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“Sunlight is said to be the Best of Disinfectants”
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By George H. Friedman*

These words were uttered by Supreme Court Justice Louis Brandeis over one hundred years ago in an article titled, What Publicity Can Do.  The thrust of Justice Brandeis’ comment was that transparency leads to good behavior.  And, indeed it does.  When I get to ethics in my law class at Fordham, I teach “The New York Times Rule,” which states essentially “never do anything you wouldn’t want to see reported on the front page of the New York Times.”[1] The message always resonates with the students, especially when I hold up the New York Times front page trumpeting the sordid details of the Eliot Spitzer debacle. It was with this in mind that I welcomed the chance to comment publicly on the joint letter the FINRA Dispute Resolution Task Force (“Task Force”) received January 21st from PIABA and several other consumer groups urging it to recommend the release of data about the FINRA arbitration programAlthough I was quoted with great accuracy, I thought it would be helpful if I expanded on my thoughts.

Background

A January 22nd SAC Blog post covered the PIABA letter story in some detail, which I repeat here in truncated fashion with SAC’s permission. The January 21st letter, which was announced in a Press Release the same day, was signed by Americans for Financial Reform, the Alliance for Justice, the Center for Justice and Democracy, Consumers Union, National Consumers League, Public Citizen, the National Association of Consumer Advocates, US PIRG, and PIABA.

The Task Force was created last summer to “suggest strategies to enhance the transparency, impartiality, and efficiency of FINRA’s securities dispute resolution forum.” The group’s letter urges the Task Force to recommend to FINRA “the release of information, including data in the form of studies and reports, that FINRA and/or the SEC have collected regarding investor awareness and understanding of predispute binding mandatory (or forced) arbitration; effectiveness of FINRA's arbitrator selection process; prevalence of forced arbitration clauses in brokerage firm and investment advisory contracts; and other feedback that FINRA has collected from investors about any or all of these issues.”

What I said and Why

Shedding light on the system enhances perceptions of fairness and is a good idea.  I believe strongly that perceptions of fairness, especially investor and employee perceptions, are improved by making public more information about the FINRA Dispute Resolution program.  Let’s face facts: FINRA handles over 99% of all securities arbitrations, and  virtually all retail customer contracts require investors to arbitrate disputes with their broker.  Ditto for securities industry employees.  We’ll save for another day the question of mandatory arbitration; I’ve already published my thoughts on that one.  But the bottom line is this: perceptions of fairness and overall confidence in the arbitration system go up when light is shed on it.  In this regard, I agree with Brandeis and PIABA and the letter’s other signatories.

But looking backwards in this massive data dump is not the way to do it.  The letter suggests a massive release of backward looking data. Specifically, the letter closes with a one-page appendix listing five specific areas of interest: 1) investor awareness and understanding of predispute binding mandatory (or forced) arbitration; data to support stated goals of FINRA's arbitrator selection process; the prevalence of forced arbitration clauses in brokerage firm contracts; and other feedback that FINRA has collected from investors about any or all of these issues; 2)  investigations regarding arbitration awards, in particular any data allowing comparison of cases where investors are awarded a fraction of their losses to those where investors are fully compensated for their losses; 3) arbitrators' records, including any analysis of the percentage of cases in which individual arbitrators have found in favor of a brokerage firm over an investor or vice versa; 4) the likelihood of an investor prevailing on any particular type of claim or the likelihood of any particular arbitrator issuing an award in favor of an investor or a brokerage firm; and 5) whether investor protection is less secure in the investment advisory context where the choice of arbitration providers is solely within the discretion of the investment advisers or in FINRA arbitration, the required forum for brokerage firms.

What’s the problem?

  • As SAC notes, much of what would be released would be old or irrelevant. For example, do investors really care about the track record of non-public arbitrators when recent rule changes make it very unlikely such arbitrators will be appointed to their case?
  • Gathering this data would place an enormous strain on FINRA staff. Having spent 14 years as Director of Arbitration, I can back up that statement.  Providing data to the SEC or GAO when those agencies conducted inspections was always a bear.
  • Some information is confidential. Does an investor really want made public great details on their investing history, beyond what’s stated in an award (which already is made public)? What about other investors whose information is contained in FINRA’s records?
  • Much of the requested data is already public. That’s right. For example, numbers 2, 3, and 4 above are already “out there” for anyone interested in doing the legwork or paying someone else to do it.  FINRA makes public on its Website its own arbitration awards and those of other programs it administers.  Or, those not inclined to do the legwork can pay a provider like SAC to analyze the data.

FINRA should reveal the number of arbitrators available by hearing location to indicate where they may be short-handed to hear disputes. It would have been evident there weren't enough arbitrators in the area to handle the surge in Puerto Rico bond fund cases if that data were available.  Actually, I wouldn’t limit it to areas where the local roster is thin.  More on that below.

What are your Ideas, Friedman?

I’m quoted as stating “it would be better to focus on gathering new data or highlighting existing data,” a statement I stand behind.  Here are some forward looking ideas I have or endorse:

  • Publishing the number of panelists by hearing location. Brandeis would especially love this one. Methinks that, had this information been public when the Puerto Rico bond fund problem surfaced, someone would have said to FINRA “How on earth are you going to handle a surge in cases with only a handful of arbitrators?”
  • Publishing Aggregate Arbitrator Performance Data. As I state above, data on individual arbitrator track records is already public for those willing to do the research or pay someone else to do it. I do suggest that FINRA publish aggregate data.  How’s that?  Toward the end of each case, FINRA asks participants to evaluate staff and arbitrator performance.  It also asks arbitrators to evaluate each other.  I suggest FINRA periodically publish the compiled results.  For example, questions address participants’ views on arbitrator professionalism, ability, knowledge, hearing conduct, and overall performance.  Making public the aggregate responses would go a long way toward bolstering perceptions of fairness.
  • Publishing Aggregate Forum Performance Data: For that matter, FINRA should also publish compiled data on how participants evaluate it.  The same end-of-case survey among other things asks users to evaluate how well staff performed, how knowledgeable they were, and how fairly  they carried out their duties.
  • Airing “Recovery Rate Percentages.” To be clear, I think this is essentially a meaningless stat. Courts are not judged by it, and it presumes that every claim asserted is 100% valid.  Don’t take my word for it.  Seth Lipner, a prominent investors’ attorney and a past president of PIABA, published an article in 2006 demonstrating why it’s an unsound measure.[2] Nonetheless, grownups should be permitted to judge for themselves.  I trust FINRA to add the appropriate disclaimer.  Also, other similar arbitration fora such as the National Futures Association, already do this.
  • Making public high level results of NAMC meetings, just as FINRA does for its Board meetings. Again why keep this a secret?
  • Publishing the Task Force’s Activities: I recommend that the Task Force keep the public up to date on its activities and, of course, results. FINRA made public the Ruder Task Force results, and then published a ten-year "report card" in 2007;[3] it should do so for this Task Force as well.

The Bottom Line

FINRA should open the windows and let the sun shine in.  In the end, I think the public will find there’s not much that needs disinfecting.

______

*George H. Friedman, an ADR consultant and Chairman of the Board of Directors of Arbitration Resolution Services, Inc., retired in 2013 as FINRA’s Executive Vice President and Director of Arbitration, a position he held from 1998. In his extensive career, he previously held a variety of positions of responsibility at the American Arbitration Association, most recently as Senior Vice President from 1994 to 1998. He is an Adjunct Professor of Law at Fordham Law School. Mr. Friedman serves on the Board of Editors of the Securities Arbitration Commentator.  He holds a B.A. from Queens College, a J.D. from Rutgers Law School, and is a Certified Regulatory and Compliance Professional (Wharton-FINRA Institute). 

[1] See McDonald, Business Ethics and “The New York Times Rule” (December 8, 2010), available at <http://businessethicsblog.com/2010/12/08/business-ethics-and-the-new-york-times-rule/>.

[2] See Lipner, Study of Arbitration Recovery Statistics, The Neural Corner (June 2006), available at <http://www.finra.org/ArbitrationAndMediation/Arbitrators/CaseGuidanceResources/NeutralCorner/P016939>.

[3] Why it should cost $20 for a hard copy is puzzling.  A PDF should be available online for free in my opinion.

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