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By: Leo G. Kogan
Most retail investors have signed a customer agreement requiring that all claims against their broker or financial advisor be resolved through arbitration. Last week, the House Financial Services’ Committee took a step toward making such mandatory arbitration provisions a thing of the past by passing H.R. 2620, the “Investor Choice Act.” If made into law, the bill would amend the Securities Exchange Act of 1934 to prohibit broker-dealers from entering into agreements with customers if those agreements mandate arbitration or restrict a customer’s ability to select a forum or participate in a class action. The bill would also amend the Investment Advisors Act of 1940 to prohibit investment advisors from entering into similar agreements.
While the H.R. 2620 is unlikely to become law anytime soon, passage by the House Financial Service Committee is a significant step towards the drive to ban mandatory arbitration in the financial services industry. In support of their decision to move the bill forward, the House Financial Services Committee produced a background memo raising several concerns about mandatory arbitration. A closer inspection of the Committee’s background memo suggests that many of its concerns regarding FINRA arbitration are misplaced.
The Committee’s memo notes that arbitrations are often decided by non-lawyers who are not bound by legal precedent or the federal rules of evidence but provides no explanation as to why this state of affairs favors broker-dealers as opposed to investors, or why a non-lawyer arbitrator is less qualified to issue an award than a non-lawyer juror. Notably, the Public Investors Advocate Bar Association (“PIABA”), which supports the Investor Choice Act, takes the opposite viewpoint regarding arbitrators’ education level and advocates for arbitrators with fewer advanced degrees.1
The Committee also purports to be concerned that “nearly of 30% of arbitration awards against brokers went unpaid in 2020,” but, as pointed out by the American Securities Association, the article cited by the Committee for this statistic makes no such claim.2 Nor does the Committee explain how a move away from arbitration would result in more awards being paid. The Committee also raises concerns about arbitration proceedings being confidential, though it does not explain why making the proceedings public would result in fairer or more equitable decisions.
Finally, the Committee asserts that “[f]orced arbitration provisions have resulted in less than desirable outcomes for investors as awards by arbitration panels can be lower than litigation and are not a fair method to resolve a dispute as securities industry insiders can be part of the arbitration panels hearing and deciding the outcome of the arbitration and damages, if any.” But here again, the Committee does not provide supporting evidence, nor does it explain what it means by “can be” or “less than desirable.” And the Committee’s expressed concerns about “industry insiders” serving as arbitrators suggests a lack of familiarity with the FINRA arbitration process, which for the last ten years has allowed investors to strike all industry arbitrators.
The advantages of arbitration are well known and have been succinctly summarized by the U.S. Supreme Court:
The advantages of arbitration are many: it is usually cheaper and faster than litigation; it can have simpler procedural and evidentiary rules; it normally minimizes hostility and is less disruptive of ongoing and future business dealings among the parties; it is often more flexible in regard to scheduling of times and places of hearings and discovery devices.”
This is particularly true for FINRA arbitration, which the Securities Industry and Financial Markets Association (SIFMA) argues has “worked effectively for decades because it is subject to public oversight, regulatory oversight by multiple independent regulators, and rules of procedure that are designed to benefit investors.”
Notwithstanding the Committee’s decision to move the bill forward for a House vote, the H.R. 2620 is unlikely to become law anytime soon. Even if the bill were to pass in a closely divided House, supporters would still need 60 votes in the Senate, a near impossible feat in today’s bitterly partisan environment. FINRA arbitration is not going anywhere. For now.