NASD Manual Rule 10301(a) requires every member firm to arbitrate any dispute with a customer if demanded by the customer. Since Shearson demanded the enforcement of arbitration clauses in the case of Shearson/American Express, Inc. vs. McMahon, the courts practically have enforced arbitration clauses when customers have filed lawsuits in the court systems. If you think this is a good idea, keep reading.
Arbitration, as opposed to litigation, was extolled as the greatest thing since canned beer for the securities industry. The virtues, according to the early proponents, were that it was faster, cheaper, and more confidential than going through the time, cost, and publicity of a court battle. It is no longer faster and cheaper. In addition, the forfeited legal rights clearly offset the alleged benefits. One only needs to read the arbitration awards and court decisions to see it is expensive, time consuming, and that the rules of evidence do not apply. Whatâ€™s more, there is no appeal from the decision, and punitive damages can be awarded.
It used to be that an arbitration case was often completed in six months. Today, it is unusual to complete a hearing in less than a year, and even two years is not uncommon. This is due to discovery and coordinating the schedules of the attorneys, witnesses and arbitrators. In court, a judge sets the schedule, which the parties then have to meet. Thus, speed is no longer an advantage over the courts. Arbitration is no longer cheap. The cost of responding to a claim for arbitration, compared to the cost of litigation, has increased dramatically. In addition, there is a surcharge for NASD member firms. Not only is there the cost of responding, there is a charge for adjourning a hearing date, as well as a charge for each day of the hearing. In a recent case, there was a $1,000.00 charge, even though the father of the primary witness for the firm unexpectedly had to be hospitalized. On top of these charges, the panel can award forum fees, which can total thousands of dollars more.
The cost of filing a lawsuit in federal courts is $250.00. There is no cost for filing a response. There is no surcharge. There are, normally, no $1,000.00 penalties for adjournments in the court system.
If the above is not discouraging, the other shortcomings of arbitration should make every broker/dealer question the wisdom of making arbitration mandatory. In reality, there are no rules of evidence in an arbitration hearing. While the federal rules of evidence are supposedly followed, they are not strictly enforced.
Hearsay testimony is commonplace. It is not uncommon to have a witness relate a conversation with absolutely no opportunity to cross-examine the party on the other side of the conversation. While motions to strike testimony can be made, they are seldom granted. The favorite ruling by the panel is, â€œWe will hear the testimony for whatever weight we choose to give it.â€ This does not create a warm and fuzzy feeling.
The same attitude prevails in the introduction of documents. Documents are often admitted without proper authentication. This does not usually pose a problem because the attorneys generally agree in advance on the documents to be introduced into evidence. However, it becomes critical when there are allegations of forgery. It has been estimated that twenty-five percent of the documents executed in the 1990s for the purchase of limited partnerships were forged.
The Code of Arbitration has extended the statute of limitations. The Sarbanes-Oxley Act extended the statute of limitations to five years from the three years of the 1934 Securities Exchange Act. Most state statute of limitations under the Uniform Securities Act are four years. The Code of Arbitration Procedure extends this by making claims eligible for arbitration to six years. In over 200 arbitrations, I cannot remember one time that a motion for dismissal was granted because of the statute of limitations. While it has been suggested as a recent change, I cannot remember a motion for summary dismissal being granted for failure to state a claim upon which relief can be granted prior to the start of a hearing. Even when the Claim for Arbitration failed to list the name of one stock or bond, it was not dismissed. The failure to grant such a motion can lead to a full-blown hearing, with days of testimony, legal fees, costs, and with an eventual award for which no explanation is given. In a court setting, such motions for summary judgment are routinely granted.
One other alleged virtue of arbitration is confidentiality. This really means that there is little or no precedential law that the arbitrators are required to follow. There is, in reality, no basis for the courts to vacate a decision by an arbitration panel. The Federal Arbitration Act lists four premises for appealing the decision of an arbitration panel. The states have a similar law. However, one only needs to read the opinions of the United States Supreme Court, the various federal courts of appeal, and the state appellate courts to see that the chances of vacating an arbitration award are slim to none. The United States Court of Appeals for the First Circuit joined numerous other Circuits this year in announcing a harsh standard for vacating arbitration awards on the basis that they are in manifest disregard of the law. In McCarthy vs. Citicorp Global Markets, Inc., Case No. 06-1001 (1st Cir. Sept. 19, 2006), the Court vacated a District Court Order that set aside an arbitration award. The Court of Appeal held that to prevail in establishing manifest disregard, â€œthere must be some showing in the record, other than the result obtained, that the arbitrators knew the law and expressly disregarded it. ... â€˜Disregardâ€™ implies that the arbitrators appreciated the existence of a governing legal rule but willfully decided not to apply it.â€ The District Court had previously vacated a decision by the Panel and remanded with instructions, which it believed the Panel â€œmightâ€ have disregarded on remand. The Court of Appeal held that this was insufficient to vacate the Panelâ€™s second award because, as stated by the Supreme Court in United Paperworkers Intâ€™l Union vs. Miusco, Inc., 484 U.S. 29, 38 (1987), courts â€œdo not sit to hear claims of factual or legal error by an arbitrator as an appellate court does in reviewing decisions of lower courts.â€ The First Circuit concluded that even if legal error is â€œpainfully clear, courts are not authorized to reconsider the merits of arbitration awards.â€
As the United States Supreme Court wrote in the United Paperworkers Intâ€™l Unioncase, â€œAs long as the arbitrator is even arguably construing or applying the contract and acting within the scope of [her] authority, that a court is convinced [she] committed serious error does not suffice to overturn [her] decision.â€ With this standard, it is very difficult to get any arbitration decision vacated.
Finally, thanks to another decision involving Shearson, the decision in the Mastrobouno case made it possible for arbitration panels to award punitive damages. Many states do not allow for the awarding of punitive damages by juries. So you tell me, why is the brokerage community in love with arbitration?
Walter L. Baumgardner is an attorney in St. Clair Shores, Michigan with the firm of Musilli, Brennan, LLC. He has defended brokerage firms as well as represented numerous customers in over 200 arbitration cases. He has been series seven licensed for over thirty years and was branch office manager for over twenty years. He lectured on compliance issues and serves as an arbitrator for the NASD. He can be reached at: 586-778-0900.