t o the Hiqh Cost of Litigation

Center for Public Resources Neu York, Neb\ York \’ol. 10, No. 11 November 1992

~ Securities ADR. A report last spring by the General ;iccoiintirig Ofiicc finding “no indication ofa pro-industry bias” in securities arbitration. m a y not tell the Lvholc s t o q . In pact, (;.,\(j’s emphasis on empirical analysis overlooks ;inccdotaI evitiencc that investors may r io t get fair treatment in the intei-twilled \ \ ~or lc l of the scciiritirs industry anti arbitrators, say attoi-iicys and corisiiltailts familiar ivith thc s)’stem. Xrnoiig the improvements these critics rt‘(~oniiiiciid: forni;d arbitrator- selection standartis; ;I rcquircrnent that arbitrators issue ;i brief statement explaining the

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reasons for thcir decisioris; and iiiore sti.iiigeiit peer review. ..... Page I65

Court ADR. (:oiifidentiality is often citcci as one ofthe major reason3 tIisputarits use ADR, particularly in ;I tour-t setting. Yet a s states c1raf.t orders of I-cfcrcnce, court rules o r special statutes implementing ADR programs, they strrlggle to bal;mcc two coinpctiiig values: an interest in prornotiiig settlements versus the goal o l pi-ovitling access to “eve17 inan’s’’ evidence. In a special supplement this moii th , 1 4 / / o ~ - t ~ a ~ ~ 7 ~ e 5 presents excerpts from a chapter on confidentiality in court-XDK. coiitaiiicd in i~

forth coining CPR man ual , (,’our/ .WX: I : ‘ ~ ? P ~ I 17 o/’f’rogrci m / h i p . ‘I% c c h apt cr , which compares confidentiality rules in differcn tjurisdictions, atltlrcsses the coIiccrns that arise in connection with cornrnllnicatioris bct\vcen neutrals ;ind the collr-t. I t also considcrs how policies on confidenti:dity m a y compete ~vith policies i-cg;rding public access to proceedings arid outcomes of the pitblic,justice svstcni. .Page 173

Australian ADR. What rok should lawyers play in hDR? (:an courts coiiipel mediation? Should the chief focus of mrdiatioil he cost savings or the qiialit) o f the sc ttlemen t ? How may ~ v c best a p pi-oach i ssi it”r s i i i-r-oiiii di I 1 g train in g ai I d a< c rcdi La- tion of mediators? These issues, topics of c ~ ~ r r e n t ticbate in Lhe United States, wel-e among the subjects discussed this siiiiiiiier at thc First International (hnferciicc iii Australia on Alternative Dispute Rcsolutioii. Sue M. Duncombe, F.uecutive Ofiiccr of the Australian org;iiiiration, IXADR (I.a\%?ers E n g q c d in Xltrrnati\c 1)ispiitr Resolution), and Frank E. A. Sander, a Pi-ofeessor at Hanartl 1 . a ~ School, prclxircd a report for Allrrnaliws about the conference. _. .__ ................... Page 167

Nonjudicial Neutrals. Strapped by ;I fiscal crisis, the New York Supreinc Court in Manhattan has accepted iiii offer by pri\ate XDR providers t o stipply dispute resolution senices on a pro bono basis. Shol-t term, the pr-ojcct siipplirs a happy synergy. But ultimately court officials will need to clarify the relationship between the courts and private providers of neutral scnices. . . Page I66

Stipulated Reversals. The (hlifornia Supreme ( h u r t has honored a stipula- tion by the parties requesting a reversal of the trial court judgment. X prcsiiniption in favor such stipulations savesjutlicial resources and serves the best intcrests of the litigants, the court found. .............................................................................. Page I72

Briefs ....................................... Page I71 Drawing hv C ~ l l ~ t ~ i ................ Page 171

Quote of the Month ............... Page 172

Securities ADR Is it Fair To Investors? By Carole Gould Is securities arbitration fair to inves- tors? Ask Joan Hunt Smith. The 61- )car-old divorced investor f’rom Illi- nois used a stockbroker from Shearson 1,ehmari Brothers--a college friend of‘a friend-who put her heavily into options, creating losses of more than $2.50,000. A lawyer she consulted rec- ommended arbitration as cheaper and more efficient than litigation. During the ensuing hearing at the Chicago Board of Options, Shearson’s fraudu- lent in-house statements, used to qualie Ms. Smith for riskier investments, came to light. “The ages on the forms were wrong, and so were the addresses,” Ms. Smith say. “They had my daughter attending college at Michigan, n o t \Ve 11 e sl ey. They put any t h i rig they wanted on those fornis,”which she had never signed.

While Shearson’s main office in New York cleared Ms. Smith and her daugh- ter only for covered calls, the Chicago manager claimed at the arbitration hearing that he got complete clear- ance from New York by telephone. I n fact he had signed three quali5ing forms for Ms. Smith, using figures for her income and networth that rose on each form.

In the course of meetings held be- fore the arbitrdtion hearings, Ms. Smith learned that the chief panel member assigned to her case had neglected to

(continurd on paye 168)

16s A l l ~ l l l a ~ l \ ~ \

Securities ADR (continuPd,f,-r,rn, f r m / p a p ) mention his involvement in another case concerning the S ~ ~ i i e broker. When asked to recuse himself, he refused.

In the intertwined world of the s r c w rities industry and arbitrators, the chief’ legal counsel for Shearson was a former chairman of the arbitration corninit- tee for the Chicago Board and had worked there with a member of Ms. Smith’s panel. After four days’ worth of hearings, she was awarded, without explanation, $10,001. It’s riot sui-pris- ing that she concludes: “The whole thing is a travesty and a crime-it isn’t a fair forum for individual investors.”

Given the explosive growth of arbi- tration-the number of cases filed with self-regulatory organizations shot up from 830 in 1980 to 5,332 in 1990- the issue is a critical one. But last spring, the General Accounting Office re- leased a report that found “no indica- tion o f a pro-industry bias.” I n its two- year study, the congressional watchdog compared arbitration results at four SKO-sponsored forurns with the rc- sults in cases handled by the American hbitrdtiOIi Association and found no statistical correlation between specific forums and arbitration results. To rc- cap, the study found that individual investors received awards about 60 of the time, and the awards averaged about 60 percent of the amounts claimed. Investors who were repre-

scii tcd by laiiyers, however, v , ~ r c 1 . 6 titncs more likely t o receive a highel.- thall-a\~er-agc award.

NO one f;r~ll ts the GAO’s ttiethOd01- ogy, which was “as thorough antl pi-oper as possible,” says Sani;intlia Rahin, editor of the Smiri~tes .4rOi/r(i- tioil Corntnpn/nlor in Maple~vood, N.J.

But tlie tbvo people who cornmis- sionetl the GAO report, Represents- tivcsJohn D. Diiigell, chait-tnan of the House Committee on Energy and Co ni in c rce and Edwa I-d , J . Mar key, chairman of the Subcoininittcc on Telecorrirnunicatioris and Finance, tlis- piited its conclusioiis of fiairncss. S p r - cifically they want to require in rach arbitration a brief‘ statement cxplain- ing the reasons for arlitrators‘ c h i - sions. Also missing is “a wasonable level ofassurance regarding either the independence of the arbitrators o r their competence i n arbitrating dis- putes,” the coiigressnien said i n ;i,joint statement, To ensure fairness, they want the Securities and Exchange C:o i n 111 i ssion arid th c SKOs t ( dcvc 1 o p hrrnal arbitrator selection stat tdards, verify information provided by cur- rent and would-be arbitrators antl cre- ate a way t o ensure aclequatc ;irhitra- tor training. They warn that if the SEC antl SROs fail t o (lo so, in thc next Congress they “will give lrgislativc~ irn- petiis t o these reforms.”

Their concerns iire echoed by the attorneys and consliltants who Tvor-k extensively with the arbitration systetn.

t iga t i o t i si i n ply tlidn ’ t

empirical study cannot address thc fait-- iicss of‘ the arbitration process, which r-eqriires a subjective appt-oach. Indeed, anecdotal evidence collected from field practitioners offers a startling look a t how t h e process works in practice.

The real problrni arises t i o t from how ;irbitrators are srlectetl but fi-om the way their pcrforrnancc is evalu- ated, says Mary Callioun, president of the (hlhoun Consulting Group, a se- ciirities arbitration consultatit i n Watertown, Mass. Under tlie current peer review system, each arbitrator

plete a form evaluating the conduct of the other arbitrators on the panel.

In theory, the peer review pi-ocess is the forurn’s best source of infornia- tion about their arbitrators, says Ms. (:alhoun. But in practice few arbitra- tors receive their peer e\.aluation forms and those that do rarely complete them. As an independent consultant,

area attorneys who complain t o hei- alx)ut the conduct of their fellow ar-bi- ti-ators. Mihen she asks \diether they completed their peer review forms, the answer is ~is~idly, “what form?”

To better inipleinent the peer rc- view process, Ms. Calhoun recorn- mends that administrators be required to distribute forms and then withhold arbitrators’ payc h ccks as an i t i cen tive for them t o complete the forms. She

go fx enouglr, nlan)’ of thctn sa!’. An

sllould bc asked by the SKO to cotil-

Ms. Calhoun talks to rr1any Roston-

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also favors asking disputants to e ~ i l u - ate their arbitrators, before the awards are disclosed.

More valuable information could easily be gathered by reviewing chal- lenges for cause. When an arbitrator is repeatedly challenged for inconipc- tence, or prejudgment o n the issues, or improper conduct, that should be a warning to the sponsoring forum, says Ms. Calhoun.

Several of the regulatory organim- tions are concerned enough to insti- gate their own reforms. The AAA re- cently set up a task force to address the issue ofarbitrator training and ~

hopes 10 make its reconinien- datioris to the A4.A practice committee before the end of the year. The 19-member task force, made up of representa- tives of the securities industry and at tor neys who cus tc )mar- ily handle cases for aggrieved customers, is reviewing differ- ences between the rules of the A4.A atid the SKOs. Arrioiig its main focuses are the size and quality of arbitration panels, privacy, postponements, ex- per ts , applicable law, preheariiig proctxlure, discov- ery, and interim relief, says George H. Friedniari, vice president for case adniiiiistra-

pool information, profcssioii;il a h - trators can increase tlir drniatitl for their services a t t l i e same time.

Indeed, whilc thr C;AO repot-t tneti-

tioned that liealy use of certain arbitm

of partialit). to\vartl the inchistry,” the agency stopped short of an obvious task we1 I-su i t ed t o eiii pi ri cal s t I id\,: re- viewing the issiic by comp;iritig the ire- stilts ofcasrs decided I ~ y ~ i t - l ~ i t r ~ i t o t - s ~ v l i o carncd 10 o r niorc fees in otie year, f 0 t - example, to those who were less active.

M s . (Mhoui i , whose Jiriii tracks arvartls i n the Boston area, i;a!.s of fi-c-

tc )rs “Itlay 1-1 ave crra tr d at 1 ap”~“’’”’ Ice

Anecdotal evidence

reveals that “professional

arbitrators”- those

whose fees represent a

substantial portion of

their income- tend to

find against investors.

hard t o accept how naive other peoplr can be,” lie says.

<~hicfaniong tlir conitiirtitors’ con- ccriis were punitive damages. “I ~ . o u l d have liked the (;A0 to say tha t arbitra-

a n y award the!, tleetii,just,” s ; i y David E. Robbiiis, an attorneynith kiiifiiian, (;iltlen 8c (;;irlin, in New M’ork, who cliairrd the I’racticing l.aw Institute prograins on securities 211-bitratioti in 1986. Since customer5 Lisiially have no choice but t o arbitrate, tliiis forfeiting punitive d;iniagcs t h a t w o u l d h r granted in courts, “ i t would have heen

tors shollld h;1vc the po\vet- t o grant

-

tion for the AAA. For its part, tlie Securitirs Indus t ry

Conference on Arhitration, a loose confederation of‘ SROs, thy NASD, the Securities Industry Associatioli arid otli- ers, is considering developing a train- ing program for arbitrators. I n an Oct. 27 letter to the SEC, it also reconi- mends verifjiving background informa- tion supplied lly arbitrators. Meanwhile, the NASD is awaiting approval-ex- pected this spring-on its proposal t o make public all customer awards and names of the arbitrators who decided the cases.

Another thorny issur is that of’ “pro- fessional arbitrators” whose fees rep- resent a substantial part of their i n come. Experts say such arbitrators tend to find against investors in order t o

preserve their reputation among bro- kerages and thus their income stream-and because tlir brokerages

queiit arbitrators, “most of’ the time, they ride ;igiitist claitn;itits.” She cited one ;irbitrator who riilcd i ti t;ivor of the hi-okci-ages in 18 of his last 2 3 cases. hiid Ms. Srriitli, the titihappy investor cited earlier, said that tirarl\, all the income of two arbitrxtoi-s h a - - iiig a case related t o lirrs \ \ a s deri\.rd from the securities iiidiistt-y, ;tccord- iiig to the ar1,itrator biograph ics sup- plied t o licr lawytm b y the h’w.

Son1 c prac t i t ioners qu cstioii the l i e 4 for indiistr).-~iffiliatc.tl, ‘11 1 , I tratol~s ‘

at a1 I . U t;ders tan ding how tht. indus- tr-y works is irrclcvant 11cc;iusc~ most cases are decided on the lmsis of facts and credibility, not the legal issues, says Theotlorc C;. Eppenstcin, a Ncw Yolk lauyer who sprciali/vs i t i secut-i- ties and coitiitiotlities xl)iit-;itioii. .Atid even lion-affiliated arhittxtot-s \ v h o have business lxickgrounds “find i t

good if ’ the GXO came d o n ~ i strongly on tlie concrptual fair-

I n its report, C A C ) fbuiitl that putiitivr daniages \vere aivardetl in only 12 percent of the SRO cases, nine percent of cases hrard at the &4. The mediati

of‘ aniouiits claiiiietl a t SKOs and fivt. percent at the AAl.

To be fXr, argues (:onst;intine N. ki t sor i s , prof’e5sor a t P o r d h ;I ni LAW School, i n Sew M)rk (:it)., arbi- tration “cannot be ~ i srd a s a vehicle t o strip claimitits of their rcnicdics.” 111 a i i article publishrtl las t !‘ear i n the Fordliani Urban I m v . J o i i r n a l , 1’1-ofessor Katsoris Ivi-ote, “if‘

ness of the ~tI-gun~ellt,” lie s a > s .

fi,r the a\vartls Tvcle 1 1 percrtit

LT t i i v e r s i t y

thcsc arbitt-atioii clauses art’ now ex- Ixmcletl t o also deny punitive damages [:is n n n y itidusti-y groups \vii;h to] , the cotit-ts should re-exaitiine whcthcr siicli clauses are oppressive and 1111-

coiiscioiiable; atid ifthc cowts do not, then (hiigress should take i i p the is- s11r.

M a n y of‘ these coIlcel‘lls unfortll- iiatcly nwiild I K liiiiiiliar ones t o Ms. Smith, \ v h o c1iar;ictcriYes xl’oiti-ation a s “the most insidious thing ever per- petrated o n ;in individual investor.” In her case, at least, ;I fcclcral district court judge i n (:hic;igo agreed. He took the i i t i i i s i i a l step, in a related suit filed uinder the Kiicketerr Itiflueiiccd, ( h r r u p t Organi/ations r\ct, of’ over- t 11 r ti i iig t h c x b i t trat io I i award. Th c judge directed, in ;I 1988 decision, that the case lie rclieard. M s . Smith’s new arbitration hearing is pending. d