Investors Lose in Recent Arbitration Rulings

Arbitration has become the only show in town for investors who have disputes with their brokers and brokerage firms.

By now, virtually every big investment house in the nation requires investors to sign arbitration contracts agreeing to submit to binding arbitration in the event of a dispute. The brokerages maintain that the process results in quicker settlements, allowing both the investor and the brokerage to avoid a costly and protracted trial.

Often arbitration does work just that way. Settlements are fast and legal expenses are small on both sides. That’s one of the reasons that arbitration is gaining steam in a number of other industries, including banking and medical services.

However, some recent legal rulings have left securities industry arbitration experts troubled.

During the late 1980s and early ‘90s, arbitration seemed to be swinging in favor of investors, who were winning compensatory and punitive damages in greater numbers.

In the past year, however, rule changes and legal decisions have significantly limited investor rights, said Hartley T. Bernstein, partner at Brandeis, Bernstein & Wasserman in New York.

The changes came on three fronts.

First, the securities industry was able to push through new rules that require arbitrators to provide a written statement delineating why a decision was made and how damages were computed in instances where punitive damages are awarded.

In the past, such written decisions were rare, which made it virtually impossible to appeal an arbitration decision. There was simply too little information given to provide a basis for an appeal. Now, almost any decision that awards the investor punitive damages is reviewed for possible appeal by the securities firm involved, Bernstein noted.

It is important to mention that investors did not win any similar concessions that would require a written explanation when they lose at arbitration.

Secondly, investors have lost their right to choose the American Arbitration Assn. over panels put together by the New York Stock Exchange or the National Assn. of Securities Dealers, Bernstein said.

Until last year, investors whose stock was listed on the American Stock Exchange could often bypass arbitration clause restrictions that required them to take disputes to these industry panels by jumping through the “American Stock Exchange window” that allowed investors to choose the American Arbitration Assn. instead.

However, a series of recent court rulings say even that window is closed. If your arbitration clause says disputes must be taken to the NASD or the NYSE panels, they must, Bernstein said.

“As equitable as the NYSE and NASD would like to be, they are broker-dealers and thus a self-regulatory agency,” Bernstein said. “You are at the mercy of their ability to choose fair arbitrators.”

And since the investor’s ability to appeal is almost nil, getting a fair panel is of paramount importance.

Finally, last June, an appeals court ruled that if an arbitration contract says your dispute will be governed by the laws in the state of New York, you will be too, regardless of where you live and do business. This is particularly important because the contracts at most of the nation’s largest securities firms say just that. And New York law specifically prohibits arbitrators from awarding punitive damages, no matter how flagrant or abusive the brokers’ practices, Bernstein said.

Instead, investors can be compensated only for their actual losses under New York law. Federal law has no restrictions, and many other states, including California, specifically allow for punitive damage awards.

Of course, the law is ever-evolving. It’s possible that future legal decisions will swing back to favoring investors. But right now it looks as if the brokerage firms have all the cards.

How can investors help their odds?

* Don’t sign an arbitration agreement unless you have to.

* If you must sign such an agreement, make sure you read it and understand what it says.

* If the agreement states that your potential dispute must be governed by New York law, scratch out New York and write in “federal.”

* If the agreement states you must use NASD or NYSE panels, scratch out the clause and write in that you can choose the American Arbitration Assn.

If the brokerage accepts the changes or simply files the contract without disputing them, you have a good chance of getting the treatment you’d prefer if you have a dispute, Bernstein said.

Of course, brokerage firms don’t have to accept your changes. But you also don’t have to deal with that particular brokerage.