Regulators Investigate the Fairness of Mandatory Arbitration Clauses in Brokerage Contracts

Representing Investors Nationwide

Stock fraud victims who want to try and get their money back are usually bound to resolve their disputes through FINRA (Financial Industry Regulatory Authority) arbitration proceedings. That’s because nearly all client agreements signed by brokerage firm customers contain an arbitration clause, forcing them to seek justice through arbitration in lieu of court proceedings.

Whether or not FINRA arbitration is actually fair to investors (or slanted in favor of Wall Street brokerage firms) is hotly debated. Indeed, a lot of evidence points to the fact that arbitration hurts investors more than it helps them.

Recent news indicates that the Consumer Financial Protection Bureau (CFPB) and the Securities and Exchange Commission (SEC) are finally taking notice. These agencies have launched investigations to determine the benefits of putting across-the-board limitations on arbitration clauses. These investigations aren’t just an information gathering exercise to shed light on the inadequacies of arbitration either, they have teeth.

The Dodd–Frank Wall Street Reform and Consumer Protection Act (enacted in July 2010) gives the CFPB and SEC regulatory authority over what brokerage firms can and can’t put inside their contracts. In fact, the CFPB and SEC may decide to ban mandatory arbitration clauses altogether. A change like this would have landmark implications for the way investors interact with their stockbrokers, mainly because stockbrokers and insurance companies will be exposed to more litigation risks. It would also change how lawyers pursue stock fraud claims on behalf of their clients.

Proponents of FINRA arbitration (mainly big Wall Street brokerage houses, banks and insurance companies) say arbitration is a way to prevent undue stress on the court system. They argue that the vast number of customer complaints, if forced to go through the court system, would place heavy burdens on an overburdened legal system. Proponents also say arbitration clauses protect brokerage firms and insurance companies from frivolous class action lawsuits that are costly to defend. They say these class actions benefit the plaintiff attorneys who pursue them more than individual victims.

On the other hand, opponents to arbitration clauses say that all these ‘protections’ end up shielding Wall Street firms from litigation risks more than they protect investors from harm. They say that the benefits of arbitration pale in comparison to the evil of having an investment industry operating unchecked by the law.

Opponents of FINRA arbitration say arbitration is a ‘kangaroo court’ operating outside the law more than anything else. They point to the fact that FINRA arbitrators are often ex-stockbrokers or other industry-biased professionals. They also argue that arbitrators are often non-attorneys who do not have the capacity to rule on sensitive matters of law. As a result of all this, opponents say that arbitrators will in many cases ignore the law and make decisions based on how they ‘feel’ or based on their own internal morality – much like a king would do.

Sometimes this can work in favor of a fraud victim, but opponents say that wronged investors are in danger of getting the short end of the stick when potentially biased arbitrators don’t make decisions based on law. On a larger scale, they say that brokerage firms and stockbrokers are much more likely to violate the laws enacted to protect consumers if they know they are less likely to be held accountable.

It will be very interesting to see how this most recent manifestation of The Dodd–Frank Wall Street Reform and Consumer Protection Act unfolds. The CFPB and SEC have stated they are taking a neutral approach toward this investigation and are open to the idea that arbitration is just as fair as court proceedings. However, they are also poised to take action if mandatory arbitration is shown to be harming consumers.

Let’s keep an eye on this topic and hope it culminates into a giant step forward for consumer rights and investor protection.