Before we begin, I'd like everybody to remove their shoes. We are about to enter Wall Street's Holy of Holies: The inner sanctum, the great asbestos-lined chamber that insulates retail brokerages from their worst enemies, their customers.
I am speaking about the Great Unmentionable Non-Issue that has totally un-roiled the guardians of the public in the U.S. Congress as they thunder against the excesses of Wall Street, and contemplate a financial reform package that only barely touches upon this enormous, glaring, undiscussed atrocity. I am referring to the loophole that Wall Street has carved out of the U.S. Constitution, specifically the Seventh Amendment, which guarantees the right of trial by jury for any lawsuit where the amount in dispute is more than $20 (not adjusted for inflation). It's the system that requires aggrieved customers to take their cases not to a court of law, but to a Wall Street arbitration panel.
This has been an open sore for decades, since a 1987 Supreme Court ruling, Shearson/American Express vs. McMahon, in which the court upheld the constitutionality of clauses in brokerage agreements that require disputes with brokers to be brought before industry arbitration panels. Whenever efforts have been made to curtail arbitration, financial services lobbyists have screamed like kids with skinned knees. The financial reform legislation now shuffling through Congress gives the
the authority, which it probably already had, to limit or abolish mandatory arbitration clauses in brokerage agreements. It also gives similar authority to the new Bureau of Consumer Financial Protection being erected within the
God forbid Congress should do that itself. The victims, after all, are an unorganized group of hapless small investors. They have zero clout. So don't hold your breath about anything actually being done.
Apart from financial services, arbitration has crept its way into consumer and even employment contracts, curbing the right to a court trial in everything from credit card agreements to cell phone and even nursing home contracts. The Supreme Court is taking up the issue again. Even if the high court curbs
, you can bet that the financial services industry will run to Congress to repair any damage.
Discover Financial Services
are among the credit card issuers that have mandatory arbitration clauses in their card agreements, and the list of retail brokerages insisting on arbitration is nearly endless:
Bank of America
, and even discount brokers like
. That's a formidable lobbying force, subsidized with your bailout tax dollars.
For years, Wall Street's lobbyists have maintained that arbitration is the fair, speedy and low-cost way of adjudicating disputes. Every stock exchange used to have its own arbitration panel, but now we have only the one operated by FINRA. In its official description of the
, FINRA makes arbitration panels seem just like those jury trials that the Constitution guarantees to everybody but brokerage customers. "Arbitrators are people from all walks of life. . . . Some arbitrators work in the securities industry; others may be teachers, homemakers, investors, business people, medical professionals, or lawyers. What is most important is that arbitrators are impartial to the particular case and sufficiently knowledgeable in the area of controversy."
That description doesn't quite capture the majesty of the process -- from Wall Street's perspective. There is a right to production of documents, but little recourse if firms stonewall and the arbitrators don't care. Legal niceties like that tend to be overlooked, arbitrator opinions rarely detail their reasons for granting or denying damages, and there is virtually no chance of a successful appeal no matter how goofy the arbitrators behave. Contrary to securities industry propaganda, costs are much higher than going to court, and sometimes are astronomical.
Tom Ajamie, a Houston securities lawyer who has tangled with biased arbitration panels for years, has a list of arbitration horror stories that he has accumulated. They are, he says, "just a few examples, out of hundreds, that show the arbitration system at its worst." The arbitration system, he says, "is demeaning and unjust to investors."
There's the case of the Griffins, a North Carolina couple who filed a case against their brokers at Morgan Stanley Dean Witter, claiming fraud, negligence and other bad stuff involving mutual funds. They asked for $200,000 in damages. They won! Yes sir, the Griffins won -- an award of $1,500. They were socked with forum fees of $9,975, exclusive of their lawyer bills. Why? The arbitrators didn't say.
Then we have the lady in Florida, Barbara Nguyen, whose case against Merrill Lynch was so egregious that the panel awarded punitive damages. The total awarded, $11,000, was consumed by her lawyer bills and the $4,700 in forum fees.
Now, keep in mind that as far as FINRA is concerned, these are success stories. They are two of the 42% of cases decided in 2006 that are proudly trotted out by FINRA as decisions in which damages were awarded to investors. The number is now up to about 48%, and has been as low as 37%, in 2007. What FINRA doesn't tell you is that those numbers include cases in which the panels award pennies on the dollar, and/or awards exceeded by fees.
You know, I'm willing to keep an open mind. Maybe I'm wrong. Maybe arbitration is terrific. Let's give Wall Street firms a taste of their own medicine. Whenever they sue somebody, they should be forced into the kind of arbitration that they shove down their customers' throats. Their adversaries should set up the panels and be guaranteed a seat on every one. Let's see how much they like it.
Gary Weiss has covered Wall Street wrongdoing for nearly two decades. His coverage of stock fraud at BusinessWeek won many awards, and included a cover story, ?The Mob on Wall Street,? that exposed mob infiltration of brokerages. He uncovered the Salomon Brothers bond trading scandal, and wrote extensively on the dangers posed by hedge funds, Internet fraud and out-of-control leverage. He was a contributing editor at Cond?ast Porfolio, writing about the people most intimately involved in the financial crisis, from Timothy Geithner to Bernard Madoff. His book Born to Steal (Warner Books: 2003), described the Mafia's takeover of brokerage houses in the 1990s. Wall Street Versus America (Portfolio: 2006) was a hard-hitting account of investor rip-offs. He blogs at garyweiss.blogspot.com.