Testimony of Tanya Solov
Director, Illinois Securities Department
Illinois Secretary of State
On behalf of the North American Securities Administrators Association
Before the
United States Senate Committee on the Judiciary
Constitution Subcommittee
“S. 1782, the Arbitration Fairness Act of 2007″
December 12, 2007
Chairman Feingold, Ranking Member Brownback, and Members of the
Subcommittee,
I am Tanya Solov, Director of the Illinois Securities Department and I am
honored to convey the North American Securities Administrators Association’s
(NASAA)1support for S. 1782, the Arbitration Fairness Act of 2007. State
securities administrators view this issue with such importance that the
second item listed on NASAA’s 2007 Pro-Investor Legislative Agenda was
“Restore Fairness and Balance in the Securities Arbitration System.” We’re
delighted with your leadership on this subject and thank you for the
opportunity to testify about arbitration from the perspective of investors
on Main Street.
The Role of State Securities Regulators
The securities administrators in your states are responsible for enforcing
state securities laws, the licensing of firms and investment professionals,
registering certain securities offerings, examining broker-dealers and
investment advisers, and providing investor education programs and
materials. Like me, ten of my colleagues are appointed by their Secretaries
of State, others by their Governors, some are independent commissions, and
five fall under the jurisdiction of their states’ Attorneys General. We have
been called the “local cops on the securities beat,” and I believe that is
an accurate characterization.
As the securities director for the state of Illinois, I interact with
investors who approach me at various programs across the state or call my
office with inquiries and complaints. My office works with criminal
authorities to prosecute companies and individuals who commit crimes against
our citizens, and brings civil actions for injunctions, penalties and
restitution for investors. We also educate our constituents through
publications, videos and seminars so that they may be better able to protect
themselves.
Mandatory Securities Arbitration
The Constitutional right of investors to have their day in court was
rendered meaningless after the U.S. Supreme Court held in Shearson/American
Express Inc. v. McMahon, 482 U.S. 220 (1987), that predispute arbitration
clauses were enforceable in the securities context. The impact of that
decision is more profound today because the profile of those investing in
our capital markets has changed significantly since the McMahon case was
decided in 1987. We’ve gone from a nation of savers to one of investors.
Twenty years ago, those investing in the securities markets were higher
income individuals with other secure sources of income such as a defined
benefit pension plan. Today, roughly half of all U.S. households rely on the
securities markets to plan and prepare for their financial futures. They
include school teachers, fire fighters and policemen who work in your
communities, invest in their 401(k) retirement plans, and depend on their
financial advisors’ representations regarding their financial future.
Twenty years ago, investors had a choice of investing with a firm that
required arbitration or one that recognized a judicial forum for disputes.
Today, almost every broker-dealer includes in their customer agreements, a
predispute arbitration provision that forces public investors to submit all
disputes that they may have with the firm and/or its associated persons to
mandatory arbitration. The only chance of recovery for most investors who
fall victim to wrongdoing on Wall Street is through a single securities
arbitration forum maintained by the securities industry. Many investors
remain unaware of this industry arbitration provision, fail to appreciate
its significance, or feel powerless to negotiate a different approach to
dispute resolution with their brokers.
It is not surprising that many investors view industry arbitration as biased
and unfair. Even in 1987, Justice Blackmun, in the McMahon dissent, noted:
“The uniform opposition of investors to compelled arbitration and the
overwhelming support of the securities industry for the process suggest that
there must be some truth to the investors’ belief that the securities
industry has an advantage in a forum under its own control.” (482 U.S. 220,
260, citing Sheldon H. Elson of the ABA Arbitration Task Force). Investors’
perception that the industry has an advantage is bolstered by arbitration
statistics. An investor’s chance of winning an arbitration award has
declined from approximately 60% in 1989-90 to about 43% by 2006. (See
Securities Arbitration-How Investors Fare, GA/GGD-92-74, (May 11, 1992);
NASD Dispute Resolution Statistics). It is also noteworthy that a “win” in
arbitration often amounts to recovery of only a fraction of the losses
incurred by the investor and, in certain instances, the sum awarded amounted
to less than the costs and fees the investor paid out of pocket to pursuethe case.
When arbitration is inadequate to protect the substantive rights of
investors, an independent judicial forum must be an option. Arbitration may
be desirable and adequate if both parties knowingly and voluntarily agree to
waive the Constitutional rights provided in court. The decision to make this
waiver should be made at the time the dispute arises. At this point, both
parties may make the determination whether their particular dispute is best
decided in a court of law with court-supervised discovery, a written
opinion, and appellate review of complex legal issues.
The Financial Industry Regulatory Authority (FINRA) should require its
member firms to offer their customers a meaningful choice between binding
arbitration and civil litigation. If arbitration really is fair,
inexpensive, and quick, as its adherents claim, then these benefits will
prompt investors to choose arbitration. If, on the other hand, arbitration
does not offer these advantages, then this mode of dispute resolution should
not be forced upon the investing public.
NASAA believes the “take-it-or-leave-it” clause in brokerage contracts is
inherently unfair to investors, and we support the Arbitration Fairness Act
of 2007 as a positive step in the right direction. In the securities
context, the investor and the brokerage firms are not on equal footing.
Brokerage firms have significantly more resources to fight investor claims
and they currently have the benefit of arbitrating in their own industry
forum with an industry member hearing the case. Adding to this advantage is
the level of familiarity and comfort that firms have in the arbitration
forum. Brokerage firms are literally “repeat customers” having resolved
thousands of complaints by arbitration and by this fact enjoy an advantage
over the individual investor who may well be facing an arbitration panel for
the first time. The hazards of litigation for the firm are thereby reduced
further diminishing a firm’s motivation to settle a complaint. The option to
litigate in an independent judicial forum would go a long way towards
bringing balance to the process and helping wronged investors in their
attempts to recover their losses.
Until mandatory securities arbitration is a thing of the past, NASAA will
continue to work to eliminate the inherent industry bias in the existing
system. NASAA has been at the forefront of trying to make certain the
securities arbitration system is fair and transparent to all. We recognize
that over the years NASD, now FINRA, adopted a number of changes in an
effort to improve the arbitration system, but more is needed. The
consolidation of NASD and NYSE into FINRA has effectively resulted in a
single industry run forum for the resolution of disputes between public
customers and the securities industry. As a consequence, NASAA’s concerns,and those of others actively engaged in arbitration issues, have been
further heightened. Indeed, the public members of the Securities Industry
Conference on Arbitration (SICA) wrote to Securities and Exchange Commission
Chairman Christopher Cox2 to address certain questions raised by the
consolidation with respect to the future of securities arbitration. NASAA
believes that absent the option of pursuing a claim in court, investors
should at least be given a choice of arbitration forums; however, where
there is no choice but arbitration through a program administered by FINRA,
then this one forum must at least be independent and fair to investors.
Reforms to the Current System
Securities arbitration cases are heard by a three-member panel that includes
one “non-public” or securities industry member, and two “public” members,
who may have worked in the industry. Neither of the public arbitrators is
required to be an investor advocate, even though the non-public arbitrator
is required to be an industry representative, and only FINRA, the industry
SRO, selects who is qualified to be in the arbitrator pool. As long as
arbitration panels include a mandatory industry representative of the
securities industry and include public arbitrators who could have ties to
the industry, the arbitration process will be both perceptively and
fundamentally unfair to investors.
Many have justified mandatory industry participation based on the industry
representative’s role as an educator for the other panelists. It may be
acceptable only if all parties in the case voluntarily agree that an
industry expert is needed. However, if there is not agreement then there is
no justification for the industry presence. First and foremost, expert
witnesses ably serve the purpose of educating the arbitrators. In addition,
where arbitration was once selected on a voluntary basis by investors
seeking to handle simple disputes, the advent of mandatory arbitration moved
all customer grievances to a more sophisticated arbitration process. Cases
are typically presented by lawyers, they generally last for several days and
the use of retained expert witnesses to present industry practices,
procedures and rules to the panels is typical.
The very notion of having a matter heard by a panel of independent
arbitrators assumes that they come to the arbitration process with no
preconceived opinion or interest in any party or issue at conflict. However,
industry arbitrators bring their particular experiences, based on their
firm’s training, policies and procedures, to the decision-making process. As
evidenced by industry scandals and regulatory enforcement actions, the
industry’s way of doing things is not always in conformance with the law.
Even if the industry arbitrator has no preconceived notions, the industry
arbitrator creates a presumption of bias that is contrary to the principlesof fair play and substantial justice. Do courts in complex medical
malpractice cases insist that one physician be empanelled in the jury box to
“educate” the other jurors? Clearly, such a requirement in a judicial
proceeding would be dismissed as creating a bias that would taint the final
ruling and pervert the concept of a fair hearing. It is also disconcerting
that the industry believes that the public arbitrators are not capable of
understanding a case and rendering a decision. If that is indeed true,
investors should not be forced to bring their case in such a forum. NASAA
submits that intellectual honesty should not be discarded at the door of the
arbitration forum.
When McMahon was decided, that Court noted several arbitration forums where
industry members sat on the panels. In most of those instances, the parties
in arbitration were also both industry members who were on equal footing.
Consequently, industry arbitrators and their expertise would have been
appropriate. That is not the case in securities cases where the investor is
not on equal footing with the brokerage firm. (McMahon, 482 U.S. at 224,
citing Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc. 473 U.S. 614
(1985)).
Additionally, one could readily conclude that the assertion that arbitrators
must be “educated” by an industry-affiliated panelist indicates that the
current training of arbitrators is inadequate. While a pool of uneducated
arbitrators is a serious problem, there are ways to correct this which will
not taint the average investor’s view of a currently mandatory process.
NASAA urges the removal of mandatory industry arbitrators from the
arbitration process, and for public arbitrators to have no ties to the
industry. This change will bring greater fairness to securities arbitration
and instill greater confidence in retail investors that their complaints
will be heard in a fair and unbiased forum.
Change The Definition Of A “Win” In Arbitration
FINRA should improve the statistics that it collects and disseminates on
arbitration, particularly with respect to outcomes. Proponents of
arbitration often point out that investors receive “some amount of
compensation” in over half of the arbitrations that result in a decision.
See, e.g., Linda D. Feinberg, Testimony Before the Subcommittee on Capital
Markets, Insurance, and Government Sponsored Enterprises, House Committee on
Financial Services, at 1 (Mar. 17, 2005).3 To the extent this statistic is
intended to suggest that investors “win” more often than not, it is
misleading. An investor who recovers only a small fraction of their losses
in the arbitration process can hardly be described as a “winner,” especially
when attorneys’ fees and costs are added to the mix. Much more accurate, forexample, would be data reflecting the ratio of amounts awarded in relation
to damages claimed. Fairly assessing the pros and cons of arbitration as a
means of dispute resolution requires access to meaningful and accurate
statistics.
State securities regulators often hear directly from investors who relay
their experiences and concerns about the arbitration process. NASAA is in a
position to communicate such problems to the SEC and FINRA. Recently, NASAA
was admitted as a voting member to SICA which is one group that works on
arbitration procedures and issues. It would also be beneficial to allow
NASAA to be an official observer at the National Arbitration and Mediation
Committee (NAMC) meetings where FINRA will address arbitration rules and
procedures.
Conclusion
NASAA believes that securities arbitration system should be truly voluntary,
that more meaningful and accurate statistics concerning arbitration outcomes
should be compiled and disseminated, and the balance in the composition of
arbitration panels should be restored.
As long as securities arbitration remains mandatory, investors will continue
to face a system that is not fair and transparent to all. For this reason,
NASAA supports the passage of S.1782, the Arbitration Fairness Act of 2007,
and respectfully suggests that it be amended to clarify that its provisions
extend to securities arbitration.
I thank the Chairman and each member of this Subcommittee for allowing me
the opportunity to appear today. I look forward to answering any questions
you have and providing additional assistance to you in the future.
1 The oldest international organization devoted to investor protection, the
North American Securities Administrators Association, Inc., was organized in
1919. Its membership consists of the securities administrators in the 50
states, the District of Columbia, the U.S. Virgin Islands, Canada, Mexico
and Puerto Rico. NASAA is the voice of securities agencies responsible for
grass-roots investor protection and efficient capital formation.
2 Letter from Public Members of SICA to SEC Chairman Christopher Cox, (Jan.
12, 2007) (on file with author).
3 Available at
http://www.nasd.com/web/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_013652
&ssSourceNodeId=1263.
http://judiciary.senate.gov/hearing.cfm?id=3055
