For 15 years, individual investors with a beef against their brokers have had to submit to arbitration, but those who say the process is stacked against investors see an opportunity to change it.
Companies that steered clear of the trouble much of the securities industry has had in the past 18 months are taking advantage of their clean slates to attract investors, observers say. That will put pressure on the rest of the industry to make broad changes - including to the arbitration process, its critics hope.
Robert Weiss, a securities lawyer with Hooper & Weiss LLC, argued that by touting their pristine image, Wachovia Corp. and Prudential Securities, which have agreed to combine their retail brokerages to create the nation's third-largest brokerage firm, could effect such change.
The industry fails to make the system fairer at its peril, Mr. Weiss said. "No one in their right mind is going to trust" a company that "hides behind this crooked arbitration process."
The practice has always had its detractors, but they have become more voluble - and attracted some high-profile advocates for revision.
During the Feb. 5 confirmation hearing for Securities and Exchange Commission nominee William Donaldson, Sen. Jon Corzine asked Mr. Donaldson if he planned to address arbitration, which the senator said "is basically established in conjunction with the industry."
The New Jersey Democrat - who happens to be the former co-chief executive of Goldman Sachs Group - went on to question whether investors receive a fair review.
Mr. Donaldson responded that it is a "very legitimate question to examine the arbitration process as it is being practiced today. And I would do that. I would do just that."
A spokesman for Sen. Corzine said that the lawmaker is concerned that more than 60% of investors who win their arbitration hearings never receive a dime and that he "expects" Mr. Donaldson and the SEC to take action.
Wachovia Securities, the brokerage arm of the Charlotte banking company, was not a party to last year's research imbroglio. Prudential Securities was contaminated by association during the mid-1990s account-churning scandal at its affiliated life insurer, but casting itself as a pure research and brokerage firm for the past two years, it too was distanced from the latest investment banking controversy.
With rival brokerages, especially Merrill Lynch & Co. and Citigroup Inc.'s Salomon Smith Barney, still scraping off the mud from 18 months of investigations, Wachovia and Prudential look pleasantly clean in their bid to join forces and could have the moral authority to drive reform, observers said.
Whether the combined Wachovia and Prudential would take up the banner is unclear. They and all other Wall Street firms require their customers to use arbitration to settle disputes. For decades courts had held that arbitration clauses were unenforceable because they violated the Securities Act of 1933 and the Securities Exchange Act of 1934. But in 1987 the Supreme Court ruled in Shearson v. McMahon that such clauses are enforceable, which essentially froze investors out of the courts.
The National Association of Securities Dealers handles 90% of the cases and the New York Stock Exchange hears the rest, according to a study conducted by Hooper & Weiss.
Christopher Bebel, a partner with Shepherd, Smith & Bebel in Houston and a former prosecutor with the SEC and the Department of Justice, called Sen. Corzine's remarks "right on target." Significant modifications are needed, he said, "because investors are not getting a fair shake."
Tom Ajamie, a partner with Schirrmeister Ajamie in Houston, agreed. "It's not just an opinion" that arbitrators are "very biased toward" the industry, he said.
Charges of partiality surfaced as soon as the system was implemented. Both parties (investor and broker) going into an arbitration are given lists of arbitrators. They each rank their preferences and then the NASD makes the assignment. Some panels have three arbitrators. Disputes with claims under $50,000 have one arbitrator. The selection process fuels charges that arbitrators - many are culled from the industry - are prejudiced.
A 1992 report by the General Accounting Office found "no indication" of a pro-industry bias but concluded that the self-regulated process "lacked internal controls to provide investors with reasonable assurance that arbitrators were independent and competent."
The GAO found little reason to change those conclusions in a 2000 study. It said many investors with successful claims never receive payment. In 1998, for example, it found that 49% of awards went unpaid and that 12% were only partially paid.
Many scoff at the notion that arbitration is inherently unfair to investors.
Debra G. Speyer, a securities lawyer who serves on arbitration panels, said she sees no evidence of a pro-industry slant. "I understand that a lot of people across the country do feel that it's a biased process, but I haven't found that to be the case," she said. "I've found the panels that I've dealt with very interested in coming to a just resolution."
Richard C. Szuch, a securities defense attorney and partner at the Princeton, N.J., law firm of Lowenstein Sandler PC, said legitimate claims receive awards in the arbitration process, just as in any jury trial.
"Customers frequently prevail, and I think they prevail when they should and don't when they shouldn't," said Mr. Szuch, who also serves on arbitration panels. "There are aberrational results, but in my own experience the system works."
Still, as the bear market stretches on - and presumably more investors have issues with the way their accounts are handled - several attorneys said arbitration panels have become even less willing to return lost funds to investors, which exacerbates the problem.
Arbitrators awarded total damages of $139 million last year, versus $97 million in 2001. Last year was the second consecutive record year, NASD Dispute Resolution Inc. reported Wednesday. The number of new cases rose 11%, to 7,704.
Mr. Ajamie - who won the largest arbitration award in history, $429 million against a Paine Webber broker now serving time in federal prison - said panel members are concerned that brokerage firm could go under if hit with too many judgments.
In addition, the market malaise of the past three years makes them less sympathetic to claimants, he said. "There's a callous attitude that it was just a bear market."
Adam Pritchard, a securities law professor at the University of Michigan, said the supposition that arbitration is unfair is driven largely by the fact that the NASD or NYSE determines who is eligible for the panels. That is fodder enough for critics like Mr. Weiss, who maintain that the process needs to be administered independently.
Mr. Pritchard said there is no strong evidence of bias. "The plaintiffs do relatively well in arbitration - although the prospects for the home run are not as good."
Mr. Weiss remains optimistic. The industry has a choice: develop a fair process or keep the status quo, he said. "If they stonewall and they fight, they're going to go out of business."
