This statistical study posits that securities industry participants in FINRA arbitration enjoy an information advantage, which gives them a tactical advantage in selecting arbitrators, and that tactical advantage translates into the more frequent selection of “industry-friendly” arbitrators in cases with consumers.
From this view of the system, the authors are able to build a model wherein arbitrators compete for selection and, in doing so, create a gradual shift to where “all arbitrators slant[ ] towards being industry-friendly.” Ironically for those long familiar with the history of arbitrator selection in securities arbitration, the authors’ proposed solution to this conundrum results in limiting the input of the parties and opting for a more objective assignment process.
The National Bureau of Economic Research (“NBER”) is a private, non-profit research organization. While this “working paper,” compiled and authored by Mark L. Egan, Harvard Business School, Gregor Matvos, McCombs School of Business (UT), and Amit Seru, Stanford Graduate School of Business, is published under the NBER name, the authors caution that it has not been reviewed by the NBER Board of Directors, as would be an “official” NBER publication.
Do Industry Firms have an Informational Advantage?
The authors are trying to reach conclusions on a general proposition: “whether firms have an informational advantage in selecting arbitrators in consumer arbitration, and the impact of the arbitrator selection process on outcomes.” They choose as their laboratory for experiment the FINRA forum, for a variety of reasons, and they select roughly 9,000 Awards for inspection. The Study derives its urgency from the relative ubiquity of pre-dispute arbitration clauses (“PDAA”) in consumer contracts today, including “all brokerage firms, the largest insurance companies..., the largest financial firms..., and largest fintech firms.” The authors also identify online retailers, wireless providers, and “sharing economy firms” as being pervasive users of PDAAs.
Finding: Stingier Arbitrators Serve Less Often
The first question the authors set out to answer asks whether “some arbitrators [are] systematically more industry friendly and others more consumer friendly?” They find that 37% of the variation in awards relates to “observable case characteristics,” but 60% of the variation relies upon the presiding arbitrator(s). So, some arbitrators consistently award less (industry-friendly) and others more (consumer-friendly). Those granting lower awards, it turns out, serve more often. They are “roughly forty percent more likely to be selected in a given year than their consumer friendly counterparts.” That suggests the firms are “tak[ing] advantage of these systematic differences.”
Finding: Arbitrator Selection is Key
Among the evidentiary findings that support this conclusion about firms utilizing superior information and experience to gain a selection advantage are statistics showing: (1) a 50% decrease in the advantage when FINRA reduced the number of available strikes in 2007; and (2) “consumers who use attorneys who specialize in arbitration fare better in arbitration” with more consumer friendly arbitrators. A “stylized model of arbitrator selection” built by the authors and based upon the award data enables them to project a number of things that guide their conclusions and recommendations. They find, for instance, that switching to random selection would increase awards by $40,000 on average. A FINRA rule change in 2016 that increased the number of Public Arbitrators to 15 actually exacerbated the information advantage problem (albeit to a small degree). Increasing fees -- often proposed as a way to enhance fairness and panel competence -- would actually cost consumers $31,000 off the average award.
(ed: *For us -- data-hounds, but statistical novices -- this kind of analysis provides material we can’t get anywhere else. For instance, the Egan-Matvos-Seru team announces a 32% mean recovery rate (albeit with a standard deviation of 67%) for customers (median: 51%). Only 6% of the time were consumers not represented by counsel (that suggests the Study excluded small claims); PIABA members represented consumers in only 7% of the cases (this surprisingly low percentage, we think, can be explained alternatively: PIABA members actually get more cases than this, but, as sophisticated counsel familiar with defense counsel, they settle more often. This Study deals with Awards.). Among 20,231 arbitrators who were seated on the 8,828 Awards surveyed, 7,891 unique arbitrators served. 3,917 arbitrators served more than once during the survey period. Cross-referencing to BrokerCheck, the authors found that about 40% of the seated arbitrators had experience as financial advisors or brokers (that tells us that the sample spread back to the 90s, because, with 70% of the Panels today comprised of All-Public Arbitrators, this could not be. We did not see a finding that such arbitrators were generally more industry-friendly. **Seems to us if the authors would just publish a list of industry-friendly and consumer-friendly arbitrators, it would level the playing field in one fell swoop, no? Basically, if you want to know whether your candidate for an arbitrator seat is consumer-friendly or industry friendly, see how much they “deviate” from the 32% median recovery rate.) (SAC Ref. No. 2018-44-01)
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