The conventional wisdom is to analogize securities arbitrators to judges. For example, the Arbitrators’ Manual compiled by the Securities Industry Conference on Arbitration tells arbitrators that they will be “viewed by parties in an arbitration proceeding much as a judge would be viewed in a court of law.” And, at first glance, the three arbitrators sitting at the end of the table may indeed look – except for the tape recorder – like three appellate judges sitting behind the bench.
The debate about “explained awards” adopts the judicial analogy. Proponents of explained awards argue, among other things, that requiring arbitrator/”judges” to prepare opinions will facilitate subsequent review of their awards by real judges. Similarly, opponents argue, among other things, that arbitrator/”judges” cannot be expected to prepare “explained awards” without the benefit of having law clerks as real judges do.
The analogy contains a grain of truth, at least for the panel chair, who is charged, as a judge is, with ruling on – and, in practice, usually overruling – evidentiary objections. In my view, however, the more accurate analogy for securities arbitrators is not to judges, but to jurors. Like jurors, securities arbitrators – with a few exceptions – do not make their living hearing cases. Like jurors, securities arbitrators are not required to have a law degree. Like jurors (in many jurisdictions), securities arbitrators fill out a questionnaire describing their background and disclosing their prior service and are subject, through the list selection process, to a form of peremptory challenge.
Most importantly, the principal role played by arbitrators at a hearing is akin to that played by jurors in a courtroom: to listen to the testimony and to decide, if not who’s telling truth, at least whose version of events is more believable. Many cases boil down to credibility contests: Was the customer’s investment objective safety of principal (as she testified) or aggressive growth (as the broker testified)? Did the broker disclose that the variable annuity carries a surrender charge (as he testified) or fail to mention that early withdrawals would result in a penalty (as the customer testified)? Resolving questions like these requires not judicial training or experience, but an appreciation for human nature and an ability to apply common sense.
Yet if the proper analogy for securities arbitrators is to jurors rather than to judges, perhaps it is time to take the next step and provide securities arbitrators with the one tool that jurors are given that arbitrators are not: instructions in the law. And perhaps it is also time to tell arbitrators explicitly, as jurors are, that they should reach their decision by applying the law to the facts.
Even under the current system, there are instances in which the arbitrators are told, at least implicitly, to follow the law. For example, the Award Information Sheet requires citation to “authority” for an award of punitive or RICO damages and for an award of attorneys’ fees. Presumably, this is not an empty exercise, and instead means that the arbitrators should award punitive or RICO damages or attorneys’ fees only if the law allows it. One can even find fleeting references to a duty to follow the law in advice given by the FINRA Dispute Resolution staff to arbitrators. For example, in aN article in the Neutral Corner, the Associate Director of Neutral Management informed arbitrators, “If the parties provide the panel with the law, the law is clear, and it applies to the facts of the case, then the law should be followed.” (emphasis supplied)1
Yet nothing in the FINRA Code of Arbitration Procedure, the Arbitrator’s Manual, or the Arbitrator’s Reference Guide expressly provides for instructing the arbitrators about the law or requires them to follow it in reaching their decisions. In my view, establishing such a regime would improve the securities arbitration process by promoting rationality and predictability without sacrificing efficiency and finality.
The primary benefit of instructing the arbitrators about the law and telling them to reach their decision by applying the law to the facts is that it would encourage arbitrators to think systematically about each claim and defense and thereby enhance the likelihood that the award will have a rational basis. Lawyers who try securities arbitration cases disagree about the extent to which the current system produces “irrational” results. But all of us have at least one favorite story about an award that left us shaking our heads. And even if there isn’t a current problem with rampant irrationality, enhanced rationality would be a virtue: Just as an unexamined life may not be worth living, an unreasoned decision is not worth respecting. Moreover, regardless of whether “rational” can be equated with “fair” in some metaphysical sense, I suspect that litigants who know that their fate is in the hands of decision-makers who are explicitly adjured to play by the rules will gain confidence that they will get a “fair” shake.
Enhanced rationality should also lead to increased predictability. Under the current system, the failure to require arbitrators to follow the law introduces a “wild card” factor into the analysis of the likely outcome of a case. Part of my standard speech to clients when evaluating a case is that, since the arbitrators need not follow the law, it is possible that they may rule against us – or for us – based on nothing more than their inner concepts of “justice” regardless of how the evidence goes in. This risk is as unquantifiable as it is amorphous. A regime requiring arbitrators to follow the law will not remove all uncertainty in evaluating a case, but it will reduce the wild card factor. And this in itself would be a good thing: Cases whose only chance of success depends on finding a panel willing to ignore the lack of proof on one or more elements of a claim may not be filed in the first place. And arguably meritorious cases may settle more often because counsel representing the parties will be able to assess the value of the claim more reliably.
Providing arbitrators with instructions about the law would not be difficult or costly. The legal rules setting forth the elements of the claims most often asserted by customers – misrepresentation, unauthorized trading, unsuitability, and churning – are, to a large extent, straightforward and well-established. So, too, are the legal rules setting forth the elements of the affirmative defenses most often asserted by respondents, such as failure to mitigate and ratification. Having read dozens of claimant’s hearing briefs over the years, I rarely have had occasion to quarrel with my opponent’s description of the underlying legal principles (it’s usually the facts that he gets all wrong). If the briefs submitted by the parties are not sufficient to inform the panel about the law, many federal and state courts already have promulgated standard jury instructions for use in securities cases, which could easily be adapted for arbitrations. And even where no such instructions exist, would it be too much to hope that organizations like PIABA and the SIA could agree on a set of basic instructions?
Since, in my experience, it is usually counsel for the respondent who emphasizes the law in closing arguments, it might be argued that telling the arbitrators that they should decide the case by applying the law to the facts would tilt the balance in favor of the firm. But this argument assumes either that the law governing broker-customer litigation is biased against investors (which would be news to those of us who have been living with cases such as Duffy v. Cavalier2 for more than a decade) or that securities arbitrators would go out of their way to apply the law in a way disadvantageous to the customer (which posits a degree of venality that only the most jaded would claim to exist). To the contrary, requiring arbitrators to apply neutral principles would make the process even more impartial.
To be sure, a regime that requires arbitrators to follow the law probably would reduce – but not eliminate – the number of cases in which the claimant recovers on a claim that would never succeed in court. But is that such a bad thing? A few years ago, the authors of one of the leading securities law treatises published an article identifying several categories of cases in which arbitration panels had “stretched or reached beyond existing legal authority” in order to find for claimants.3 The article was more descriptive than prescriptive – although the authors did suggest that, if the trend continued, brokerage firms “may wish to reconsider the wisdom” of mandatory arbitration – but it did not contend that these results were justifiable, merely explainable on the grounds that the arbitrators apparently desired to expand “the rights and the protections” afforded investors.
It is questionable, however, whether such an expansion is a proper function of arbitration panels as distinguished from legislative or rule-making bodies. If Congress or the SEC wants to impose liability without fault on brokerage firms, let them say so. I suppose one could defend the “right” of arbitrators to reach results not supported by the law as a way to punish brokers for conduct that, although not illegal, was somehow not up to snuff in the arbitrators’ view. But, again, setting industry standards is the job of the SEC and FINRA, neither of which has proven shy about enforcing the regulators’ idea of “best practices”; we don’t need arbitrators to fill that role on an ad hoc basis.
Likewise, a regime that requires arbitrators to follow the law may reduce the number of cases in which the arbitrators “split the baby.” But not necessarily. After all, juries who receive instructions on the law reach “compromise verdicts” all the time; why would arbitrators be less likely to do so? Moreover, unlike some commentators,4 I am not convinced that there is something inherently wrong with “all or nothing” results: If the claimant fails to prove her case, why should she get anything? The securities laws may indeed be intended to protect investors, but that does not mean that the securities arbitration process should be designed to compensate investors for losses even though they can show no wrongdoing by the broker. Nor am I troubled by a system that forces the decision-maker to choose between competing versions of the facts to which to apply the law. This is, of course, what jurors do every day. And if a properly instructed jury would find against the claimant based on the evidence presented, why should the claim fare better before an arbitration panel? It may be more soothing psychologically to the parties to receive an award where “nobody wins,” but providing psychic solace should not be the goal of the securities arbitration process.
Of course, if one accepted the premise that the purpose of securities arbitration is to “settle disputes” rather than to “decide cases,”5 perhaps the lack of any requirement that the arbitrators follow the law is a benefit. But if the premise is true, why not go all the way and eliminate the adjudicatory features of the arbitration process altogether? Instead of arbitrators, we could employ “settlement judges” with an acknowledged reputation for “fairness” and empower them to impose their idea of “rough justice” to bring the parties to their senses. Unfortunately, until science figures out a way to clone Jimmy Carter, the roster of qualified settlement judges may be rather slim. In the meantime, securities arbitrations are going to be conducted like trials, and, if so, enhancing rationality and predictability can only be a plus.
A regime that provides for instructing arbitrators about the law and requiring them to apply it in reaching a decision would not entail a wholesale revision of the securities arbitration process. In particular, it need not be accompanied by a mandate for “explained awards.” Jurors, of course, are not required to “explain” their verdicts, and the goal of ensuring that arbitrators act thoughtfully would be promoted just as, if not more, effectively by providing them with a framework for deciding the case as it would be by forcing them to write an opinion “explaining” the result. As some commentators have noted, the “explained awards” proposal seems more concerned about “perceptions” of how the securities arbitration process works than it is with the reality. But if we can improve reality, perceptions will follow.
Nor would the regime necessarily make arbitration awards more vulnerable to attack on motions to vacate. Requiring arbitrators to follow the law would not make it any easier, or harder, to establish the existence of the statutory grounds set forth in the Federal Arbitration Act for vacating awards. And, although such a requirement might make it easier to establish the threshold fact underlying a “manifest disregard” argument – i.e., that the arbitrators knew the law – it would not make it easier to satisfy the rest of the test – i.e., that, knowing the law, the arbitrators chose to disregard it. Indeed, to the extent that the system requires arbitrators to follow the law, their awards would be even more entitled than they are today to a presumption of regularity and therefore be more, not less, likely to be confirmed.
Generally speaking, I subscribe to the old saw, “If it ain’t broke, don’t fix it.” I also agree that securities arbitration, as it now exists, actually works pretty well. But that conclusion doesn’t mean the process can’t be improved. Instructing the arbitrators about the law and requiring them to follow it in reaching a decision will enhance rationality and predictability without compromising efficiency and finality. It is an idea whose time has come.
1 Jisook Lee, “How to Conduct a Deliberation,” The Neutral Corner – August 2005 at 4.
2 215 Cal. App. 3d 1517 (1989).
3 Lewis D. Lowenfels and Alan R. Bromberg, “Beyond Precedent: Arbitral Extensions of Securities Laws,” 57 The Business Lawyer 999 (May 2002).
4 Aegis J. Frumento, “Can’t Get No Satisfaction !,” Securities Arbitration Commentator, Vol. 2005, No. 3 (April 2005).
5 Id.