Financial Institutions Law Alert

Congressional rumblings about outlawing mandatory arbitration clauses are relatively common, but they have not been successful. Ever since a hard-won battle in the 1980s, the industry has been calling the shots about where investors could plead their case and the predictable efforts to change that have gone nowhere.

This time around, things may be a little different.

Start with the fact that a wave of populist voters earned President Biden both the House and the Senate. Now he’s crisscrossing the country, stumping for his three trillion-dollar infrastructure plan, arguing that a guaranteed tax hike for individuals and corporations is the best way to get that done. So with all of this happening, no one should be surprised by the ascendance of the Investors Choice Act, which would not only ban future mandatory arbitration clauses but void the ones already in existence.

The bill that was introduced in the House and the Senate by Rep. Bill Foster of Illinois and Sen. Jeff Merkley of Oregon, would amend the Securities Exchange Act to make it illegal for any “broker, dealer, funding portal or any municipal securities dealer” to include a mandate for arbitration, restrict or condition a client from selecting or designating a forum for the dispute or taking part in a class-action or consolidated proceeding.

"Individuals shouldn't need to surrender their legal rights because they choose to work with a financial advisor or broker-dealer to plan for their retirement and invest their hard-earned money," Foster said in a statement. "This legislation levels the playing field for consumers and prevents them from being victims of a rigged system that denies them fair legal recourse if they are wronged."

At least 12 Democratic members of the House and Senate have signed on as co-sponsors of the bill. Progressive standard-bearer Sen. Elizabeth Warren (D-Mass) is one of those sponsors.

During SEC Head Gary Gensler’s recent confirmation hearing, Warren queried “. . . let me ask about the tilted roulette tables on Wall Street. If someone has been cheated by a broker-dealer…should that company be able to use forced arbitration clauses to avoid getting sued and held accountable?”

Gensler, in an effort to express some middle-ground, responded, ". . .while arbitration has its place, I think it's also important that investors. . . have an avenue to redress their claims in the courts.”

Warren, aware that Dodd-Frank gave the SEC the power to end mandatory arbitration well over ten years ago and did nothing about it, completed the exchange with a not-so-gentle warning, "Congress has given the tools to the SEC. We just need the SEC to pick up these tools and use them. The SEC has been asleep on the job for long enough. It's time for the Commission to get off its behind and protect investors and consumers, and I expect to see progress on all of these areas under your leadership.”

In an effort to push back against the strong support the legislation is getting from certain progressives, SIFMA President and CEO Ken Bentsen said in a statement, “The securities arbitration system has worked effectively for decades because it is subject to public oversight, regulatory oversight by multiple independent regulators, and rules of procedure that are designed to benefit investors . . . Pre-dispute arbitration agreements are a vital component of this system.”

With no other industry voices currently speaking up, Bentsen may be a lone voice in the woods. The North American Securities Administrators Association (NASAA), and the Public Investors Advocate Bar Association (PIABA) have voiced their support for the legislation.

“NASAA has long been concerned with the widespread use of mandatory pre-dispute arbitration clauses in customer contracts used by broker-dealers and, where applicable, investment advisers,” former President Christopher Gerald said. “These ‘take it or leave it’ provisions deny retail investors important choices in resolving disputes with their investment professionals.”

PIABA President David P. Meyer supports the legislation but contrasts the current disadvantages facing large bank and RIA clients by differentiating FINRA arbitration versus other non-securities-specific forums. “Investors who are customers of brokerage firms have been at a severe disadvantage for decades now by being forced into the single avenue of mandatory arbitration. Investors who are customers of registered investment advisors are typically forced into arbitration forums that are cost-prohibitive and not well suited to handle investment disputes.”

Meyer admits that FINRA’s Dispute Resolution system has its advantages for clients: “Arbitration of investment disputes has its upsides, and FINRA has made great improvements to its dispute resolution forum for brokers and brokerage firms over the past 20 years. However, when an investor has a dispute with a registered investment advisor (as opposed to a broker or brokerage firm), they are usually forced into other arbitration forums which have not made the same improvements and which are often cost-prohibitive. Investors may be left with no justice at all, and firms are not held accountable for their misconduct."

Meyer has raised an interesting issue when it comes to dispute resolution. Is it true that clients of FINRA-registered firms get a better shot at a fair hearing than other forums?

FINRA has gone through a near-complete overhaul of its dispute resolution system. Here are just a few examples.

In 2011, FINRA abandoned Notice To Members 99-90, which promulgated multiple and often overlapping lists of discoverable documents segregated by the type of case being heard. FINRA simplified discovery in Notice to Members 11-17 by consolidating a 14 list system into a discrete two-list system of documents, one for customers and one for banks. By doing so, FINRA made discovery cleaner with fewer gaps for interpretation and stricter mandates for banks to comply.

In September 2013, after a pilot program begun in 2011, the SEC approved the amendment to FINRA Rule 12403, which, in essence, eliminated the industry arbitrator. The rule was cleverly written to allow either side to "strike" the entire industry list, but it was common knowledge that the move was made to assuage the complaints of the Claimants’ bar which saw the industry arbitrator as one more witness in the room for the banks.

With this change, FINRA panels were allowed to go from one-third bank-related to zero.

Assuming FINRA’s changes are not enough for everyone, what does the public gain by access to the court system? The bigger question might be, what does it lose? Let's start with time.

FINRA guidance to arbitrators on scheduling hearings is to set those hearing dates within nine months of the filing of the arbitration. There is even a codified procedure for expediting the hearing schedule for clients who are merely over a certain age or "infirm."

Ask any civil attorney if he/she can get your case to trial in state or federal court in under a year, and they might just laugh out loud.

Then there’s discovery. FINRA “discourages” the use of depositions or interrogatories, which means in almost every case, there are none, which means no pre-deposition discovery and the endless motion practice that takes place in-between.

If the Investors Choice Act is really all about protecting the "little guy," the “little guy” has to ask himself if he has years and years to get locked up in litigation and appeals with banks that can easily afford to do so. Most of those “little guys” need the money they are fighting for in arbitration today, not in three to five years.

Finally, there is just that, finality. Arbitration decisions are binding, so that means with very few exceptions, there is no appeal. If a client wins, the bank writes a check.

Proponents of the bill would argue that no matter the venue, Main Street is merely looking for a choice as to where it can bring its case, but Wall Street will find ways to exercise its own choices as well.

Should this legislation pass, the shape of retail investing and Wall Street’s willingness to accept litigation risk will change. Congress can tell Wall Street that it may not impose mandatory arbitration on its clients, but it can’t tell Wall Street who to do business with. Larger firms may be less willing to take clients that they see as more significant risks, and those folks may have no choice but to do business with smaller firms.

The current structure is by no means perfect. Maybe Congress should take a close look at how the industry works and come up with more reasonable, creative alternatives instead of taking a broad brush to the problem. History tells us that path is unlikely.
Right now, the individual investor should be careful about what she asks for because these days, she just might get it.

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