Securities Arbitration: Actions Needed to Address Problem of Unpaid
Awards (Chapter Report, 06/15/2000, GAO/GGD-00-115).
Pursuant to a congressional request, GAO provided information on issues
relating to the arbitration process in the securities industry, focusing
on: (1) whether arbitration forums had implemented recommendations made
in GAO's 1992 report and whether the changes were effective; (2) how
investors fared in award decisions; and (3) the extent to which
investors were paid the amounts awarded by arbitration panels.
GAO noted that: (1) the securities industry self-regulatory
organizations (SRO)--the National Association of Securities Dealers
(NASD) and the New York Stock Exchange (NYSE)--implemented GAO's 1992
recommendations by giving arbitration participants a larger role in
selecting arbitrators, periodically surveying arbitrators to verify
background information, and improving arbitrator training; (2) NASD and
NYSE generally assessed arbitrator performance using methods such as
participant evaluations, focus groups, and discussions with arbitration
attorneys; (3) NASD and NYSE believes that this participant feedback
indicated that the program changes have improved investors' perceptions
of arbitrator performance and the fairness of the arbitration process;
(4) GAO could not reach conclusions about the fairness of the
arbitration process from case outcome statistics; (5) investors did not
receive as high a percentage of favorable arbitration awards during any
year from 1992 through 1998, 49 to 57 percent, as they had during the
period of January 1989 through 1990, 59 percent; (6) the percentage of
the amount claimed that was awarded also declined during this period;
(7) however, an increase in the percentage of cases settled during this
period, generally 50 to 60 percent of the total cases concluded, may
have changed the mix of cases going to a final arbitration award
decision; (8) GAO's survey of investors who received awards in 1998
found that a number of broker-dealers that had left the securities
industry often did not pay arbitration awards rendered against them; (9)
nearly all unpaid awards were from cases decided in NASD's arbitration
forum; (10) when investors complained, NASD took action to suspend
nonpaying broker-dealers and had success in recovering awards; (11) most
of the unpaid awards resulted from broker-dealers that were no longer in
business; (12) NASD is considering changes to its processes to reduce
costs and increase options for investors, but these changes still may
not address the problem of defunct brokers not paying awards; (13)
ultimately, recovering losses caused by undercapitalized, financially
irresponsible, or unscrupulous broker-dealers is difficult, if not
impossible, for investors; and (14) educating investors about the risks
of doing business with such broker-dealers could help them avoid
situations that may result in unpaid awards.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-00-115
TITLE: Securities Arbitration: Actions Needed to Address Problem
of Unpaid Awards
DATE: 06/15/2000
SUBJECT: Securities arbitration
Brokerage industry
Arbitrators
Administrative remedies
Stock exchanges
Securities regulation
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GAO/GGD-00-115
United States General Accounting Office
GAO
Report to Congressional Requesters
June 2000
GAO/GGD-00-115
SECURITIES ARBITRATION
Actions Needed to Address Problem of Unpaid
Awards
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Contents
Page 101GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid
Awards
Executive Summary 4
Chapter 1 14
Introduction
How Arbitration Is Designed to Work 14
SROs Administer and SEC Oversees 15
Securities Arbitration
Objectives, Scope, and Methodology 15
Chapter 2 18
SROs Have Made Changes
to Improve Their
Arbitration Programs
SEC Has Worked With SROs to Improve 18
Securities Arbitration
SROs Have Made Changes to Improve 18
Their Arbitration Processes
SROs Seek Participants' Views to 21
Assess Effects of Program Changes
Chapter 3 23
Arbitration Awards
Favoring Investors
Declined, but More Cases
Were Settled
Investors Have Not Fared as Well in 23
Award Decisions as They Did Before
1992, but More Cases Were Settled
Factors Affecting Awards for Investors 25
Other Comparisons in Arbitration Case 28
Processing
Use of AAA Has Declined 29
Few Securities Disputes Are Litigated, 32
Most Are Dismissed
Chapter 4 33
Many Arbitration Awards
Were Not Paid
Over Half of Awardees Were Not Paid 33
NASD Did Not Routinely Determine If 36
Arbitration Awards Were Paid
NASD Is Considering Changes to Address 38
Award Nonpayment by Broker-Dealers
That Are No Longer in Business
Other Potential Solutions to the 39
Problem of Unpaid Awards
Chapter 5 44
Conclusions and
Recommendations
Conclusions 44
Recommendations 44
Agency Comments and Our Evaluation 45
Appendixes Appendix I: Methodology for Analyzing 50
Arbitration Results
Appendix II: Awardee Survey 60
Methodology
Appendix III: Awardee Survey 64
Questionnaire
Appendix IV: Comments From the NASD 66
Regulation, Inc.
Appendix V: Comments From the New York 73
Stock Exchange
Appendix VI: Comments From the 75
Securities and Exchange Commission
Appendix VII: GAO Contacts and Staff 78
Acknowledgments
Tables Table 3.1: Percentage of Cases Decided 26
in Favor of Investors in 1998
Table 3.2: Size and Range of 28
Investors' Claim Amounts in 1998
Table 3.3: Average Processing Time 29
for Cases Decided in 1998 (Days)
Table 3.4: Firms Requiring Predispute 30
Arbitration Clauses in Accounts for
Individual Investors as of July 1999
Table 3.5: AAA Investor-Initiated, 31
Securities-Related Awards and Results
for Investors, 1992 Through 1998
Table 4.1: Estimates of the Percentage 34
of Monetary Customer Arbitration
Awards Issued by All Forums and NASD
in 1998 That Broker-Dealers or
Individual Brokers Paid Nothing, Paid
Partially, or Paid Fully
Table 4.2: Estimates of Percentage of 34
Award Cases Paid in Full and Dollar
Amounts Paid in 1998, by Size of
Award
Table I.1: Arbitration Cases Won and 54
Lost, Odds on Winning Derived From
Them, and Odds Ratios Indicating the
Effects of Various Characteristics of
Arbitration Cases on the Odds on
Winning
Table I.2: Arbitration Cases Won That 58
Received Awards That Were More or
Less Than 50 Percent of the Amount
Claimed, and Odds Ratios Indicating
the Effects of Various Claim
Characteristics on Winning Sizable
Awards
Table II.1: Disposition of Sample 61
Figures Figure 3.1: Percentage of Decisions 24
Favoring Investors and Awards to
Amounts Claimed, January 1989 Through
June 1990 and January 1992 Through
December 1998
Abbreviations
AAA American Arbitration Association
ICS Investors Compensation Scheme
NASD National Association of Securities
Dealers
NASDR NASD Regulation, Inc.
NYSE New York Stock Exchange
SAC Securities Arbitration Commentator
SEC Securities and Exchange Commission
SIA Securities Industry Association
SICA Securities Industry Conference on
Arbitration
SIPC Securities Investor Protection
Corporation
SRO self-regulatory organization
B-281372
Page 2GAO/GGD-00-115 Actions Needed to Address Problem of Unpa
id Awards
B-281372
June 15, 2000
The Honorable John D. Dingell
Ranking Minority Member, Committee on
Commerce
House of Representatives
The Honorable Edward J. Markey
House of Representatives
This report responds to your July 30, 1998, and September 23,
1998, requests that we evaluate issues relating to the
arbitration process in the securities industry. On the basis
of your requests, this report discusses (1) whether
arbitration forums had implemented recommendations made in our
1992 report, Securities Arbitration: How Investors Fare
(GAO/GGD-92-74, May 11, 1992) and assessed the effectiveness
of the changes; (2) how investors fared in securities
arbitration award decisions; and (3) the extent to which
investors were paid the amounts awarded by arbitration panels.
This report includes recommendations to the Chairman, U.S.
Securities and Exchange Commission, regarding regulatory
actions to address the problem of unpaid arbitration awards.
As agreed with your offices, 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 Tom Bliley, Chairman,
House Committee on Commerce; Representative Michael G. Oxley,
Chairman, and Representative Edolphus Towns, Ranking Minority
Member, Subcommittee on Finance and Hazardous Materials, House
Committee on Commerce; the Honorable Arthur Levitt, Chairman,
U.S. Securities and Exchange Commission; Mr. Frank Zarb,
Chairman, National Association of Securities Dealers; Mr.
Richard Grasso, Chairman, New York Stock Exchange; and other
interested parties. We will also make copies available to
others upon request.
If you have any questions on matters discussed in this report,
please call me or
Michael Burnett at (202) 512-8678. Other major contributors to
this report are acknowledged in appendix VII.
Thomas J. McCool
Director, Financial Institutions
and Markets Issues
Executive Summary
Page 7GAO/GGD-00-115 Actions Needed to Address Pro
blem of Unpaid Awards
Purpose
The securities industry uses arbitration to
resolve disputes between industry members and
individual investors that involve hundreds of
millions of dollars each year. Congress, state
regulators, and investor groups have questioned
whether an arbitration system that is administered
largely by securities self-regulatory
organizations (SRO) is fair and impartial. In a
1992 report on arbitration, GAO found no
indication of a proindustry bias, but concluded
that SRO-sponsored forums lacked internal controls
to provide investors with reasonable assurance
that arbitrators were independent and competent.1
GAO recommended ways for the industry to improve
arbitrator selection, qualifications, and
training.
Because of their continuing concerns about
SRO-sponsored arbitration, Representative John D.
Dingell, Ranking Minority Member of the House
Committee on Commerce, and Representative Edward
J. Markey asked GAO to update its 1992 review of
securities arbitration programs. Specifically,
they wanted to know (1) whether arbitration forums
had implemented GAO's recommendations and assessed
the effectiveness of the changes; (2) how
investors fared in securities arbitration; and (3)
the extent to which investors were paid their
arbitration awards.
Results in Brief
The securities industry SROs-the National
Association of Securities Dealers (NASD) and the
New York Stock Exchange (NYSE)-implemented GAO's
1992 recommendations by giving arbitration
participants a larger role in selecting
arbitrators, periodically surveying arbitrators to
verify background information, and improving
arbitrator training. NASD and NYSE generally
assessed arbitrator performance using methods such
as participant evaluations, focus groups, and
discussions with arbitration attorneys. They said
that this participant feedback indicated that the
program changes have improved investors'
perceptions of arbitrator performance and the
fairness of the arbitration process.
GAO could not reach conclusions about the fairness
of the arbitration process from case outcome
statistics. Investors did not receive as high a
percentage of favorable arbitration awards during
any year from 1992 through 1998, 49 to 57 percent,
as they had during the period of January 1989
through June 1990, 59 percent. The percentage of
the amount claimed that was awarded also declined
during this period, 46 to 57 percent, compared
with the earlier period, 61 percent. However, an
increase in the percentage of cases settled during
this period, generally 50 to 60 percent of the
total cases concluded, may have changed the mix of
cases going to a final arbitration award decision.
For some of these cases, broker-dealers may have
chosen not to arbitrate because they reasonably
expected to lose. For this reason, the declining
win rate could indicate little or no change in the
fairness of the arbitration process. GAO could not
apply the same technique it used in 1992 to
determine whether arbitration results implied
anything about the fairness of SRO-sponsored
arbitration because the caseloads at an
independent forum, the American Arbitration
Association (AAA), and at the courts were too
small to make meaningful comparisons.
More importantly, however, GAO's survey of
investors who received awards in 1998 found that a
number of broker-dealers that had left the
securities industry often did not pay arbitration
awards rendered against them. GAO's survey found
that 49 percent of the awards rendered in 1998
were not paid at all and an additional 12 percent
were only partially paid. GAO estimated that the
amount of unpaid awards was about $129 million, or
80 percent of the $161 million awarded to
investors during 1998. About $13 million, or 8
percent of the unpaid awards, were still being
disputed in court through such actions as a motion
to vacate or modify the award. Nearly all of the
unpaid awards were from cases decided in NASD's
arbitration forum. When investors complained, NASD
took action to suspend nonpaying broker-dealers
and had success in recovering awards, but it did
not monitor the payment of arbitration awards. In
addition, most of the unpaid awards resulted from
broker-dealers that were no longer in business.
NASD is considering changes to its processes to
reduce costs and increase options for investors,
but these changes still may not address the
problem of defunct brokers not paying awards.
Ultimately, recovering losses caused by
undercapitalized, financially irresponsible, or
unscrupulous broker-dealers is difficult-if not
impossible-for investors. Educating investors
about the risks of doing business with such broker-
dealers could help them avoid situations that may
result in unpaid awards. In addition, investors'
arbitration attorneys have suggested alternative
approaches to address the problem of unpaid
awards.
This report contains recommendations to the
Chairman of the U.S. Securities and Exchange
Commission (SEC) regarding regulatory actions
needed to address the problem of unpaid awards.
SEC, NYSE, and NASD generally agreed with the
report's recommendations, but expressed concern
about certain aspects of GAO's analysis. They also
suggested several technical changes to the report,
which GAO has included where appropriate.
Background
Arbitration, an alternative to suing in
court, is a process that uses a neutral third
party to resolve differences between two parties
in controversy. Most broker-dealers require their
customers to sign predispute arbitration
agreements that require disputes to be resolved
through SRO-sponsored arbitration. Investors can
initiate arbitration proceedings by filing claims
with SRO-sponsored arbitration forums and paying
filing fees. The forums then provide both parties
with a list of potential arbitrators from which
they can select who will arbitrate their dispute.
The arbitrators' decisions are final and can only
be appealed to the courts for narrowly defined
reasons, such as arbitrator misconduct or bias.
Arbitration awards are to be paid within 30 days
from the date of the award, unless a party seeks
judicial review of the award.
The SROs, primarily NASD and NYSE, administer
and oversee securities arbitration programs. SEC
is responsible for overseeing the SROs' operations
to ensure that they comply with securities laws
and rules, including those that pertain to
arbitration.
Principal Findings
SROs Have Made Program Changes Consistent With GAO
Recommendations
NASD and NYSE have initiated new arbitration
processes that respond to GAO's 1992
recommendations. For example, NASD no longer
suggests arbitrators for particular cases but
produces a computer-generated list by rotation of
eligible arbitrators from which the parties are to
select. NYSE has also provided the parties more
autonomy in selecting their arbitrators, and both
SROs periodically check arbitrators' backgrounds
and require them to take training.
The SROs made these changes to improve the
arbitration process and participants' confidence
in arbitration. To assess arbitrator performance,
the SROs obtained participant feedback on various
aspects of their arbitration experience through
evaluation forms. The SROs used the results of
these evaluations to identify the need for
training programs, to counsel arbitrators about
deficiencies or problems, and to evaluate
arbitrator performance. However, many participants
did not complete the evaluation forms. SRO
officials said that the forms that were completed
indicated improvement in participants' perceptions
of arbitrator quality. In addition, these
officials said that they periodically discussed
arbitration processes and specific program changes
with various participants, including focus groups,
and conducted limited surveys of participants to
assess the effects of specific changes. These
officials also said the results of these processes
have shown that perceptions of arbitrator
performance and the fairness of the arbitration
process have improved.
Arbitration Award Decisions Did Not Favor
Investors as Often as They Did Before 1992
The percentage of cases in which arbitrators'
decisions favored investors has declined from the
59 percent GAO found for cases decided from
January 1989 through June 1990. The percentage
favoring investors averaged about 51 percent for
the period of 1992 through 1996, then increased to
a high of 57 percent in 1998. The amount of awards
made to investors as a percentage of what they
claimed also declined during 1992 through 1998,
from the 61 percent that GAO previously found to
an average of about 51 percent of the amount
claimed. However, the extent to which arbitration
cases were settled before reaching an award
decision increased. From 1989 to 1992 less than 50
percent of cases were settled, while for 1993 to
1998, the cases settled ranged between 50 to 60
percent. This increase in the percentage of
arbitration cases settled may, in part, explain
the decline in the percentage of awards that
favored investors.
GAO could not use the results of securities
disputes at independent forums to gauge the
fairness of SRO-sponsored arbitration as it had in
1992. AAA's securities caseload declined
significantly after 1991. The number of cases AAA
decided averaged only about 35 a year from 1992
through 1998, compared with nearly 250 cases in
the January 1989 through June 1990 period that GAO
included in its 1992 report. The percentage of
favorable awards for investors at AAA declined
from 1992 through 1998 from 88 to 50 percent, but
these percentages are not statistically
significant because of the small number of cases.
GAO also could not compare arbitration
results to those achieved by investors who sued
brokers in court because so few court cases were
decided. GAO found 121 securities-related disputes
between individual investors and their broker-
dealers at 5 federal district courts. Of the 121
disputes, the courts decided 15 cases (12
percent), the parties settled 22 cases (18
percent), and the courts dismissed 85 cases (70
percent) for such reasons as being remanded to
arbitration or transferred to another district. In
the 15 decided cases, which were not enough to be
statistically significant, investors won 11 cases
(73 percent). Information was not available to
determine the percentage of claimed amounts
awarded.
Many Investors Were Not Paid Their Awards
GAO estimated that about 500 NASD awards to
investors in 1998 either were unpaid or were
partially paid. GAO developed its estimates by
surveying a random probability sample of 247 of
the 845 investors who received monetary awards in
cases decided in 1998. Nearly all of the
nonpayments involved NASD-decided cases.
NASD did not have procedures to monitor
whether awards were paid, but it did follow up
when investors complained. In 1998, investors
filed 142 such complaints. These complaints were
the only source of information NASD had on unpaid
or partially paid awards. When it received written
complaints, NASD sent letters to the nonpaying
brokers or broker-dealers threatening to remove
them from the securities industry. Although this
did not always help investors recover their
awards, in total, NASD suspensions or the threat
of suspension resulted in about 40 percent of
these unpaid awards being paid or otherwise
settled to the satisfaction of the investors.
Timely information about whether arbitration
awards have been paid could help NASD better
assist investors who have not been paid awards.
Most of the unpaid awards resulted from broker-
dealers that were no longer in business. NASD had
no procedures to address this problem, but is
considering changes to its arbitration program to
help investors who have disputes with these broker-
dealers. These changes include notifying the
investors of their broker-dealers' status when the
investors file an arbitration claim, limiting the
ability of a defunct broker-dealer to enforce a
predispute arbitration agreement against a
customer, and establishing a rule to streamline
the arbitration process when the broker-dealer is
defunct and fails to appear. Such actions may help
investors obtain more timely judgments against
defunct broker-dealers, but these actions do not
help them avoid broker-dealers that might not pay.
SEC and the SROs have extensive investor-education
programs, but these have not included data on the
extent of award nonpayment. Publicizing this
information, along with related investor-education
information, might better focus investor attention
on the possibility of unpaid arbitration awards.
Encouraging investors to use the Central
Registration Depository to more thoroughly
evaluate the background of broker-dealers and
individual brokers that they intend to do business
with might help investors better make these
important decisions.
Some attorneys who have represented investors in
securities arbitration have proposed alternative
methods to better ensure payment of awards. These
alternative methods include having the Securities
Investor Protection Corporation (SIPC) cover
unpaid awards, establishing a separate SRO-
sponsored fund to pay awards, or increasing broker
funds that are available to pay awards through
additional capital or bonding requirements.2 GAO
did not assess the feasibility of these proposals
but obtained the views of SEC; NASD; and affected
organization officials, including SIPC officials
and those who represent arbitration attorneys and
broker-dealers.
Recommendations
GAO recommends that the Chairman, SEC, require
NASD to adopt procedures for monitoring the
payment of arbitration awards. Such procedures
should include requesting the parties in an
arbitration to notify NASD, by the end of the 30-
day payment period, about the payment status of
any monetary award, so NASD can begin timely
suspension proceedings against nonpaying broker-
dealers, as appropriate.
GAO recommends that the Chairman require NASD to
develop procedures addressing the problem of
unpaid awards caused by failed broker-dealers to
help reduce costs and increase options for
investors, such as the changes NASD is
considering.
GAO also recommends that the Chairman work with
the SROs to (1) develop and publicize information
to focus investor attention on the possibility of
unpaid arbitration awards and (2) encourage
investors to more thoroughly evaluate the
backgrounds of broker-dealers and individual
brokers with whom they intend to do business.
Lastly, GAO recommends that the Chairman
periodically examine the extent of nonpayment of
SRO arbitration awards to determine the
effectiveness of actions taken to improve the
payment of awards. To the extent unpaid awards
remain a problem, the Chairman should establish a
process to assess the feasibility of alternative
approaches to addressing this problem.
Agency Comments
NASD Regulation, Inc., the NASD subsidiary
with primary responsibility for its arbitration
program through the Office of Dispute Resolution;
NYSE; and SEC provided written comments on a draft
of this report, which are reprinted in appendixes
IV, V, and VI. These organizations generally
agreed that the draft report revealed a
potentially serious problem with the nonpayment of
arbitration awards by broker-dealers and
individual brokers that had left the industry and
agreed with GAO's recommendations to address this
problem. However, they expressed specific concerns
about some of the approaches GAO used and some of
the results of its analysis that are discussed in
detail in chapter 5.
_______________________________
1 Securities Arbitration: How Investors Fare
(GAO/GGD-92-74, May 11, 1992).
2 SIPC is a nonprofit membership corporation of
broker-dealers, which protects customers of failed
broker-dealers against loss of cash and securities
up to statutorily defined limits.
Chapter 1
Introduction
Page 17GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
Arbitration is used to resolve disputes
between broker-dealers or individual brokers and
their public customers (called investors). As an
alternative to suing in court, arbitration uses a
neutral third party to resolve differences between
two parties in controversy. The arbitration
process in the securities industry has generally
occurred in self-regulatory organization (SRO)-
sponsored forums that are overseen by the
Securities and Exchange Commission (SEC). The
number of arbitrations in these forums has
averaged about 6,400 cases a year since 1992,
after more investors became involved in the
markets and as broker-dealers required them to
arbitrate disputes in SRO-sponsored forums. In
addition, the Supreme Court ruled in 1987 that
investors who had signed predispute arbitration
clauses could be compelled to resolve their
disputes with broker-dealers by arbitration.1
Before 1987, arbitration caseloads were fewer than
3,000 a year, but these caseloads increased in
number between 1987 and 1992.
How Arbitration Is Designed to Work
Customers' experience with arbitration
generally begins when broker-dealers require them,
before opening an account, to sign a contract that
includes a predispute arbitration clause. If a
dispute subsequently arises between the customer
and the broker-dealer, the customer can file an
arbitration claim with the forum indicated in the
predispute agreement and with any SRO of which the
broker-dealer is a member.
In a customer-initiated arbitration case, the
customer files a statement of claim with the
designated SRO-sponsored arbitration forum, along
with a filing fee that is based on the amount in
controversy. The customer must also submit a
refundable deposit to cover the cost of the first
prehearing or hearing session. The forum's
director of arbitration serves the statement of
claim on the broker-dealer or individual broker
(called respondents) against whom the claim has
been brought. The respondent has from 20 to 45
days, depending on the forum used, to answer the
claim with any defenses and related claims. A
single arbitrator can be used to resolve claims
under $25,000, solely on the basis of the parties'
claims, when a hearing is not requested. Unless
otherwise requested by a party, a single
arbitrator can also be used to decide claims that
are greater than $25,000 but less than $50,000.
For all other cases, unless otherwise agreed to by
the parties, a panel of three arbitrators is
appointed to hear the dispute. After the filing
process, the director of arbitration provides the
parties with a list of potential arbitrators, most
of whom are public rather than industry
arbitrators, to hear the dispute. The parties
indicate their preference and may challenge
specific arbitrators on the list.
Once the panel of arbitrators has been
selected, the panel conducts hearings that may
last a day or more depending on the complexity of
the case. Arbitrators are to render their
decisions after the presentation of the evidence
at the hearings. They are not required to provide
a reason or a written opinion when they make an
award decision. The statement usually provides the
amount awarded and any other nonmonetary relief.
The award is final and is only subject to court
review for narrowly defined reasons, such as
arbitrator partiality, fraud, or disregard of the
law. However, a court can confirm an arbitration
award to establish a judgment against the party
owing the award. Unless a party files a motion to
vacate or modify the award, awards are to be paid
within 30 days of the award date. If the award is
not paid within 30 days, interest will accrue at
the legal rate or the rate specified by the
arbitrators in the award.
SROs Administer and SEC Oversees Securities
Arbitration
Securities arbitration proceedings are
administered through arbitration forums sponsored
by various SROs, such as the National Association
of Securities Dealers (NASD) and the New York
Stock Exchange (NYSE). SEC is responsible for
overseeing the SROs' operations to ensure that
they comply with securities laws and rules,
including those that pertain to arbitration. The
SROs are not-for-profit organizations that have
primary regulatory responsibility under the
Securities Exchange Act of 1934 to adopt and
enforce standards of conduct for their members.
The SRO arbitration forums are funded from several
sources, such as claim filing fees, charges for
the use of facilities, per case member surcharges
and case processing fees, and subsidies from SRO
general revenues. SEC oversees the SROs'
rulemaking regarding arbitration and inspects SRO
arbitration programs for compliance with the
securities laws and SRO rules.
The American Arbitration Association (AAA)
also administers securities arbitration
proceedings. AAA is an independent, not-for-profit
organization that handles dispute resolution for
several industries and is not regulated by SEC.
AAA is funded fully from case processing fees.
Parties in AAA arbitration cases also must pay the
arbitrators' fee and other costs.
Objectives, Scope, and Methodology
Because of their continuing concerns about
how investors fare in SRO-sponsored arbitration
forums, and whether investors are paid their
awards, Representative John D. Dingell, Ranking
Minority Member, House Committee on Commerce, and
Representative Edward J. Markey asked us to update
our 1992 report on securities arbitration
programs.2 Our objectives were to determine (1)
whether securities arbitration forums had
implemented our 1992 recommendations and assessed
the effectiveness of the changes, (2) how
investors fared in securities arbitration award
decisions, and (3) the extent to which investors
received the amounts awarded by arbitration
panels.
To obtain information on the changes to
arbitration programs that NYSE and NASD made to
address our 1992 recommendations and any
assessments of those changes, we interviewed SEC
and SRO arbitration forum officials. We also
analyzed the revised arbitrator application forms,
including arbitrator profile forms, and other
background information the forums use to select
individuals for the arbitrator pool. We
interviewed forum officials about their
verification of the information submitted. We also
reviewed the arbitrators' manual and schedules of
courses available and attended a course given to
chairpersons of arbitration panels. In addition,
we reviewed arbitration participant evaluation
forms used by NASD and NYSE and their analyses of
evaluation results.
To obtain information on the use of predispute
arbitration clauses, we sent a questionnaire to
the top 10 broker-dealers by numbers of retail
sales representatives listed in the Securities
Industry Association's (SIA) Securities Industry
Yearbook 1998-1999 and 2 broker-dealers that
provide on-line brokerage services. Nine of the
12, including both on-line broker-dealers,
responded to our questionnaire.
To determine how investors fared in
arbitration award decisions, we used various
statistical techniques to analyze arbitration
awards for cases involving investors in disputes
with securities broker-dealers. We obtained
information on securities arbitration awards from
a database maintained by the Securities
Arbitration Commentator, Inc., (SAC) of Maplewood,
NJ. This database includes information on
arbitration awards decided at all SRO-sponsored
forums and AAA, and the database contained the
only comprehensive, consistent data available
without reviewing case files at all of the forums.
However, because this database is limited to
awards, we were unable to provide a detailed
analysis of investors' claims that were settled or
withdrawn. We performed tests to assess the
reliability of the SAC database. Our methodologies
and statistical procedures are discussed in detail
in appendix I. To determine how investors fared in
court, we reviewed court case records for five
selected eastern U.S. districts-the District of
Columbia, Maryland, northern Illinois, southern
New York, and eastern Virginia. We chose these
districts because of their proximity to major
securities markets and convenient locations.
To determine the extent to which arbitration
awards were not paid, we surveyed a random sample
of 247 awards from the 845 monetary awards to
investors that we identified in the SAC database
as being decided in 1998. Eighty-five percent of
the sampled awardees responded to our survey.
Survey estimates made in this report, which are
projected to the entire population of 1998 awards,
are subject to sampling error. Unless otherwise
noted, all percentage estimates from the survey
have sampling errors of plus or minus 5 percentage
points or less, and all total dollar estimates
have sampling errors of plus or minus 10 percent
or less. Our survey methodology is discussed in
detail in appendix II. Our survey questionnaire is
shown in appendix III. We obtained additional
information on unpaid 1998 awards from NASD
records of written complaints and records related
to its processing of those complaints. To obtain
information on the status of broker-dealers
identified as not paying an award, we sent NASD a
list of those broker-dealers, and its staff
determined the broker-dealers' status.
To obtain information and views on possible
solutions to the problem of unpaid awards, we
interviewed regulatory officials and officials of
the Securities Investor Protection Corporation
(SIPC) and organizations that represent
arbitration attorneys and broker-dealers.
We requested comments on a draft of this
report from the Chairmen of SEC, NASD, and NYSE.
Their comments are discussed in chapter 5. Our
work was conducted in Washington, D.C., and
vicinity; New York, NY, and vicinity; Boca Raton,
FL; Baltimore, MD; Chicago, IL; and San Francisco,
CA, between October 1998 and May 2000. Our work
was performed in accordance with generally
accepted government auditing standards.
_______________________________
1 Shearson/American Express, Inc., v. McMahon, 482
U.S. 220 (1987).
2 Securities Arbitration: How Investors Fare
(GAO/GGD-92-74, May 11, 1992).
Chapter 2
SROs Have Made Changes to Improve Their
Arbitration Programs
Page 22GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
Since our 1992 report, SEC has worked with NASD
and NYSE to strengthen the arbitration process.1
These SROs have made several changes to improve
their arbitration processes, many of which respond
to our recommendations. To assess the
effectiveness of program changes, the SROs sought
participants' views on their satisfaction with
arbitrator performance and the effectiveness of
program changes. NASD and NYSE officials told us
that they believed the overall process has
improved and is fair for investors.
SEC Has Worked With SROs to Improve Securities
Arbitration
Since 1992, SEC has worked with the SROs to
strengthen the securities arbitration process
through its rule reviews and inspections. SEC
officials told us that one of the most important
rule changes they recently approved involved
NASD's arbitrator selection process, which is
discussed in the next section. In addition, SEC
has completed two arbitration program inspections
each at NASD and NYSE since 1992. SEC is currently
conducting an inspection of NASD's program and
plans to begin an inspection of NYSE's program in
2000. Since 1992, SEC also has inspected
arbitration programs at other SROs, such as the
Chicago Board Options Exchange and the Pacific
Exchange.
According to SEC officials, SEC reviews SRO
administration and processing of arbitration cases
in each inspection. In addition, they said SEC
examines SRO arbitrator pools, focusing on SRO's
recruitment, training, and evaluation of
arbitrators. In each inspection, SEC advises the
SRO of any deficiencies found and recommends that
the SRO implement remedial measures to correct the
deficiencies. SEC also follows up with the SRO to
ensure that the SRO implements SEC's
recommendations. SEC staff further noted that one
of the purposes of their inspections is to
evaluate the impact of any changes in the
arbitration process.
SROs Have Made Changes to Improve Their
Arbitration Processes
NASD and NYSE officials told us that they have
made several changes to improve their arbitration
processes since our 1992 report. They said the
changes address each of the report's
recommendations, which were that the SROs should
develop standards for selecting arbitrators,
verify information submitted by arbitrators, and
establish specific training for arbitrators. NYSE
and NASD have also sponsored a symposium and task
force, respectively, to address issues relating to
the arbitration process. NYSE's Symposium on
Arbitration in 1994 and NASD's Arbitration Policy
Task Force in 1996 addressed the adequacy of SRO
information on arbitrators and the arbitrators'
experience. Both groups also identified needed
changes in the arbitration selection process and
the training of arbitrators.
NASD Made Changes to Improve Its Program
NASD officials told us that they have made
significant changes to their arbitration program
in response to our recommendations addressing
arbitrator qualification, selection, and training.
For example, NASD now requires 5 to 8 years of
professional or practical experience for
applicants to become NASD arbitrators. NASD also
surveyed arbitrators in 1992 and again at the end
of 1998 to review and verify the accuracy of
information on their background. In addition, NASD
officials said that they check background
information when arbitrators are selected to
decide disputes. NASD requires the arbitrators to
sign an oath or affirmation indicating that the
information on their background is accurate.
NASD officials told us that one of NASD's most
significant changes has been the change to its
rules that provides for selection of arbitrators
from a list. Under the previous rules, NASD staff
provided the parties with a list of three
arbitrators. The parties had one peremptory
challenge and unlimited challenges for cause to
eliminate particular arbitrators. The new rules
provide for a list selection process that gives
the parties a greater role in choosing who will
decide their cases. Under the new process, NASD
supplies a list of up to 15 names that are
selected by computerized rotation of the
arbitrator roster. The parties can strike anyone
from the list and rank the remaining arbitrators
according to their preferences. If the parties
cannot agree, they are assigned the next available
arbitrator on the computerized list to fill any
remaining vacancies. NASD also revised the list of
arbitrators, eliminating names for various
reasons, such as unsatisfactory evaluations in
previous arbitration cases, failure to complete
new training requirements, lack of interest, or
conflicts of interest that would prevent them from
serving as independent arbitrators.
In January 1993, NASD began requiring all new
arbitrators to complete introductory training
before becoming eligible to serve on a case.
According to an NASD official, the training
program has been refined in the past 5 years. One
of the refinements, which began in March 1998,
requires arbitrators to pass a test on arbitration
procedures to become eligible to serve on a case.
NASD also has taken action to separate its
arbitration activities from its market and
regulatory activities. In September 1999, SEC
approved a new NASD subsidiary-NASD Dispute
Resolution, Inc.-which is to be responsible for
managing arbitration disputes. NASD reported that
this change, which should be operational by the
summer of 2000, would make the arbitration process
more independent. An NASD official also said that
NASD had made other changes to its arbitration
program, including encouraging parties to try
mediation to resolve disputes before going to
arbitration, issuing a Discovery Guide to define
which documents should be exchanged among the
parties in the arbitration process, streamlining
the claim process, and establishing a Web site on
arbitration issues.
NYSE Made Changes to Improve Its Program
NYSE officials told us that NYSE, among other
things, has established a new arbitrator profile
for maintaining information on arbitrators'
background and qualifications. NYSE also has
developed procedures for verifying this
information and established training standards for
arbitrators. The profile serves as the initial
disclosure of information about arbitrators to the
parties, counsels, or witnesses in a particular
case. The profile includes information on
employment history, education, professional and
arbitration experience, brokerage affiliation, and
arbitration training. NYSE also requires potential
arbitrators to have a minimum of 5 years
experience in their chosen profession or to have
two letters from members of their profession or
the community that endorse arbitrator nominees and
address their experience and character. NYSE
officials said that this information assists them
in selecting potential arbitrators.
NYSE officials stated that NYSE continually checks
arbitrators' qualifications. The officials noted
that each time arbitrators are assigned a new
case, NYSE asks the arbitrators to review, update,
and sign their profile information. They said that
NYSE also verifies this information annually for
each arbitrator as well as checks arbitrators'
disciplinary histories for past securities or
criminal violations. As part of the arbitrator
profile, NYSE is to disclose any disciplinary
history that does not warrant the arbitrator's
removal from the pool. Arbitrators who receive
poor evaluations on more than one occasion may be
removed from the pool. In addition, arbitrators
who are suspended or barred by a regulatory
organization or who fail to disclose their
disciplinary history are also to be removed from
the arbitrator pool. In addition, NYSE may (1)
temporarily disqualify arbitrators if they are
currently the subject of a complaint or
investigation and (2) permanently disqualify
arbitrators for failure to disclose material
information or for being subject to a finding of
fraud by a court or arbitration.
NYSE is also trying a new process for selecting
arbitrators. Under a pilot program, NYSE permits
the parties in arbitration to choose from two
options to select their arbitrators. NYSE either
provides the parties with a list of 3 arbitrators,
allowing specific opportunities to remove an
arbitrator from the list, or the parties can
request random lists of up to 15 arbitrators. NYSE
officials told us that they have received
favorable responses from the parties on the
available alternatives.
NYSE has also conducted arbitrator training
seminars on procedures, issues, and ongoing
developments concerning securities arbitration. It
requires all new arbitrators to attend the
arbitrator-training program and expects all
arbitrators to periodically attend additional
training. In addition, NYSE officials said that
NYSE has an arbitration Web site that provides
information to investors, including on-line access
to all arbitration awards issued since 1992. These
officials said NYSE also has pilot programs that
encourage the use of mediation and more efficient
case processing through administrative conferences
with the arbitrators to resolve preliminary
matters.
SROs Seek Participants' Views to Assess Effects of
Program Changes
To assess the effects of their program changes,
NASD and NYSE use participant evaluations to
obtain investor perceptions about arbitrator
performance on individual cases. Officials from
these SROs said that their review of the
evaluations has shown a high level of participant
satisfaction with arbitrators' performances. These
officials said that they also use other methods to
evaluate the effects of program changes, such as
focus groups and meetings with individual
arbitration participants. Overall, these officials
said that the arbitration process has improved and
is fair for investors.
The evaluation forms that the SROs use focus on
arbitrators' skills and traits, such as display of
professionalism and sensitivity during the
proceedings, whether the case was conducted
according to prescribed procedures, and whether
arbitrators displayed knowledge of the securities
industry. Forum officials said that they use these
evaluations to develop training programs, counsel
arbitrators about deficiencies or problems, and
determine if certain arbitrators should continue
to be on the list of arbitrators for the specific
forum.
NASD officials told us that getting participants
to complete the evaluation forms has been
extremely difficult for the forums over the years.
The January 1996 Arbitration Policy Task Force
Report2 recommended that NASD make a greater
effort to improve participants' response rate.
Shortly after the report was published, NASD
developed a new evaluation form to elicit a higher
participant response rate. An independent analysis
of NASD's participant responses by professors of
the Department of Social Sciences at the United
States Military Academy at West Point found that
for 2,037 cases closed by hearing between December
1, 1997, and April 1, 1999, the response rate
varied from 10 to 20 percent. NASD officials told
us that although they strive to have a greater
degree of participation, West Point professors
told these officials that the response rate
provided a valid statistical sample. For example,
the professors' analyses showed that, of the
parties responding, 93 percent indicated that
their cases were handled fairly and without bias.
An NASD official said NASD plans to continue such
analyses of the parties' evaluations to identify
overall trends in responses.
The participant evaluation forms have not included
questions on process changes. SRO officials said
that this use of the evaluations to assess program
changes is inappropriate because investors rarely
have more than one experience in arbitration and,
therefore, have no point of reference from which
to gauge the effect of specific changes to the
program. SEC officials noted that the sole purpose
of the evaluations is to assess arbitrator
performance.
The SROs have also used other methods to assess
participant satisfaction and the effectiveness of
program changes. During 1999, NASD conducted focus
groups with customer and industry participants to
obtain feedback and comments about its new list
selection process. NASD also surveyed selected
attorneys who were frequent participants in
arbitration to assess the effectiveness of the
arbitrator selection program. NYSE officials said
that they also met regularly with participant
attorneys to assess overall satisfaction with the
NYSE program.
SEC officials also noted that NASD and NYSE
arbitration program officials, as well as those of
other SROs, meet quarterly with representatives of
both public investors and the industry through the
Securities Industry Conference on Arbitration
(SICA).3 These officials said that SICA has
provided a useful forum for the SROs to assess the
effectiveness of specific arbitration program
changes.
_______________________________
1 Securities Arbitration: How Investors Fare
(GAO/GGD-92-74, May 11, 1992).
2 Securities Arbitration Reform: Report of the
Arbitration Policy Task Force to the Board of
Governors National Association of Securities
Dealers, Inc., January 1996.
3 SICA, formed in 1977, is a cooperative effort of
representatives of the securities industry; the
SROs; and the public to implement a uniform
arbitration system, monitor that system, and
change it as appropriate or required. SEC staff
said they also attend SICA meetings.
Chapter 3
Arbitration Awards Favoring Investors Declined,
but More Cases Were Settled
Page 32GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
Our analysis of arbitration results from 1992
through 1998 showed that the percentage of cases
decided in favor of investors had declined
compared with cases decided before 1992. The
awards investors received as a percentage of the
total amount that they claimed had also declined.
However, during this period, the percentage of
cases settled without an arbitrator's decision has
increased, which SEC officials said may explain
the declines in awards favoring investors. We
reviewed several factors that might affect award
outcomes, such as representation by an attorney or
size of claim. The factors that affected case
outcomes were similar to those we identified in
1992.
In 1992, we also compared the results of
arbitration in SRO-sponsored forums with those in
an independent forum, AAA, to provide an
indication of the fairness of SRO-sponsored
arbitration. However, AAA's securities caseload
declined significantly after 1990, and although
AAA awards to investors also declined from 1992 to
1998, its caseload is no longer large enough to
provide a meaningful comparison. Also, as in 1992,
we could not compare arbitration results to those
achieved by investors in litigation because the
processes were different and so few cases were
decided in court. Without comparison to such
benchmarks, statistics on case outcomes and
settlements provide limited information about the
fairness of the arbitration process.
Investors Have Not Fared as Well in Award
Decisions as They Did Before 1992, but More Cases
Were Settled
In 1992, we reported that 59 percent of investors
received favorable decisions in cases arbitrated
from January 1989 through June 1990. This
percentage declined to an average of about 51
percent for cases decided from 1992 through 1996
and increased to 56 percent in 1997 and 57 percent
in 1998. (See fig. 3.1.) Similarly, we reported in
1992 that investors who had favorable decisions
received an average of 61 percent of the dollar
amount they claimed. This percentage declined to
an average of about 51 percent during 1992 through
1998, ranging from a low of 46 percent in 1994 to
a high of 57 percent in 1997.1 (See fig. 3.1.)
Figure 3.1: Percentage of Decisions Favoring
Investors and Awards to Amounts Claimed, January
1989 Through June 1990 and January 1992 Through
December 1998
Source: GAO analysis of arbitration award data.
Regulatory officials attribute the decline in
arbitration results favoring investors to a
corresponding increase in the percentage of cases
settled. These officials said the higher
percentage of cases that are settled tends to
reduce the percentage of arbitration award
decisions in which investors might receive
favorable awards because broker-dealers are more
likely to try to settle cases that they think they
might lose. We estimate that between 1992 and
1998, the percentage of cases settled ranged from
43 percent in 1992 to 50 percent or greater for
the years 1993 through 1998, reaching a high of 60
percent in 1997. In 1992, we reported that
settlements occurred in 44 percent of SRO cases
and 33 percent of AAA cases.
The NASD and NYSE arbitration forums decided
most of the cases that were arbitrated during 1992
through 1998. For example, NASD's arbitrators
decided 1,428 cases, or 92 percent, of the total
1,552 customer-initiated arbitration cases in
1998. NYSE decided 90 cases, or 6 percent of these
cases. The other forums accounted for the
remaining 2 percent of these cases.2
We could not determine the reasons for the
differences in overall case outcomes from year to
year. Each arbitration case has different
participants and varying circumstances relating to
the claims and, therefore, must be judged on its
own merits. Attempting to evaluate these factors
would have involved time-consuming detailed
reviews of case files, extensive examination of
the relationships among these variables, and
subjective judgments about the merits of
individual cases. Also, differences in the
membership among SROs could affect the result, and
the investment products involved could be more
complex and risky from one year to the next. In
addition, investors having similar claims could
simply be asking for higher amounts from one year
to the next, which could change the percentage of
the claim awarded with no difference in the type
of case or the amounts awarded.
Factors Affecting Awards for Investors
For arbitration cases decided from 1992 through
1998, we used a multivariate analysis to evaluate
how certain factors affected investors' chances of
winning an award and the size of the award
relative to the amount claimed. This analysis
allows simultaneous evaluation of the effects of
several factors on a particular result and
estimation of the effects of any one factor by
controlling or holding constant all other factors.
(See app. I.)
Factors Affecting Arbitration Results
Without adjusting for differences in membership,
our multivariate analysis showed that when other
factors are controlled, investors were 23 percent
more likely to receive a favorable decision at
NASD between 1992 and 1998 than at NYSE. Investors
received favorable decisions in an average of
about 54 percent of the cases at NASD during this
time period as compared with 45 percent at NYSE.
For the most recent year, as shown in table 3.1,
the percentage of all cases decided in favor of
investors in 1998 at NASD was 57 percent compared
with 50 percent at NYSE. Of the 34 cases decided
at the other forums, 15 favored investors.
Table 3.1: Percentage of Cases Decided in Favor of
Investors in 1998
Forum Percent
Industrywidea 57%
NASD 57
NYSE 50
aIncludes SRO-sponsored forums and AAA.
Source: GAO analysis of arbitration award data.
SEC and NYSE officials told us these differences
could be attributed to differences in NASD and
NYSE membership. Securities regulations require
every broker-dealer that has public customers to
register with, and be a member of, NASD. As a
result, they said NASD members include the newer,
less established or less capitalized broker-
dealers that may be more likely to take actions or
fail to exercise proper internal controls over
actions that could cause them to lose arbitration
decisions. NYSE members must be able to pay the
cost of a seat on the exchange (one recently sold
for about $2 million); therefore, these members
generally include the larger, more established
broker-dealers.
When adjusted for the differences in membership at
NASD and NYSE, our analysis showed an
insignificant difference in the results of their
arbitration decisions. We compared the results of
cases for large broker-dealers that were members
of both NASD and NYSE and had multiple awards in
both forums. These awards accounted for over 31
percent of all investor-initiated arbitration
cases decided from 1992 through 1998. At NASD,
investors won 44 percent of the awards. At NYSE,
they won 41 percent of the awards. NASD
arbitrators awarded investors more than 50 percent
of the amount they claimed 37 percent of the time,
while NYSE awards were more than 50 percent of the
amount claimed 33 percent of the time.
In addition to looking at different forums' effect
on cases decided by arbitration, we also looked at
other factors to determine whether they could have
affected case outcomes. These factors were (1) the
type of disposition (i.e., customer-member,
customer-employee, or small claim); (2) the year
of arbitrator's decision; (3) attorney
representation; (4) claim components, such as
compensatory damages, punitive damages, or
attorney fees; (5) filing of counterclaim; (6)
whether the process included a hearing of the
evidence or a review of written evidence; (7) the
processing time; (8) the total claim amount; and
(9) the number of hearings. Our analysis indicated
that investors were 27 percent more likely to
receive an award if an attorney represented them.
In 1992, attorney representation did not affect
whether investors received favorable decisions.
The components of the claim also were correlated
to case outcome. Investors filing claims that
included more than compensatory damages, such as
punitive damages, interest, or various fees, were
more than twice as likely to receive an award. We
did not address this factor in 1992.
Cases that involved a higher number of hearing
sessions were also more likely to be decided in
favor of investors.3 Investors who had between 5
and 10 hearing sessions were 27 percent more
likely to receive favorable decisions, and if they
had 11 or more hearings, they were 113 percent
more likely to receive a favorable decision than
claims involving fewer than 5 hearings. In 1992,
we reported that investors were about 40 percent
more likely to receive an award if they had a
hearing than investors whose cases were decided
only after a review of written evidence.
Whether a broker-dealer filed a counterclaim
against an investor also affected case outcomes. A
broker-dealer may file a counterclaim against the
investor after receiving the investor's claim.
Investors were 43 percent more likely to receive a
favorable decision if the broker-dealer did not
file a counterclaim. In 1992, counterclaims were
not factors in case outcomes.
Our analysis also shows that investors' chances of
receiving a favorable decision in arbitration
decreased from 1992 to 1995 but have increased
since 1995. In 1998, investors were 33 percent
more likely to receive a favorable decision than
they were in 1995. Detailed results of our
analysis are shown in appendix I.
Factors Affecting the Amount Awarded
Without adjusting for differences in membership,
our multivariate analysis showed that investors
who received a favorable decision at NASD were 45
percent more likely to receive an award in excess
of 50 percent of their claim than investors who
received favorable decisions in other forums. In
1992, we found that forum did not affect the
amount of award. In addition, investors with
attorney representation in cases occurring at any
forum were 30 percent more likely to receive an
award greater than 50 percent of the amount
claimed. In 1992, investors represented by
attorneys were 60 percent more likely to receive
an award in excess of the average award amount.
The size of the claim also affected award amounts
and the odds of winning a sizable award varied by
the year they were awarded. Claims involving
$10,000 to $100,000 were only 60 percent as likely
as claims under $10,000 to receive an award over
50 percent of the amount claimed. Claims involving
more than $100,000 were only 27 percent as likely
to receive an award over 50 percent of the amount
claimed. We reported in 1992 that claims under
$20,000 were nearly 4 times as likely as larger
claims to result in an award greater than the
average percentage of the amount claimed. By 1998,
the odds of winning a greater than average award
were 30 percent higher than in 1992 and 50 percent
higher than in 1995. We could not determine from
our analysis whether the amounts claimed were
justified or excessive. Unless the investor
requests a hearing or the arbitrator calls one,
claims of $25,000 or less are decided by one
arbitrator after a review of written evidence. Our
analysis showed that investors who had arbitrators
decide their cases on the basis of the written
evidence were about 40 percent more likely to
receive an award over 50 percent of the amount
claimed than those that had hearings.
Other Comparisons in Arbitration Case Processing
In addition to the factors that could have
affected case outcomes, we also analyzed
differences in the size of investor claims, the
processing times, and the types of claims
initiated by investors among SRO-sponsored forums.
For example, the median investors' claim
industrywide in 1998 was $64,000, and the median
claim was higher at NYSE than at NASD. Table 3.2
provides the range of claim amounts filed for the
industry and for NYSE and NASD in 1998.
Table 3.2: Size and Range of Investors' Claim
Amounts in 1998
Forum Investors' claim amounts
Low High Mean Median
Industrywidea $200 $40,563,0 $320,00 $64,00
00 0 0
NASD 200
23,500,00 288,000 63,200
0
NYSE 700
7,500,000 384,000 75,000
aIncludes SRO-sponsored forums and AAA.
Source: GAO analysis of arbitration award data.
Table 3.3 shows the average time it took to decide
a case at SRO-sponsored forums based either on
reviews of written evidence or a hearing.
Decisions made after a hearing took considerably
more time than ones made only on the basis of the
written evidence. Smaller claims can be decided
solely on the basis of the written evidence. To
determine the time it took, we used the dates from
when the forum received an investor's claim to
when the forum sent the arbitrators' decisions to
the parties. Disputes decided at NASD took longer
to resolve than those at NYSE. NASD officials told
us that their cases took longer because of their
larger caseload and the parties' increased
involvement in the process.
Table 3.3: Average Processing Time for Cases
Decided in 1998 (Days)
Forum Average processing time
(days)
Hearing Written
submission
Industrywidea 504 281
NASD 519 289
NYSE 311 134
aIncludes SRO-sponsored forums and AAA.
Source: GAO analysis of arbitration award data.
Investors attempting to recover compensatory
damages was the primary reason that cases entered
arbitration. An award of compensatory damages may
include the party's actual dollar loss and any
other damages, such as interest or lost profits. A
party in arbitration can also claim punitive
damages, or compensation in excess of actual
damages, which are intended to punish wrongdoers.
In addition, a party may claim attorney fees and
other expenses of the arbitration process, such as
forum fees.
Investors claimed punitive damages in about 20
percent (317 cases) of the 1,552 total cases
decided in 1998. This percentage was less than the
28 percent we reported for cases decided by SRO
forums in 1992. Arbitrators awarded punitive
damages in 107 cases, or about 34 percent of the
317 decided cases in which investors requested
such damages. This was a significant increase from
the 12 percent we reported in 1992.
Investors claimed reimbursement for attorney fees
in about 10 percent (148 cases) of the 1,552 total
cases decided in 1998. This percentage had
decreased considerably from the 30 percent we
reported in 1992. Investors received attorney fees
in 100, or 68 percent, of the 148 cases in which
they claimed such fees. This percentage was
considerably more than the 17 percent we reported
in 1992. Arbitrators also awarded attorney fees in
44 cases in which investors had not requested such
fees. We also obtained information on lost
interest and other costs associated with the claim
that we did not include in our 1992 report.
Investors claimed these costs in 14 percent (211
cases) of the total cases decided in 1998. They
received these costs in 160 cases, or 76 percent
of the 211 decided cases in which they claimed
these costs.
Use of AAA Has Declined
In 1992, we compared SRO-sponsored arbitration
results to those at AAA, as an indication of the
fairness of the arbitration process. We found no
significant differences in case outcomes. We could
not make the same comparison for this report
because AAA's securities caseload declined
significantly from what we reported in 1992 and,
therefore, AAA's results no longer provided as
meaningful a comparison to SRO-sponsored forums.
Predispute Agreements Require the Use of SRO-
Sponsored Forums
Since our 1992 report, large broker-dealers'
policies requiring predispute arbitration
agreements have expanded to include cash accounts
in addition to margin and option accounts. The
nine broker-dealer firms that replied to our
survey required individual investors to agree to
resolve their disputes through SRO-sponsored
arbitration as a condition of opening most types
of accounts.4 The only exceptions were for
investors who opened plain cash accounts. As shown
in table 3.4, six of the nine broker-dealers told
us that they require predispute agreements to open
at least some retail cash accounts; the remaining
three broker-dealers did not require such
agreements. In 1992, we reported that eight of the
nine large broker-dealers that responded to our
survey did not require individual investors who
opened retail cash accounts as of December 1,
1990, to sign agreements containing arbitration
clauses. All nine of the broker-dealers that
responded to our survey and had margin accounts
said they required predispute agreements for
customers who opened these accounts. For broker-
dealers having option accounts, eight of nine said
they required such agreements.
Table 3.4: Firms Requiring Predispute Arbitration
Clauses in Accounts for Individual Investors as of
July 1999
Account types Predispute arbitration clause
Accounts Required for Required Not
that all for required
did not use such some for
accounts accounts such
accounts
Retail Plain Cash 0 4 2 3
Retail IRA Cash 0 8 1 0
Retail 401 K Cash 2 6 1 0
Retail Margin 0 9 0 0
Retail Options 1 8 0 0
Institutional 1 5 2 1
Source: GAO analysis of broker-dealer survey data.
The large broker-dealers we surveyed did not offer
their customers AAA as a choice to arbitrate a
dispute. Some of the reasons the large firms gave
for their policy of using SRO-sponsored forums
were lower costs, a more timely process than at
the independent forums, and arbitrators' knowledge
of the securities industry.
Few Results at AAA
According to AAA officials, broker-dealer
predispute agreements that require investors to
use SRO-sponsored arbitration forums have caused
AAA's securities-related caseload to decline
significantly. In our 1992 report, we analyzed the
results of 248 AAA investor-initiated, securities-
related awards from the period of December 1989
through June 1990. As table 3.5 shows, from 1992
through 1998, AAA averaged only about 35 such
awards a year, ranging from a low of 20 awards in
1998 to a high of 49 in 1996. Also, as shown in
the table, investors received favorable decisions
and large percentages of their claims often in the
early 1990s and then both results declined through
the years, until 1998 when investors received
favorable decisions in 50 percent of the cases and
received 13 percent of their claims.
Table 3.5: AAA Investor-Initiated, Securities-
Related Awards and Results for Investors, 1992
Through 1998
Year Percentage of Percentage
Investor- favorable of claims
initiated, decisions for awarded
securities- investors
related
awards
1992 24 88% 79%
1993 25 80 72
1994 43 72 52
1995 46 63 56
1996 49 53 48
1997 35 54 48
1998 20 50 13
Source: GAO analysis of arbitration award data.
AAA officials told us that they were still
interested in deciding securities arbitration
disputes. In January 2000, SICA started a 2-year
cooperative pilot program to give brokerage
customers the option to use non-SRO forums to
arbitrate disputes. NASD, NYSE, and other SROs are
to cooperate in the pilot program, and seven
retail brokerages committed to participate. Under
the program, customers that have qualified claims
with one of the participating brokerages may have
the option of having their dispute heard at a non-
SRO forum designated by the brokerage. The two
participating non-SRO forums are AAA and the
Judicial Arbitration and Mediation Service.
Few Securities Disputes Are Litigated, Most Are
Dismissed
As in 1992, the results of arbitration and court
cases are not comparable because of the inherent
differences in the processes5 and their respective
outcomes and the small number of litigated cases.
Most of the securities-related court cases we
reviewed were dismissed. We identified 817
securities and commodities cases that were
terminated (decided or dismissed by the court or
settled by the parties before a court decision)
between January 1997 and December 1998, at the 5
federal district courts we visited. The courts'
information systems did not distinguish securities
cases from commodity cases, but we reviewed the
817 cases and identified 121 to be securities-
related disputes between individual investors and
their broker-dealers. Of the 121 disputes, 15 (12
percent) were decided in court; 22 (18 percent)
were settled by the parties before a court
decision; and 85 (70 percent) were dismissed for
various reasons, such as they were remanded to
arbitration or were transferred to another
district.
The 15 cases the courts decided, 11 in favor of
the investor, were not statistically significant.
We could not determine what percentage of investor
claims the courts awarded because the claims often
were not quantified. For the 10 cases in which the
claims were quantified, the investors were awarded
(1) the full compensatory amount claimed in 7
cases and (2) the full punitive amount in 5 of the
7 cases in which punitive damages were requested.
The average time to litigate the 15 cases was 930
days and the median time was 1,151 days. The
average time to settle the 21 cases was 1,045
days; the median time was 644 days. The average
time to litigate the 23 cases we reviewed for our
1992 report, was 744 days; the median time was 594
days. The settlement time averaged 510 days, and
the median time was 365 days.
_______________________________
1 Our analysis did not calculate the percentages
of claim amounts awarded separately for
compensatory and punitive damages.
2 The other three forums were AAA, Chicago Board
Options Exchange, and the Pacific Exchange.
3 Cases that required a large number of hearings
may have many different characteristics that
affect their outcomes from those that required
fewer hearings. We did not have information on
these characteristics, and they are not identified
in our analysis. Therefore, our analysis should
not be interpreted as implying that prolonging
cases will positively affect their outcomes.
4 We surveyed the use of predispute arbitration
agreements for the 10 largest broker-dealers by
number of retail representatives and 2 additional
brokers that provide on-line brokerage services.
We sent questionnaires to the 12 broker-dealers
and 9 responded.
5 For example, the amount of discovery allowed and
rules of evidence are different. See appendix I of
our 1992 report (GAO/GGD-92-74).
Chapter 4
Many Arbitration Awards Were Not Paid
Page 37GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
On the basis of our survey of investors who
received arbitration awards during 1998, we
estimated that 49 percent of the awards were not
paid, and an additional 12 percent were partially
paid.1 Our estimates showed that these investors
did not receive nearly 80 percent of the $161
million that they were awarded.2 Nearly all of the
unpaid awards involved arbitration cases decided
in NASD's arbitration forum. Investors who
complained to NASD had some success in collecting
their awards when NASD initiated suspension
proceedings against the nonpaying broker-dealers
after receiving the complaints. However, NASD did
not routinely monitor the payment of awards to
ensure that it took timely action against the
nonpaying broker-dealers. Such actions could
provide some investors with a better chance to
collect their awards.
Better follow up on award payments, however, will
not address the primary nonpayment problem,
because most broker-dealers that failed to pay the
awards were no longer in business. To the extent
these broker-dealers may be insolvent, investors
have little chance to recover their awards. NASD's
arbitration program did not address this problem,
but after discussing our preliminary findings,
NASD suggested some program changes that might
reduce costs and increase options for investors.
In addition, some investor arbitration attorneys
have suggested other approaches that might be
considered to address the nonpayment issue.
Over Half of Awardees Were Not Paid
As table 4.1 shows, an estimated 61 percent (7
percentage points) of investors who won
arbitration awards in 1998 either were not paid or
received only partial payment. This percentage
estimate rises to 64 percent (7 percentage points)
if only NASD cases are considered. We developed
these estimates from a survey of a random
probability sample of 247 of the 845 investors who
received monetary awards in arbitration cases
decided in 1998.
Table 4.1: Estimates of the Percentage of Monetary
Customer Arbitration Awards Issued by All Forums
and NASD in 1998 That Broker-Dealers or Individual
Brokers Paid Nothing, Paid Partially, or Paid
Fully
Forum Number of Percentag Percentage
monetary e paid paid Percenta
customer nothing partially ge
awards
paid
fully
All forums 845 49%a 12% 39%a
NASD 786 52a 12 36a
aSampling error is 7 percentage points.
Source: GAO analysis of awardee survey data.
On the basis of responses from investors who
reported total dollars unpaid, we estimated that
unpaid awards amounted to $129 million, or 80
percent (8 percentage points), of the $161 million
total awarded in 1998.3 The unpaid awards included
an estimated $55 million ($8 million) of unpaid
awards for punitive damages. Table 4.2 shows that,
in general, larger awards were less likely to be
paid than smaller awards. For example, only 5
percent of awards of $1.15 million and over were
paid in full, compared with 44 percent (9
percentage points) of awards under $100,000. Also,
only 17 percent (6 percentage points) of the total
dollars owed in awards of $1.15 million and over
were paid, compared with 43 percent (12 percentage
points) of the total dollars owed for awards under
$100,000.
Table 4.2: Estimates of Percentage of Award Cases
Paid in Full and Dollar Amounts Paid in 1998, by
Size of Award
Range of Percentage Total Percentage
award of awards dollars of total
amount Number of paid awarded dollars
awards in full paid in
part and
in full
$1.15 22 5% $82,281,6 17%a
million and 00
over
$277,000 up 73 20 24
to $1.15 39,350,60
million 0
$100,000 up 130 38b 21,858,90 37b
to $277,000 0
Under 620 44c 17,318,87 43d
$100,000 0
aSampling error is 6 percent.
bSampling error is 17 percent.
cSampling error is 9 percent.
dSampling error is 12 percent.
Source: GAO analysis of awardee survey data.
Our survey allowed respondents to cite one or more
reasons for nonpayment or partial payment of their
awards, on the basis of their knowledge of the
cases. The most frequently mentioned reasons were
� the broker-dealer was out-of-business,
estimated to be a reason in 53 percent (9
percentage points sampling error) of all late or
unpaid awards;
� the broker-dealer claimed to be financially
unable to pay the award, estimated at 32 percent
(8 percentage points);
� an individual broker (associated person)
owing part or all of the award could not be
located, estimated at 28 percent (8 percentage
points); or
� the broker-dealer had filed for bankruptcy,
estimated at 21 percent (7 percentage points).
We also estimated that for 3 percent4 of the
unpaid awards, the award was not paid because the
award had been modified or vacated by a court, or
such a measure was pending, which are legitimate
reasons for nonpayment. In an estimated 8 percent5
of the cases, nonpayment or partial payment was in
some way due to the occurrence of a postaward
settlement, a compromised award (in which the
awardees agreed to accept less than the full
award), or an installment payment arrangement.
Most survey respondents with unpaid or
partially paid awards reported taking a variety of
actions to collect their awards. Survey
respondents said they complained to the forum in
an estimated 71 percent (10 percentage points) of
the cases in which they received an award; 67
percent (10 percentage points) said they
complained to the broker-dealer, an individual
broker, or their attorneys; 67 percent (11
percentage points) said they took "further legal
action"; and 34 percent (11 percentage points)
reported filing a complaint with SEC about the
unpaid award.
Forums in our sample, other than NASD,
decided too few awards in 1998 to be projected
with meaningful results. Of the 44 NYSE
arbitration cases decided in 1998 in which
investors received monetary awards, we sampled 10
and received 8 responses. Seven of the eight
respondents said their awards were fully paid, and
one said the principle amount of the award was
paid but the respondent declined to pay the forum
fee, which he was awarded.6 Of the 10 AAA awards
in 1998, we sampled 4 and received responses from
3. Two of the three respondents said their awards
were fully paid, and one said nothing was paid. We
did not receive a response from the one Pacific
Exchange awardee in our sample.
The number of completely unpaid NASD awards
was estimated to be 410 (60 percentage points),
representing nearly all (99.7 percent) of the 411
(60 percentage points) unpaid awards in all
forums. Partially paid NASD awards numbered about
95 (37 percentage points), comprising most (94
percent) of the 101 (39 percentage points)
partially paid awards for all forums. After
removing non-NASD awards from our analysis, we
estimate that 52 percent (7 percentage points) of
the 786 NASD customer awards issued in 1998 were
completely unpaid, 12 percent were partially paid,
and 36 percent (7 percentage points) were paid in
full (see table 4.1).
NASD Did Not Routinely Determine If Arbitration
Awards Were Paid
Our estimates indicate that 504 (60 percentage
points) NASD awards made in 1998 were either not
paid or partially paid, but NASD records showed
that it only received written complaints of
nonpayment in 142 cases.7 These complaints were
the only source of information NASD had on unpaid
or partially paid awards. When it received a
complaint, NASD initiated suspension proceedings
against nonpaying broker-dealers and often had
success in compelling them to pay awards.
After an NASD arbitration panel renders an award,
NASD is to send copies of the award to the
claimant and the respondent, including a cover
letter noting that all monetary awards are to be
paid within 30 days of receipt. NASD may suspend
or cancel a broker-dealer's membership or an
individual broker's registration if they are the
respondents in an arbitration award and fail to
comply with the award or an arbitration settlement
agreement. When NASD receives a complaint that a
member firm or individual broker failed to pay an
award or settled amount, it sends a warning letter
indicating that the respondent's
membership/registration will be suspended unless
one or more of five conditions had been met. To
avoid being suspended, the respondent (or his/her
attorney) must send NASD documentary evidence
showing that
� the award has been paid,
� the parties have agreed to installments or
have otherwise agreed to settle the matter,
� the award has been modified or vacated by a
court,
� an action to modify or vacate the award is
pending in a court, or
� a bankruptcy filing is pending or a
bankruptcy court has discharged the award.
NASD revocation procedures also allow the
respondent to request a hearing on the matter to
consider whether (1) the respondent was given
notification of the award, (2) the respondent
satisfied the award, and (3) a valid reason exists
for the respondent's failure to comply with the
award.
NASD sent warning letters to all of its
member broker-dealers and individual brokers who
were involved in the 142 investor complaint cases
about nonpayment of 1998 awards. In 49 cases, the
NASD member paid the award, agreed to an
installment plan, or otherwise settled the matter
without being suspended. Members in 14 cases
sought a court order to vacate the award; 5 filed
for bankruptcy, and 9 requested a hearing (3 of
which also filed a motion to vacate). The parties
settled one of the nine cases before the hearing.
The hearing decisions for the other eight cases
resulted in two award payments, three suspensions,
and two dismissals because the members had
terminated their NASD membership and were no
longer subject to NASD actions. The final case was
dismissed because the member filed a motion to
vacate the award. NASD suspended the other 68
members because they failed to respond to the
warning letter, 4 of these members eventually paid
the award and were reinstated. In total, NASD
action resulted in about 40 percent of the awards
being paid or otherwise settled to the
satisfaction of the investors.
NASD officials told us they did not attempt
to enforce the payment of awards without receiving
a complaint of nonpayment. They said that attempts
to enforce payment might give the appearance of
favoring one side in arbitration over the other.
They also said that NASD members are liable for
paying interest on unpaid awards, which encourages
prompt payment.
Although remaining neutral is important to
help maintain the credibility of an SRO-sponsored
forum, ensuring that investors are paid
arbitration awards is an important part of
maintaining their confidence in arbitration. Some
proactive actions can be taken that would not
affect NASD's position. For example, as we
previously discussed, NASD sends letters to both
parties notifying them of the award and the 30-day
payment requirement, then takes no further action
unless investors complain. However, the large
difference in our estimates of the number of
investors who reported that they did not get paid
and the number of complaints on which NASD took
action, may indicate that many unpaid investors do
not complain to NASD or that NASD responds only to
written formal complaints. Thus, nonpaying brokers
may continue to operate with no action being
taken. Taking action to monitor the status of
award payments and identify nonpaying brokers as
soon as payment is due not only could benefit
investors but also could help preserve their
confidence in the arbitration process and thus
benefit the entire securities industry.
NASD could determine the status of award payment
by requiring both parties to notify it when they
have paid an award or received payment, at least
by the end of the 30-day payment period. Data
developed through this process could help NASD
timely identify nonpaying broker-dealers or
individual brokers and limit their ability to
continue to operate without paying awards. This
could be especially important because our survey
results showed that a few broker-dealers were
responsible for several nonpayments. For example,
10 broker-dealers were each responsible for 3 or
more unpaid awards, which in sum accounted for 62
unpaid awards-about 25 percent of the 247 awards
in our sample.
NASD Is Considering Changes to Address Award
Nonpayment by Broker-Dealers That Are No Longer in
Business
The primary cause of unpaid arbitration awards was
broker-dealers and individual brokers who were no
longer in business and had left the securities
industry. NASD's arbitration program had no
procedures to help investors deal with these
failed broker-dealers. As a result, investors had
to go through the arbitration process to obtain a
judgment against these broker-dealers whether or
not they were still in business. This would have
been both expensive and time-consuming to the
investors. NASD is considering making several
program changes that might help investors better
deal with failed broker-dealers.
Our survey respondents identified 65 broker-
dealers that had failed to pay at least 1 award.
NASD officials reported to us that 13 of these
broker-dealers were still active, while 52 went
out of business after they had been expelled,
suspended, terminated, or canceled from NASD
membership or liquidated. According to NASD
information, 25 of these broker-dealers were known
to conduct business in microcap stocks. All 25 of
these microcap broker-dealers were among the 52
identified as no longer in business. Our survey
also identified 15 individual brokers that
respondents indicated had not paid awards. We did
not have enough information on them to accurately
identify the individuals and determine their
status.
As the statistics show, investors who filed claims
against broker-dealers that were no longer in
business had little likelihood of getting paid
their awards. SEC officials noted that to help
recover all or part of their awards, these
investors may confirm their arbitration awards in
court. Doing this, the officials said, gives
investors the ability to convert awards into
judgments, which they then can try to enforce
against any assets of the failed broker-dealer or
individual broker that can be located.
NASD officials said they are considering ideas for
several program changes to reduce costs and
increase options for investors seeking to
establish a claim and judgment against defunct
brokers. First, they would propose to NASD's Board
and SEC a rule amendment that a respondent broker-
dealer that has been terminated, suspended, or
barred from NASD, or that is otherwise defunct,
cannot enforce a predispute agreement against a
customer in an NASD forum. Second, they also would
propose a rule amendment to provide streamlined
default proceedings for cases in which the
terminated or defunct broker-dealer does not
appear, but the investor affirmatively elects to
pursue arbitration. Third, they would propose to
advise investors that make arbitration claims of
the status of the broker-dealer (such as
terminated, out of business, or expelled) so these
investors could better evaluate whether to
continue with arbitration or to proceed in some
other forum, such as in court. Although the
changes NASD is considering may not ultimately
result in investors receiving their arbitration
award payments from broker-dealers that are no
longer in business, they could reduce the costs of
the process and increase the options available for
investors.
Other Potential Solutions to the Problem of Unpaid
Awards
The broker-dealer or individual broker that an
investor chooses might ultimately influence the
investors' chances of recovering an arbitration
award because many nonpayments were caused by
failed broker-dealers. Regulatory officials told
us that failed broker-dealers were often
undercapitalized, financially irresponsible, or
unscrupulous. SEC and the SROs have education
programs to help investors understand the
potential risks of dealing with such broker-
dealers, but these programs have not included data
on the extent of award nonpayment. Publicizing
such data might better focus investor attention on
the possibility of unpaid awards. In addition,
encouraging investors to use the Central
Registration Depository8 to more thoroughly
evaluate the background of a broker-dealer or
individual broker could help investors who are
considering opening brokerage accounts to avoid
doing business with potentially troublesome
brokers.
Some attorneys who have represented investors in
securities arbitration have proposed other methods
to ensure that investors are paid their
arbitration awards. Their proposals include
� providing SIPC coverage of unpaid awards,
� establishing a separate SRO-sponsored fund
for unpaid awards, and
� increasing the availability of funds from
broker-dealers or individual brokers to pay awards
by raising net capital requirements or requiring
additional bonding or insurance to cover
malpractice claims.
We did not assess the feasibility of these
proposals but obtained the views of SEC, NASD, and
affected organization officials, including SIPC
officials and officials of organizations that
represent arbitration attorneys and broker-
dealers.
The first proposal would provide for payment of
unpaid arbitration awards from SIPC funds.
Congress enacted the Securities Investor
Protection Act in 1970, which established SIPC,
after the failure of many broker-dealers raised
fears of a run on solvent broker-dealers. The
statute's purpose is to encourage investors to
leave their securities with broker-dealers by
protecting the firms' custodial function. The
act's provisions are designed to effect an
expeditious return of all customer securities and
cash held at a failed broker-dealer. SIPC
officials told us that changing SIPC's mission to
include coverage of all unpaid arbitration awards
would require amending the Securities Investor
Protection Act. The officials said coverage of
unpaid awards would increase SIPC's caseload and
require it to become larger and increase its need
for resources. For example, SIPC, which protects
only against broker-dealer insolvency in certain
situations, had 29 employees at the end of 1998.
In contrast, the United Kingdom's Investor
Compensation Scheme (ICS) had over 115 employees
as of March 1999. ICS is similar in function to
SIPC in that it protects investors against
insolvency, but ICS provides broader coverage of
investor losses due to fraud. SIPC officials also
noted that many arbitration awards are granted by
default when a broker-dealer, that has gone out of
business, fails to contest a claim. Thus, they
said, the validity of the claim was never tested.
Officials of SIA told us that expanding SIPC
coverage to include all unpaid arbitration awards,
if funded by assessments on broker-dealers, could
increase costs for broker-dealers and investors.
They also said that expanded coverage might
encourage frivolous arbitration claims and reduce
incentives for investors to carefully choose their
brokers and investments. SEC officials agreed that
expanded coverage could create moral hazards.
In addition, SEC officials noted that paying
possibly $129 million (our estimate of the amount
of unpaid claims in 1998) a year to cover such
claims would quickly exhaust the SIPC fund ($1.1
billion), which is intended as a reserve against
the failure of a large broker-dealer. The fund was
built up over the last 3 decades by assessing
broker-dealers a percentage of their yearly gross
revenues. SEC officials pointed out that the
majority of this funding came from the handful of
broker-dealers that consistently have yearly
revenues far in excess of the vast majority of all
active broker-dealers. The task of replenishing
the fund would again fall largely on the shoulders
of these few broker-dealers, which SEC said are
well capitalized, have adequate reserves to cover
arbitration judgments, and are not delinquent in
paying such awards. We are reviewing SIPC
operations in detail at the request of the Ranking
Minority Member, House Committee on Commerce, and
plan to report the results in a separate report.
The second proposal made by the arbitration
attorneys was to establish a separate SRO-
sponsored fund to cover the compensatory damages
part (actual investor losses) of unpaid
arbitration awards. Arbitration attorneys
suggested that such a fund could be financed from
either one or a combination of (1) interest from
the SIPC fund, (2) a charge on investor
transactions, (3) fees on broker-dealers and
individual brokers, and (4) funds obtained from
NASD money penalties. These attorneys suggested
that the fund be limited to the payment of
investor claims of compensatory damages after an
award is deemed "uncollectable," that is, when the
liable party has left the securities industry. SEC
and industry officials said that establishing such
a fund could pose the same disadvantages as
expanding SIPC coverage, including increased costs
for broker-dealers and investors and the
discouragement of broker and investor diligence.
SEC officials also emphasized that the SIPC fund
stands as a reserve against the failure of a large
broker-dealer, and that the interest from the fund
pays for SIPC's operations and the costs of small
firm liquidations, of which there are
approximately seven new proceedings each year.
These officials said that diverting the interest
to satisfy unpaid arbitration awards would deplete
the fund's principal and could create the funding
problems previously discussed. SEC officials noted
that the level of the SIPC fund dropped from about
$1.196 billion to $1.129 billion during the 1999
calendar year.
The third proposal was to increase the funds
available to brokers to pay arbitration awards by
increasing net capital requirements. Arbitration
attorneys suggested that additional broker-dealer
capital could be set aside in escrow for a period
of time, such as 2 years after their membership is
terminated, so that these funds would be available
to pay awards when the broker-dealer leaves the
industry. SEC officials said that the purpose of
the net capital rule is to require broker-dealers
to maintain sufficient liquid assets to be able to
self-liquidate in an orderly manner. This
benefits investors by allowing insolvent broker-
dealers to remain operating long enough to
transfer customer assets out of the firm. These
officials said the rule relies on accounting
principles and, therefore, is not equipped to
create reserves against the potential for adverse
arbitration awards that might arise in a broker-
dealer's future. SEC officials said that to
establish reserves against the type of arbitration
awards that go unpaid (such as awards that are
based on claims not covered by the Securities
Investor Protection Act, and which bankrupt a firm
or cause it to close) would necessitate a
substantial increase in the minimum capital
requirements. These officials noted that investors
obtaining arbitration awards would be general
creditors of the failed broker-dealer. Therefore,
absent an amendment to the U.S. Bankruptcy Code,
the reserves would need to be large enough to
cover all creditor claims for this proposal to
provide meaningful assistance to investors.
SEC officials stated that, in their view, a
sizable increase in the net capital requirements
would force many small broker-dealers out of the
industry, and unduly penalize those broker-dealers
operating in a responsible manner. Moreover, the
costs of maintaining this additional capital could
eventually be passed on to investors, at least in
part. SEC officials also noted that effectively
barring small broker-dealers from entering the
securities business by raising net capital
requirements could hurt investors by limiting
their choice of broker-dealers. Industry officials
said that they did not know how much net capital
requirements would have to increase to cover
investor claims.
In addition, SEC officials pointed out that, under
the net capital rule, broker-dealers must
immediately book a liability after receiving an
adverse arbitration award. Therefore, to remain in
business, the broker-dealer must maintain
sufficient capital to cover the amount of the
award. Furthermore, these officials said that
under Generally Accepted Accounting Principles, a
broker-dealer must record a liability for a
pending arbitration claim if it is likely the
broker-dealer will lose and if the amount of the
pending award is reasonably certain. They said
this accounting principle requires broker-dealers
to evaluate all pending claims and determine
whether the claims need to be booked as
liabilities for net capital purposes. SEC
officials stated that they would determine whether
this evaluation process should be made more
transparent to regulators by requiring thorough
documentation.
Other methods suggested to increase the
availability of funds from broker-dealers to
provide for payment of awards were to place
additional bond requirements or have broker-
dealers and individual brokers carry explicit
insurance to protect against malpractice claims.
Industry officials said these methods also could
raise costs on broker-dealers industrywide and
ultimately on investors. Industry officials were
uncertain how much insurance would be needed and
whether insurers would be willing to underwrite
the coverage without limitation on liability. NASD
Rule 3020 already requires that member broker-
dealers maintain a blanket fidelity bond to
protect against various losses, including
fraudulent trading. Coverage varies from $25,000
to $500,000 depending on the broker-dealers' net
capital requirement. However, the bond provides
only first-party coverage, meaning only the broker-
dealer could file a claim. Also, the required
coverage, especially for small broker-dealers,
might not be enough to pay for multiple awards
exceeding $25,000.
_______________________________
1 Our estimates are based on survey responses of
claimants or their representatives regarding the
status of award payment from a representative
random probability sample of awards favoring
investors decided in 1998. We did not follow up to
validate the accuracy of the survey responses.
Survey estimates also are subject to sampling
error. Unless otherwise noted, all estimates of
percentages have sampling errors of plus or minus
5 percentage points or less, and all estimates of
total numbers (e.g., of awards or dollars) have
sampling errors of plus or minus 10 percent or
less of those total values. This percentage
estimate (49 percent) has a sampling error of 7
percentage points.
2 In 3 percent of these cases, survey responses
indicated that the award had been modified or
vacated by a court or such action was pending. If
we exclude all of these awards from the sample
because they legitimately may no longer be owed to
the investors, our estimate of the unpaid dollar
amount of the awards decreases to 72 percent. Our
other estimates do not vary significantly when
these cases are excluded.
3 When the 3 percent of unpaid awards for which
survey respondents said the award was modified or
vacated by a court or pending in court are
excluded, the dollar amount of unpaid awards falls
to $116 million, or 72 percent. Other estimates do
not vary significantly when these cases are
excluded.
4 The sampling error for this small estimate
results in a 95-percent confidence interval around
the value ranging from 1 to 10 percent.
5 The confidence interval ranges from 3 to 17
percent.
6 NYSE officials said that a review of the award
indicates that the forum fee, which was $15, was
not part of the award to the investor.
7 Our survey respondents said that they complained
to the forum in an estimated 71 percent of the
cases, or about 360 awards. This number vastly
exceeds the 142 cases in which NASD records
contained a complaint letter about a 1998 unpaid
award. Similarly, SEC officials told us that they
received far fewer complaints than the estimated
34 percent reported by our sample respondents. We
do not know why the survey results and reported
complaints received differed.
8 The Central Registration Depository is a
database that NASD maintains containing employment
and disciplinary histories of individual brokers
as well as disciplinary actions taken against
member broker-dealer firms.
Chapter 5
Conclusions and Recommendations
Page 46GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
Conclusions
NASD and NYSE have made changes to their
arbitration programs that are consistent with our
1992 recommendations and intended to improve the
fairness of the arbitration process. These changes
appear reasonable, and NASD and NYSE evaluations
have shown that the changes have improved both the
process and investors' perceptions of its
fairness.
We could not determine whether the decline in the
percentage of awards that favored investors
indicated anything about the fairness of SRO-
sponsored arbitration. An increase in the
percentage of settled cases-some of which broker-
dealers may have chosen not to arbitrate because
they reasonably expected to lose-may have changed
the mix of cases going to arbitration. For this
reason, the declining win rates may not indicate a
change in the fairness of the arbitration process.
Unlike our 1992 report, we did not have sufficient
cases from AAA to compare the results of an
independent forum to the SRO-sponsored forums.
Also, we did not find enough securities-related
court cases to compare results with the SRO
forums. However, the high dismissal rate of
securities-related court cases may indicate that,
in general, investors have not fared better in
court.
The securities industry, its regulators, and
Congress should be concerned about the extent to
which arbitration awards are unpaid. Regardless of
how effective and fair the arbitration decision
process may be, unpaid awards could negatively
affect investors' confidence in arbitration. A
timely NASD follow-up program on award payments
would likely improve the chances that some
investors would be paid their awards. In addition,
investors would save time and money in
establishing their claims if NASD implemented the
types of actions it is considering.
Ultimately, recovering losses caused by
undercapitalized, financially irresponsible, or
unscrupulous broker-dealers is difficult, if not
impossible, for investors. However, data developed
from monitoring award payments should help educate
investors about the possibility of unpaid awards
associated with doing business with these broker-
dealers. In addition, encouraging investors who
are considering opening brokerage accounts to use
the Central Registration Depository to evaluate
the background of a broker-dealer or individual
broker could help them make better decisions. The
arbitration attorneys' suggested award payment
alternatives raise policy issues that warrant
careful consideration and resolution before they
could be effectively implemented.
Recommendations
We recommend that the Chairman, SEC, require NASD
to adopt procedures for monitoring the payment of
arbitration awards. Such procedures should include
requesting the parties in an arbitration to notify
NASD, by the end of the 30-day payment period,
about the payment status of any monetary award, so
NASD can begin timely suspension proceedings
against nonpaying broker-dealers, as appropriate.
We recommend that the Chairman require NASD to
develop procedures addressing the problem of
unpaid awards caused by failed broker-dealers to
help reduce costs and increase options for
investors, such as the changes NASD is
considering.
We recommend that the Chairman work with the SROs
to (1) develop and publicize information to focus
investor attention on the possibility of unpaid
arbitration awards and (2) encourage investors to
more thoroughly evaluate the backgrounds of broker-
dealers and individual brokers with whom they
intend to do business.
Lastly, we recommend that the Chairman
periodically examine the extent of nonpayment of
SRO arbitration awards to determine the
effectiveness of actions taken to improve the
payment of awards. To the extent unpaid awards
remain a problem, the Chairman should establish a
process to assess the feasibility of alternative
approaches to addressing the problem of unpaid
awards.
Agency Comments and Our Evaluation
NASD Regulation, Inc. (NASDR), the NASD
subsidiary with primary responsibility for its
arbitration program through the Office of Dispute
Resolution; NYSE; and SEC provided written
comments on a draft of this report, which are
reprinted in appendixes IV, V, and VI. These
organizations generally agreed that our draft
report revealed a potentially serious problem with
the nonpayment of arbitration awards by broker-
dealers and individual brokers that had left the
industry, and they agreed with our recommendations
to address this problem. However, these
organizations expressed specific concerns about
some of the analytic approaches we used and the
results of our analysis. Also, NASD provided
additional information on the actions it has taken
to improve the overall efficiency and fairness of
its arbitration program and to evaluate the
effects of these changes.
NASDR noted that the problem of unpaid awards does
not indicate a problem with the NASD arbitration
program but rather of bankrupt or defunct firms.
It said that the same collection problems against
these firms exist when investors take their claims
to court or non-SRO arbitration forums.
Nonetheless, NASDR agreed that appropriate
measures need to be taken to encourage prompt
payment of arbitrator awards and proposed several
initiatives to address award nonpayment. If
effectively implemented, these initiatives would
comply with the intent of our recommendations.
NASDR expressed concern about our conclusion that
the statistics show arbitration awards favoring
investors have declined since before 1992. NASDR
cited data from SICA, both for all SROs and for
NASD, that show the recent trend has been more
favorable to investors with the composite figures
from all SROs reaching higher levels in 1997 and
1998 than at any time in the previous 17 years.
They said this trend continued in 1999 when
investors won 61 percent of awards. The SICA data
and the SAC database, which we used for our
analysis, were developed from different sources,
but produced similar results for the 1992 through
1998 period. However, the data from our previous
report, which we developed from an extensive
review of individual case files for cases decided
over an 18-month period from January 1989 through
June 1990, show a considerably higher percentage
of favorable results for investors, 59 percent,
than the yearly SICA data show for either 1989 or
1990, 53 percent for both years. We did not do any
work during this review to attempt to explain
these differences.
NASDR also discussed its attempts to follow up on
the unpaid awards we identified to determine
whether current members were involved. This task
was difficult because our survey results were
confidential, and we could only provide NASDR with
the names of broker-dealers and the number of
unpaid awards attributed to each. NASDR's review
of cases found only 21 that involved current
member firms, and in 10 of those cases, NASDR
reported that the firm had no obligation to pay
the award. Because we only provided limited
information, we do not know if the cases NASDR
included in its review were the same cases that we
surveyed.
NASDR also questioned the methodology used to
obtain the sample of awards we surveyed to obtain
estimates of their payment. It was concerned that
oversampling of the largest awards may have skewed
the survey to include a greater percentage of
awards against broker-dealers that are no longer
in business. As described in appendix II, we
sampled at a higher rate for large and medium
awards than for small awards to provide more
precise estimates for each stratum and across the
entire population. However, in producing the
estimates, we weighted responses to account
statistically for all members of the population,
including those that were not selected or did not
respond to the survey. For example, all 95 of the
largest awards were sampled, so they were each
assigned a weight of 1 to represent only
themselves. We assigned small awards larger
weights to represent other small awards not
sampled. Thus, the oversampling of large awards
provided more precise estimates for those awards
but did not overrepresent those large awards in
our estimates for the entire population of awards.
NYSE had no objections to our findings and
recommendations but objected to our classification
of one NYSE award as partially paid, solely on the
basis of the response provided to our survey. NYSE
validated that the award was fully paid, and we
provided that information in our report. We did
not use these data to project our sample results
for NYSE.
NYSE agreed with our finding that the decline in
award decisions favoring investors could indicate
little or no change in the fairness of the
arbitration process. It further noted the
information in the report that, in its view,
supports the fairness of SRO arbitration. However,
NYSE expressed concern about our analysis of
factors affecting arbitration results with the SRO
being one of the factors. NYSE noted that it is
difficult to compare the results in arbitration
unless similar claims and similar broker-dealers
are used. We provided a separate analysis of
awards against a common set of broker-dealers for
NASD and NYSE but could not provide a similar
distinction among claims. Any analysis of this
sort is limited to the available data. We had
information on several of the characteristics of
cases and claimants, which we analyzed in a
rigorous and systematic fashion. We acknowledge
that more and better information might have
altered our results. Unless the information we
were missing is significantly associated with the
characteristics we had available, our estimates,
which were based on hundreds to thousands of award
observations, provide unbiased estimates of the
effects of those characteristics.
SEC stated that the report provides useful data to
confirm the message it has brought repeatedly to
investors over the past 8 years: investors must
investigate before they invest. SEC suggested that
we could have provided more meaningful information
about the fairness of SRO arbitration by comparing
the procedures used by the SRO arbitration forums
against independently developed standards for
alternative dispute resolution. SEC said such an
analysis would show that the SRO procedures
measure favorably against the standards. Although
measuring procedures against standards may provide
a useful indicator of the fairness of the
arbitration process, our requesters asked us to
determine the outcomes of cases to assess how
investors fared in securities arbitration award
decisions. We could not comment on the fairness of
the SRO arbitration process based on the
statistics alone unless they could be measured
against the outcomes of securities cases at an
independent forum or the courts because these are
the only other venues for resolving securities
disputes.
SEC also stated that our analysis of arbitration
awards failed to distinguish between the amounts
of compensatory damages claimed and awarded and
punitive damages claimed and awarded. To the
extent compensatory damages represent the actual
losses of investors, a separate analysis of the
awards for these damages may have provided useful
information about whether investors recovered
their actual losses through arbitration. We
focused on the total amounts awarded because our
objective was to determine how investors fared
overall in arbitration award decisions rather than
whether they recovered their actual losses.
However, we include in chapter 3 data on the
frequency with which punitive damages were claimed
and awarded in 1998 that are comparable to data of
our 1992 report.
SEC also requested that our report provide greater
detail on the payment of awards of less than
$100,000 and from $100,000 to $277,000. It stated
that this information would be useful for average
investors who might decide to forego seeking
restitution in the mistaken belief that
arbitration awards are not paid. We now show these
data in table 4.2.
In addition, SEC asked that we clarify that broker-
dealers that stay in business have a good payment
record. Although, the information presented in our
report suggests this may be true, we did not
specifically analyze the payment records of these
broker-dealers.
Appendix I
Methodology for Analyzing Arbitration Results
Page 59GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
To determine how investors fared in securities
arbitration, we analyzed arbitration award data.
We used the award data to calculate rates
(percentages) reflecting the extent to which
investors won awards, damages investors' claimed
were awarded, and various factors influenced
arbitration outcomes.
Arbitration Case Data
The data we used to describe the characteristics
of cases brought to arbitration and their outcomes
were obtained from Securities Arbitration
Commentator, Inc. (SAC), Maplewood, NJ. SAC is a
commercial research firm that maintains a database
of information from publicly available records on
decided cases from all of the self-regulatory
organization (SRO) arbitration forums and the
American Arbitration Association (AAA).
The SAC database contained information on
arbitration awards that resulted from (1) customer
(investor) claims of damages against SRO-member
broker-dealers (called customer-member claims) or
their individual registered representatives
(called customer-employee claims) and (2)
investors' small claims cases of less than a
specified dollar amount (which only apply to
customer-member claims), that SAC maintained as a
separate award category, covering the period from
January 1, 1992, through December 31, 1998. By
definition, these data did not include records of
cases that were settled or dismissed before a
decision was reached. Estimates of the percentage
of cases settled were from data provided by SICA.
The 11,290 cases in the database included
fields describing 113 variables such as the
following: the name of the forum; the parties
involved in the proceeding (customer-member,
customer-employee, small claims, etc.); type of
claim; amounts claimed; and amounts awarded.
We analyzed the following cross tabulations to
understand the data and plan the analysis:
� the number of awards in favor of (won) and
against (lost) investors, by year and by
forum;
� the difference between the amount awarded and
the amount claimed, by year and by forum;
� type of damages claimed,by year;
� amount of damages claimed, by year and by
forum;
� type of award, by year and by forum;
� amount of award, by year and by forum; and
� processing time, by year and by forum.
Our data reliability assessment included several
steps. First, to assess the reliability of the
data we selected a simple random sample of 350
arbitration award records in the SAC database and
compared them to the corresponding hard-copy
awards as issued by the forums that we obtained
from SAC. This analysis determined the percentage
of records that contained more than one inaccurate
field and the percentage of inaccurate fields. The
analysis showed that 4.0 percent of the sample
records had errors in more than one field. Further
analysis showed that the 95-percent confidence
interval for the percentage of records with more
than one error was 2.2 to 6.7 percent. The second
analysis showed that 1.1 percent of the fields
were incorrect. The 95-percent confidence interval
bounds for the percentage of the fields that were
incorrect ranged from 0.7 to 1.6 percent.
Second, SAC also verified the completeness of
awards in its database of closed awards through
comparison to lists of closed awards at NASD
Regulation, Inc., annual arbitration reports
published by the Securities Industry Conference on
Arbitration (SICA), and summary statistics of the
National Association of Securities Dealers (NASD)
arbitration program. Similar steps were taken to
ensure receipt of all Municipal Securities
Rulemaking Board and American Stock Exchange
awards. AAA awards recorded in the SAC database
were checked against AAA records by AAA. Awards
rendered by the Pacific Exchange, The Chicago
Board Options Exchange, Inc., and the Philadelphia
Stock Exchange were routinely reviewed and
compared with forum reports to spot any
discrepancies with the SAC data. In 1998, SAC
began the practice of checking with the New York
Stock Exchange (NYSE) to determine that the NYSE
awards contained in SAC's database represented all
of the public awards rendered at the NYSE.
However, because we could not be sure that any
list or records of awards included all awards
issued, we could not ensure that the SAC data
included all awards issued from January 1992
through December 1998.
To account for differences in membership
among forums we calculated these percentages for a
data set of awards involving major broker-dealers
that had multiple awards in both NASD and NYSE. We
identified the major broker-dealer cases as those
involving the major broker-dealers in the industry
in terms of registered retail sales
representatives. We also limited our major broker-
dealer analysis to those broker-dealers involved
in multiple arbitration awards at both NYSE and
NASD. On the basis of this definition, there were
3,502 major broker-dealer cases in the SAC
database. These cases represented 31 percent of
all of the cases in the database.
To provide descriptive information on the
extent to which investors won arbitration awards
and the amount of damages claimed that was
awarded, we calculated percentages for the amount
of awards in which investors won and lost
decisions and percentages for the amount claimed
that was awarded.
We analyzed these percentages by forum for
all cases in the database. In addition, we
analyzed won and lost percentages by forum for the
award cases involving the selected major broker-
dealers with multiple awards in both forums. For
all cases in the databases (before selection of
cases involving the major broker-dealers),
percentages of investor-favorable decisions were
45 percent at NYSE, 54 percent at NASD, and 53
percent in all other forums. For only those cases
selected as major broker-dealers, these
percentages were 41 percent at NYSE, 44 percent at
NASD, and 53 percent for all other forums.
A significant number of investors received awards
for less than half of the amount claimed across
all forums. At NYSE, 60 percent of investor awards
were for less than half of the amount claimed
while at NASD, 50 percent of investor awards were
for less than half of the amount claimed. The
corresponding figure in all other forums was 40
percent.
Similar results were found for the subset of cases
that involved major broker-dealers with multiple
awards in both NASD and NYSE. For example, at
NYSE, 62 percent of investor awards were for less
than half of the amount claimed while at NASD, 58
percent of investor awards were for less than half
of the amount claimed. The corresponding figure in
all other forums was 44 percent.
Loglinear Analysis of Arbitration Outcomes
We also used the SAC data to determine the
factors that affected the outcome of securities
arbitration in this time period. To characterize
the features of arbitration cases that are
associated with certain outcomes, we examined the
influence of a number of factors in a multivariate
model.
We analyzed the data on arbitration cases in
two steps. First, we investigated which
characteristics of the claims of damages affected
the likelihood that cases were won (decided in
favor of the investor) rather than lost (decided
against the investor). Second, we investigated,
for claims of damages that were won and in which a
monetary award was sought, which claim
characteristics affected the likelihood that the
amount awarded was more than 50 percent of the
amount sought. The claim characteristics we
considered included (1) the year of the claim
(1992, 1993, 1994, 1995, 1996, 1997, or 1998); (2)
the type of disposition (customer-member or
customer-employee); (3) whether the claimant was
represented by an attorney; (4) whether the
claimant was seeking compensation only; (5)
whether a counterclaim was made; (6) whether there
was a hearing; (7) the time it took to process the
claim (less than 6 months, 6 to 11 months, 12 to
24 months, or more than 24 months); (8) the forum
in which the claim was brought (NASD, NYSE, or
Other); (9) the claim amount sought ($0, $1 to
$9,999, $10,000 to $100,000, or more than
$100,000); and (10) the number of hearings (0, 1
to 4, 5 to 10, or more than 10).1
In these analyses, we determined the size and
statistical significance of the effect that each
of these claim characteristics had on whether
cases were won, and on whether more than 50
percent of the amount claimed was awarded. We
first looked at the effect of each characteristic
ignoring every other, and then used multivariate
logistic regression models to estimate the net
effect of each of these characteristics, or the
effects they had on these two outcomes when the
associations between claim characteristics were
controlled and all characteristics were considered
simultaneously. Odds and odds ratios, which we
describe below, were used to estimate the size of
the effects of the different claim
characteristics, and chi-square statistics and
Wald statistics were used to determine whether
they were statistically significant (i.e., large
enough that they could not be assumed to be due to
random fluctuations or chance).
Our primary results are summarized in tables
I.1 and I.2 below. The first table shows the
effects of the various characteristics of
arbitration cases on the likelihood that cases
were won. The second table shows the effects of
these same characteristics on the likelihood that
cases that were won were decided for more than 50
percent of the total amount claimed (or sought) by
the individual who filed the claim.
Table I.1: Arbitration Cases Won and Lost, Odds
on Winning Derived From Them, and Odds Ratios
Indicating the Effects of Various Characteristics
of Arbitration Cases on the Odds on Winning
Variable/Category Arbitration Odds on Observ Predict
result win ed ed odds
odds ratios
ratios
Win Lose Total
Type of claim filed
Customer-Member 5,75 5,194 10,948 1.11 - -
4
Customer-Employee 191 151 342 1.26 1.14 0.85
Year
1992 973 846 1,819 1.15 - -
1993 782 754 1,536 1.04 0.90 0.88
1994 669 645 1,314 1.04 0.90 0.84
1995 771 808 1,579 0.95 0.83 0.76
1996 986 919 1,905 1.07 0.93 0.85
1997 886 699 1,585 1.27 1.10 1.02
1998 878 674 1,552 1.30 1.13 1.01
Representation
Attorney 5,43 4,698 10,133 1.16 - -
5
No attorney 510 647 1,157 0.79 0.68 0.79
Claim components
Compensation Plusa 2,24 1,004 3,246 2.23 - -
2
Compensation Only 3,40 3,999 7,404 0.85 0.38 0.43
5
Counterclaim made
No 5,74 5,128 10,871 1.12 - -
3
Yes 202 217 419 0.93 0.83 0.70
Type of case
Written 1,45 1,672 3,131 0.87 - -
9
Hearing 4,28 3,489 7,775 1.23 1.41 Omitted
6
Processing time
< 6mos. 474 616 1,090 0.77 - -
6 mos. - 11 mos. 2,47 2,366 4,841 1.05 1.36 0.99b
5
12 mos. - 24 mos. 2,41 1,918 4,331 1.26 1.20 0.99
3
> 24 mos. 524 393 917 1.33 1.06 0.99
Forum
NASD 5,08 4,411 9,493 1.15 - -
2
NYSE 509 621 1,130 0.82 0.71 0.81
Other 354 313 667 1.13 0.98 0.90
Total claim
$0 374 354 728 1.06 - -
$1-$9,999 1,64 1,944 3,584 0.84 0.79 0.75b
0
$10,000 -$100,000 1,78 1,674 3,462 1.07 1.01 0.78
8
>100,000 2,00 1,273 3,276 1.57 1.48 0.80
3
Number of hearings
0 1,45 1,672 3,131 0.87 - -
9
1-4 2,78 2,608 5,389 1.07 1.23 1.02
1
5-10 1,09 712 1,806 1.54 1.77 1.27
4
>10 411 168 579 2.45 2.79 2.12
Note: Odds ratios in the next to the last column
are derived from the observed odds and indicate
the effect of each claim characteristic when other
characteristics are ignored. Odds ratios in the
last column are from a multivariate model and
indicate the effect of each claim characteristic
when the effects of all other claim
characteristics are statistically controlled.
aCompensatory damages plus other damages,
including punitive damages, attorney fees, and
forum fees.
bNot significant.
Source: GAO analysis of arbitration award data.
The odds on winning in table I.1 tell us how
many claims were won for every claim that was
lost. For the small number of customer-employee
claims filed between 1992 and 1998, for example,
the odds on winning (versus losing) were 191/151 =
1.26. This implies that 1.26 customer-employee
claims were won for every one that was lost or,
multiplying by 100, that 126 customer-employee
claims were won for every 100 that were lost. For
customer-member claims, the odds on winning were
lower and equal to 1.11 (111 were won for every
100 that were lost). The odds ratio in the
penultimate column of the table, which equals
1.26/1.11 or 1.14, tells us that the odds on
winning were higher among customer-employee claims
than among customer-member claims, by a factor of
1.14. We can also interpret this as meaning that
the odds on winning were 14 percent higher among
customer-employee claims than among customer-
member claims. This odds ratio and the others in
the same column indicate the effects each factor
and the other factors had on award outcome when
each factor is assessed while ignoring the others.
The odds ratios in the final column of the table
are more appropriate for assessing the effects
these factors had on award outcome, since they are
derived from statistical models that estimate the
effects of each factor net of every other.
Focusing on the predicted odds ratios in the
final column of table I.1, our principal findings
with respect to the odds on arbitration cases
being won can be stated as follows:
� When the effects of other factors were
controlled, the type of claim filed, processing
time, and amount claimed had no significant
effects on whether arbitration cases were won or
lost.
� The year in which claims were filed had a
significant effect. Between 1992 and 1995, the
odds ratio declined gradually-in 1995 the odds on
winning were only 3/4 of what they were in 1992
(or in 1992 they were about 32 percent higher than
in 1995). Between 1995 and 1997-98, the odds on
winning increased by 33 percent, so that, net of
all other factors, the odds on winning ended up at
the end of the period precisely where they were at
the beginning of it.
� Cases in which claimants were not represented
by attorneys had lower odds on being won, by a
factor of 0.79. Stated differently, the odds on
winning were higher when attorneys represented
claimants by a factor of 1.0/0.79 = 1.27, or by 27
percent.
� Claims seeking only compensation were less
than half as likely-or less likely by a factor of
0.43, to be precise-as other claims to be won.
Alternatively, claims involving more than
compensation were more than twice as likely (2.32
times as likely) to be won.
� Claims in which no counterclaims were filed
were 1.0/0.70 = 1.43 times as likely to be won, or
43 percent more likely.
� NASD claims, not adjusted for differences in
membership, were more likely than NYSE claims to
be won, by a factor of 1.0/0.81 = 1.23, or by 23
percent. We found (in supplemental analyses not
shown) this difference to be similar across all
years. The small number of claims that were filed
in other forums were somewhat less likely than
NASD claims to be won and somewhat more likely
than NYSE claims to be won, but they were not
significantly different from either.
� Claims that involved no hearings were not
significantly different in terms of their odds on
being won from those that involved between one and
four hearings. Claims involving 5 to10 hearings
were 27 percent more likely to be won, and claims
involving 11 or more hearings were 113 percent
more likely to be won than written claims.
Table I.2 provides information pertaining to the
second outcome we considered, involving whether
cases that were won were decided for more than 50
percent of the amount claimed. Focusing on the
odds ratios in the final column of table I.2, our
principal findings with respect to the odds on
arbitration cases that were won being decided for
more than 50 percent of the total claimed
(henceforth referred to as "the odds on winning
sizable awards") can be stated as follows:
� The size of the award was unaffected by
whether more than compensation was sought, whether
a counterclaim was filed, and processing time.
� The type of claim filed had an immense effect
on the odds on winning sizable awards, which was
impossible to estimate with the data at hand.
While slightly fewer than half of customer-member
claims that were won received sizable awards, none
of the customer-employee claims did.
� The year in which claims were filed had a
significant effect. Between 1992 and 1995, the
odds on winning sizable awards dropped by roughly
10 percent. Between 1994-95 and 1998, the odds on
winning a sizable award increased gradually. In
1998, the odds on winning a sizable award were
roughly 30 percent higher than they had been in
1992 and 50 percent higher than in 1995.
� Cases in which attorneys did not represent
the claimants had lower odds on winning a sizable
award, by a factor of 0.77. Stated differently,
the odds on winning were higher when attorneys
represented claimants by a factor of 1.0/0.77 =
1.30, or by 30 percent.
� NASD claims, not adjusted for differences in
membership, were more likely than NYSE claims to
involve sizable awards, by a factor of 1.0/0.69 =
1.45, or by 45 percent. The small number of claims
that were filed in other forums were somewhat less
likely than NASD claims, and somewhat more likely
than NYSE claims, to involve sizable awards, but
they were not significantly different from either.
� Larger claims were less likely than small
ones to win sizable awards. Claims involving
$10,000 to $100,000 were only roughly 60 percent
as likely as smaller claims to win sizable awards,
and claims involving more than $100,000 were
roughly 27 percent as likely as smaller claims to
win sizable awards.
� Claims that involved no hearings were more
likely than claims involving hearings to win
sizable awards, though the number of hearings
appeared to make little difference. In general,
written claims were between 30 percent to 56
percent more likely than others to involve sizable
awards (i.e., 1.0/0.77 = 1.30, or 30 percent;
1.0/0.64= 1.56, or 56 percent; and 1.0/0.69 =
1.45, or 45 percent).
Table I.2: Arbitration Cases Won That Received
Awards That Were More or Less Than 50 Percent of
the Amount Claimed, and Odds Ratios Indicating the
Effects of Various Claim Characteristics on
Winning Sizable Awards
Variable/Category Percentage of Total
claim awarded
Odds on Observed Predicte
> 50 odds d odds
percent ratios ratios
< 50 > 50
perce percent
nt
Type of claim filed
Customer-Member 2,821 2,565 5,386 0.91 - -
Customer-Employee 183 0 183 0.00
Year
1992 506 397 903 0.78 - -
1993 407 323 730 0.79 1.01 1.06
1994 356 268 624 0.75 0.96 0.94
1995 387 335 722 0.87 1.12 0.86
1996 483 430 913 0.89 1.14 1.01
1997 428 412 840 0.96 1.23 1.20
1998 437 400 837 0.92 1.18 1.29
Representation
Attorney 2,770 2,302 5,072 0.83 - -
No attorney 234 263 497 1.12 1.35 0.77
Claim components
Compensation Plusa 1,255 898 2,153 0.72 - -
Compensation Only 1,744 1,659 3,403 0.95 1.32 0.94b
Counterclaim made
No 2,888 2,494 5,382 0.86 - -
Yes 116 71 187 0.61 0.71 0.80b
Type of case
Written 487 934 1421 1.92 - -
Hearing 2,454 1,546 4,000 0.63 0.33 Omitted
Processing time
< 6mos. 158 293 451 1.85 - -
6 mos. - 11 mos. 1,185 1,185 2,370 1.00 0.54 0.99b
12 mos. - 24 mos. 1,355 892 2,247 0.66 0.66 0.99
> 24 mos. 296 182 478 0.61 0.92 0.99
Forum
NASD 2,553 2,254 4,807 0.88 - -
NYSE 308 176 484 0.57 0.65 0.69
Other 143 135 278 0.94 1.07 0.93
Total claim
$1-$9,999 553 1,087 1,640 1.97 - -
$10,000 -$100,000 966 822 1,788 0.85 0.43 0.59
>$100,000 1,413 588 2,001 0.42 0.21 0.27
Number of hearings
0 487 934 1,421 1.92 - -
1-4 1,510 1,118 2,628 0.74 0.39 0.77
5-10 684 316 1,000 0.46 0.24 0.64
>10 260 112 372 0.43 0.22 0.69
Note 1: The analyses above pertain only to
arbitration cases that sought monetary
compensation and were won by the claimant.
Note 2: Odds ratios in the next to the last column
are derived from the observed odds and indicate
the effect of each claim characteristic when other
characteristics are ignored. Odds ratios in the
last column are from a multivariate model and
indicate the effect of each claim characteristic
when the effects of all other claim
characteristics are statistically controlled.
aCompensatory damages plus other damages,
including punitive damages, attorney fees, and
forum fees.
bNot significant.
Source: GAO analysis of arbitration award data.
_______________________________
1 Preliminary analyses (not shown) revealed that
the categories we used to represent the processing
time, forum, claim amount, and number of hearings
were suitable to capture the effects of these
variables. That is, the large bulk of the
variation in the outcomes we were looking at is
between the categories we created, rather than
within them.
Appendix II
Awardee Survey Methodology
Page 62GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
To determine the extent to which monetary
awards that arbitrators made were actually paid to
investors, we surveyed a representative random
probability sample of individual investors winning
awards in 1998 cases. We used survey data to
estimate the proportion of awards completely and
partially unpaid, and the total dollar amount
unpaid.
Population and Sample Design
Our target population consisted of all
arbitration cases brought by individual investors
against broker-dealers or their representatives
that were closed in 1998 with a monetary award
being granted. Using the SAC database to generate
our sample frame, we initially identified an
actual study population of 852 such award cases.
We drew a stratified random probability
sample of 250 awards. Three strata were created on
the basis of the dollar amount of the award, and
sample cases were selected at a relatively higher
rate from the larger awards. See table II.1 for
the allocation of the sample across the strata.
With this statistically valid probability sample,
each member of the study population had a nonzero
probability of being included, and that
probability could be computed for any member. The
sample was designed to provide us with acceptably
precise estimates of the proportion of awards paid
and unpaid, and the total dollar amount of awards
paid and unpaid, across the entire population.
After drawing the sample, we discovered three
pairs of duplicate elements, and an additional
four pairs of duplicate entries in the sample
frame derived from the SAC database that had not
been randomly selected into the sample. This
resulted in a final working sample size of 247 and
a population total of 845.
Administration of Survey
Because the sample frame created from the SAC
database did not contain mailing addresses and
telephone numbers of awardees or their attorneys,
we asked the SROs to provide that contact
information for our sample of 247 awards.
According to AAA officials, AAA's policy is not to
release information that would identify claimants,
so it was necessary to allow the company to mail
our survey questionnaires directly to the
claimants or their attorneys for the four AAA
awards drawn into our sample.
We chose to mail our questionnaires to the
attorneys identified as the representatives for
the awardees, rather than the awardees themselves,
except in cases in which awardees represented
themselves. We did this because the survey
pretests suggested that attorneys were more likely
to be able to provide the necessary information,
and since they often worked for many clients,
could sometimes answer for more than one of our
sampled cases.
For each sampled award, we prepared a
questionnaire preprinted with the short caption
(title) of the case, the names of parties
involved, the award amount, and the date the
arbitration decision was issued. The
questionnaire requested that attorneys on that
case (or the awardees themselves) indicate whether
that particular award had been paid, how much of
the payment had been received, whether payment was
timely, reasons for nonpayment, and actions taken
to collect the award. Appendix III contains a
copy of the questionnaire.
We mailed out the questionnaires on September
24, 1999, and asked AAA to mail questionnaires to
their awardees simultaneously. On October 22,
1999, we sent a follow-up mailing with another
copy of the questionnaire to the 116 sample
elements from forums other than AAA who had not
yet responded.
On December 6, 1999, we began to make
telephone calls to the 84 attorneys or awardees
that had not yet responded, or for whom mailed
questionnaires had earlier been returned as
undeliverable. If we were successful in
contacting nonrespondents by telephone, we
conducted a telephone interview to complete as
many of the items from the mail questionnaire as
possible. On December 15, 1999, we ended
fieldwork.
Disposition of Sample
We received 209 usable responses, which was
an overall unit response rate of approximately 85
percent. Because not all respondents provided an
answer to each question they were eligible to
answer, the item response rates vary and are
generally lower than the 85-percent unit response
rate.
Table II.1: Disposition of Sample
Stratum Popula Sample Disposition Response
tion size rate
size
Nonresponse Usable response
Refus Undeliver All other Mail Telephone
al able nonrespon response response
se
Large 22 22 0 0 1 15 6 95%
awards
Medium 73 73 2 1 6 41 23 88
awards
Small 750 152 1 5 22 104 20 82
awards
Total 845 247 3 6 29 160 49 85%
Note: Large awards are those that are $1.15
million or greater, medium awards are $277,000 to
less than $1.15 million, and small awards are
under $277,000.
Source: GAO analysis of arbitration award data.
To produce the estimates from this survey,
answers from each responding case were weighted in
the analysis to account statistically for all the
members of the population, including those that
were not selected or did not respond to the
survey.
Survey Error and Data Quality
Estimates from sample surveys are subject to
a number of sources of error, which can be grouped
into the following categories: coverage error,
sampling error, nonresponse error, measurement
error, and processing error. We took a number of
steps to limit these errors.
Surveys may be subject to coverage error, which
occurs when the sampling frame does not fully
represent the target population of interest. We
could not ensure that the SAC data from which our
frame was constructed included all awards (see
app. I). We detected seven pairs of duplicate
elements in our sample frame, which were removed
before the survey was conducted.
Sampling error exists because we followed a
probability procedure that is based on random
selections, and our sample is only one of a large
number of samples that we might have drawn. Since
each sample could have provided different
estimates, we express our confidence in the
precision of our particular sample's results as a
95-percent confidence interval (e.g., �7
percentage points). This is the interval that
would contain the actual population value for 95-
percent of the samples we could have drawn. As a
result, we are 95-percent confident that each of
the confidence intervals in this report will
include the true values in the study population.
Nonresponse error arises when surveys are
unsuccessful in obtaining some or all information
from eligible sample elements. To the extent that
those not providing information would have
provided significantly different information from
those that did respond, bias from nonresponse can
also result. Because the seriousness of this type
of error is often proportional to the level of
missing data, response rates are commonly used as
indirect measures of nonresponse error and bias.
We took steps to maximize response rates, such as
multiple mailings and telephone follow-up to
convert nonrespondents to respondents.
Measurement errors are defined as differences
between the reported and true values of the
characteristics under study. Such errors can
arise from the way questions are worded,
differences in how questions are interpreted by
respondents, deficiencies in the sources of
information available to respondents, or
intentional misreporting by respondents. To
minimize such errors, we asked subject matter
experts to review our questionnaire and pretested
the questionnaire with several attorneys
representing cases in our sample frame. We did
not, however, verify the substance of answers
given by awardees or their attorneys.
Finally, surveys may be subject to processing
error in data entry, processing, and analysis. We
verified the accuracy of a small sample of
keypunched records by comparing them to their
corresponding questionnaires, and corrected errors
found. Less than 1 percent of the data items we
checked had random keypunch errors that would not
have been corrected during data processing.
Analysis programs were also independently
verified.
Appendix III
Awardee Survey Questionnaire
Page 65GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
Appendix IV
Comments From the NASD Regulation, Inc.
Page 72GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
Appendix V
Comments From the New York Stock Exchange
Page 74GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
Appendix VI
Comments From the Securities and Exchange
Commission
Page 77GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
Appendix VII
GAO Contacts and Staff Acknowledgments
Page 78GAO/GGD-00-115 Actions Needed to Address Pr
oblem of Unpaid Awards
GAO Contacts
Thomas J. McCool (202) 512-8678
Michael A. Burnett (202) 512-8678
Acknowledgments
In addition to the persons named above,
Lamont Kincaid, Richard J. Hillman, Carl Ramirez,
Barry Reed (Retired), Michelle A. Sager, Sidney H.
Schwartz, Douglas M. Sloane, and David Tarosky
made key contributions to this report.
*** End of Document ***