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If Broker Arbitration Is Good for Investors, Why Is It Mandatory?

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In my February Investment Advisor Column (Is FINRA the Fox Guarding the Henhouse? and the follow-up Feb. 23 blog, Broker Arb Lessons From Animal House and Brian Hamburger), I wrote about the FINRA Dispute Resolution Task Force’s Dec. 16 recommendations for improving its mandatory dispute arbitration system. Despite acknowledging that FINRA has a bit of a PR problem with the “debate over the fairness of its pre dispute arbitration agreements,” the vast majority of the Task Force’s 51 recommendations deal instead with issues such as training and paying arbitrators, to “considering, studying, reviewing, or monitoring” other issues. 

(See FINRA Broker Arbitration Task Force Suggests 51 Changes.)

A few of those recommendations purported to address the “lack of transparency” of the arbitration decisions: which to my mind, is the primary source of the distrust of the mandatory system. But none of them came close to suggesting that FINRA arbitration cases be publicly disclosed, like other legal hearings. That would cover the claims, the defense’s responses, the panel’s decisions, its reasoning and the amount of the awards. That way, we could all decide for ourselves how “fair” the system really is.  

To get a more informed opinion about why FINRA doesn’t do this, I had a subsequent conversation with securities attorney Brian Hamburger, CEO of the RIA compliance firm Market Counsel, and senior partner of the Hamburger Law Firm. Brian pointed out that “the lack of transparency of FINRA arbitration cases is intentional. By making the case records public, the increased scrutiny would invite challenges to the decisions, requiring an appeals system like we have in the courts.” In turn, he said, that would drive up the costs of disputes, “which the arbitration system is intended to keep down.” 

That’s certainly a fair point, and frankly, one I hadn’t thought of. Yet to me it raises the question of why securities arbitration needs to be mandatory in the first place. If FINRA’s arbitration system and its lower costs are, as it claims, as fair to investors as it is to brokerage firms, why not leave it up to either party—the investor or the BD—to opt, instead, for a more costly but transparent and appealable venue? If, given the choice, most investors with grievances against their brokers and/or their firms choose arbitration on their own, then no harm done, and the FINRA arbitration system is vindicated. But if many investors chose the higher-priced system, that would send a message, too. 

The bottom line here is that as a de facto self-regulatory organization, FINRA and its member broker-dealers inherently have a massive public relations problem—one that isn’t going to go away with some lipstick and a bit of makeup. Forcing its investor clients into FINRA-run arbitration to resolve their disputes with its member firms isn’t helping the industry’s image: no matter how much they pay arbitrators or “study” their procedures.   

Hamburger suggests that FINRA could solve the problem by using an outside arbitration system, such as the one administered by the American Arbitration Association. That would certainly help. But it wouldn’t solve the “lower cost through lack of transparency and right to appeal” problem. And, consequently, I doubt it would have much of an impact on the seemingly widespread distrust of the system by investors and other outside observers.

If the securities industry really wants to “solve” its PR problem on arbitration, it’s going to have to give investors the choice of venues for resolving disputes with their BDs. Without choice, all the talk just appears self-serving.


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