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Judge Slams FINRA Arbitration

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Until March 12, 2012, Deborah Gale Evans, a partner in the Boston law firm of Michaels, Ward & Rabinovitz, was enjoying great professional success. The Michaels Ward firm is well known for its expertise in securities litigation and regulation. According to its website, the firm represents banks, broker dealers and others in court and arbitration proceedings. Ms. Evans specializes in representing broker-dealers in arbitrations before the Financial Industry Regulatory Authority (FINRA).

If you have an account with a retail broker, or are employed by one, you signed an agreement requiring you to submit all disputes to mandatory arbitration administered by FINRA. The idea of requiring investors and employees to arbitrate disputes before a tribunal appointed by the very industry being sued is deeply troubling. Because it deprives American citizens of their constitutional rights to access to the courtroom and trial by a jury of their peers, it has neither the appearance nor the reality of impartiality. Among others, I testified before Congress and urged it to enact legislation prohibiting mandatory arbitration clauses as being fundamentally unfair.

A study I co-authored of more than 14,000 FINRA arbitration awards over a ten-year period found that investors with significant claims suing major brokerage firms could expect to recover only 12 percent of the amount claimed. It is not surprising that many investors required to submit to this process perceive it to be biased against them.

Ms. Evans represented Wells Fargo Advisors in a dispute with a former financial adviser, Clifford J. Watts, III. Watts had signed a promissory note in favor of his former employer, Wachovia, which was later bought by Wells Fargo. The note provided for payment of the unpaid principal, plus interest upon termination. Watts quit Wells Fargo but refused to pay the balance due on the note, claiming that it was really a bonus and that the terms of his employment were materially changed after the acquisition, forcing his termination.

The FINRA panel decided in favor of Wells Fargo and ordered Watts to pay the principal, interest and to reimburse Wells Fargo for its attorney's fees in the amount of $60,480.25. Stung by this defeat, Watts filed a motion in the United States District Court for the Western District of North Carolina to overturn the award (case # 5:11cv 48, reported at 2012 LEXIS U.S. Dist. LEXIS 32244). Wells Fargo asked the Court to enforce it. Normally, efforts to overturn an arbitration award are unsuccessful because the legal grounds for doing so are very narrow. Motions to enforce an award are almost always granted.

That's where it got interesting.

The U.S. District Judge assigned to decide the case was Max O. Cogburn Jr. He joined the Court in 2011, after being appointed by President Obama.

Judge Cogburn heard oral argument on the motions to vacate and confirm. Ms. Evans argued for Wells Fargo.

In a stinging rebuke to both Ms. Evans and (more importantly) to the FINRA arbitration process, Judge Cogburn has some choice words for both. When he asked Ms. Evans if the Court has the power to vacate an award if it found the underlying agreement was illegal (which it clearly does), Ms. Evans "... immediately challenged the Court's statement." Apparently not sensing Judge Cogburn's concerns, Ms. Evans told him that Wells Fargo "... handles hundreds of arbitrations a year" and that she handles 30 or 40 of them as counsel. She then uttered these words, which I am sure she now regrets: "I've never lost one and I've never not gotten attorney's fees. I always win these cases."

Judge Cogburn was not impressed with this track record, noting: "Now there's a level playing field."

Either Ms. Evans is a combination of Clarence Darrow and F. Lee Bailey or the process is rigged in favor of the securities industry. Judge Cogburn made it clear how he came out on this issue.

The Court noted that the securities industry's "constant and prolific participation" in these arbitrations gave it "a clear advantage over the individual employee or customer" because the industry knows which arbitrators will favor its position. That fact, coupled with the limited review permitted by the Courts, results in a "... process in which, as in this case, counsel for the bank can remain undefeated 30 or 40 times a year."

Ms. Evans lectured the Judge on the "voluntary" nature of arbitration and its cost savings benefits. Judge Cogburn rejected these arguments as "disingenuous," correctly noting that employees and customers have no recourse other than to sign these agreements. He turned the "saving money" argument on its head, noting that "... since the individuals seldom win and are forced to reimburse costs and attorneys fees, the only ones saving money are large institutions like the claimant."

Nevertheless, and with obvious misgivings, the Court confirmed that part of the arbitration award requiring repayment of principal and interest of the note. However, it vacated the award of attorney's fees, finding that the amount of those fees was pulled "out of thin air" and was "completely arbitrary."

To date, congressional efforts to ban mandatory arbitration have met with formidable and highly effective resistance from the securities industry and business lobbies. Maybe Judge Cogburn's decision will spur renewed interest in this legislation, which is long overdue. In the interim, attorneys like Ms. Evans should ask themselves whether their stunning success is attributable to their legal skill or the lack of impartiality of FINRA arbitration panels.

I called Ms. Evans and sent her several e-mails asking for her comments on this decision. I received no response.

Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of "The Smartest Investment Book You'll Ever Read," "The Smartest 401(k) Book You'll Ever Read," "The Smartest Retirement Book You'll Ever Read" and "The Smartest Portfolio You'll Ever Own." His new book is "The Smartest Money Book You'll Ever Read." The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.