If you have an investment account, read this. It’ll take about 10 minutes.
If your stockbroker or financial advisor misled you, you can do something about it.
But not in court.
You have go to through arbitration, where three people will be your judge, jury and executor of the case.
I’ve applied to be an arbitrator.
Be afraid. Be very afraid.
Technically, just about anybody can be an arbitrator in such cases. I say “just about,” because white collar ex-felons are automatically disqualified. However, there are arbitrators who have gone through bankruptcy or been convicted of a DUI.
Arbitrators don’t need a financial background. They don’t need to understand the stock market. They don’t have to explain their decisions. They don’t even have to follow the law.
Their decisions are final.
“I think that’s why people consider it a place of rough justice,” says a former arbitrator. Still, he thinks the system works more often than it doesn’t, and arbitration saves taxpayers a ton of money by keeping cases out of court.
I decided to pull back the curtain on how arbitration works, with the help of three people:
Jay Lanstein is CEO of Cantella & Co., a Boston-based broker-dealer who’s been a defendant in arbitration cases. Defendants are called “respondents” in arbitration.
Jason Kueser is a Kansas City attorney who’s represented dozens of people bringing cases — they’re called “claimants.”
Lou Straney is founder of Arbitration Insight, providing consulting, trial preparation and expert witness services. He’s been involved in about 700 arbitration cases.
WHAT IS THIS ARBITRATION OF WHICH YOU SPEAK?
“The ability of an investor to demand arbitration existed back in the mid-1800s with the New York Stock Exchange,” says Rick Berry, Executive Vice President and Director of FINRA Dispute Resolution Services.
FINRA stands for Financial Industry Regulatory Authority. It’s a private, self-regulatory agency funded by securities firms doing business in the United States.
For the last several years, FINRA has been in charge of arbitration between a customer and a stockbroker, or between a stockbroker and an employer. If you actually read your contract with your financial advisor, you’ll discover that you almost always have to go to arbitration if there’s a dispute. You can’t sue in court.
Berry says the average arbitration case lasts 14 months, which is much shorter than a court case and a lot less expensive. He describes it as “fast, fair and efficient.”
Arbitrators include dentists, accountants, librarians and attorneys. “We just want smart, fair, analytical people who can come to a fair decision.”
There are over 8,600 FINRA arbitrators. Each is paid $600 for an 8-hour day of hearings, plus a few hundred bucks for some pre-hearing services. Most arbitration panels are made up of three people, and one of them is the chairperson (who makes $850 a day).
HOW IT WORKS
When you decide to sue your broker, or when brokers sue their employers, a complaint is filed with FINRA’s dispute resolution arm.
FINRA then supplies attorneys for both sides with three separate lists of arbitrators’ names, randomly generated, one list for each slot on the panel. All the arbitrators have to live in the same region as the claimant (the person suing).
The lists include each arbitrator’s background — work experience, education, financial and legal disclosures — and also how they’ve ruled in past FINRA cases.
Attorneys for all sides can strike a certain number of people from the lists and then rank the rest. FINRA figures out which three of the remaining names are most preferred by everyone. A panel is born.
Most panels these days are made up of “public” arbitrators, people who have never worked in the securities industry. Claimants can request an arbitrator who has worked in the securities industry, called a “non-public arbitrator,” who might be preferable if you don’t want to spend a lot of time explaining something very complex. On the other hand, an industry arbitrator might be biased toward the defense, er, the respondent.
After a panel is chosen, there will be some pre-hearing conferences plus limited discovery allowing both sides to exchange information. There are no depositions, and motions to dismiss are never granted early, no matter how bogus a claim may appear.
Finally, there’s the actual hearing, which is similar to a trial, with opening statements, witness testimony and closing arguments. The average hearing lasts about a week.
Unlike court, if the person bringing the case doesn’t appear, the hearing will still proceed. The show must go on.
“I fired a broker for blatant tax fraud, and he sued me,” says Jay Lanstein, who owns the brokerage firm. The guy never showed up to the hearing, “but the panel still made me present my case.”
After the hearing ends, the panel deliberates in private. A former arbitrator who wishes to remain anonymous called deliberation a collaborative process where arbitrators go over their notes. Sometimes there are strong disagreements, but he says they usually reach a compromise. “Every panelist I’ve ever worked with is very intent on trying to do the right thing,” he says. “I think they take their job very seriously.”
Once a decision is reached, arbitrators release a statement announcing it, usually within a month… and usually with no explanation attached. The whole thing is, like, one page.
Damages have to be paid relatively quickly, though recovering them can be difficult.
Appeals are almost never granted.
YOU WIN SOME, YOU LOSE SOME
Here are a couple of cases where Jason Kueser represented the customer, the claimant.
In one case from 2016, Samantha Skorija accused her broker at VSR Financial Services in Kansas City of putting her money into investments “that were unsuitable for Claimant’s investment goals and risk tolerance.”
Skorija wanted about $28,000 for out-of-pocket losses, plus another $38,000 in statutory damages.
The arbitrators awarded her $27,015, plus interest. “All requests for punitive damages are denied,” they wrote in their decision.
Why denied? We’ll never know!
In another case, Kueser represented a woman named Teresa Vollenweider, who went after her broker at Morgan Stanley for, among other things, fees and commissions. She was seeking damages as high as $365,000, plus punitive damages and attorneys’ fees.
She lost. Why? Well, we kinda know.
“Claimant’s claims are denied in their entirety,” wrote the panel, adding a partial explanation. Even though the woman was charged fees she never would’ve agreed to, arbitrators wrote that the trades “were overall profitable,” and turning back the clock on them would not be to her benefit.
Brokerage firm CEO Jay Lanstein, who’s been on the other side of the table as a respondent (defendant), found arbitration eye-opening.
“I expected it to be very much about the law,” he says. “It was far from that.” Instead, the proceeding focused more on the industry “standard of care” — what’s expected of an advisor, and how much a customer should be paying attention.
“They can take a case that’s 12 years old,” he says, “and even though there’s a federal rule that says it shouldn’t even be eligible for arbitration at all… they can say, ‘You know what? We’re going to give this guy $2 million anyway.’”
Consultant Lou Straney says it’s not as bad as all that. “They can’t totally disregard [the law], that would be grounds for a reversal,” he says — though he admits that reversals are rare. Usually a case is overturned because an arbitrator didn’t disclose a conflict.
Straney has seen a thing or two as an expert witness. During a break in a hearing in New York, “The broker involved was arrested by the FBI.” In one case in Hawaii, the claimant tripped and fell while walking into the hearing and had to be hospitalized. He couldn’t attend any of the hearing, “but he prevailed.”
Few cases make it all the way to a hearing, though, and the number of claims settled beforehand is rising. Straney says his favorite comment about the process explains why — “If investors understood the stress, frustration, and financial uncertainty associated with the process, they would do most anything to avoid the experience.”
Rick Berry at FINRA says about 80% of cases are now settled, often through mediation, which is “better than getting a decision imposed from the arbitrators.”
IN OVER THEIR HEADS?
It seems like you could be flipping burgers at McDonald’s and qualify as an arbitrator (more on that below). Not that there’s anything wrong with flipping burgers, but are some arbitrators in over their heads?
“I do think that there are some issues in these cases that can be a little beyond the scope of understanding of arbitrators,” says attorney Jason Kueser. “I think there are some issues in cases that are honestly beyond the scope of understanding of the attorneys, too.”
Brokerage CEO Lanstein says he’s never seen anyone out of their depth and he’s actually been pleasantly surprised at how attentive arbitrators are. That said, “I’ve had at least one case in which the arbitrator said it was going to be his last case before he retired, and perhaps he should have retired a little bit sooner.”
Lou Straney has learned not to jump to conclusions about an arbitrator. “Their demeanor, their questions, whether they take notes or don’t take notes, can be deceiving.”
JAY-Z AND ARBITRATOR DIVERSITY
Most arbitrators are white and male, something FINRA has been trying to change. Rick Berry says the organization added 1,000 new arbitrators in 2020. In that new class, “We had 40% women, 14% were African American.”
The issue of arbitrator diversity became news in 2019 when Jay-Z complained about it to the New York State Supreme Court. The musician was involved in a trademark dispute with clothing maker Iconix — an issue not being handled by FINRA. Under Jay-Z’s agreement with Iconix, he had to go through private arbitration, using someone provided by the American Arbitration Association (again, not FINRA).
Reuters reports that when Jay-Z discovered “only two of the more than 200 arbitrators proposed by the American Arbitration Association identified as African-American and had no conflicts of interest,” he went to court to stop the process. He said the lack of Black arbitrators constituted racial discrimination under New York law, “and voided his earlier agreement to arbitrate with Iconix.”
AAA then added more Black arbitrators to the process, and Jay-Z agreed to go through with arbitration. Both sides later settled.
As FINRA continues to tackle the issue, attorney Kueser would like to see more progress. “I feel like there’s not a lot of diversity with respect to the arbitrator roster.”
He says as long as arbitration training is adequate, it’s good to have a mix of people, even burger-flippers. “I think there’s some implicit biases that come into play when you have an arbitration panel of three highly educated individuals that might find it hard to believe that someone could be duped.”
Many arbitrators are older, and nearly everyone has a story about one falling asleep.
Brokerage firm CEO Jay Lanstein blames the attorneys.
“Some attorneys don’t have enough common sense, or are not paying enough attention to see, ‘Okay, this arbitrator is looking up at the sky and thinking to himself’ — you can almost see him thinking — ‘When is this guy gonna move on to something? I’m not buying this at all.’”
Lanstein is amazed those attorneys keep droning on. “Eventually the arbitrator falls asleep. I mean, it’s human nature, to an extent.”
Attorney Kueser wonders if some arbitrators tailor their awards in order to be picked for future panels — they don’t want to be seen as always favoring one side or the other. “They do [the job] for a reason, and that is, presumably, because they want to sit as an arbitrator,” he says. “There is a monetary aspect to that.”
He points to the historical list of awards. “Investors win about 40% to maybe 45% of cases, and when they win awards, usually it’s 40 to 45 cents on the dollar. So again, you’re talking middle of the road.”
The more moderate you are, the more often you’ll be chosen, right?
“I disagree with that,” counters consultant Lou Straney. “I found that arbitrators generally are very, very fair.”
FINRA’s Rick Berry says if an arbitrator was in it for the money, they could make a lot more with other arbitration services, like the AAA cited above in Jay-Z’s case. Arbitrators can sometimes set their own rates at other services, while at FINRA, the pay is set for you. “It’s so low.”
CAN THE SYSTEM BE BETTER?
I asked everyone what changes they’d like to see.
Attorney Jason Kueser doesn’t think arbitration should be mandatory, but optional. “I think there are cases that are good for arbitration, I think there are cases that are better suited for litigation.”
He’d also like to see standards applied to things like calculating damages. He’d really like to be able to give his client a reason why they did or did not win. “The word ‘arbitration’ and ‘arbitrary’ share the same root,” he points out.
Rick Berry says FINRA considered making arbitrators explain their decisions, but he was surprised at how much pushback the idea received. Both sides now have to agree for an explanation to be provided, but apparently most decide some things are better left unsaid.
Jay Lanstein, who runs the brokerage firm, would like to have earlier motions to dismiss before he spends time and money on a case that is clearly bogus. And someone filing a bogus claim should be penalized. “I think if everyone knew that if you bring a frivolous claim, it’s going to hit you in the wallet, you wouldn’t do it again.”
He and others also wish something could be done to make it easier to collect damages, which go unpaid in an estimated 30% of cases. FINRA has a new rule to force firms with a history of misconduct to set aside money for potential future arbitration awards, but Lou Straney says the rule doesn’t go far enough. Some of these small firms “can simply close up shop and open another broker-dealer under a new name, sometimes in the same physical location.”
Still, everyone agrees arbitration is much faster and cheaper than going to court.
“It does work,” says Lou Straney.
“You do have a way to try to resolve a dispute,” says Jason Kueser.
Jay Lanstein (mostly) agrees. “Because everyone’s universally unhappy with it, maybe that means it works,” he says. “No one’s happy with court, either.”
HOW DO YOU BECOME AN ARBITRATOR?
Rick Berry says to become an arbitrator, “You just need to have two years of college and five years of relevant business experience,” though he says most arbitrators have four-year degrees. So while a burger-flipper could technically qualify, it’s unlikely to happen.
Berry is especially keen to find more candidates in mid-sized cities like Jacksonville and Salt Lake City.
Be warned, though, it’s a lengthy application followed by an even lengthier background check.
If you survive the background check, there’s some online training, followed by a test. Berry says you don’t have to understand the stock market to pass the test. Expert witnesses during hearings will explain how the market works. Arbitrators just need “to be smart and analytical, and able to follow the evidence and make a decision.”
Why do it? Rick Berry calls it a public service. Plus, “It’s so interesting. Every fact pattern is different,” he says. “You have helped people come to a conclusion.”
JANE WELLS, PROFESSIONAL ARBITRATOR
I decided to apply to be an arbitrator to see 1) if I’d like it, and 2) discover how the process works. I’ve made it through the first round of background checks, and I’m currently in the second round. (I have no idea what that means, but I’m told the process could take a couple of months.)
This article may end my chances — hello, FINRA background checker! — but even if I make it through, would anyone pick me to be on their panel? Would you?