With the downturn taking its toll on investors' portfolios, the Financial Industry Regulatory Authority (FINRA) is seeing a substantial increase in the number of complaints filed against brokers and advisers. But even as these firms are getting hit hard with arbitration, three more just signed up for a pilot program aimed at giving investors more choices in their bids to recover losses.
The program, run through FINRA, allows investors to choose whether the panels deciding their cases have a representative from the securities industry. While traditionally controversial, the issue of industry panelists has taken on increasing importance lately as the number of dispute-resolution cases balloons.
In FINRA's arbitration cases, when investors file claims to recover upwards of $100,000, their cases go to three-member panels. Before the pilot launched last year, such panels always included exactly one industry representative and two other members (referred to as public panelists) trained by FINRA but not associated with the securities industry. But the initiative allows investors to opt for three public panelists, and so far around half of the participants have done just that. This even split underscores a deep divide in how investors view the objectivity of industry representatives.
"There are any number of conscientious industry reps who feel like it's their job to maintain the integrity of the brokerage business," says Brian Smiley, an Atlanta lawyer and the president of the Public Investors Arbitration Bar Association (PIABA), a group whose member attorneys represent investors in arbitration cases.
"On the flip side, we are in an era when increasingly the matters that go to arbitration involve industrywide misconduct where all of the firms—and particularly all the big firms—did it," he continues. "So it's hard for an industry representative to give a disinterested opinion because he may be condemning a practice that his own firm engaged in." PIABA, for its part, maintains a neutral stance on industry arbiters, preferring instead that investors have the chance to decide for themselves.
As part of the recent expansion of the pilot, Chase, Oppenheimer, and Raymond James volunteered to take part. At the same time, five of the 11 original firms have beefed up their participation. Under the terms of the pilot, firms put aside a set number of cases in which they will allow investors to veto the presence of an industry representative. Investors filing claims against these firms then get to opt into the program on a first-come basis.
But even as firms step up their interest in the initiative, some are quick to question their motives and call the participation an attempt to avoid what the securities industry considers to be more unsavory proposals at the federal level.
In particular, Congress has long been considering the Arbitration Fairness Act, which would nullify mandatory-arbitration clauses in brokerage contracts. And a recent financial regulation proposal by Democratic Rep. Paul Kanjorski of Pennsylvania contains a provision that would give the Securities and Exchange Commission the ability to ban the clauses. Investment firms like the clauses because they prevent investors from filling individual lawsuits to recover losses. Many people believe investors would fare better in court than they do in arbitration.
Andrew Stoltmann, a securities lawyer in Chicago, argues that by making a small concession, firms hope to convince federal regulators that sweeping changes are not necessary. "That is originally what caused some firms to enter into the pilot program and now is causing . . . other firms to jump into it as well," he says. "I think nothing scares the securities industry more than Congress and the government sniffing around, and the securities industry is trying to cut them off at the pass."
With the new round of interest, the pilot can accommodate 411 cases. So far, approximately 244 of those spots have been claimed. The program began last year and will run through next October. Since arbitration cases that go to hearings can take over a year to resolve, FINRA officials are just now starting to see the impacts of their experiment. "Now that we're one year in, we'll start to see some of the actual results of the claims that are filed under the program," says FINRA spokesperson Brendan Intindola. After the pilot ends, FINRA will review its effect on outcomes and decide on any long-term policy changes.
In the arbitration cases in question, investors file claims against securities companies. Common charges include breach of fiduciary duty, misrepresentation, and negligence. There has been a rash of filings during the recession, with downtrodden investors putting their brokers and advisers under increased scrutiny. Through August, FINRA had received 4,991 new dispute-resolution cases this year. That's up 65 percent from the same period in 2008. Recently, mutual funds have been the most common type of security involved in arbitration filings.