This story appeared in Jim Hamilton's World of Securities Regulation.
Historically, claims for violations of the federal securities laws were considered to be non-arbitrable based on the doctrine enunciated by the U.S. Supreme Court in Wilko v. Swan (U.S. Sup. Ct. 1953), 1952-1956 CCH Dec. ¶90,640. In Wilko, the Court held that an agreement to arbitrate claims under Section 12(a)(2) of the Securities Act was not enforceable. However, as arbitration gained increasing judicial favor, the Court began to chip away at the Wilko doctrine and in 1989 expressly overruled it. The Court ruled that a pre-dispute agreement to arbitrate an investor’s securities claims against a brokerage firm was enforceable in view of the strong federal policy favoring arbitration. Rodriguez v. Shearson/American Express, Inc. (U.S. Sup. Ct. 1989), 1989 CCH Dec. ¶94.407.
Broker-dealers generally require their customers to contract at account opening to arbitrate all disputes. Although arbitration may be a reasonable option for many consumers to accept after a dispute arises, mandating a particular venue and up-front method of adjudicating disputes, and thereby eliminating access to courts, may unjustifiably undermine investor interests. Thus, the Obama Administration recommends legislation that would give the SEC clear authority to prohibit mandatory arbitration clauses in broker-dealer and investment advisory accounts with retail customers. The legislation should also provide that, before using such authority, the SEC would need to conduct a study on the use of mandatory arbitration clauses in these contracts. The study shall consider whether investors are harmed by being unable to obtain effective redress of legitimate grievances, as well as whether changes to arbitration are appropriate. Financial Regulatory Reform, A New Foundation, Treasury Department, June 2009
The House financial reform legislation, HR 4173, would enable the SEC to restrict or even prohibit the use of mandatory arbitration clauses in contracts with broker-dealers and investment advisers. . Mandatory arbitration clauses inserted into brokerage firm contracts will no longer restrict the ability of defrauded investors to seek redress in the courts for wrongdoing.
The House legislation also directs the GAO to report to Congress within one year of enactment on the costs to parties of an arbitration proceeding using the arbitration system operated by FINRA and overseen by the SEC as compared to litigation and the percentage of recovery of the total amount of a claim in an arbitration proceeding using the FINRA arbitration system.
The Senate reform bill, S 3217m would authorize the SEC to reaffirm, or prohibit, or impose conditions on the use of mandatory arbitration in brokerage or advisory agreements. Thus, the Senate bill authorizes the SEC to reaffirm and essentially sanction the staus quo of mandatory arbitration. The House bill does not authorize the SEC to reaffirm the status quo.