Thursday, February 23, 2006

A Broken System

There's a good article in the New York Times about the stacked-deck securities arbitration system. The inherent unfairness of the system, which denies brokerage customers their Constitutional right to the courts, is the focus of the first chapter of Wall Street Versus America. The chapter is available on my website, here.

According to the Times piece, a big WorldCom shareholder, having lost a $900 million securities arbitration against Citigroup, is asking a federal court to overturn the decision on the grounds that the arbitrator had an undisclosed conflict of interest. If true, that would be contrary to NASD rules.

However, I think the issue here is much broader. Even when the rules are followed to the letter, investors are deprived of a truly neutral forum in which to adjudicate their complaints. The courts, with all their failings, provide such a forum.

The investor in this Citi case has a very high hurdle to surmount if he is to win his case. That's because arbitration is designed to provide finality. That's fine in situations in which people voluntarily consent to arbitration. But you have no choice if you are a brokerage customer. It's part of the standard language of brokerage agreements.

The Times piece quotes a lawyer as saying that "arbitration was a cost-effective way of resolving disputes, but only if the disclosure system could be trusted."

Well, if it's so great, why not make it voluntary? Investors should have that choice, and regulators should require brokerages to give them that choice. Make no mistake about it: that won't happen if the public doesn't demand it. Right now, the only "public pressure" that comes their way is from a small handful of cultlike fanatics on the phony "naked shorting" issue.

It would be great to see the same kind of pressure exerted by real investors on a real issue. Mandatory arbitration is one such issue. Unfortunately, there are no murkily-funded pressure groups or email spams or letter-writing campaigns -- such as sustain the naked-shorting cultiests -- devoted to fighting mandatory securities arbitration. So the injustice of the system continues every day, ignored by the industry's putative watchdogs.


Wall Street Versus America: The Rampant Greed and Dishonesty That Imperil Your Investments will be published by Penguin USA on April 6.

Click here for its listing and here for my web site.


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