Clash over mandatory arbitration agreements heats up
If mandatory arbitration clauses disappeared in customer agreements, many brokers would lose their default setting for resolving client disputes: The industry won't let them go lightly.
Industry groups including SIFMA and the U.S. Chamber of Commerce are opposing a new proposal in Congress that would bar brokers and investment advisors from including that fine print in customer agreements.
Clauses that require mandatory arbitration of customer disputes are a staple of the brokerage industry, routinely included in customer agreements to ensure that those disputes don't escalate into costly legal proceedings in the regular judicial system.
But critics of those provisions have argued that arbitration, particularly in FINRA's forum, puts customers at a disadvantage while the proceedings have arcane rules and are conducted in secrecy.
In addition to barring mandatory arbitration clauses in broker and advisor agreements, the Investor Choice Act, authored by Rep. Bill Foster (D-Ill.), would also bar corporations from including mandatory arbitration clauses for customer disputes in their bylaws.
At a recent hearing considering that, and a handful of other financial bills, Tom Quaadman, executive vice president with the Chamber of Commerce, defended the arbitration process as a vital dispute resolution tool that helps clients and advisors alike avoid lengthy and costly litigation.
"Arbitration helps lower the cost, it helps for speedier awards," Quaadman said.
Further, he argued, just because a customer dispute begins in arbitration, it doesn't mean that it will go on to be heard in FINRA's forum. "Even with the FINRA arbitration awards, there's a significant number of FINRA arbitration cases that are settled before they even go to the arbitration process," he said.
According to FINRA's own numbers, 17% of the cases that concluded last year were decided by arbitrators, with the remaining 83% settled directly between the parties, handled by a mediator or resolved in some other way.
In matters involving customer disputes (rather than intra-industry squabbles) that were decided by arbitrators, customers were awarded damages in 40% of the cases concluded in 2018.
Arbitration is "less expensive, faster, and closely supervised and regulated by the SEC and FINRA," according to SIFMA's statement to the House Financial Services Committee's Subcommittee on Investor Protection, Entrepreneurship and Capital Markets. "Broker-dealers include arbitration clauses in customer contracts so that firms can appropriately price their products and services, as the cost of resolving future disputes is simply part of the cost of running a business."
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But FINRA's arbitration process has no shortage of critics, among them Remington Gregg, an attorney with the consumer rights group Public Citizen, who called forced arbitration "a secretive, privatized system of justice."
"It deprives people of their day in court, there are no rules of evidence and almost no procedural safeguards, no requirement that the arbitrator follow the law or precedent," Gregg told members of the subcommittee.
A FINRA spokeswoman did not respond to a request for comment on the proposal to bar forced arbitration clauses or to criticisms of its arbitration process.
Under the legislation, the arbitration process would still be available as a channel for resolving disputes, but it would preserve access to the regular judicial system for customers. Forced arbitration clauses in existing customer agreements would be voided under the law.
Forced arbitration clauses in existing customer agreements would be voided under the law.
That element of choice is crucial for investors and their counsel to determine the appropriate setting to pursue a claim against a broker or advisor, argues Melanie Lubin, Maryland's securities commissioner, who testified in support of the measure on behalf of the North American Securities Administrators Association.
"They shouldn't be locked in from the beginning to have to only go to arbitration," Lubin says.
"Frankly I've seen a lot of cases that lawyers don't want to go near that somebody probably could have gone into small claims court if they didn't sign the pre-dispute arbitration clause in their customer agreement," she added. "That way that's inexpensive you can do it yourself, sometimes they're very clear-cut cases and it gets resolved very quickly."