Securities Arbitration and the Arbitration Fairness Act

On May 5, I reported on this blog about the Arbitration Fairness Act of 2009, now introduced into both the Senate and the House to amend the Federal Arbitration Act to invalidate pre-dispute arbitration clauses in consumer services, franchise and employment agreements.  As currently drafted, it is unclear whether the proposed Act would cover PDAAs in the securities industry.  When Congress was considering the 2007 version of the Act, which was not enacted, Senator Feingold announced at a hearing on the Senate version of the legislation that the AFA of 2007 was intended to cover arbitration clauses in account agreements between investors and their brokers and that the legislation would be amended in committee to eliminate any confusion as to its scope.  Since 2007, SIFMA, the trade association for the securities industry, has engaged in substantial lobbying efforts to persuade Congress not to extend the AFA to the securities industry, including the release of a White Paper arguing that securities arbitration is fair to investors.  It remains to be seen whether these lobbying efforts will prove successful.

 

In recent years, I have argued (in this article) that securities arbitration, which takes place primarily in FINRA’s dispute resolution forum, is fair to investors.  Most recently, I have argued (here) that factors other than the substantive fairness of the forum are responsible, at least in part, for investors’ negative perceptions of FINRA arbitration.  As a result, I have been asked whether I believe the AFA should apply to pre-dispute arbitration clauses in customer agreements with their securities brokerage firms.

 

Securities arbitration is vastly different from the consumer arbitration that the AFA is designed to remedy, for the following reasons:

  • Unlike the SEC – whose oversight is designed to ensure that FINRA’s rules protect investors — no administrative agency has oversight of consumer arbitration forums;
  • FINRA Conduct Rule 3110(f) precludes brokerage firms from including unfair or unconscionable provisions in investor PDAAs;
  • Forum fees are subsidized by the securities industry rendering investors’ cost to pursue securities arbitration substantially lower relative to consumer arbitration;
  • FINRA rules preclude unfair or unconscionable arbitration procedures, and ensure fairness for the investor claimant; 
  • Brokerage firms are barred from imposing a class action waiver in their PDAAs;
  • FINRA tracks and publishes regularly statistics regarding the speed of resolution and the outcomes of customer cases, to promote transparency;
  • FINRA fosters forum access by investors through efforts to facilitate pro se filing and to support law school clinics to fill gaps in representation;
  • FINRA’s Code of Arbitraton for Customer Disputes contains provisions that expressly contradict the types of unfair consumer arbitration provisions that the AFA targets, including required notice of the claim (R12300, 12301), an opportunity to be heard (R12600), a right to be represented (R12208), a hearing location convenient for the customer (R12213), and decision by a neutral arbitrator (R12400, 12408, 12414). 
  • The Customer Code also allows investors to pursue class action claims in court (R12204), permits extensive discovery (Rules 12505-12513), and provides for the waiver of filing fees upon ample demonstration of financial hardship (12900(a)(1)).

Because securities arbitration is quite different from other forms of consumer arbitration, I do not believe that Congress should extend the AFA to cover FINRA arbitration.  While I find it difficult to take any position that limits investor choice, if Congress were to sweep securities arbitration into the wide net of public condemnation towards consumer arbitration, it would unduly blemish a system of dispute resolution that, albeit far from perfect, does not suffer from the flaws that the bill identifies in other types of consumer arbitration and that the bill is designed to combat.  By lumping securities arbitration with consumer arbitration, Congress would endanger the vitality of the securities arbitration system that has been developed over the past twenty years under extensive SEC oversight.