A dispute with your broker? You may have to rely on arbitration
Boston — When investors go to a broker and ask to open an account, they are usually asked to sign a broker-customer contract. What the stock market's 508-point plunge in October highlighted was that many investors don't read the fine print. ``Sometimes they don't even have a copy of the contract,'' says Robert Dyer, a lawyer at Duckworth, Allen, & Dyer in Orlando, Fla., who spends most of his time settling investor disputes with brokers through arbitration.
A rise in the number of complaints of poorly executed trades, charges of inaccessible and irresponsible brokers, and unfair margin calls, coupled with a United States Supreme Court ruling in June, is expected to dump a fresh load of arbitration cases on the exchanges next year. (The Supreme Court said that mandatory-arbitration clauses in written customer agreements are legally binding.)
Many investors did not realize that their brokers would demand prompt settlement of margin calls when the market fell. An understanding of the settlement process has hardly improved, even though over the last five years the amount of margin debt held by American investors has quadrupled, to $44 billion, according to a report by the American Arbitration Association (AAA), a nonprofit organization in Washington, D.C.
Customers may not realize that when they sign contracts containing mandatory-arbitration clauses, they are ``waiving their right to a trial by jury,'' says Richard Shell, assistant professor of legal studies at the University of Pennsylvania's Wharton School of Business.
Mandatory-arbitration clauses tend not to be brought to the customers' attention, observes Mr. Shell, because brokers do not have to make them prominent.
A mandatory-arbitration agreement stipulates that a dispute between an investor and broker cannot be taken to court, but must be decided by an ``impartial'' person or panel of arbitrators. The investor can go either to a self-regulating organization (SRO), such as those monitored by the major exchanges, or to the AAA, if his contract gives him the choice. Otherwise the investor must work through the SRO to which his broker belongs.
The Securities and Exchange Commission estimates that about 50 percent of broker-investor disputes are handled by arbitration. Because the SEC cannot regulate the SROs, no uniform arbitration procedure has been established.
Even before ``Black Monday,'' requests for hearings at the American Stock Exchange's SRO were up about 50 percent, says arbitration director Scott Noah. Since the market crisis, the major markets expect another increase six months down the road, says Martha Cid, spokeswoman at the New York Stock Exchange.
In August the SEC sent the exchanges proposed changes for arbitration procedures, says Sarah Ackerson, the SEC's assistant director of market regulation.
Some lawyers connected with arbitration tend to be cynical about what the exchanges will do with these proposals. ``It's normal for [the exchanges] to do the minimum for the public that they can get away with,'' Mr. Dyer, the lawyer, says.
Studies of arbitration results show that customers recover about half the time they file a claim, and they recover about half of what they ask for when they recover. In a report released this month, the AAA found the three biggest investor complaints about SROs are:
Even though each three-member panel must be made up of one member from the securities industry and two from the general public, those from the general public are often former securities industry officials or lawyers whose firms do business with securities concerns.
``SROs say, `These are your arbitrators, and you'll have to live with it,''' says Hartley Bernstein, a New York lawyer who specializes in securities disputes. The AAA, on the other hand, gives both sides the chance to choose from a large pool of arbitrators, he adds.
For claims under $50,000, investors tend to represent themselves. ``They're often wiped out,'' Dyer says, ``and the only way they can hire a lawyer is based on a contingency fee,'' taken from what they recover. Most brokers, on the other hand, are accompanied by a lawyer.
Without equal representation, Shell at Wharton says, ``there's no guarantee the arbitration panel will be impartial.''
Damage awards are also rare in arbitration cases. If the investors win, the most money they can hope to recover is only a percentage of what they lost. ``The investor gets no interest, no fees, and no explanation of why the decision was made,'' Dyer says.
Shell says the implications of investors' perceptions like those in the AAA report ``are dangerous for all of us.'' If investors do not understand the process, do not know what they have signed contracts for, and lose confidence in the fairness of the judicial system, ``they'll invest less, and that's a problem,'' he says.
The exchanges are trying to alleviate some difficulties with changes in the hearings process, including bringing in arbitrators from outside the securities industry and educating arbitrators on damage awards.
In addition, the exchanges are considering using the ``discovery process,'' which lawyers use in court cases to let both parties know what each will argue before the case goes to trial.
The SEC is also looking at how widespread the inclusion of arbitration clauses is, says Ms. Ackerson at the SEC.