We should not have an industry 
judging itself. All we are asking for as representatives of 
investors is that there be a totally impartial administration 
and that the three people sitting there are completely 
impartial, unaffiliated with anyone, which is exactly what Ms. 
Kupersmith's mother would want if she did have a claim against 
her broker. She would not want a panel that is one-third biased 
any more than she would want a jury that is one-third biased or 
a judge who says one-third of my mind is made up before we 
start.
    I thank you again, Mr. Chairman. I thank you again, 
Congressman Frank, for the opportunity to share my views with 
you.
    [The prepared statement of Daniel R. Solin can be found on 
page 111 in the appendix.]
    Mr. Ryun. Thank you very much.
    I want to thank all the panelists for coming. I know you 
have tremendous insight into what this process is all about. 
The discussion has been good today about arbitration process 
and how to make it more transparent. Specifically, it is 
important that the investors are well informed and it is very 
clearly understood what this process is all about.
    With that in mind, I want to inquire a little about the 
process of ensuring that investors understand what they are 
doing when they sign a pre-dispute arbitration agreement. 
Specifically, what is done to make sure that each investor 
knows that the signing of the agreement effectively waives 
their right to sue? I will be interested in any comments anyone 
has to make on that.
    Mr. Katsoris. At SICA, we had passed a rule that the 
arbitration clause be highlighted in the agreement that the 
customer signs at the beginning. SICA had passed an additional 
rule that that clause be separately initialed by the customer 
so there would be no doubt that the customer saw that 
arbitration clause. Unfortunately, no SRO has passed it. I 
would recommend that they re-think that and adopt the SICA rule 
which is still on the books that they separately initial that 
arbitration clause. That would defuse the argument that 
somebody did not see it, and perhaps solve that problem for the 
future.
    Mr. Ryun. Mr. Solin?
    Mr. Solin. Thank you, Mr. Chairman. Picture what happens 
when an investor in this country goes to open up his account. 
He is confronted with a slew of account opening statements. 
More often, the broker already has his trust or he would not be 
there. He is entrusting him usually with his or her life 
savings. These arbitration clauses are not negotiated the way 
any normal bilateral agreement between two equals would be 
negotiated.
    As a practical matter, if the investor does not sign 
whatever is in those papers, they have nowhere to go if they 
want to invest in this country. The issue is not, I would 
respectfully suggest, do investors know that there is a 
mandatory arbitration clause. The issue is whether all 
investors in this country should be required to sign a 
mandatory arbitration clause that consigns them to resolve all 
of their disputes by an industry organization.
    Mr. Ryun. Let me address this a little bit differently, if 
I may. I would like to go to Linda Fienberg from NASD. You 
testified the presence of an industry arbitrator on the panel 
does not influence the outcome of the arbitration in favor of 
the broker. I think it is an important point that merits 
further discussion and I would like to have any further 
comments you would like to make.
    Ms. Fienberg. Thank you, Chairman Ryun.
    We are, first and foremost of course, a regulator of the 
securities industry. As a result, we are very concerned not 
only about the quality of the forum, but also about its 
fairness and the appearance of fairness. Therefore, we have 
reviewed our award data to be sure that there is no bias in the 
process because of the industry arbitrator. Here is what we 
found. About 98 percent of awards are unanimous. In 2004 for 
example, there were a little over 1,100 cases in which the 
customer prevailed. In only 32 of those cases was there a 
dissent: 21 times by public arbitrators and only 11 times by 
non-public arbitrators, reflecting the two-and-one composition 
of panels.
    Looking at the flip side, we reviewed the awards of the 
entire roster of arbitrators who had signed at least eight 
awards. We found the same thing. Of 1,226 arbitrators with 
eight or more awards, only 41 ruled for the industry 75 percent 
or more of the time; 28 of the 41 were public arbitrators; only 
13 were industry. Of the 1,226, 209 decided in favor of 
investors 75 percent or more of the time. Of the 209, 67 were 
industry arbitrators or 32 percent, and 142 were public 
arbitrators.
    In addition, we are satisfied by the many surveys that have 
been taken by the GAO, by the SEC examinations and audits, by 
the most recent one done by Professor Perino under the auspices 
of the SEC, that there is no unfairness in the forum and our 
surveys reflect that the actual participants in the forum, the 
investors in the forum, do not believe that they have gotten an 
unfair shake at the end of the day.
    Mr. Ryun. I am going to give Mr. Frank an opportunity. I 
know we are about to move into final passage and I would like 
him to have an opportunity to ask some questions as well.
    Mr. Frank. Thank you, Mr. Ryun. I just want to reassure the 
panel, and I know you have come a long way, and there are only 
a couple of us. It is a Thursday afternoon. It was not the 
optimal time, but there are 10 people sitting up here behind 
us, staff members, and getting information to them is the best 
way to get information across. So you are not testifying vainly 
and I think you are adding significantly because of the 
presence of the people who do a lot of the thinking around 
here, to the basic knowledge.
    Mr. Lackritz, one question, you really believe that this is 
really good for the investor, right, the system?
    Mr. Lackritz. Yes, I do.
    Mr. Frank. Do you think the investors are so stupid that 
they would not know that if you did not force it on them? I 
mean, why don't you make it voluntary? You answered the 
objections partially. There is an objection to having it case-
by-case whether or not you go to arbitration. And I know the 
Chairman asked a very good question which is, well, shouldn't 
we know about it in advance.
    But the question you have to put is, what good would it do 
the investor to know about it? It is a contract of adhesion, so 
you know about it. So what are you going to do? Go out and sign 
with nobody? So why shouldn't it be that the investor is asked, 
and you can say this if you know, arbitration would be a lot 
better for you, and here is the record, than going to court? Do 
you want to sign this clause or not? Why not make it voluntary 
with the investor?
    Mr. Lackritz. First of all, I do believe this process is 
good for investors.
    Mr. Frank. I know that, but we only have 5 minutes. Don't 
repeat.
    Mr. Lackritz. I think that rather than larding up opening 
an account with a lot of due process requirements----
    Mr. Frank. Excuse me. Answer my question, Marc, come on. 
You know that we have a limited amount of time. Don't do a 
Greenspan on me and filibuster.
    [Laughter.]
    The question is this: Why do you not give the investor the 
choice to go into the arbitration system or not? Why would that 
not be better?
    Mr. Lackritz. Because number one, it is a solution in 
search of a problem. Number two, I think that the mandatory 
structure in fact provides a regulatory oversight mechanism 
that provides far more scrutiny and makes the process far 
better.
    Mr. Frank. Let me ask NASD, if in fact we had a system 
where investors could decide to go into the arbitration or not, 
would that impeded your ability to oversee the system for those 
that agreed to it?
    Ms. Fienberg. I actually believe if given----
    Mr. Frank. That is a straightforward question.
    Ms. Fienberg. I am going to answer. I believe that most 
investors would still----
    Mr. Frank. That is not what I asked you. Please, you are 
all very intelligent people, a simple question. The suggestion 
was it has to be made mandatory for everybody to provide 
regulatory oversight. Would you be capable of administering 
regulatory oversight if it was optional for whether or not 
there was arbitration in every case?
    Ms. Fienberg. We could still have our regulatory oversight 
over those cases that came into arbitration.
    Mr. Frank. Good. That was the question. Thank you for the 
answer. Look, you can repeat yourselves, but the point is this. 
You are giving answers that are not fully responsive. I think 
you make a very good case for arbitration. I would like to see 
it somewhat changed, but I do not understand you think the 
investors who you generally think are wise people, we are often 
told, you know, honor their choices and not infringe on them. 
But let me put it this way, if individual investors, according 
to you, I think, and others, are smart enough to take half of 
their Social Security accounts and decide how to run the rest 
of their lives with it, why aren't they smart enough to decide 
whether they want to go into a mandatory arbitration system?
    Mr. Lackritz. You raise a philosophical question in terms 
of how much freedom do you want to give people. If in fact 
people have a choice, when you know one system is better than 
the other, do you want to bar them from in fact picking a 
system that is going to be worse for them or not. So it gets 
back to paternalism. I completely agree with----
    Mr. Frank. Okay, so your argument is that you know, and you 
have certainly more experience in this than the investors, 
because you know that this system is better for them, you do 
not want them to be able to make the bad choice. You may hear 
that argument in the Social Security context, by the way, made 
by some people on the other side. But you have not made a case 
to me as to why it has to be mandatory. Certainly, it would 
work sometimes. I understand the argument for mandatory if you 
need a critical mass of participants, but I think you would 
have that anyway.
    The other question now is with regard to the industry 
member. Why couldn't there be industry members providing 
expertise without a vote? I mean, we have that all the time. 
Look, expertise about votes? I just started out by mentioning 
there are 10 people sitting up here who will know at any given 
time more about these subjects than any of us because they do 
not have to march in parades. They have a certain advantage in 
terms of their time allocation. So they do not vote, but they 
know a great deal and have a great deal of input. Why is it 
necessary, and let me ask any of the panelists, to give that 
person a vote to get the benefit of his or her expertise? Yes, 
sir.
    Mr. Katsoris. I have heard this debate many, many times 
about the industry against the public. I was on SICA when----
    Mr. Frank. Excuse me, sir. I just asked a simple question. 
Why is it necessary?
    Mr. Katsoris. I will try to develop a----
    Mr. Frank. No, you are not. Why is it necessary to give 
that person a vote to get the benefit of his or her expertise?
    Mr. Katsoris. I do not mind if you dismantle the whole 
present process of industry participation.
    Mr. Frank. That is not what I asked you, sir. If you do not 
want to answer the question I asked, it is voluntary. This is 
not arbitration. There is no contract of adhesion. I would like 
anyone who wanted to to ask the question, why is it not 
possible to get the expertise, because I think there is an 
argument for the expertise. Why is it not possible to get that 
expertise without giving that person a vote? Mr. Solin?
    Mr. Solin. Mr. Frank, that is exactly what happens in every 
arbitration I have been in. It is not necessary, is the answer 
to your question, because each side calls expert witnesses who 
provide all the expertise that the panel needs.
    Mr. Frank. Okay, I figured that, because somebody suggested 
to me, well, and maybe it was Mr. Lackritz who said, well, you 
know, you get conflicting experts and you need one to be the 
arbitrator, but I think that argument refutes itself. The fact 
is, this is not science. This is not something that is 
indisputable, although in today's political climate even 
science is not indisputable if you do not like it for religious 
reasons, but the notion that one expert somehow cuts through 
everyone else's expertise seems to me problematic.
    Mr. Lackritz?
    Mr. Lackritz. Yes, with all due respect, you are proceeding 
from an assumption that the industry involvement here is 
problematic.
    Mr. Frank. I am not. Excuse me, you lose me. I want to be 
cooperative here, but you lose me when you will not answer the 
question. I do not understand why you won't. The question is: 
Is there not a way to get expertise without giving that person 
a vote? I know you have said this to me before, well, you know, 
if there is no crisis, you don't change it. We are often asked 
to make changes without there being a total crisis. But in any 
case, that is a question that is aside from your hurt feelings 
because I have even raised the issue that you are not perfect. 
The question is: Why is it not possible to get that expertise 
without giving the person a vote? That is not disposative of 
whether or not the person ought to vote.
    Ms. Fienberg. If I may, we believe it is necessary in order 
to promote transparency. If this person were in the panel but 
did not have a vote, then people choosing this person would not 
have a track record as they do with all the awards from the 
industry and the public.
    Also, in order to avoid impasses, in order to save money, 
you would still have to have three voting arbitrators. That 
means you would increase the delays because you would have four 
people's schedules to consider. It would be more costly because 
you would be paying four arbitrators instead of three, and of 
course I am not sure we would be able to get that person if 
they did not have the ability to have the same rights as the 
other three members of the panel.
    Mr. Frank. I am skeptical of that, but I appreciate your 
answer to the question. Let me close with this, Mr. Chairman, 
because you do stress again the importance of transparency. 
That is why you believe it is important to have the decisions, 
the reasons published. Mr. Lackritz suggests that this would be 
a degree of litigiousness that might significantly detract from 
the process. I am wondering if any member of the panel would 
like to comment on that. Let's start with you, and that is my 
message.
    Mr. Katsoris. I do not think that you need an industry 
arbitrator anymore. I think we have outlived that, which 
started originally 30 year ago or so. However, if you eliminate 
categories, you eliminate all categories, throw everybody into 
the pool, and depend upon peremptory challenges and challenges 
for cause like any other judicial system.
    Mr. Frank. I appreciate that. Let me ask, how do you deal 
with the argument that reducing the reasons to writing would 
somehow detract from the flexibility and superiority of 
arbitration over litigation?
    Ms. Shockman. Thank you, Congressman. I think that the 
issue of reasoned awards, and PIABA believes the issue of 
reasoned awards is way down near the bottom of things that 
really need to be addressed. It is true that investors, after 
cases when they have lost those cases, and when they have won 
them and gotten some teeny-tiny fraction award, they want to 
know what happened.
    Mr. Frank. I am sorry. I apologize if I am unusually 
inarticulate today. I did not ask in general your opinion of 
doing them in writing. I was asking specifically whether 
reducing them to writing would be so burdensome that it would 
reduce the advantage of arbitration over the courts. That is a 
separate question.
    Ms. Shockman. I do not think it would be so burdensome that 
it would reduce the advantage of arbitration.
    Mr. Frank. The general rule that I make, which is if I ask 
you a question and you do not like the answer that you would 
have to give, do not answer it, but do not answer a different 
question, because I mean that is not the way I think so that is 
not helpful.
    Does anybody else have a comment on whether this would be 
so burdensome?
    Mr. Katsoris. Congressman Frank, I wrote an article last 
week. I think I sent it to all the members of this panel: 
Beware of what you ask for, you might just get it. It has to 
deal with reasoned awards. I think most of the panel has it. I 
have another 10 copies here. I will leave them here. This is a 
debate between myself and a member of PIABA as to the pros and 
cons of reasoned awards.
    Mr. Frank. All right. I appreciate that. Once the staff has 
read it, they will tell me about it. I guess again I will try 
one more time, the argument that reducing things to writing 
would make it too burdensome. Does anybody want to comment on 
that?
    Ms. Fienberg. NASD does not believe it would add an extra 
burden. The awards, of course, are already in writing, but 
there is not an explanation in many of them as to why an 
investor won or lost. We get many complaints from investors, as 
Ms. Shockman indicated, if they have not prevailed, as to what 
happened, why did the panel turn down their claim.
    We have structured this proposal so that investors get to 
choose whether to have this explained decision, so when they 
choose in advance whether they want it or not, they can factor 
in that it might be slightly longer until they get that award. 
We are prepared to provide sufficient staff so that it will not 
take longer or burden the process.
    Mr. Frank. Let me ask Mr. Perino, do you have any view on 
whether or not they should be written down, the reasons?
    Mr. Perino. I am hoping this answer is going to satisfy 
your responsiveness requirement. There is nothing inherent with 
writing them down in and of itself, but the more procedural and 
other requirements that you require in arbitration, if it is 
that----
    Mr. Frank. I agree. It is cumulative, but I have not heard 
a lot of other proposals. This one in terms of, if we only did 
that, would it be a qualitative difference?
    Mr. Perino. If the parties want a reasoned award, there is 
absolutely no reason not to give it to them. There is one 
potential downside with reasoned awards. Arbitrators sometimes 
reach decisions based on what they view as the equities of the 
situation as opposed to what the law actually requires. That 
may actually harm investors in some cases if a reasoned award 
is required.
    Mr. Frank. It is one thing, though, of course to give 
reasoned awards. That does not necessarily mean that there then 
has to be a compilation or that in any way it is considered to 
have precedential value. You could separate that out. Does the 
NASD proposal assume precedential value?
    Ms. Fienberg. No, absolutely not, Congressman Frank. This 
would not be precedential, just as they are not now. Even 
today, many arbitrators do in fact write explanations of their 
decisions and they are not precedential and they would not be 
if this new rule is approved by the SEC after public comment.
    Mr. Frank. Thank you, Mr. Chairman.
    Mr. Ryun. Thank you very much to the panelists for coming. 
I appreciate your insight. Let me just make an observation. I 
know there is room for improvement. I tend to think, though, 
unless something is completely broken, let's be careful in 
fixing it. If it is something that seems to move through in 
months as opposed to years, I would hate to add more expense 
and longevity to it.
    So let me just say this in closing, since there are no 
other members for questions, we need to continue to have this 
dialogue and do things that would help improve the system. I 
want to thank you very much for being here.
    This meeting stands adjourned.
    [Whereupon, at 3:18 p.m., the subcommittee was adjourned.]


                            A P P E N D I X



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