Securities Arbitration Is Flawed, Investor Group Claims

Financial adviser with clientsInvestors who bring disputes involving suspected broker misconduct, unsuitable investment advice and other complaints to arbitration may not be getting a fair resolution because the pool of arbitrators lacks diversity, according to a report released Tuesday by a group that represents claimants.

Most of the arbitrators who serve the Financial Industry Regulatory Authority (FINRA), the self-regulator for the brokerage industry, are men who have a “socioeconomic status that put them out of touch with the average investor,” said the report by the Public Investors Arbitration Bar Association (PIABA). Consequently, those decisions may favor the broker and his or her firm, not the investor.

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PIABA is a nonprofit association of lawyers who represent investors in arbitration hearings. The report said decisions by arbitration panels favoring investors have dropped sharply since 1992.

Investors who’ve lost money in investments and believe they’ve been wronged by their advisers generally must use mandatory arbitration to resolve the dispute. Customers generally must agree to arbitration when they open a brokerage account and the arbitrator’s ruling is binding. FINRA is the industry-funded watchdog that oversees the process. A FINRA spokeswoman said 6,383 arbitrators currently were in the pool of potential arbitrators. There were 3,714 new cases in 2013 and 2,660 through August of this year, according to FINRA.

“The [FINRA] pool is not diverse; it’s heavily weighted toward lawyers … because FINRA tends to reach out to and recruit from bar associations,” said Jason Doss, PIABA president and one of the authors of the report. “You need arbitrators with different backgrounds and experiences that they bring to the table” for fair results, he said.

The report also criticized FINRA for its “flawed” disclosure process.

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According to the report, FINRA can’t guarantee that its arbitrators are impartial because the system “is not designed to elicit meaningful or timely disclosures about actual or potential conflicts of interest and/or biases.” It said FINRA relies on the arbitrators to self-report conflicts and biases. It also said FINRA requires arbitrators to update their personal information only after they’re selected to be on a panel.

FINRA took issue with the report. In a statement, the regulator said that “win rates increase or decrease depending upon the controversy involved, market events and counsel.” It also said the agency has made “substantial efforts to recruit and train arbitrators from diverse backgrounds.”

The investors’ group analyzed the backgrounds of 5,375 FINRA arbitrators from disclosure reports dating back to 1992. Overall, it said, 80 percent were men. Most of the arbitrators had advanced university degrees. The reports did not disclose race or income.

In 1992, Doss said, about 60 percent of investors were successful in arbitration and received about 60 percent of the amount they claimed. Last year, he said, investors won only 42 percent of the time, and in some states they received as little as a penny on the dollar. He said PIABA used government and FINRA data for those figures.

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The report called on the U.S. Securities and Exchange Commission to conduct a study examining whether diversity among FINRA arbitrators affects decisions in cases and awards. It also urged the SEC to form an independent group to oversee FINRA’s arbitration process.

Doss also encouraged lawmakers to pass the Investor Choice Act of 2013, which would allow investors to pursue claims of wrongdoing in court, if they preferred, rather than being forced into mandatory arbitration.

Photo: kzenon/iStock

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