Sense on Cents

How would you like to bring a case in which the counterparty is not only defendant, but judge and jury as well? Probably not, right?

Welcome to the world of Wall Street arbitration.

Investors, when opening an account with a bank or broker, are compelled to sign an agreement stating that any dispute will be adjudicated via an arbitration process. On its surface, arbitration is not a bad process. It is utilized in many industries. That said, for arbitration to be uniformly fair the arbitrators must be disinterested parties. Does that happen on Wall Street? Come on, be serious!! The deck is stacked against investors in arbitration. Why?

Arbitrators obviously need to have a thorough knowledge of the financial industry in order to pass judgment. Beyond that, though, Wall Street arbitrators and arbitration have lots of issues and embedded conflicts.

Let’s take a harder look at the arbitration process. The Wall Street Journal provides a brief overview, Securities Arbitration Is Faulted:

Attorneys who represent investors have asked the Securities and Exchange Commission to drop a requirement that a securities-industry representative sit on arbitration panels.

Yes, that statement right there highlights the embedded conflict in the arbitration process. Let me simplify. Say, for example, an investor brings a complaint against his Morgan Stanley broker. On the arbitration board will sit a representative from Goldman Sachs. Simultaneously, right down the hall an investor brings a complaint against his Goldman Sachs broker. On the arbitration board sits a representative from Morgan Stanley.  Level playing field? Come on.

Investors who open a brokerage account generally sign away their rights to sue the broker or the firm for bad advice. They have to settle disputes through arbitration run by the Financial Industry Regulatory Authority, which is funded by the industry.

What do we learn here? The case obviously will not be arbitrated in your lawyer’s office and similarly not in the offices of the broker’s attorney. Who holds court? The Financial Industry Regulatory Authority, FINRA, which is funded by Wall Street. Conflict of interest? At least on the surface it would appear as such. For those unfamiliar with FINRA, this is the organization which has yet to issue their 2008 Annual Report and dumped $647 million in Auction Rate Securities either shortly before or as the ARS market was failing. Feeling confident yet? Me neither. (more…)