The Securities Law Home Page 

      Recent Developments in Arbitration, Mediation and Other Alternate Dispute Resolution Techniques

      By Joel Leifer, Esq. 
      A client of mine just received an arbitration claim with an NASD file number in the low 2600's. Based on this it appears that 1996 is going to be what has become an average year for cases filed. However, based on a rather unscientific poll with a probable margin of error in three figures, the large brokerage firms say they are experiencing a downturn in case inventories and new filings.

       What does all this mean? Probably not too much except that the sustained bull market, now into its fifth year, is not producing the number of dissatisfied customers a less favorable market environment would. This supports the obviously cynical, depraved, partisan views of the defense bar that customers do not complain if they are making money: a) regardless of the possibility that their accounts are being overtraded; b) or are loaded with otherwise unsuitable securities, or c) they are the victims of other schemes and scams that they will only first recognize when they have lost a substantial part of their hard earned retirement funds, which they had been promised would only be invested in safe, conservative blue chip securities.

       It is of course a given that losses are always of "retirement" funds and that the salesperson on the other end of the phone line, to whom they were first introduced by a rather mechanical sounding voice, absolutely promised to invest only in the safest and soundest and bluest of blue chips. Having once represented a brokerage firm and its salesman who were accused of selling unsuitable securities (i.e., a unit trust filled chock full of Treasuries of varying maturities, which unfortunately had declined in value because of a rise in interest rates) one tends to lend some credence to such uncharitable views.

       In a rather timely article (at least for the author of this article) Rick Ryder and his people at the Securities Arbitration Commentator have just published their fourth Public Customer Award Survey (the "Survey") covering the almost 10,000 awards issued during the period from May 1, 1989, through June 30, 1995. Given my opening observations it is not surprising that the Survey shows an absolute decline in the number of awards, albeit accompanied by an increase in settlements, a downward trend in what the Survey calls the "win rate," i.e., the number of customer recoveries compared to the number of cases filed, and the "recovery rate," i.e., the amount actually awarded to the customer compared to the amount claimed by the customer. The Survey does confirm what anyone active on the securities arbitration scene knows intuitively, that claim size has increased, as has the average size of awards.

       Given the almost hypnotic fascination of the securities arbitration bar with punitive damages, which I will talk more about below, the Survey's findings on this subject are of some interest. While the Survey found that the incidence of punitive damages in all cases filed was only 2.1 percent, this percentage increases dramatically to 6.9 percent of awards more than $1,000,000. According to the Survey, this compares almost equally with punitive damage awards in civil jury verdicts. Also of interest is the finding that securities arbitrators tend to award punitive damages in lower amounts proportionally to the compensatory damage award than do civil juries, with 88 percent of the punitive damage awards being three or less times the compensatory award.

      Mediation

      Rather then continue to crib from Rick and his fine publication, I commend the May, 1996, edition to anyone with an interest in some very practical and useful information. Given the very short lifespan of NASD-sponsored mediation, no such comparable statistics are available as yet. However the NASD has published some very early numbers that definitely give hope for the success of the program.

       The April, 1996, edition of The Neutral Evaluator, an NASD publication addressed to its arbitrators, reported that during the first eight months of the program, 80 of the 94 cases assigned to mediators resulted in settlement. The cases, with claims ranging in size from $20,000 to $4,000,000, took on average a bit more than 40 days to complete after the parties agreed to mediate, compared to the average of 11 months for arbitration. According to the NASD, based upon post mediation surveys, the comments of participants appear to be uniformly favorable, as in their comments on the program's savings in " . . . time, money and aggravation."

       

      Early Neutral Evaluation

      Also of interest was the article announcing that the NASD planned to initiate a pilot program to evaluate the recommendation of the NASD Arbitration Policy Task Force to add Early Neutral Evaluation ("ENE") services to the dispute resolution mechanisms provided by the NASD. The pilot program is to begin in 1997 and will attempt to replicate similar programs in various state and federal courts.

       ENE is described as somewhere between mediation, where the mediator's purpose is to assist the parties to settle some or all of the disputed issues, and arbitration, where the arbitrator decides the disputed issues. ENE is not primarily intended as a settlement device, but rather as an aid to case management by resolving discovery disputes, setting discovery targets and schedules, identifying and clarifying issues and generally assisting the parties to come to an agreement on how the case is to be conducted. If ENE does nothing more than provide the equivalent of a court-appointed master or magistrate who is designated to supervise discovery, it will have earned a valued place in securities dispute resolution.

       

      The Ruder Commission Report

      The report of the NASD's Arbitration Policy Task Force, commonly referred to as the "Ruder Commission," was issued in January, 1996, and was received, in the press at least, as a "done deal." Five months later very little has been "done" and with regard to the most controversial recommendations it is likely that nothing will ever get done. Before turning to the major recommendations and where they presently stand, some comments are appropriate as to what the report and its reception tells us about the arbitration process, its constituencies and its practitioners.

       First is the realization that the only organized group truly enamored of arbitration, securities or otherwise, is the courts. The courts absolutely love arbitration because it represents the most successful method extant of diverting a very large amount of litigation to somewhere else, i.e., other than the courts. As long as this remains true, and I can see no reason why it ever should change, the courts will encourage and sustain the arbitration process.

       Therefore, the problem is obviously not the courts, but the various arbitration constituencies. Simply put, everyone involved, litigants, counsel, regulators, but particularly the regulators and the organized bar, both claimants and defense, lacks confidence and trust in the system and thinks it has to be reformed. Reform has come to mean making the process more like court litigation, while piously proclaiming that arbitration has to remain simple, inexpensive, prompt and responsive. None of the foregoing are by any means noticeable attributes of litigation.

       Historically, arbitration evolved from peer group dispute resolution by laymen with specialized knowledge of at least some of the circumstances underlying the dispute. Primarily, arbitration was used to resolve commercial disputes between members of specific trades or commercial groups, with the obligation to arbitrate being a condition of membership in the trade or commercial group. The arbitrators were chosen from within the membership of the group because of their standing and knowledge of the group's customs, practices and trade usages. Sounds familiar, doesn't it?

       The result of this kind of dispute resolution was a human, commonsensical, "street smart" rough justice that depended for enforcement more upon the status and respect the arbitrators had in their particular community than in resort to the courts. This was the system that was in effect within the securities industry for the resolution of disputes among participants in the industry before McMahon. The problems began when the system was significantly expanded to resolve disputes between industry participants and non-participant clients who had no stake in seeing the system work for the benefit of an industry in which they had no part, except as customers to be exploited. To the contrary, the customers speaking through their self-appointed representatives, the plaintiffs' bar, had the rather selfish, but not unexpected desire to see the arbitration system work primarily for their benefit and not for some presumed greater good.

       Given the lack of any perceived common interest between the industry, its customers, and their lawyers and now between the industry and its employees and their lawyers, each side was compelled to take positions it perceived as giving it some advantage. Lack of any common interest in doing what was best for an industry not particularly noted for the breadth of its vision, left only the pursuit of more parochial interests and the loss of any ability or willingness to seek an overall, long-term solution. The best example of this is McMahon itself, a decision obtained by one brokerage firm without consultation or advice from any other segment of the industry except as amici curiae.1

       The Securities and Exchange Commission, the one possible player with the respect, authority and intellectual firepower to impose such a solution has unfortunately chosen to take a back seat to the other interested groups and comment only when it absolutely cannot avoid involvement. The Securities Industry Conference on Arbitration ("SICA"), which has played this role in the past, was deliberately excluded from the Ruder Commission as the NASD decided to go it alone.

       The next best bet was the NASD, the organization that is now the single largest forum for the resolution of securities industry disputes and therefore the organization that one would expect would play the largest role as policy initiator. Having decided to exclude SICA and other SRD's, the Ruder Commission was the NASD's attempt to fill the self-created void in securities arbitration policy making.

       Unfortunately the Ruder Commission was dominated by lawyers, who as a group tend to fixate on process rather than on policy. As a result we have some proposed changes in rules rather than any attempt to focus on the true nature of securities arbitration. Nowhere is the question asked whether it is still possible, given the altered environment, to restore some semblance of the original purpose of arbitration or should we stop tinkering at the margins and be looking at something completely different?

       While the question is never specifically asked, or in fact answered, in so many words, it is rather clear that the Ruder Commission believes that arbitration in its traditional sense cannot work because of the lack of any mutuality of interest among the participants in the arbitration system. The result, not unexpectedly, is unfortunately a hybrid created by grafting onto the original arbitration stock, litigation like appendages which satisfy no one, neither those who pine for the simplicity of classic arbitration, nor those who would like to see a full-scale return to the procedural niceties of litigation.

       The Ruder Commission made more than 70 recommendations for changes in present arbitration procedures, some of which we will discuss under the following headings:

       

      Simplified Arbitration

      The Commission recommended that the dollar ceiling for simplified arbitration, i.e., one arbitrator who decides the issues in most case solely on written submissions, be raised from $10,000 to $30,000. Parties with larger claims would be allowed to elect the simplified procedures by mutual consent. Use of a single arbitrator for claims up to $50,000 was also recommended, provided the parties consented. We will probably see the ceiling for simplified procedure claims progressively increased over the next few years as a solution to shortages of qualified arbitrators, overburdened dockets and resulting delays and increased costs.

       

      Mediation and neutral evaluation

      As described above, events have overtaken these recommendations. The NASD has apparently successfully launched its mediation program and expects to have its ENE program operating on a pilot basis in 1997.

       

      Arbitrator improvement and selection procedures

      In an exercise that reminds one of Professor Higgins' question in "My Fair Lady" " . . . why can't a woman be more like a man," the Ruder Commission engages in its most obvious effort to make arbitration more like litigation. The Commission would fundamentally change traditional arbitration's reliance on lay arbitrators whose most important qualifications are technical knowledge of the industry and personal stature, to a system which ultimately must result in the creation of a core group of professional arbitrators. The logical progression is to full-time hearing officers as has occurred in NASD and NYSE disciplinary proceedings.

       Under these proposals the arbitrators would be required to maintain and improve skills by significantly expanded training and assume more control of the entire arbitration process by earlier appointment. Obviously such arbitrators would have to be paid a much higher stipend than at present. The cost of the new and improved arbitrators has to come primarily from the industry that underwrites the costs of the major arbitration forums. No doubt some of this increased cost will be passed on to the participants by increases in filing fees and other user charges.

       The Commission also recommended the selection method for arbitrators be changed to the AAA method. Instead of appointment by NASD staff, arbitrators would be selected by the parties from a list provided by the NASD. This supposedly will cure any perceived unfairness resulting from having the NASD, an industry affiliated organization, chose the arbitrators.

       No one of course has ever seriously suggested, much less attempted to prove, that the NASD is biased toward the industry. The irony of this nonsense is that as anyone who has spent more than a few days in the industry knows, the NASD is, if anything, perceived by the industry as an adversary, not a proponent. But perceptions by the industry are accorded very little weight when more politically correct "perceptions" are in vogue, particularly when such "perceived unfairness" is proclaimed in the editorial pages of the New York Times.

       

      Eligibility and Collateral Litigation

      The issue of eligibility and the related problem of collateral litigation are dealt with by handing the problem off to the arbitrators; not, however, the new future group of "super arbitrators" who remain to be trained and/or recruited, but today's hardy band of amateurs. The eligibility issue arises from the requirement that a claim be asserted within six years of the date the transaction giving rise to a claim occurred. Suffice it to say that this provision, which is not a statute of limitations, although it looks like, sounds like, walks like and has the same effect as a statute of limitations, has given rise to a great deal of collateral litigation.

       The collateral litigation regarding eligibility comes about because the defense bar is uncomfortable leaving it to the arbitrators to decide eligibility issues, preferring to have the courts make such decisions. The claimants, on the other hand, are strongly desirous of having the arbitrators decide these issues and opposed to the courts doing so. A remarkable reversal of viewpoint from pre-McMahon days.

       The reason for this change of heart is that both sides, oddly enough, believe the same thing; that the arbitrators, if left to their own devices, would decide the underlying merits without due deference to the lawyers' beloved intricacies of the law regarding eligibility and statutes of limitations. So much for a simple, inexpensive, fast and responsive method of dispute resolution.

       On these issues the Ruder Commission once more straddles the fence. The Commission recommends that the eligibility rule be suspended for three years to allow the arbitrators to demonstrate that they can correctly decide statutes of limitations issues "based on the applicable law." It is not explained why arbitrators should be allowed to demonstrate their competence to decide statutes of limitations issues but not eligibility issues. Similarly left unexplained is why the "applicable law" is not the law of arbitration which requires great deference to the decisions of arbitrators, almost regardless of how they arrived at their decision.

       The complementary recommendation is to bar collateral litigation of "non substantive" issues. The obvious question is whether litigation to determine whether an issue is substantive or non substantive is itself "substantive" or "non substantive."

       

      Discovery

      The major change recommended by the Commission is to require automatic production of prescribed documents within a time certain. Documents other then those required to be produced automatically would be producible if they are " . . . reasonably likely to be relevant and important to [the] resolution of the issues in dispute." This standard should be interpreted as liberally as the Federal Rules requirements, i.e., likely to lead to the discovery of relevant evidence.

       Because this recommendation puts a great deal of authority in the hands of the arbitrators, it is of course dependent upon implementation of the recommendations regarding arbitrator training and early appointment. Anything that simplifies procedure and speeds up the resolution of disputes is to be commended. However, determining what documents should or should not be produced is often a function of how much one knows about the business. This is as true of counsel as it is true of arbitrators, and unless all concerned know what they are about, the recommendations will not produce much of an improvement.

       

      Punitive damages

      The Ruder Commission recommends continuing to permit punitive damage awards where such awards are permitted under the investor's home court system, subject to maximum damages of the lesser of $750,000 or twice the compensatory damage award. In addition the arbitrators would be required to provide a written record of their reasons for making such an award.

       With the results of The Securities Arbitrator Commentator's awards survey in hand we have an advantage over the Ruder Commission. What the Survey teaches is that the "problem" of punitive damages may very well be illusory, unless one believes that punitive damages should not be permitted under any circumstances in securities arbitration.

       Given that awards of punitive damages in arbitration mirror the award of punitive damages by civil juries and that arbitral awards of punitive damages are smaller in proportion to compensatory damage awards than punitive damage awards by civil juries, the Ruder Commission may have proposed a solution to a problem that doesn't exist. Of course if one truly believed in arbitration as an effective system for dispute resolution it is hard to understand why any limits should be imposed on the arbitrators authority to fashion appropriate remedies.

       

      Conclusion

      As of today the NASD has not acted on any of the Ruder Commission's recommendations and based upon the drumfire of criticism that has greeted a number of the proposals including those relating to punitive damages, eligibility and collateral litigation, early adoption of all the recommendations does not seem likely. In a June 2, 1996 interview with the interactive edition of the New York Times, Mary Shapiro, the new head of the NASDR, had the following to say regarding the arbitration proposals now before her organization:

       Q. What changes are you making in arbitration?

       A. Arbitration is a terribly important process. We handle over 6,000 cases a year. It is, in many instances, the only forum that investors have for resolving their disputes with their brokers, and we need to do everything we can to insure that it is as fair and efficient as possible.

       We'll be, over the course of the next several months, implementing a number of specific reforms to the arbitration program that were recommended by a task force that David Ruder, the former SEC chairman, formulated earlier this year.

       Q. Some of those recommendations have run into trouble, haven't they?

       A. The vast majority will be implemented, and that will enormously improve the efficiency and the fairness of the arbitration process. Those go to things like the ability of the public investor to have a role in picking who the arbitrators are, and selecting from a broader list, better training for arbitrators, better control of the hearing process by arbitrators, clearer discovery rights for the parties and things like that.

       On the very controversial issues, such as the availability of punitive damages in arbitration and how old a case or a matter may be and still be eligible to go to arbitration, we're trying to build consensus. Decisions will be made by the board in July.

       Its certainly been an interesting year. While we await the decision of the NASD board, some predictions are in order:

       Only those recommendations of the Ruder Commission dealing with non-controversial issues such as arbitrator training and selection and control of the arbitration process by the arbitrators including document production will be implemented.

       SICA, which was excluded from the process will be brought back into the picture as the only possible forum to build consensus for substantive rule changes.

       Punitive damages will become a non issue as the Supreme Court continues to define the constitutional limits of what is appropriate by way of punitive damages.

       Both sides will continue to loudly proclaim their support for arbitration while continuing to seek modifications that help only their cause.

       One will not hear anyone on the industry side ever admit that McMahon should never have been appealed.

       No member of the claimants' bar will ever admit that arbitration is the best thing to come along since res ipsa loquitur.2

       1. friends of the court. 2. It speaks for itself. 

      This article originally appeared in the July/August 1996 issue of the NSCP Currents, a publication of the National Society of Compliance Professionals, 24 Millerton Road, Lakeville, CT 06039. Reprinted with permission of the National Society of Compliance Professionals and the author. 

      For more on the nuts and bolts of securities arbitration, read Securities Arbitration Procedure Manual. An excellent book for participants in a securities arbitration, and their attorneys,  with explanations of fundamental securities law concepts. This is the one to start with if you want to obtain a basic understanding of securities law concepts, and arbitration procedure. You can purchase the book, online, through a partnership between SEC Law.com and Amazon.com. Just follow the link.
      This page is part of The Securities Law Home Page, the Online Guide to the Law Of the Securities Markets. Copyright 1997, Mark J. Astarita. All rights reserved. Reproduction of this page is prohibited. Please see our terms of use statement. Nothing contained herein is intended as legal or financial advice. Please read our disclaimer before continuing. We are interested in your comments, suggestions and questions.
       
       
       
       

      Keywords: arbitration securities stock broker fraud nasd nyse aaa