[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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24-398 WASHINGTON : 2005
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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
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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
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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
March 17, 2005
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