Alternative dispute resolution mechanisms have existed for over 200 years, but it was not until the Supreme Court’s decision in Shearson v. MacMahon, 482 U.S. 220 (1987), that arbitration became the primary dispute resolution method in the securities industry. Each year, thousands of cases are filed with the National Association of Securities Dealers Dispute Resolution forum (“NASD DR”), with over six thousand in 2005 alone.1 Approximately 80% of cases initiated in 2005 were brought by investors against their broker and/or broker-dealer. The remaining 20% represents claims by brokers against their employer or broker-dealers against each other. The conduct most often complained of included breach of fiduciary duty, negligence, unsuitability, misrepresentation, breach of contract, and failure to supervise.
NASD DR maintains a roster of approximately 7,000 arbitrators. Approximately 25-35% of all cases are decided by NASD arbitrators, while the remaining 70-75% are resolved by other means, including direct settlement, mediation, and withdrawal. NASD DR also maintains a roster of approximately 1,000 mediators, which parties may enlist at any time during their case. If parties choose to participate in NASD mediation, NASD will waive the arbitration hearing postponement fee, if necessary.
Why Arbitrate Securities Disputes Before the NASD?
Arbitration is favored in the securities industry for good reason. Arbitration awards are final and binding, subject to judicial review only under very limited circumstances. Thus, there is finality and certainty in the awards issued by NASD arbitration panels. In addition, prevailing parties may seek confirmation of arbitration awards by a court in order to enforce a judgment and ensure payment.
Membership in the NASD by the registered representative and their firms creates a contractual obligation to arbitrate securities disputes. Sections 1, 8 and 12 of the NASD Code of Arbitration Procedure provide that members and associated persons must submit to arbitration at the demand of customers or other member firms.
In order for brokers or firms to be able to compel customers to arbitrate, however, there must be a specific contractual obligation (i.e. a contract signed by the customer) in order to do so. As a result, nearly every broker-dealer includes a pre-dispute arbitration clause in their new account documents. Given the mandate of the Supreme Court in MacMahon, the Federal Arbitration Act, and Wisconsin Statute Section 788.01, as well as the strong public policy favoring arbitration, these clauses are very likely to be upheld by Wisconsin Courts. Initiating litigation in state court, despite the existence of such a clause, will likely result in needless attorney’s fees and delay when the likely outcome is an order requiring the parties to arbitrate their dispute.
NASD arbitrators are intimately familiar with NASD rules and securities laws and are uniquely qualified to resolve these types of disputes. According to NASD, its arbitrators must also complete comprehensive training and pass a written test prior to serving on an arbitration panel.
Parties are given the opportunity to approve the composition of the arbitration panel, including approval of the panel chairperson. Pursuant to NASD Rule 10308, parties are given a list of potential arbitrators and detailed information regarding the arbitrators’ employment history and background. Parties are also given the opportunity to strike arbitrators for any reason and then rank the remaining arbitrators from the list in order of preference. This stands in stark contrast to judicial proceedings in which parties typically must live with the judge assigned to the case unless there are grounds for substitution or recusal.
Consistent with the goal of the providing a quicker, more cost-effective method of dispute resolution, discovery is very different in arbitration proceedings than in formal litigation. The most notable difference is the fact that depositions are not among the available discovery tools. However, parties may submit requests for information and documents, and may issue subpoenas to third parties (such as other brokerage firms) to obtain information. Parties are also bound by the 20-day exchange rule, which requires certain information and materials to be provided to the other side no less than 20 days before the hearing. Should discovery disputes arise, parties may request a pre-hearing discovery conference before a member of the panel and obtain orders requiring the other side to respond to outstanding discovery requests.
While the rules of evidence apply to arbitration proceedings, parties and arbitrators are not necessarily bound by those rules to the same extent as in court proceedings. Given the less formal nature of arbitration proceedings, parties very often stipulate to issues such as authenticity of documents and basic facts, obviating the need to present time-consuming witness testimony.
Similarly, arbitrators are typically more lenient with regard to cross-examination of witnesses, often allowing cross-examinations to go beyond the scope of direct examination. Arbitrators are also given the opportunity to question witnesses, which can be very useful in clarifying a witness’s testimony or distilling issues that the panel finds important.
While the goal of alternative dispute resolution is to provide a faster, more streamlined method of resolving disputes than going through the judicial system, NASD DR is not necessarily quicker than most Wisconsin state courts. NASD arbitration cases take, on average, about 14 to 16 months to conclude if they proceed through the arbitration hearing. According to the Wisconsin Court System website, the average age of civil cases at disposition in 2005 was approximately 3 months.
However, as indicated above, only about 25-35% of all arbitration cases are resolved by the arbitration panel. Resolution by other means, including mediation and settlement, takes substantially less time.
Similarly, while arbitration is typically less expensive in the long-run, the initial filing fees are significantly more than what is required by Wisconsin state courts. For example, a customer filing a claim with unspecified damages is required to submit a deposit of $1,250, or a $250 claim filing fee and $1,000 hearing session deposit for a three-arbitrator panel. In contrast, the filing fee for civil actions involving claims for money judgment in excess of $5,000 in Wisconsin circuit court is $256.
In addition, NASD and NYSE guidelines provide that arbitration hearings are to be held at the location of the customer at the time of the dispute. This has the practical effect of requiring brokers and brokerage firms to be prepared cover the costs of travel, and pay the costs of their witnesses to travel, to wherever their customers reside. These costs can quickly add up when you include airfare, lodging and meals for all of the necessary parties and witnesses over the course of the arbitration hearing.
Finally, the fact that arbitration awards are final, binding, and subject to review on appeal only in very limited circumstances cuts both ways, particularly for the losing party. Nevertheless, given the structure of NASD DR, the parties are given ample opportunity to present their case to a very qualified arbitration panel, meaning that the conclusions reached by the panel are likely to well-reasoned and fair. Unlike judicial decisions, however, parties are not provided with the reasoning behind the panel’s decision, only amount of the award, if any.
Arbitration is the primary dispute resolution method in the securities industry for good reason, and is likely to remain as such in the future.
For information, please contact Monica M. Riederer at 414.277.3459, or firstname.lastname@example.org.
1 Facts and statistics regarding NASD DR are taken from www.nasd.com.