Issue Focus: Mandatory Pre-dispute Arbitration

Congress Should Improve the Fairness of the Securities Arbitration Process 

Learn More About Forced Arbitration

Section 921 of the Dodd-Frank Act provided the SEC with rulemaking authority to prohibit or impose conditions on the use of forced pre-dispute arbitration agreements if it determines it is in the interest of the public or investors. Pursuant  to this provision, Congress should encourage the SEC to exercise its authority to propose or adopt rules prohibiting or conditioning pre-dispute agreements mandating arbitration.

 “Investors should not be forced into the ‘take it or leave it’ scenario they now face with mandatory pre-dispute arbitration clauses in customer agreements with their broker-dealers.”
Heath Abshure, NASAA President & Arkansas Securities Commissioner | NASAA/SEC 19(d) Conference | April 16, 2013

In recent years, states also have seen the emergence of forced arbitration clauses in contracts between state-registered investment advisers and their clients, despite the fiduciary duty imposed upon investment advisers. In the 113th Congress, NASAA will seek legislation empowering state regulators to curtail the use of such clauses and to take the steps necessary  to provide investors with a choice for dispute resolution.

NASAA remains committed to ensuring that arbitration forums and procedures create an even playing field. But, we also believe that arbitration should not be the sole forum available to aggrieved investors, especially those investing small amounts.

When it comes to addressing disputes that may arise between investors and their broker-dealers, investors should have a choice of arbitration or litigation. Investors should not be forced into the “take it or leave it” scenario they now face with mandatory pre-dispute arbitration clauses in customer agreements with their broker-dealers.

These clauses have become that much more troubling to NASAA in light of the recent decision in the FINRA enforcement proceeding against Charles Schwab.

This ruling would essentially allow broker-dealers to prohibit participation in class actions against them by their customers. That’s wrong on the merits and bad public policy.

This is especially true given that Section 921 of the Dodd-Frank Act provided the SEC with rulemaking authority to prohibit or impose conditions on the use of mandatory pre-dispute arbitration agreements.

Congress Should Strengthen Private Remedies for Victims of Fraud

Congressional action to extend private remedies to victims of securities fraud is particularly urgent in light of then SEC Chairman Elisse Walter’s announcement on January 18, 2013, that the SEC will soon proceed with rulemakings to implement the Jumpstart Our Business Startups Act (JOBS Act), which will legalize equity “crowdfunding” and allow the advertising of private placements. The JOBS Act will greatly increase the number of small investments in small, private companies. As a result, a single instance of fraud might easily result in damages to a large number of people. At the same time, however, the losses may be small enough that a private legal action by a single victim is not economically feasible.

To ensure that victims of securities fraud will have recourse, NASAA urges the 113th Congress to explore amending federal law to ensure that all investors, especially those investing small amounts, have a reasonable avenue to seek recovery. Failure to provide recourse to defrauded investors may have a chilling effect on future investment in these offerings and capital raising efforts generally.

“Aggrieved investors should be able to seek relief in any forum and not be forced into arbitration.”
Heath Abshure, NASAA President & Arkansas Securities Commissioner | SIFMA Compliance & Legal Society Annual Meeting | March 19, 2013

While NASAA remains committed to ensuring that arbitration forums and procedures create an even playing field, NASAA also believes that arbitration should not be the sole forum available to aggrieved investors. Aggrieved investors should be able to seek relief in any forum and not be forced into an expensive arbitration that could foreclose the ability to obtain relief.

Accordingly, state securities regulators urge the 113th Congress to take steps to ensure that private remedies for securities frauds are strengthened and expanded.

Rep. Ellison Questions SEC Chair Mary Jo White on Arbitration 

Congress Questions Schwab Class Action Waiver


Link to transcript

Resources

On the Record

NASAA has long advocated for and supported efforts to bring fairness to the securities arbitration system.

2013
“When it comes to addressing disputes that may arise between investors and their broker-dealers, investors should have a choice of arbitration or litigation. Investors should not be forced into the “take it or leave it” scenario they now face with mandatory pre-dispute arbitration clauses in customer agreements with their broker-dealers. These clauses have become that much more troubling to NASAA in light of the recent decision in the FINRA enforcement proceeding against Schwab. This ruling would essentially allow broker-dealers to prohibit participation in class actions against them by their customers. That’s wrong on the merits and bad public policy.”

“NASAA will take steps to encourage the SEC to exercise its authority to propose or adopt rules prohibiting or conditioning pre-dispute agreements mandating arbitration. Aggrieved investors should be able to seek relief in any forum and not be forced into arbitration. Failure to provide recourse to defrauded investors may have a chilling effect on future investment in these offerings and capital raising efforts generally. If the SEC is unwilling or unable to take action then we will encourage Congress to pass legislation that would dramatically curb the use of these mandatory provisions.

2012
“We should act to identify and seek to remedy unfairness in laws, regulations or administrative procedures that threaten to harm investors, such as mandatory arbitration. When appropriate, we must speak on behalf of small investors whose voices cannot be heard over the din of the lobbyists and industry.”

  • Heath Abshure, NASAA President & Arkansas Securities Commissioner
    Presidential Address
    September 11, 2012


2011
“States have also taken the lead in pressing for reform in the securities arbitration system. For several years, NASAA has voiced concern over apparent inequalities in the arbitration system. As NASAA president, I will continue to support a more level playing field for investors with legitimate claims against their brokers.”

  • Jack E. Herstein, NASAA President & Assistant Director, Nebraska Department of Banking and Finance, Bureau of Securities
    Presidential Address
    September 13, 2011 

“No matter how many safeguards are instituted, a SRO has substantial and inherent conflicts of interest that governmental regulators do not. This is particularly true where industry and investor interests’ conflict, as in the case of mandatory pre-dispute arbitration clauses and the disclosure or expungement of prior settlements, judgments and investor claims.”

“Arbitration has been presented to the investing public as an inexpensive, informal, totally private process that results in a speedy resolution of cases. However, the mandatory arbitration provisions in contracts take away the ability of a harmed customer to “have their day in court” by forcing investors into a forum that limits discovery, reduces the pleading standards and allows decisions in which there is severely limited appeal. Arbitration as it exists does not treat the investing public fairly. If the system were a level playing field, arbitration probably would not be a universal requirement of the brokerage industry, and the investing public likely would embrace it voluntarily. Not surprisingly, studies have confirmed the belief that the securities arbitration forum is not perceived as fair to investors, and recovery rates in fact favor the securities industry.”

2009
“We believe that Congress should prohibit the mandatory nature of securities arbitration. Short of an outright Congressional prohibition, Section 201 of the Discussion Draft is a positive step in the right direction, but it should be amended to require that the SEC prohibit mandatory, predispute arbitration and offer a meaningful choice between binding arbitration and civil litigation. This choice should be solely that of the investor. If arbitration really is fair, inexpensive, and quick, as its adherents claim, then these benefits will prompt investors to choose arbitration. If, on the other hand, arbitration does not offer these advantages, then this mode of dispute resolution should not be forced upon the investing public.When arbitration is inadequate to protect the substantive rights of investors, an independent judicial forum must be an option. Arbitration may be desirable and adequate if both parties knowingly and voluntarily agree to waive the constitutional rights provided in court. If an investor decides to waive his or her constitutional rights, this decision should be made at the time the dispute arises, not at the time the account is opened. At this point, both parties may make the determination whether their particular dispute is best decided in a court of law (especially small claims court) with court-supervised discovery, a written opinion, and appellate review of complex legal issues.”

“The only chance of recovery for most investors who fall victim to Wall Street wrongdoing is through a single securities arbitration forum controlled by the securities industry. NASAA believes that the securities arbitration system should be truly voluntary and that Congress should end mandatory securities arbitration.”

“We all know arbitration is not working. It is time to end mandatory, industry-run arbitration for investors. The harmful effects of mandatory arbitration have been well-documented in numerous studies. Both houses of Congress have responded with legislation that would prohibit the use of mandatory arbitration clauses in a wide range of consumer services, including securities. No further studies are necessary. Mandatory arbitration clauses should be banned without delay and investors should have the right to choose between litigation or arbitration as the forum for resolving disputes with their financial services firms. And if investors elect arbitration, they should be able to choose an independent arbitration forum, not just a forum operated by the industry.

  • Denise Voigt Crawford, NASAA President & Texas Securities Commissioner
    Presidential Address
    Se
    ptember 15, 2009

“Over twenty years ago, investors had a choice of investing with a firm that required arbitration or one that recognized a judicial forum for disputes. Today, almost every broker-dealer includes in their customer agreements, a predispute arbitration provision that forces public investors to submit all disputes that they may have with the firm and/or its associated persons to mandatory arbitration. . . . Many investors remain unaware of this industry arbitration provision, fail to appreciate its significance, or are powerless to negotiate a different approach to dispute resolution with their brokers. . . . As long as securities arbitration remains mandatory, investors will continue to face a system that is not fair and transparent to all. For this reason, NASAA supports the passage of H.R. 1020, the “Arbitration Fairness Act of 2009,” and respectfully suggests that it be amended to clarify that its provisions extend to securities arbitration.”

“As long as securities arbitration remains mandatory, investors will continue to face a system that is not fair and transparent to all. That is why NASAA included passage of the Arbitration Fairness Act as a key component of its Pro-Investor Legislative Agenda for the 111th Congress.”

  • Fred J. Joseph, NASAA President & Colorado Securities Commissioner
    NASAA News Release
    May 21, 2009

“Even if the decision to participate in arbitration becomes truly voluntary, other changes are necessary to ensure that the arbitration process is fair. NASAA believes a major step toward improving the integrity of the arbitration system is the removal of the mandatory industry arbitrator. This mandatory industry arbitrator, with their industry ties, automatically puts the investor at an unfair disadvantage. State securities regulators believe Congress should also review other aspects of arbitration, to determine, for example, if there is sufficient disclosure of potential conflicts by panel members; if the selection, qualification, and composition of the panels is fair to the parties; if arbitrators receive adequate training; if explanations of awards are sufficient; and if the system is fast and economical for investors. Where deficiencies are found, Congress should act to ensure that the system is improved.”

Members of Congress have seen that the scales of justice have tilted away from consumers in arbitration proceedings and attempted to rectify this situation in the last session of Congress with S. 1782 and H.R. 3010, the “Arbitration Fairness Act of 2007,” introduced by Senator Russ Feingold (D-WI) and Congressman Hank Johnson (D-GA) respectively. NASAA supported this legislation and looks forward to its reintroduction, with an amendment to clarify that its provisions extend to securities arbitration.”

2008
 “NASAA has long held that a choice between arbitration and the courts for resolving disputes should be a fundamental right for investors. Because the arbitration system has evolved into a mandatory condition imposed by the industry, it is imperative that the system of dispute resolution be fair, transparent and free from bias.”

  • Karen Tyler, NASAA President & North Dakota Securities Commissioner
    NASAA News Release
    February 6, 2008

“The SICA study’s results are disturbing, and they support what state regulators have been hearing from investors in their states – investors believe that the arbitration forum they are forced to participate in is rigged against them.”

  • Bryan Lantagne, Director of the Massachusetts Securities Division
    NASAA News Release
    February 6, 2008

“State securities regulators believe Congress should also review the manner in which arbitrations are conducted to determine if there is sufficient disclosure of potential conflicts by panel members; to determine if selection, qualification, and composition of the panels is fair to the parties; whether the arbitrators receive adequate training; if explanations of awards are sufficient; if the system is fast and economical for investors; and if the entire arbitration process should be optional, not mandatory, for investors.”

2007 
“The recent consolidation of NASD and NYSE into the Financial Industry Regulatory Authority (FINRA) has effectively resulted in a single industry run forum for the resolution of disputes between public customers and the securities industry. NASAA believes that absent the option of pursuing a claim in court, investors should at least be given a choice of arbitration forums; however, where there is no choice but arbitration through a program administered by FINRA, then this one forum must at least be independent and fair to investors.”

“In 2003, NASAA formed an Arbitration Project Group, chaired by Massachusetts Securities Director Bryan Lantagne, to study the securities arbitration system to determine if changes are necessary to enhance justice for investors. State securities regulators believe Congress should review the manner in which arbitrations are conducted to determine . . .  if the entire arbitration process should be optional, not mandatory, for investors. NASAA has offered, and continues to offer, our willingness to work with all interested parties in reviewing the arbitration system and its processes.”

2006 
“Under the leadership of Illinois Securities Director Tanya Solov, NASAA’s Broker-Dealer Section has focused a national spotlight on the fairness of the arbitration system currently in place to settle securities-related disputes. I’ve asked Arizona’s Matt Neubert to continue this effort as the section’s new chair to help bring change to an apparently flawed system. As long as the current composition of arbitration panels consist of a mandatory industry representative and public arbitrators who maintain significant ties to industry, the process is fundamentally unfair to investors.”

  • Joseph P. Borg, NASAA President & Alabama Securities Director
    Presidential Address
    September 19, 2006

2005 
“The Wall Street scandals of recent years have prompted a record number of investors throughout the United States to seek relief through arbitration. Last year, NASAA focused attention on arbitration issues during a public forum in Washington, D.C. This year, we intend to urge the NASD to make several improvements in the arbitration process. We recognize that the NASD has adopted a number of changes in recent years in an effort to upgrade the arbitration system. These developments are encouraging, but also troubling; encouraging because they offer incremental improvements in the arbitration process, but troubling because they reveal flaws in the system that have endured for too long and need to be corrected. In particular, NASAA believes that the NASD should compile and disseminate more meaningful and accurate statistics concerning arbitration outcomes, and should achieve balance in the composition of arbitration panels. We also believe that the NASD should consider ways to make arbitration truly voluntary.”

  • Patricia Struck, NASAA President & Wisconsin Securities Administrator
    Presidential Address
    September 13, 2005

2003 
 “I will ask the Broker-Dealer Section to thoroughly examine the issue of arbitration and I invite the SEC, the SROs and others to join us in this effort. Since our nation’s investors are compelled to seek arbitration to resolve disputes with Wall Street we need to make sure that they are treated fairly.”

  • Ralph Lambiase, NASAA President & Connecticut Securities Director
    Presidential Address
    September 16, 2003