On May 7, 2013, the House (H.R. 1844) and Senate (S. 878) both submitted bills that would amend the Federal Arbitration Act, Title 9 of the United States Code. The bills would invalidate predispute arbitration agreements—any agreement to arbitrate a dispute that had not yet arisen at the time of the making of the agreement—in employment, consumer, antitrust, or civil rights disputes.
These are not the first bills of their kind. In fact, Congress considered and rejected similar legislation in 1988, 2007, 2009, and 2011. The most recent bills, however, carry some additional momentum as a result of being submitted only three years after Section 21 of the Dodd-Frank Act granted the SEC authority to prohibit or impose conditions on the use of predispute arbitration agreements if doing so is in the “public interest.”
Since 1972, investors have had an absolute right to have their dispute arbitrated, under the NASD rules. And since the U.S. Supreme Court’s decision in Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 225-226 (1987), investment firms have consistently entered into valid and enforceable predispute arbitration agreements with their customers. Questions about the fairness and efficacy of arbitration proceedings, however, have become prevalent in light of the passing of the Dodd-Frank Act and the government’s perceived push for added investor protection. In most debates related to arbitration, and, specifically, the appropriateness of predispute arbitration clauses in the securities industry, advocates often defend the process by saying it is faster and less expensive than state or federal court litigation. Critics, on the other hand, who typically claim to be advancing the interest of the customer, attack the process by saying it favors industry members and improperly forces customers into the forum. Lost in these traditional arguments is how arbitration, particularly FINRA arbitration, actually favors claimants/customers in many situations.
Uncertainty creates risk. And when the tools generally used to defend claims in state and federal court are removed in FINRA arbitration forums, respondents are faced with increased uncertainty and thus increased risk.
The first tool removed in FINRA arbitration is the use of dispositive motions. Under FINRA Rule 12504 and 12206, motions to dismiss are discouraged, and there are only three narrow situations in which a respondent has a legal basis to file such a motion: 1) when a respondent was previously released from the claims through a signed settlement agreement or release, 2) when a respondent was not associated with the conduct at issue, or 3) when the claims are not eligible for arbitration under FINRA Rule 12206. If the claimant fails to articulate a valid cause of action, a respondent may not file a motion to dismiss. If the claimant asserts a cause of action that is not recognized under state or federal law, the respondent may not file a motion to dismiss. If the claimant files a claim that is barred by the applicable statute of limitations, the respondent may not file a motion to dismiss. Unlike state and federal court, a respondent is thus faced with a decision: either settle or take the case to hearing, uncertain of what the result will be.
If the respondent decides to take the case to hearing, it will be faced with the same uncertainty as trial—but with less information. Under FINRA Rule 12507, interrogatories—written questions to the opposing party about the case—are not permitted. “Requests for information”, as they are called in the FINRA rules, are limited to the identification of individuals, entities, and time periods. For example, a basic interrogatory in state or federal court that asks the customer to “state what misrepresentation was false and misleading” would be impermissible under the FINRA rules. The problems with these limitations are exacerbated due to FINRA’s prohibition of depositions—one of the most important discovery tools in civil litigation. Under FINRA Rule 12510, depositions are strongly discouraged and only permitted to preserve testimony of an ill or dying witness or under other extraordinary circumstances. Consequently, a respondent is not permitted to take a claimant’s or third party’s deposition prior to hearing, and will thus elicit testimony from the claimant and third parties for the first time at hearing. Talk about uncertainty. And when the hearing begins, a respondent is faced with additional obstacles. The rules of evidence, which apply in state and federal court and which are designed to exclude unreliable evidence and hearsay testimony, do not apply. This creates additional uncertainty about what evidence and testimony will ultimately be considered by the panel in making their ultimate decision.
The ultimate decision of a FINRA arbitration panel is also less clear than a trial verdict. Juries in state or federal court cases typically complete jury interrogatories that indicate why the jury came to its conclusion. There is no similar process in FINRA arbitrations. An arbitration panel simply issues a written award within 30 business days from the end of the hearing. The panel is not required to provide any explanation for its decision or any monetary award, unless the parties jointly request an explained decision 20 days before the hearing. The award is only required to list basic information about the case such as the names of the parties and an acknowledgement by the arbitrators that they have each read the pleadings and other materials filed by the parties, but it does have to include any detail about the panel’s findings. For example, an award may simply state “relief for the claimant is denied, with prejudice” or “the panel finds in favor of the claimants”, and it may express its monetary award by simply stating “the panel awards the claimant $100,000” with no explanation as to how the panel arrived at its number.
Despite the incredible uncertainty associated with FINRA arbitration, one thing is certain: a panel’s decision. FINRA does not have an appeals process through which a party can challenge an award. The only avenue to “challenge” an award is to file a motion to vacate or modify an award in state or federal court. But the legal bases for doing so are limited to situations involving arbitrator misconduct, such as an award being procured by corruption, fraud, or undue means. In practice, this means the parties generally have to accept the panel’s decision as final and binding with no opportunity to appeal, for example, the admission of unreliable evidence at hearing or the panel’s incorrect application of governing law.
Arbitration, as all forums do, has its advantages and disadvantages. But in the context of discussing the Arbitration Fairness Act of 2013, advocates for the arbitration process must understand what procedural safeguards are given up in favor of a process that is only sometimes faster and sometimes cheaper, especially when the pace and expense of litigation can be managed by defense counsel through planning and budgeting.
If you have any questions regarding the Arbitration Fairness Act of 2013 or any other question affecting liability of financial institutions or financial services professionals, please contact one of our Financial Institutions and Financial Services Liability Practice Group members.
