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Change Is in the Wind On Investor Arbitration

Wall Street Journal

Legislative momentum may be building for a change in the way investors can resolve disputes with their brokers.

Last week, three U.S. senators spoke out to urge the Securities and Exchange Commission to make arbitration between investors and brokers voluntary. The issue may come up at a House Financial Services Committee oversight hearing in late June.

Since a 1987 court ruling allowing them to do so, brokerage firms have generally required their clients to take disputes to industry-run arbitration forums, arguing that the process is more efficient and cost-effective than the court system.

But investors’ advocates have long felt that the securities arbitration system is biased against them. And as the system has evolved, both sides agree that arbitration — run primarily by the National Association of Securities Dealers — has started to look more like the court system it was designed to improve upon. On top of that, the coming consolidation of member regulation functions of the NASD and NYSE Regulation, a unit of NYSE Euronext, will leave investors with just one arbitration forum.

It was in this atmosphere that the two senators — Russ Feingold (D., Wis.) and Patrick Leahy (D., Vt.) — wrote a letter to SEC Chairman Christopher Cox. Sen. Robert Casey (D., Pa.) echoed their comments in a speech to state securities regulators later in the week.

Sens. Feingold and Leahy urged the SEC to enact a rule prohibiting broker-dealers from requiring customers to sign mandatory arbitration agreements. “Investors must have the opportunity to meaningfully weigh arbitration’s benefits against a set of significant trade-offs,” they wrote. Investors “would be better off with a choice … than they are currently with no option but SRO regulation.”

An SEC spokesman declined to comment on arbitration.

Rep. Barney Frank (D., Mass.), who is the chairman of the House Financial Services Committee, also wrote a letter to Mr. Cox in late April, in response to the possibility of the SEC allowing companies to impose mandatory arbitration agreements on their shareholders; Mr. Frank pointed to broker-dealer arbitration as an example to show why the idea was a bad one.

As part of its SEC oversight responsibilities, the committee has called all five SEC commissioners to testify at a June 26 hearing that will address whether the SEC is protecting investors vigorously.

A lawyer who represents investors in arbitrations and is a former president of the Public Investors Arbitration Bar Association, said he thought the surge of congressional interest in mandatory arbitration revealed a shift in legislators’ attention.

“Both the House and Senate are now focusing on how arbitration rules affect investors, as opposed to how it affects the firms,” he said.

Some industry advocates say arbitration still works well for both sides. They point out that even as the cost and time it takes to move through the system trend upward, it’s still a lot less costly and faster than the court system.

Paul Matecki, senior vice president and general counsel at Raymond James Financial Inc., and an arbitrator, said, “I don’t see why they’re trying to fix something that no one’s been able to show is broken.”

But in the senators’ letter to the SEC, they argued that if arbitration was better for investors, investors could choose arbitration — but that having a choice was critical.

It isn’t investors who want choice, argues Matt Farley, a lawyer who represents brokerage firms in arbitrations: “No, it’s the lawyers who represent them who want a choice and want the option of being able to bludgeon the firm with the full panoply of federal discovery.”