Justices Uphold Arbitration for Brokers, Clients : U.S. Supreme Court Rules Investors Must Abide by Agreements, Cannot Sue

In a major victory for the securities industry, the Supreme Court ruled Monday that disgruntled investors may not sue their brokers in federal court if they have signed a standard securities industry agreement to submit all disputes to arbitration.

The 5-4 ruling overturned an appeals court decision in favor of a New York couple who lost $350,000 in a rapid series of stock trades and were charged another $216,000 in commissions.

The high court said the Securities Exchange Act does not give an investor the right to sue in federal court merely because he alleges that federal laws were violated by his broker. Rather, the investor must abide by any previous agreement to use arbitration.

Federal law provides for such arbitration agreements, and most brokerage firms require one before agreeing to trade stocks for an investor.

Industry Hails Decision

Securities industry officials hailed the endorsement of that system, which they contend is faster, fairer and cheaper than going to court.

The vote was “an important victory for brokerage firms as well as for the individual investor,” said Mike O’Neill, a spokesman for Shearson Lehman Bros., the defendant in the New York couple’s lawsuit.

Not only is litigation “financially unbearable for many consumers,” but arbitration panels “are better equipped than a jury to resolve what are primarily factual disputes,” O’Neill said.

Theodore Eppenstein, an attorney representing angry investors Eugene and Julia McMahon, said they “wanted a hearing before a jury of their peers in federal court. They are unsophisticated investors who were taken in.”

Unlike a jury, an arbitration panel is made up mostly of businessmen and is “more prone to be biased in favor of the brokerage,” Eppenstein said.

In accordance with the standard agreements, a list of potential arbitrators for a dispute is provided by an independent arbitration service. The disputing parties negotiate on which candidates will serve on the three-member panels.

Invested $2 Million

The McMahons, who own funeral homes in Yonkers, N.Y., invested about $2 million in 1980 with a Shearson broker, Mary Ann McNulty. The money included their savings and several trust accounts for their employees, according to their lawsuit. The couple said they gave the broker discretion in handling their accounts but, according to their lawyer, added that they wanted the funds invested conservatively.

Instead, they said, the broker “churned” the account, allegedly making a large volume of sales and purchases with the chief intention of generating commissions. After repeated inquiries, the couple said, they were shocked to learn in 1982 that there had been 3,500 trades, that they had suffered huge losses and that they owed more than $200,000 in commissions.

They filed suit, charging that the broker’s activities violated the Securities Exchange Act of 1934 and other federal statutes whose enforcement fell under the federal courts.

Justice Sandra Day O’Connor, writing for a conservative court majority, said the Federal Arbitration Act “mandates enforcement of agreements to arbitrate statutory claims.”

“Accordingly, the McMahons, having made their bargain to arbitrate, will be held to their bargain,” O’Connor wrote in the case (Shearson vs. McMahon, 86-44).

In dissent, Justice Harry A. Blackmun complained that small investors were being asked to trust the fairness of the securities industry “at a time when the industry’s abuses toward investors are more apparent than ever.”

Blackmun conceded that the arbitration system set up by the securities industry and monitored by the Securities and Exchange Commission has improved in recent years. He added, however: “There remains the danger that, at worst, compelling an investor to arbitrate securities claims puts him in a forum controlled by the securities industry.” The arbitrators may be “individuals sympathetic to the securities industry and not drawn from the public,” he said. He was joined in dissent by Justices William J. Brennan Jr., Thurgood Marshall and John Paul Stevens.

Though disappointed by the court’s ruling, the McMahons’ lawyer said he would now take their case to an arbitration panel.

“I think it is possible to get a fair hearing before a panel and we’ll try,” Eppenstein said.