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MANDATORY FINRA ARBITRATION- IS THE END IN SIGHT?

By Erwin J. Shustak, Esq. of Shustak Reynolds & Partners, P.C. posted on Tuesday, March 12, 2019.

          In the seminal, 1987 decision of Shearson v. McMahon, the U.S. Supreme Court decided that pre-dispute agreements to arbitrate securities disagreements were binding on investors. Since then, financial service firms have uniformly required that their customers sign these agreements and agree to waive a jury or court trial and, instead, head to the FINRA (formerly the NASD) arbitration panels to resolve their disputes with their firms. Before the 1987 decision in Shearson v. McMahon, arbitration was voluntary because, under federal law, arbitration agreements were considered unenforceable against investors.

            At the time, securities firms had long been using arbitration to settle intra-industry disputes--those that arose between firms, or between firms and their employees. But until 1987, those firms could not compel customers to arbitrate; customers could go to court if they so choose.

            Back then, the customer also had the option of going to arbitration. The by-laws of both the New York Stock Exchange and the NASD (and the other exchanges) required members (i.e., the brokerage firms) to arbitrate disputes with customers if the customer (but not the firm) elected arbitration. It was a one-way choice that clearly favored investors. They could choose their preferred forum. In the McMahon case, however, the securities industry challenged the then-existing interpretation of federal law- and won in the Supreme Court. Thereafter, mandatory agreements to arbitrate securities disputes would be enforceable against all investors.

            The McMahon case effectively ended one-way choice. With the securities firms uniformly requiring that customers sign arbitration agreements, and with the courts enforcing them, there was no choice at all. Since then, virtually all consumer securities cases have gone to arbitration, and the system that has been created, now run by FINRA, has been termed "mandatory arbitration."

            Over the years there have been numerous studies and arguments that mandatory arbitration of securities disputes between customers and their firms was unfair and many writers argued in favor of eliminating the mandatory arbitration of securities disputes. During the Obama administration a bill was proposed eliminating mandatory arbitration, but it never got out of committee and died on the vine.

            Recently, however, new legislation was proposed by Sen. Sherrod Brown, D-Ohio, a ranking member of the Senate Banking Committee, known as the Arbitration Fairness for Consumers Act, which would put an end to pre-dispute, mandatory arbitration agreements that are and have for many years been ubiquitous and a part of almost every brokerage/financial services agreement between an investor and his or her firm.

            Earlier this year, another bill was introduced in the House and Senate, the Forced Arbitration Injustice Repeal Act, that was broader in scope than Senator Brown’s bill and would further amend the Federal Arbitration Act.  Both proposed bills were welcomed by PIABA, the Public Investor Arbitration Bar Association, a pro-investor legal group that has been anti-mandatory arbitration since its founding around the time of the McMahon decision.  PIABA has conducted numerous studies showing how poorly investors fair in mandatory arbitrations and asserts that customers should have the option of choosing arbitration or the courts when filing claims against investment professionals.

            The proposed legislation, however, may face serious challenges on Capital Hill, where the House is controlled by Democrats, who tend to favor the end of mandatory arbitration and Republicans, who tend to favor mandatory arbitration and side with the securities industry, control the Senate.

            The Dodd-Frank financial reform law gave the Securities and Exchange Commission the authority to end mandatory arbitration, but the agency has yet to take up and consider the issue.

Shustak Reynolds & Partners, P.C.  focuses its practice on securities and financial services law and complex business disputes.  We represent many broker-dealers, registered representatives, investment advisors, investors and businesses. For more information, contact Erwin J. Shustak, Managing Partner [email protected], or call 800.496.5900 ext. 109.

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