Pace Law Review, Vol. 26, No. 1 (Fall 2005), pp. 113-132

Abstract

This paper addresses the fairness of securities arbitrations in the United States. A few decades ago, such a topic would have been relegated to the academic hinterlands. For the first fifty years following the enactment of the nation's securities laws, pre-dispute arbitration agreements between investors and the securities industry were not enforceable. In a series of decisions in the late 1980s, the Supreme Court reversed course and held that such disputes were indeed arbitrable. Following those decisions, arbitration quickly became the preferred method of dispute resolution for cases arising under the nation's securities laws, especially disputes between investors and broker-dealers. Between 1990 and 2004, the number of arbitration cases filed at the NASD rose from 3,617 to 8,201.

As securities arbitration grew in popularity, concerns over the fairness of securities arbitration proceedings quickly followed. Indeed, the ink on the Supreme Court decisions had barely dried when Congress tasked the General Accounting Office (GAO) with reporting on the fairness of securities arbitrations.

Most calls to reform securities arbitration suffer from a common flaw – they have relied largely on regulatory solutions without considering the market incentives of the arbitrators. When viewed through an economic lens, the inefficacy of this “regulatory” approach comes as no surprise. Calls for reform rest on a basic premise – that securities arbitration is unfair because the system is “captured” by the industry. If we accept that premise, then regulatory reforms are unlikely to be an effective long-term solution. Such reforms may yield ephemeral results as arbitrators and broker-dealers need time to react to shifting norms. Over the long run, however, economic analysis suggests that they will simply adapt their behavior to the new legal regime and, eventually, new norms will develop that continue to give favored treatment to the repeat players, namely the industry. Efforts to reform the perceived inequities in securities arbitration need a fresh approach.

This essay provides that approach. It applies to the peculiar problem of securities arbitration a theory that I developed in an Article in the Georgia Law Review. That Article developed an economic argument against arbitral immunity. It proposed that we strip arbitrators and arbitral institutions of any immunity that they enjoy as a matter of law. In place of that immunity, contractual damages caps and liability waivers would limit the exposure of arbitrators and arbitral institutions.

That same basic model provides a novel, viable and partly efficacious solution to the (perceived) problem of unfairness in securities arbitration. The effects of such a paradigm shift are subtle but important. This model addresses many (but, admittedly, not all) of the most vexing problems about unfairness in securities arbitration. It also better aligns the incentives of arbitrators and arbitral institutions with the “public interest” arguments that underpin calls for greater fairness in securities arbitration.

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