Justices Back Stockbrokers in Fraud Disputes : Investors Must Seek Redress From Industry Arbitrators, Not Federal Courts

The Supreme Court, in a victory for the securities industry, ruled Monday that many unhappy investors who believe that they were cheated by their stockbroker must take their complaints to an industry arbitrator, not a federal court.

The 5-4 ruling helps the stock firms avoid potentially huge damage awards by juries, which are often sympathetic to small investors who believe that they were bilked by their brokers. Instead, if an investor signs a standard contract pledging to take any dispute to arbitration, the justices said, he must abide by that deal.

Leaders of the securities industry, in briefs to the court, say these arbitration hearings are fair, speedy and unbiased. More than half of the arbitrators may have no direct ties to the industry, and in 1987, 55% of the customers’ cases that went before arbitration resulted in a damage award for the customer, the justices were told.

But a Texas lawyer who represents 17 widows who may have lost as much as $400,000 because of a shady broker said his clients would have much preferred to go to a federal court.

“This way, you are playing on their home court,” said attorney Denis Downey of Brownsville, who was on the losing end Monday. “They (arbitrators) may profess to be neutral, but they are picked by the industry. Plus, even if you win in arbitration, you usually don’t win much. Maybe a few thousand dollars in damages if you have lost $200,000.”

Federal court juries cannot only award a plaintiff damages to cover all of his or her losses, but can also tack on extra, huge punitive damage penalties to punish the broker or his company for their wrongdoing.

Still, the ruling Monday was no surprise. Two years ago, the court issued a similar ruling concerning the Securities and Exchange Act of 1934. Then, investors had sued their broker in federal court under the 1934 law, but the justices said the door to the court was closed because their contract language called for arbitration.

In this case, the 17 Texas widows had filed a federal court suit under the Securities Act of 1933. They contended, among other things, that the broker who worked for Shearson-American Express had churned their accounts and put their money into the most risky investments.

They relied on a 1953 Supreme Court ruling in the case of Wilko vs. Swan which specifically said that investors can use the 1933 Securities Act to get into federal court.

On Monday, however, the conservative majority simply overruled the 1953 decision, saying it was now “outmoded.”

“To the extent that Wilko rested on suspicion of arbitration as a method of weakening the protections afforded in the substantive law to would-be complainants,” wrote Justice Anthony M. Kennedy, “it has fallen far out of step with our current strong endorsement of the federal statutes favoring this method of resolving disputes.”

The four more liberal members--Justices John Paul Stevens, William J. Brennan Jr., Thurgood Marshall and Harry A. Blackmun--accused their colleagues of “judicial activism” since Congress has had 36 years to rewrite the securities law if it believed the Wilko ruling incorrect.

The ruling not only spares the securities industry a big headache, but does the same for the federal court system. In 1987, 2,844 securities-related complaints were filed in federal courts.

In its brief endorsing arbitration, the securities industry noted that the average U.S. judge handles 460 cases, meaning that the securities complaints alone could fill the schedules of six judges for a year.