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In House Counsel for Financial Institutions May Lose Mandatory Arbitration Option

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By Kevin Fayle on June 22, 2009 10:21 PM

The Obama administration's plan to alter regulations governing financial institutions will undoubtedly significantly impact those institutions' legal departments.  The proposal promises to profoundly alter the regulatory scheme that such institutions work under.  Nowhere is this prediction more pronounced than on the subject of mandatory arbitration of claims against lenders and brokers. 

Under the present system, individuals with a claim against lenders or brokers usually sign contracts that bind them to mandatory arbitration of their claims.  This arbitration can occur in a jurisdiction unrelated to the individual and their claim, and the right to choose the arbitrator is generally reserved for the financial institution. 
The regulatory reform plan released by the Obama administration last Wednesday states that

Many consumers do not know that they often waive their rights to trial when signing form contracts in taking out a loan, and that a private party dependent on large firms for their business will decide the case without offering the right to appeal or a public review of decisions. The [Consumer Fraud Protection Agency] should be directed to gather information and study mandatory arbitration clauses in consumer financial services and products contracts to determine to what extent, and in what contexts, they promote fair adjudication and effective redress. If the CFPA determines that mandatory arbitration fails to achieve these goals, it should be required to establish conditions for fair arbitration, or, if necessary, to ban mandatory arbitration clauses in particular contexts, such as mortgage loans.
A few pages later, the proposal comes back to the arbitration issue:

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 eliminating access to courts - may unjustifiably undermine investor interests. We recommend 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.
Obviously, the plaintiff's bar will be thrilled by the news, but legal departments across the industry are probably pretty nervous about the prospect of taking on the assistance of outside counsel for litigation that would normally go to arbitration. 

Some parties have already argued that the potential ban on mandatory arbitration clauses could have some other unintended negative externalities as well.

Writing in The Business Insider, Erin Geiger Smith argues that the adminstration's proposal

seems a clear way of increasing the costs of broker-dealer and investment advisory costs, which may mean that smaller customers find that brokerages are even less likely to deal with them than before. As usual, there seems to be very little thought given to how brokers will react to having the increased risk of litigation imposed upon them.

What's more, there are serious questions about whether it makes sense to burden the court system with additional litigation that a ban on mandatory arbitration will sure spur. In effect, a part of the costs of disputes between brokers and their customers are being transferred to the taxpayer who will pay the costs for the extra-burden on courts. It's far from clear why this shift in cost from the parties to the agreement to taxpayers is warranted. We can squint our eyes and see this as something of a bailout of customers who wind up unhappy with their broker.

All good points, to be sure, but I also see the administration's side of the argument, especially on the issue of the close relationship between the private arbitrators and the companies they rely on for their livelihood.  A recent lawsuit alleges that the National Arbitration Forum gets a little too cozy with some of the "famous parties" that come to it for arbitration services.  The suit claims that the BAG gave preferential treatment to its repeat customers, pressured arbitrators to change decisions that went against the famous parties (as they were supposedly known at the NAF), and removed cases from arbitrators that went against the famous parties.

A separate BusinessWeek report found that creditors prevailed 99.8% of the time in debt collection arbitrations conducted by the NAF

Arbitration shouldn't be eliminated as an option, especially since the increased cost once companies factor in the increase risk of litigation could put credit and investment services outside the reach of even more consumers.  Still, increased monitoring and oversight could go a long way towards ensuring that consumers receive a fair shake in an unbiased proceeding.

See Also:
The Beginning of the End of Mandatory Arbitration? (WSJ Law Blog)

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