Evaluation of Steps Taken to Address the Problem of Unpaid
Arbitration Awards (27-APR-01, GAO-01-654R).
The Securities and Exchange Commission (SEC) and securities
self-regulatory organizations have taken actions that should help
reduce the occurrence of unpaid arbitration awards. However, more
time is needed to assess the effectiveness of the actions taken
to date. Although recent data suggest that the percentage of
unpaid awards has decreased, this data was limited to a very
short time span. That data also showed that the problem of unpaid
awards was still primarily due to broker-dealers and individual
brokers leaving the securities industry without paying awards.
The National Association of Securities Dealers-Dispute
Resolution, Inc., has developed rule and procedure changes to
help address this problem. SEC also plans to continue to monitor
the payment of awards and, if nonpayment continues to be a
problem, consider other approaches. Insurance coverage of unpaid
awards, as proposed by Texas securities attorney William S.
Shepherd, could impose additional costs on investors and other
market participants and would need to be carefully examined.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-01-654R
ACCNO: A00951
TITLE: Evaluation of Steps Taken to Address the Problem of
Unpaid Arbitration Awards
DATE: 04/27/2001
SUBJECT: Securities arbitration
Securities regulation
Self-regulatory organizations
Brokerage industry
Noncompliance
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GAO-01-654R
GAO- 01- 654R Unpaid Arbitration Awards United States General Accounting
Office
Washington, DC 20548
April 27, 2001 The Honorable John D. Dingell Ranking Minority Member
Committee on Energy and Commerce House of Representatives
The Honorable Edward J. Markey House of Representatives
Subject: Evaluation of Steps Taken to Address the Problem of Unpaid
Arbitration Awards Our June 2000 report, Securities Arbitration: Actions
Needed to Address the Problem of Unpaid Awards, 1 revealed that a
significant proportion of awards against brokers had not been paid to
investors. Most of the unpaid awards were owed by brokers that had left the
securities industry. The Securities and Exchange Commission (SEC) and
securities self- regulatory organizations (SRO) have taken substantial
actions to implement recommendations we made to address this problem.
This letter responds to your January 17, 2001, request that we review the
status of certain issues addressed in our June 2000 report. Our objectives
were to (1) evaluate steps that SEC and the SROs have taken in response to
recommendations in our report, (2) provide any updated information on the
arbitration award payment rate since our last report, and (3) to comment on
proposed solutions to the unpaid award problem made in correspondence to you
by William S. Shepherd, a Texas securities attorney.
Results in Brief
SEC and the National Association of Securities Dealers- Dispute Resolution,
Inc. 2 (NASD- DR) have taken several positive steps in response to our
report recommendations that could help reduce unpaid awards. For example,
NASD- DR has begun monitoring the payment of awards by NASD member broker-
dealer firms and individual brokers and now asks investors that have won
arbitration awards to inform it when awards are not paid. NASD- DR also has
developed procedures to help investors seek alternatives to arbitration when
their broker- dealers have failed. For
1 Securities Arbitration: Actions Needed to Address the Problem of Unpaid
Awards (GAO/ GGD- 00- 115, June 15, 2000). 2 In July 2000, NASD- DR became
operational as a subsidiary of the National Association of Securities
Dealers (NASD). NASD- DR administers NASD arbitration, mediation, and other
alternative dispute resolution services.
2 GAO- 01- 654R Unpaid Arbitration Awards
example, NASD- DR has designed procedures to notify claimants when broker-
dealer firms or individual brokers are no longer registered and, therefore,
may not be influenced by NASD disciplinary procedures to pay awards. NASD-
DR has also developed a rule change to waive predispute arbitration
agreements when brokerdealers or individual brokers leave the industry.
These changes are to be effective in June 2001. In addition, SEC and NASD-
DR have made information available to warn investors about the potential for
unpaid arbitration awards and encourage investors to more thoroughly
investigate the backgrounds of brokers with whom they intend to do business.
SEC intends to periodically inspect NASD- DR?s procedures for monitoring
award payment and has arranged with NASD- DR to obtain detailed quarterly
statistics on award payment. Initial data from NASD- DR?s monitoring of the
payment of awards during mid- September through December 2000, suggests that
the rate at which awards were not paid has diminished. We reported in June
2000, that in 1998 an estimated 64 percent of awards decided by NASD- DR
forums had not been paid in full. The more recent data show that about 13
percent of awards decided from midSeptember through December 2000, were not
paid in full as of February 7, 2001. The more recent data, however, is
limited to a very short time period. As in our June report, broker- dealers
and individual brokers that had left the securities industry owed most of
the unpaid awards.
If unpaid awards remain a problem, we recommended that SEC consider other
approaches to address the problem. We discussed some of the costs and
burdens of several alternative approaches in our June 2000 report. Mr.
Shepherd?s proposal of providing insurance coverage for unpaid awards is
similar to those previously discussed approaches and would have similar
costs and burdens. Therefore, the proposal would need to be looked at
carefully. We are not making any further recommendations at this time.
Background
Arbitration, an alternative to suing in court, uses a neutral third party to
resolve differences between two parties in controversy. The securities
industry uses arbitration to resolve disputes among industry members, their
employees, and individual investors. The arbitrators? decisions are final
and can be appealed to the courts only for narrowly defined reasons, such as
misconduct or bias on the arbitrators? part. Arbitration awards are to be
paid within 30 days of the date of the award, unless a party seeks a
judicial review. SROs administer arbitration programs under SEC oversight.
NASD- DR is the largest of these accounting for about 92 percent of
investor- initiated securities arbitration cases in 1998.
Scope and Methodology
To evaluate actions taken in response to our report we reviewed available
documentation of actions taken by SEC and NASD- DR since our June 2000
report. In addition, we examined SEC and NASD- DR Web sites for information
warning investors that arbitration awards may not be paid. To provide
updated information on the rate at which arbitration awards are being paid,
we analyzed NASD- DR?s report to
3 GAO- 01- 654R Unpaid Arbitration Awards
SEC on award payment from mid- September through December 2000. In regard to
Mr. Shepherd?s proposal for insurance coverage of unpaid awards, we
addressed related proposals in our June 2000 report. We obtained comments
from SEC and NASD- DR on a draft of this report and discuss these comments
near the end of the report.
We conducted our work in Washington, D. C., during January through March
2001, in accordance with generally accepted government audit standards.
SEC and SROs Have Taken Several Positive Steps in Response to Our Report
In correspondence to you on January 2, 2001, SEC provided information on
various steps taken regarding our report findings and recommendations. SEC?s
letter addressed specific responses to our recommendations, provided the
results of NASDDR?s analysis of the status of NASD- member firms and
individuals that had not paid awards, and provided information on a pilot
program that offers investors the opportunity to use non- SRO arbitration
forums. These actions should help improve regulatory oversight of award
payment, give investors alternatives to pursue when awards are unpaid due to
failed brokers, better inform investors of the possibility of unpaid
arbitration awards, and encourage investors to more carefully choose the
brokers with whom they intend to do business. Ultimately, these actions
should help reduce the occurrence of unpaid arbitration awards.
NASD- DR Adopted Procedures to Monitor the Payment of Awards
Our June 2000 report found that an estimated 52 percent of awards
administered by NASD- DR in 1998 were totally unpaid and 12 percent were
only partially paid. We recommended that NASD- DR adopt procedures for
monitoring the payment of arbitration awards. NASD- DR has adopted
procedures that implement our recommendation. Effective September 18, 2000,
NASD- DR began requiring NASD member firms to certify in writing that they
have complied with awards against them or their individual brokers. A member
firm must, within thirty days, notify NASD- DR that it paid an award, or
that it has a valid basis for nonpayment, such as the filing of a court
action to vacate the award. In addition, NASD- DR also now asks investors to
notify it promptly if their awards have not been paid within 30 days of the
date that they received the award. These procedures allow NASD- DR to
identify which brokers are paying awards and begin suspension proceedings
against nonpaying brokers. These procedures also provide NASD- DR with a
means of compiling data that it and SEC can use to assess the extent to
which unpaid awards remain a problem.
NASD- DR Has Begun Addressing the Problem of Unpaid Awards Caused By Failed
Broker- Dealers
To improve investors chances of collecting unpaid awards caused by failed
brokerdealers we recommended that SEC require NASD- DR to develop procedures
that would help reduce costs and increase options for investors faced with
the possibility of unpaid awards. NASD- DR has adopted program changes that
should make it easier
4 GAO- 01- 654R Unpaid Arbitration Awards
for investors to establish claims and judgments against failed brokers.
NASD- DR redesigned its procedures to notify claimants if a member broker-
dealer or individual broker is no longer registered and, therefore, may not
be influenced by NASD- DR disciplinary procedures to pay awards. This
change, which is to become effective in June 2001, should provide investors
with information they need to decide whether it is in their best interest to
proceed with arbitration or seek other means of redress.
NASD- DR also has developed a rule change to help investors pursue claims
against parties from which it may be difficult to collect award payments. In
April 2001 SEC approved a NASD rule that would preclude a broker- dealer
firm that has been terminated, barred, or suspended, or that is otherwise
defunct, from enforcing a predispute arbitration clause against a customer.
This would allow the customer (investor), instead, to seek legal recourse
through the courts and establish a judgment against any assets of the
defunct broker. This rule change is to become effective in June 2001. NASD-
DR also is considering another rule change that would streamline default
proceedings whenever a terminated or defunct broker- dealer firm or
individual broker fails to answer or appear in a case and the claimant
elects to continue with arbitration. This change is intended to make it
easier for the investor to establish an award against a defunct broker-
dealer or individual broker. NASD- DR expects to file this proposed rule
change with SEC later in 2001. These rule changes should help investors save
time and money in establishing their claims and judgments against failed
brokers or seek other means of redress. These changes would satisfy the
intent of our recommendation.
SEC and NASD- DR Have Taken Actions to Make Investors Aware That Awards May
Not Be Paid
To help investors avoid the possibility of having an unpaid award, we
recommended that SEC and SROs develop information to better educate
investors about possible award nonpayment. SEC and NASD- DR have acted on
our recommendation that they (1) develop and publicize information to focus
investor attention on the possibility of unpaid arbitration awards and (2)
encourage investors to more thoroughly investigate the backgrounds of
broker- dealers and individual brokers with whom they intend to do business.
SEC has revised its online publications to contain information about the
potential for unpaid arbitration awards and to underscore the importance of
thoroughly investigating a broker?s disciplinary history. The publications
include SEC?s ?Invest Wisely,? ?Ask Questions,? and ?Check Out Brokers and
Advisors? publications. 3 For example, the ?Ask Questions? publication
contains the following text:
?Which brokerage firm or individual broker you select is very important for
several reasons. You'll want to investigate thoroughly before doing business
with a broker or firm that has a history of complaints or problems with
regulators. Also, you should know that if your firm or broker goes out of
business or declares bankruptcy, you might not be able to recover your
money- even if an
3 These online publications can be accessed through the SEC Web site (www.
sec. gov).
5 GAO- 01- 654R Unpaid Arbitration Awards
arbitrator or a court rules in your favor.? The other publications contain
similar language, and new printings of paper versions of these publications
are also to include the revised language. In addition, the discussion of
arbitration under the ?Search Key Topics? function on SEC?s Web site
includes the following language:
?Caution. When deciding whether to arbitrate, bear in mind that if your
broker or brokerage firm goes out of business or declares bankruptcy, you
might not be able to recover your money- even if the arbitrator or court
rules in your favor. That's one of the reasons why it is so important to
investigate the disciplinary history of your broker or brokerage firm before
you invest. For tips on how to do this, please read our publication entitled
Check Out Your Broker.?
SEC also said that it has added language to the standard letter SEC sends to
investors who contact it about problems. The language advises investors to
weigh the cost of proceeding with arbitration against the likelihood of
being able to collect any award if the broker- dealer has left the industry
or gone bankrupt.
SROs have also taken action to educate investors about the potential for
unpaid awards. SEC has worked with NASD- DR and the New York Stock Exchange
(NYSE) to make similar changes to their Web sites. As a result, NASD- DR has
added information in several places on its Web site about the importance of
learning about a broker?s background, and the potential for nonpayment of
arbitration awards. 4 For example, the ?How to Start an Arbitration? section
of the NASD- DR Web site includes language similar to that in SEC?s ?Search
Key Topics? cautioning investors of the possibility of not getting paid and
advising them to investigate their broker?s disciplinary history. It goes on
to provide information on how to find this background information. The NASD-
DR?s Web site also now includes a section entitled ?What If I Don?t Get
Paid,? that provides detailed information and references to other material
regarding nonpayment of awards. NYSE also has included similar information
regarding unpaid arbitration awards in its Users Guide to Arbitration, which
can be accessed through NYSE?s Web site. 5 NYSE?s and NASD- DR?s Web sites
also include the January 2001- revised Arbitration Procedures pamphlet of
the Securities Industry Conference on Arbitration. The pamphlet includes a
section entitled ?What If I Don?t Get Paid?? These changes positively
respond to our recommendation and should help call investors? attention to
these issues.
SEC Intends to Periodically Examine the Extent of Award Nonpayment
To determine the effectiveness of actions taken to reduce the extent to
which awards are not paid and whether unpaid awards remain a problem, we
recommended that SEC periodically examine the extent of award nonpayment.
SEC indicated that it has arranged with NASD- DR to obtain detailed
quarterly statistics on unpaid awards and
4 NASD Dispute Resolution, Inc., has a Web site for arbitration and
mediation information (www. nasdadr. com). 5 Information about the NYSE
arbitration program is on its Web site (www. nyse. com).
6 GAO- 01- 654R Unpaid Arbitration Awards
related NASD- DR actions. SEC said that it would periodically inspect NASD-
DR?s procedures for monitoring award payment and taking disciplinary action
against member broker- dealer firms and individual brokers that have not
paid awards. If unpaid awards remain a problem after it has assessed NASD-
DR?s new procedures, SEC said that it would consider the feasibility of
other approaches to addressing the problem.
NASD- DR Has Followed- up on the Status of Brokers With Possible Unpaid
Awards
In preparing our June 2000 report, we obtained information showing that some
broker- dealers and individual brokers that had been a party to arbitration
cases involving unpaid awards were still, perhaps inappropriately, doing
securities business. SEC indicated that NASD- DR had followed- up on this
information to determine the broker- dealers? and individual brokers? status
in the securities industry. NASD- DR?s analysis showed that in all cases
that resulted in an award against the named broker- dealer or individual,
the award had either been paid, the parties had reached a settlement, or
NASD had taken action to cancel, terminate, or suspend the broker- dealer?s
or individual broker?s membership. NASD- DR?s follow- up effort was
effective in that it documented that 18 awards had been paid or otherwise
satisfied and resulted in actions taken to eliminate 3 nonpayers from the
securities industry.
SEC Monitors Pilot Program Our June 2000 report also mentioned a 2- year
pilot program, inaugurated in January 2000, that would give brokerage
customers the opportunity to use non- SRO forums to arbitrate disputes.
Under this program, customers having qualified claims with one of seven
participating broker- dealers may have the option of using a non- SRO forum
to arbitrate their dispute. SEC said that it would continue to monitor the
pilot program. SEC reported that so far investors had shown little interest
in using the non- SRO forums perhaps because the cost to investors is
higher.
Limited Data Suggest That the Rate of Unpaid Awards Has Declined
You also asked that we apprise you of any changes in the rate at which
arbitration awards are being paid. In early February 2001, NASD- DR provided
its first report to SEC on the payment of awards. The information reported
showed that, as of December 31, 2000, 38 awards (about 13 percent) out of
296 awards-- decided since September 18, 2000, that granted investors
monetary relief against a broker- dealer or individual broker-- had not been
paid in full. As a result of its monitoring, NASD- DR instituted suspension
proceedings against 13 broker- dealer firms or individual brokers in
connection with 12 unpaid awards. 6 Two of the 12 unpaid awards were
temporarily on hold pending hearings on the matters that the respondents had
requested. The remaining 10 awards were cases in which NASD- DR had sent out
a
6 For one of these awards, NASD- DR started separate suspension proceedings
against both the member firm and a person associated with that firm.
7 GAO- 01- 654R Unpaid Arbitration Awards
warning letter and was waiting for a response. The other 26 unpaid awards
involved broker- dealers or individual brokers that were no longer in the
securities industry.
The 13 percent rate of unpaid awards for the more limited time span of
September through December 2000, is significantly lower than the estimated
64 percent for 1998 shown in our June 2000 report. We do not know the extent
to which NASD- DR?s implementation of our recommendation that it monitor the
payment of awards might be responsible for the reduction. Nor do we know to
what extent short- term fluctuations in the rate of unpaid awards may
account for part of this difference. The differences in the rates of unpaid
awards across these two time periods also may be due in part to certain
characteristics of the awards involved. For example, in our sample of 247 of
the 845 monetary awards NASD- DR arbitrators made in 1998, 10 broker-
dealers were each responsible for 3 or more unpaid awards, which in sum
accounted for 62 unpaid awards. Yet among the 296 awards NASD- DR
arbitrators made in the 4th quarter of 2000, the NASD- DR data identified
only one instance where a broker- dealer was responsible for more than one
unpaid award. Given the short time span covered by the recent data, SEC and
NASD- DR need to continue monitoring award payment to determine whether
additional steps should be taken.
The NASD- DR data also show that broker- dealers and individual brokers that
were no longer in the securities industry continued to be responsible for
most unpaid awards. In June 2000, we reported that the unpaid awards were
largely due to brokers that were no longer in business. For mid- September
through December 2000, the NASDDR data showed that such defunct brokers
accounted for 26 or 68 percent of the 38 unpaid awards. NASD- DR has said,
as noted earlier, that it is proposing rule changes in 2001 to help address
this problem. As we recommended in June 2000, SEC also plans to continue to
monitor the problem of defunct brokers that do not pay awards and assess
whether it needs to consider other approaches to address the problem.
Alternative Proposal Would Need Careful Examination
You referred to a letter from Texas securities attorney, William S.
Shepherd, who disagreed with our recommendations and proposed other
solutions to the problem of unpaid awards. Mr. Sheperd proposed that the
problem can be solved entirely by regulations that make clearing firms
liable for the acts of introducing brokers and by requiring introducing
brokers to carry insurance. As you requested, we will evaluate Mr.
Shepherd?s proposals as part of future planned work addressing the
regulation of clearing firms and introducing brokers.
Our June 2000 report discussed the notion of insurance coverage of unpaid
awards. In that report we noted the views of officials of SEC, NASD, the
Securities Investor Protection Corporation (SIPC), and the Securities
Industry Association. These officials expressed concern that expanding SIPC
coverage, for example, to include unpaid arbitration awards would quickly
exhaust the SIPC fund (of about $1.1 billion) if annual payments were to be
as high as the $129 million of unpaid awards that we estimated for 1998. 7
They also said covering unpaid awards would increase SIPC?s
7 SIPC is a nonprofit membership corporation of broker- dealers, which
provides certain protections to customers of failed broker- dealers against
loss of cash and securities up to statutorily defined limits.
8 GAO- 01- 654R Unpaid Arbitration Awards
caseload, requiring SIPC to expand and increasing its need for resources.
They also expressed concern that expanding SIPC coverage could increase
costs for brokerdealers and investors, might encourage frivolous arbitration
claims, and might reduce incentives for investors to carefully choose their
brokers and investments. The same officials said that establishing a
separate insurance fund to cover unpaid arbitration awards would pose these
same problems.
Insurance coverage of unpaid arbitration awards thus could impose additional
costs and burdens on investors and other market participants. However,
insurance coverage would not serve to prevent fraudulent practices or punish
unscrupulous brokers. In order to be equitably and effectively implemented,
such insurance, therefore, would need to be carefully examined and any
attendant problems resolved.
Conclusions
SEC and SROs have taken actions in response to our June 2000 recommendations
that should help reduce the occurrence of unpaid arbitration awards.
However, more time is needed to assess the effectiveness of the actions
taken to date. Although recent data suggest that the percentage of unpaid
awards has decreased, this data was limited to a very short time span. That
data also showed that the problem of unpaid awards was still primarily due
to broker- dealers and individual brokers leaving the securities industry
without paying awards. NASD- DR has developed certain rule and procedure
changes to help address this problem. SEC also plans to continue to monitor
the payment of awards and, if nonpayment continues to be a problem, consider
other approaches. Insurance coverage of unpaid awards, as proposed by Mr.
Shepherd, could impose additional costs on investors and other market
participants and would need to be carefully examined.
Agency Comments and Our Evaluation
NASD- DR and SEC provided written comments on a draft of this report, which
are reprinted in enclosures I and II. NASD- DR and SEC generally agreed with
the contents of this report and provided several technical comments, which
were incorporated into the final report. NASD- DR commented that we took the
appropriate caution about drawing conclusions from the limited data gathered
so far on the payment of awards in the follow- up period. Nonetheless, NASD-
DR believed that its initiatives to educate investors and monitor award
payment, along with NASD enforcement program actions, have probably helped
improve award payment to investors.
As agreed with your office, unless you publicly release its contents
earlier, we plan no further distribution of this report until 30 days from
its issue date. At that time, we will provide copies to Representative W. J.
?Billy? Tauzin, Chairman, House Committee on Energy and Commerce;
Representative Michael G. Oxley, Chairman, and Representative John J.
LaFalce, Ranking Minority Member, House Committee on Financial Services; the
Honorable Nick Lampson, House of Representatives; the Honorable Laura S.
Unger, Acting Chairman, SEC; Mr. Frank Zarb, Chairman, NASD; Mr. William S.
Shepherd; and other interested parties. We will also make copies available
to others upon request.
9 GAO- 01- 654R Unpaid Arbitration Awards
Please call me at (202) 512- 8678 if you or your staff have any questions
concerning this report. David Tarosky was a major contributor to this
report.
Richard J. Hillman, Director Financial Markets and Community Investment
10
12 GAO- 01- 654R Unpaid Arbitration Awards
Enclosure I 13 GAO- 01- 654R Unpaid Arbitration Awards GAO Comments
The following are GAO?s comments on NASD Dispute Resolution, Inc., letter
dated April 20, 2001.
1. Text was added to note that an award must be paid within thirty days,
unless there is a valid basis for nonpayment, such as the filing of a court
action to vacate the award.
2. Text was revised to indicate that the changed procedure is to become
effective in June 2001.
3. Text was added to indicate that NYSE?s and NASD- DR?s Web sites include
the Arbitration Procedures pamphlet of the Securities Industry Conference on
Arbitration, which includes a section entitled ?What If I Don?t Get Paid??
4. Footnote was modified to include mediation. 5. Text was modified to
indicate that the subject pilot program was a 2- year pilot,
inaugurated in January 2000, customers may have the option of using a non-
SRO forum, and that SEC reported that investors had shown little interest in
the program perhaps because the cost to investors is higher.
6. Caption was modified to ?Limited Data Suggest That the Rate of Unpaid
Awards Has Declined.?
*** End of document. ***