Duffy, Kevin T.

Tognino, John N.

English

bepress Legal Repository

The Role of The Courts in The Securities Industry

Fordham University School of Law

Fordham Journal of Corporate &Financial LawVolume 3, Number 1 1998 Article 2The Role of The Courts in The SecuritiesIndustryKevin T. Duffy∗ John N. Tognino†∗†Copyright c©1998 by the authors. Fordham Journal of Corporate & Financial Law is producedby The Berkeley Electronic Press (bepress). http://ir.lawnet.fordham.edu/jcflTHE ROLE OF THE COURTS IN THE SECURITIES INDUSTRYMODERATORJohn N. TogninoPANELISTHon. Kevin Thomas DuffyJOHN N. TOGNINO:Judge Dufly will examine the use of arbitration in resolving customer complaintsin the securities industry. The role of the federal courts in securities arbitration havediminished since the U.S. Supreme Court upheld the validity of arbitration clauses insecurities agreements.' Judge Duffy will also propose changes to the arbitration systemthat will increase the role of the courts.JUDGE KEVIN THOMAS DUFFY:2Ladies and gentlemen, it is a pleasure to address an outstanding group of industryleaders. In 1990, I had the opportunity to present my views on dispute arbitration to asecurities industry group. I stated then that the advantages of arbitration were itsinformal nature, its limited discovery, its lack of binding precedents, and its lack of anappeal process. I also, however, stated that these same aspects were also the1 See Shearson/American Express, Inc. v. McMahon, 482 U.S. 220 (1987); RodriguezDe Quijas v. Shearson/American Express, Inc., 490 U.S. 477, 485 (1989); see alsoRescission of Rule Governing Use of Predispute Arbitration Clauses in Broker-DealerCustomer Agreements, 52 Fed. Reg. 39,216, 39,217 (1987) (to be codified at 17 C.F.R. §240.15c2-2) (proposed Oct. 21, 1987) (rescinding Rule 15c2-2 of the Exchange Act of1934, which deemed failure to disclose inapplicability of such clauses to federalsecurities claims to be a fraudulent, manipulative or deceptive act" within the meaning ofthe Exchange Act).2 Federal District Judge in the Southern District of New York: B.A., 1954, FordhamCollege; LL.B., 1958, Fordham University School of Law; Associate, Whitman, Ravison& Coulson, New York, N.Y. (1961-1966); Partner, Gordon & Gordon, New York, N.Y.(1966-1969); Regional Administrator ofthe SEC, New York Regional office (1969-71).ROLE OF THE COURTS IN THE SECURITIES INDUSTRYdisadvantages of arbitration. 3 I noted that arbitration was intended to be a quicker andcheaper method of dispute resolution as compared to formal litigation.4 Today, I willcritically examine the securities industry arbitration process and propose a governmentalternative.I. INFORMALITY INARBITRATIONOver the last eight years formality has crept into the arbitration process. Anumber of self-regulatory organizations have developed detailed rules and handbooks toregulate the arbitration process.5 Formal mediation is now generally undertaken at thecommencement of the arbitration process. Moreover, there is now a formal barassociation that specializes in investor arbitration.63 See Matthew Press, Arbitration of Claims Under the Securities Exchange Act of1934: Is Exclusive Jurisdiction Still Justified?, 77 B.U. L. REv. 629, 650-53 (1997)(discussing disadvantages of securities arbitration such as, inter alia, lack of proceduralprotections, lack of uniform standards on which to base awards, and inhibition of thedevelopment of federal law based on specific factual disputes).4 See Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth Inc., 473 U.S. 614, 628(1985) (stating that a party agreeing to arbitration "trades the procedures and opportunityfor review of the courtroom for the simplicity, informality, and expedition ofarbitration."); But see Jean R. Stermlight, Panacea or Corporate Tool?: Debunking theSupreme Court's preference for Binding Arbitration, 74 WASH. U. L.Q. 637, 672-73(1996) (criticizing the "myth" enunciated in Mitsubishi Motors Corp. "that arbitration isas appropriate for virtually all disputes as is litigation").5 See, e.g., Constantine N. Katsoris, SICA: The First Twenty Years, 23 FORDHAM URB.L.J. 483, 488-90 (1996) (discussing the role of self-regulatory organizations indeveloping the Uniform Code of Arbitration as a means of harmonizing their separaterules).FORDHAM FINANCE, SECURITIES & TAX LAW FORUMII. LIMITED DISCOVERYEight years ago arbitration discovery was limited. Claimants in securitiesarbitration are now entitled to document discovery from brokerage firms. 7 Discoverabledocuments include client account histories, broker-dealer research on disputed securities,individual broker personnel files, compliance manuals and as many more documents asthe arbitrator will allow.8III. LACK OF BINDING PRECEDENTArbitration awards are easy to research but have limited value. The NationalAssociation of Securities Dealers ("NASD") will provide a list of an arbitrator's recentawards in any NASD sponsored arbitration. 9 The Securities Arbitration Commentatorwill provide complete background on all awards ever granted by a specific arbitrator,'0This information is of limited value because there are no formal opinions and the awards,do not have the effect of binding precedent." Thus, claimants have received awards6 Public Investors Arbitration Bar Association. See Quinn, Investor TakingStockbroker to Arbitration Doesn't Stand a Chance Without Lawyer's Help, BUFFALONEws, May 14, 1997, at B9.7 UNIF. CODE OF ARBITRATION §20 (1996); But see Press, supra note 3, at 652("[T]hough arbitrators have some power to compel discovery, it is limited by local statuteand may in some cases be insufficient to compel the production of important documentsor testimony from distant jurisdictions.") (citation omitted).s See Quinn, supra note 6, at B9 (recommending documents that investors shouldobtain to prepare for securities arbitration).9 See id.10 See id.1 See Press, supra note 3, at 643.ROLE OF THE COURTS IN THE SECURITIES INDUSTRYsimply because they have lost money or have suffered some other harm.1 2 Substantialpunitive damages were awarded against a broker-dealer that intentionally failed toproduce discovery documents. 13IV. LACK OFANAPPEAL PROCESSWithout fear of reversal on appeal, securities arbitrators decide cases withoutreferring to precedent. 4 Arbitrators often do not have any knowledge of the industry, thesecurities laws, and the applicable basis of liability.15 There are no formal rules to followin deciding claims. It may be that fewer rules are necessary for the arbitration process toreach a quick resolution. Obviously, an appeal process would delay claim resolution.V. QUICKRESOLUTIONSArbitration claims, during this bull market, will be heard within 10 months. In abear market, claims will increase and the speed of resolution will decline. In contrast, thefederal courts system handles simple cases within a two-year period. The current relativespeed of arbitration resolution is of questionable advantage. Originally, the securitiesindustry assumed that arbitrators would know enough about the industry to render quick12 See id. at 651 (noting that "arbitrators may decide awards on a purely equitable basis"and are "free to award what they feel the circumstances of the case require").13 Barbier v. Shearson Lehman Hutton Inc., 948 F.2d 117, (2d Cir. 1991).14 See Perry E. Wallace, Securities Arbitration After McMahon, Rodriguez, and theNew Rules: Can Investors' Rights Really be Protected?, 43 VAND. L. REv. 1199, 1248(1990) (noting that arbitration process does not involve strict application of legalprinciples or substantial legal research).See Shelly R. James, Arbitration in the Securities Field: Does the Present System ofArbitration Between Small Investors and Brokerage Firms Really Protect Anyone?, 21 J.FORDHAM FINANCE, SECURITIES & TAX LAW FORUMresolutions.'6 The speed of resolution is now regarded as the result of a lack of industryknowledge on the part of arbitrators.VI. LOWER COSTA recent Wall Street Journal article suggested that arbitration is not a low costalternative to formal litigation. 17 The cost of the arbitration may be $400 or more, whilethe filing fee in federal district court is $120. Moreover, the increased use of discoverywill only increase the aggregate amount of legal fees incurred in the arbitration process asa whole. Thus, the cost savings benefit of arbitration is eroding.VII. PROPOSALThe claims of securities industry customers should return to the federal courts.Arbitration is not a mandatory solution to resolving customer complaints. The securityindustry arbitration process is really a court specializing in reviewing customercomplaints. The securities laws should be amended to provide for an administrativetribunal to hear customer claims. This tribunal would issue written opinions, followprecedent, and be subject to an appeal process. Moreover, punitive damages could beCORP. L. 363, 385 (1996) (noting that "public arbitrators" required to hear claims underNASD rules are not necessarily from the securities field).16 See id.17 See Deborah Lohse, Investors' Arbitration Costs Are Increasing, WALL ST. J., June30, 1997, at C1.ROLE OF THE COURTS IN THE SECURITIES INDUSTRYeliminated and punishment could be directed against an individual broker rather than theentire broker-dealer firm.18There are other administrative tribunals within the federal court system. TheSecurities and Exchange Commission has administrative tribunals. The Social Securitysystem utilizes such tribunals. Bankruptcy courts are in fact administrative tribunals withArticle I Judges. In fact, Bankruptcy Courts constitute a unit of the district court andreceives its authority from the district courts in which it sits. This same concept could beapplied to an administrative tribunal authorized to hear the complaints of securitiescustomers.VIII. CONCLUSIONIt has been said that arbitration is only successful when both sides trust thearbitrator's decision. The securities industry and the investing public are unhappy withthe arbitration process. This suggests that the arbitration process must be fixed. Irecommend fixing the process while the market is bullish and customer claims are low.18 See Katsoris, supra, note 5, at 518 (noting the likelihood of appeal on an award forpunitive damages due to its unusual nature).

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The Role of The Courts in The Securities Industry

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