Lawyers Group Alleges NASD’s Arbitrations Biased for Firms

Lawyers representing individual investors in disputes against brokerages charged Thursday that the National Assn. of Securities Dealers has been “rigging” arbitration hearings to favor Wall Street firms–an allegation that the NASD instantly denounced.
The group charged that NASD computers have been set so that the panels conducting arbitration hearings are stacked with people friendly to the industry–a “direct and flagrant violation of federal law” that has “tainted hundreds or even thousands” of arbitrations, the Public Investors Arbitration Bar Assn. said.
“This is not an issue of a computer glitch that nobody knew about,” said Stuart Goldberg, PIABA’s general counsel. “They did it to help the brokerage industry.”
In a sharply worded rebuttal, the NASD denied the allegations as “simply irresponsible” and made with an “utter disregard” for the facts. “This system does work, and it works in accordance with the rules,” said Linda Fienberg, NASD’s head of dispute resolution.
This is a critical issue for the more than 5,000 small investors who file arbitration claims each year against full-service and online brokerages. About 90% of cases are handled by the NASD, the self-regulatory group overseeing the brokerage industry.
Investors have been forced to settle disputes with brokers in arbitration since a 1987 Supreme Court ruling barred them from filing lawsuits.
Individuals brought 5,608 arbitration cases last year, and 2,706 through June of this year. The number may grow in coming months: After the stock market’s dive in the spring, many investors who had bought stocks on credit from their brokerages have complained that the firms wrongly sold out their accounts at the market’s bottom rather than giving them a chance to put up fresh cash.
About 70% of arbitration cases are settled, the NASD’s Fienberg said. When cases go the distance and a ruling is issued by an arbitration panel, investors prevail about 60% of the time, she said.
Nevertheless, the arbitration process has long been criticized by investors’ attorneys as unfair. They say the fact that arbitrations are overseen by the NASD, an industry association, is a conflict of interest.
A report by the General Accounting Office last month found that of the investors who were awarded money by arbitration panels in 1998, 49% never received a dime and 12% got only partial payments. Unpaid awards, almost all involving NASD cases, totaled $129 million.
The NASD says fraudulent brokerages often file bankruptcy to avoid paying awards–a problem that would occur even in court cases.
In a securities arbitration, each side chooses arbitrators from a list of 15 candidates. They strike those they don’t want, and rank the remainder in order of preference. A final three-person panel is seated consisting of one “industry” member and two “public” members.
The 15-person candidate list is supposed to be spit out by an NASD computer on a rotational basis so that all candidates in the pool have an equal shot at being chosen.
But the attorneys group alleges that NASD computers have been programmed so that when one side sought arbitrators with specific expertise, the rotational system was automatically dropped–so that some candidates popped up far more than others for panels.
That favors what PIABA contends are “professional” arbitrators who are biased in favor of the securities industry because they don’t want Wall Street firms to object to their continued presence on panels.
PIABA said it was told the system works that way in a meeting last month in Chicago with a top NASD technology expert. But the NASD said Thursday that its tech expert had been given incorrect information by an outside consultant, and that the system in fact has always worked on the rotational basis.
When PIABA complained after the Chicago meeting, the NASD said it promised a formal response by July 26. PIABA maintains that the NASD originally promised an answer by Wednesday, and acted when it didn’t receive it.
PIABA said the NASD had led it to believe in recent weeks that the system could indeed be flawed. The group said it doesn’t believe the NASD’s claim Thursday that the system functioned properly all along. “If there was never any problem they would have told us that immediately,” alleged a Beverly Hills attorney and PIABA board member.