What Is Arbitration?
Arbitration is a mechanism for resolving disputes between investors and brokers, or between brokers. It is overseen by the Financial Industry Regulatory Authority (FINRA), and the decisions are final and binding. Arbitration is distinct from mediation, in which parties negotiate to reach a voluntary settlement, and decisions are not binding unless all parties agree to them. Arbitration is not the same as filing an investor complaint, in which an investor alleges wrongdoing on the part of a broker, but has no specific dispute with that broker, for which the investor seeks damages.
In practical terms, arbitration is similar to a lawsuit, but may be preferable for all parties due to the lower costs and time commitments involved.
When an investor or broker has a specific dispute with a broker that is registered with FINRA, they may file a claim with FINRA that states the alleged misconduct and the amount of money they are seeking in damages. FINRA will appoint a panel of three financial industry professionals who, unless the injured party requests otherwise, will not be employed in the securities industry. This is intended to eliminate bias, but if one of the parties suspects that a member of the panel is biased, they may request a change.
For disputes involving less than $50,000, in-person hearings are not considered necessary; rather, both parties submit written materials to a single arbitrator who decides the case. For disputes ranging from $50,000 to $100,000, in-person hearings with a single arbitrator are the most common. For disputes over $100,000, in-person hearings with three arbitrators are standard. A majority of the three-arbitrator panel (that is, two people) is necessary for a decision. Arbitrators are not required to explain their decision.
Parties filing for arbitration may represent themselves, or they may hire an attorney. In general, arbitration panels are less formalistic than the court system, so investors have a reasonable chance of being successful even when representing themselves. There are fees associated with filing for arbitration, not to mention the time and travel expenses involved, which investors should consider when pursuing this option.
Arbitration panels do not necessarily award the full amount sought in a dispute. For example, if an investor files a claim against his or her broker for $38,000, the panel may decide in the investor’s favor, but only award $10,000. Arbitration decisions are binding and not subject to appeal, except under very limited circumstances. FINRA’s mediation process, on the other hand, is not binding unless both parties agree to the settlement.
The Public Investors Arbitration Bar Association has criticized FINRA for lack of diversity on its arbitration panels and lax safeguards against bias and conflicts of interest. The regulator has argued that these criticisms are misplaced, particularly the focus on arbitrators' age.
In their terms of service, most brokers require investors to agree to mandatory arbitration to settle potential disputes, rather than going to court. Since FINRA has a near monopoly on arbitration, the organization’s panels are many investors’ only recourse.