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FINRA Statistics-What Do They Tell Us About FINRA’s Arbitration Process and Its Fairness?

As a Texas securities attorney I have been involved in the securities industry over much of the last three decades, and it seems the debate over the fairness of mandatory arbitration before FINRA between customers and firms or brokers has been heated, and near constant.  Periods of greater scrutiny seem to only coincide with any rule proposal or legislation which has the potential of tilting the playing field in one direction or the other. During this debate, FINRA statistics seem to used by both sides (the consumer advocates and the industry) to support their respective arguments, but do these statistics tell us anything about “fairness.”

For those that may not have had the pleasure of engaging in this titillating debate,  it may be generally summed up as follows:  “Is FINRA Arbitration Fair, And Does It Offer Any Compelling Advantage to Either the Industry or the Public Customer?”  It is not surprising that each constituency group argues zealously they are “right” in their analysis of fairness, or the lack thereof.  However, and more interestingly, these constituencies can sometimes be found to argue “Yes” before some audiences, and “No” before others, perhaps suggesting a more candid insight while their respective guard is down, if not some resignation, about the current process and maybe a “kiss your sister” type of fairness.

Some background may be helpful for those not familiar with the origins of the debate.  In 1987 the United States Supreme Court decided in the Shearson v. McMahon case that brokerage firms can contractually mandate arbitration for claims brought by their customers, thus forcing citizens to give up their right to the court system  and a jury.  It was heralded as a fair trade-off given the so-called fairness, efficiency, and economy of arbitration versus the court system.  Since then, the debate continues:  Is FINRA arbitration fair, and does it still offer compelling reasons to waive a right to a jury trial? Pragmatically speaking, the answer may not matter because it is likely, if not certain, that the customer agreement used by every brokerage firm contains a provision requiring mandatory arbitration before FINRA, and change to the status quo will only come, if at all, from the legislative and rule making process, or perhaps from a new decision from the Supreme Court, but don’t hold your breath.

But assuming public customers were given the choice to bring a claim in court or in the FINRA arbitration system as the Arbitration Fairness Act (and other proposed legislation) essentially proposed, the honest answer to the question lies in each person’s perception of what is fair, a rather imprecise notion.  What course would an informed consumer (or attorney) choose? As a lawyer that more often represents customers than firms in customer disputes, I take a considerable amount of time explaining the FINRA arbitration process to clients, as contrasted with the Court system.  Most customers are not aware that arbitration was mandated by their customer agreement (when is the last time you met someone that read all of the boilerplate in a multi-page agreement?), and after a lengthy explanation, I find that most customers initially perceive that some fairness has been taken from them, rather than given to them. They clearly don’t feel any notions of fairness when first confronted with their lack of choice of forum for their complaint, but as with most parties in a dispute, they end up with differing views depending on how the matter is resolved.  Clearly, at the end the case some clients have come to resent the requisite process, while others have come to appreciate the arbitration process, something that I have found to be completely unpredictable from the outset.  Is the glass half full, or half empty? The answer I hear from most public customers would be to provide them with a choice, which may be nothing more than a logical answer because they have no basis from which to compare the court system versus FINRA arbitration.

When I discuss this issue with other attorneys in this field, most tend to opine along party lines, with defense attorneys arguing that it is exceedingly fair to the customer, citing examples of recoveries which otherwise wouldn’t exist if the case were in court.  On the other hand, claimants’ attorneys complain that they wish they could take their cases to a jury of their client’s peers, arguing that finding a broker’s misconduct would result in make-whole recovery, including attorneys’ fees and in some cases punitive damages.  Of course, these arguments are predictable given their sources, but not all arguments are straight down party lines, so to speak. I heard from one panel of defense attorneys at a Continuing Legal Education seminar focused on prevailing against customer arbitration claims that they wished they could have their cases heard before a judge and a jury, suggesting that FINRA arbitration had become a forum they would rather not mandate because too many customers were receiving unwarranted recoveries from the equity minded panels of arbitrators.  This seemed a bit odd, as no defense counsel has ever volunteered to waive the arbitration provisions, and their clients (the firms) can revise their clients’ customer agreements at any time so that the customer has a choice of forum.  I think it was a bit of grandstanding, or perhaps a test to see if anyone was listening, but I doubt that any of those presenters advised their clients to forego the mandatory arbitration provisions in their standard agreements, but at least the panel’s dialogue made for a more interesting seminar.   As I said, many claimant’s attorneys also complain about the mandatory aspect of FINRA arbitration and their perception of a home-court advantage, wishing they could only get into the more more “fair” court system.  However, there are many attorneys that represent claimants in FINRA arbitration that will candidly admit (maybe not during a debate) that the arbitration system, for all of its fallacies and unpredictability, is preferable over court for the average public customer. A glass half-full for some, half-empty for others?  Regardless of any advocates’ grandstanding or complaining, for now customer disputes will be decided through mandatory arbitration before FINRA.

Should fairness be measured by the process, or the results borne of the process?  What do FINRA’s statistics show about fairness?  Not much.  Nevertheless, FINRA keeps a plethora of statistics about the cases filed through FINRA, from the number of cases filed, the types of claims, the types of product, the average days to a final hearing, how the case was resolved, etc.  Those stats don’t offer much in terms of insight into fairness. Perhaps the more interesting statistic, at least in terms of fairness, is the “win” rate.  More specifically, FINRA describes this statistic as  “Percentage (and Number) of Cases where Customer Awarded Damages.”  For example, in 2016, FINRA reports that 389 cases were decided during 2016, and 158 of those cases resulted in a customer receiving an award of damages.  This equates to a customer “win rate” of 41%, and the same analysis thus far through 2017 shows a “win rate” of 43%.  Does this mean the industry’s win rate is 59% and 57%, respectively? So, perhaps the glass is less than half-full, and more than half-empty from the customer perspective, but vice versa for the industry?

The more difficult analysis is whether the “winners” resulted in a meaningful (fair?) recovery of the compensatory damages.  For example, if a public customer lost $100,000 because of broker misconduct, and received $20,000 in an arbitration award, of which 33% was paid to the contingency fee attorney, and an additional $10,000 was spent in expenses, for a net recovery to the customer of $3,400.00, was the arbitration “fair?”  Stated a bit differently, if in the same $100,000 case where the misconduct is relatively clear, with FINRA’s recovery rate of 41%, would the “fair” value of the case be a gross recovery of $41,000.00 ? Maybe, maybe not-it depends on all of the factors at play.   But whether the customer received $1, or $100,000 is inconsequential to the FINRA tabulation–it counts as a win for the public customer in the statistics, and that in and of itself may be misleading to everyone involved.  What if the “win” rate was 90%, but the percentage of compensatory damages recovered was very modest?  What is the “win” rate was 20%, but a winning customer received 90% of the compensatory damages?  Or a winner take all system?  I would submit that such statistics would not offer any more insight into notions of fairness, but would simply change the respective arguments.

Truthfully, none of these statistics seem to provide real insight into the “fairness” debate, as FINRA does not (will not or can not) track the outcomes of arbitration in terms of the percentage recovered from properly calculated damages-in other words, how much of a customers recoverable damages caused by the firm/broker were recovered through arbitration?  I know of only a few studies that attempted to statistically analyze the outcomes of both NASD/FINRA and NYSE arbitrations in this fashion;’ one appears to be more from the perspective of the public customer, and the other is clearly that of the association of Wall Street brokerage firms and their lawyers. These reports are clearly worth reading for anyone wishing to get into the weeds of this debate, and it should come as no surprise that the Solin/O’Neal Analysis more strongly suggests a lack of fairness to the public customer, while the SIFMA Report’s subtitle leaves no doubt of the industry’s perspective.  Lest their be any doubt about their position on the subject, SIFMA’s White Paper‘s sub-title states “The success story of an investor protection focused institution that has delivered timely, cost-effective, and fair results for over 30 years.” Surprised yet?

This debate is, indeed, fiercely contested.  So much so that there have been many legislative efforts to change the law, which have been vigorously opposed, but no new laws have been passed which impact the Shearson descision. For example, the Arbitration Fairness Act, as summarized by Senator Al Franken, offered the consumer a choice of arbitration or court, after a dispute arose.  And there have been many commentators continue the debate for the constituents with whom they are most aligned, but as of now, mandatory arbitration and the FINRA system remains, certainly not unchallenged, and only slightly tweaked from time to time, but the FINRA forum nevertheless remains the only forum for the public investor that signs the firm’s customer agreements. Organizations like PIABA, an association of attorneys representing public customers against the financial and brokerage industry,  and various lawmakers continue to seek change to the mandatory arbitration landscape, and maybe fundamental change will be wrought.  But for now in this ongoing chess battle, it is “check” for the industry, and only time will tell whether it is “checkmate.”

Virtually every arbitration is different factually and the perception of fairness through an analysis of outcomes is in and of itself a troubled process.   Perhaps the more critical analysis needs to be about the process itself, rather the indeterminate outcomes and misleading statistics.  Changing the process will be difficult, and will likely depend on the agenda of whatever administration is in power. Stay tuned.  But for now the predictable debate continues for those with the long view, just as the hard work continues daily for the advocates and parties within the current system to best represent our respective clients (be it a customer or a brokerage firm) and achieve a “win” when possible, and perhaps something our clients can call fair.

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