The financial industry's cherished devil in the details may blunt his horns. But you may wind up being gored anyway.
The "devil" is in the client/agency agreement investors must sign when they open an investment account. It's called "mandatory arbitration" and it works like this: If you think you've been cheated, lied to or scammed by a broker, you must resolve the dispute before a three-person panel of "expert" industry types selected by the financial-service industry's tainted self-regulator, the Financial Industry National Regulatory Authority (FINRA).
Signing the agreement bars you from taking your complaint into court. The panel's decision is not only final, you won't even be told why you won or lost. And there are no appeals. About 70 percent of the time these industry-stacked panels tell aggrieved investors to shut up and lick their wounds.
All of this is about to change if the Securities and Exchange Commission, headed by former FINRA chief Mary Schapiro, allows investors to select "all public" panels to settle disputes.
Bravo! you cheer. The devil has lost his horns! Everyday people will be more sympathetic! Yes, they wil l-- but the brokers will also win. By allowing investors to choose all-public panels, FINRA subtly trashes the Dodd-Frank financial regulatory provision that does away with mandatory arbitration altogether and allows investors to go to court.
On the surface, many investors are inclined to see all-public panels of industry outsiders as a step in the direction of fairness. But look a little deeper and you'll discover a more insidious problem.
Industry types argue that going to court is expensive for all concerned. So why not keep arbitration on the books? It's cheaper, faster and investors get the advantage of sympathetic citizens to weigh your case. Yet at the same time, brokers dodge a bullet: With arbitration still in place, brokers can game their clients and not worry about having to do time in the old gray bar hotel.
Arbitration also relieves brokers of a fiduciary responsibility to act in the best interests of their clients; "suitability," a term of art, remains their only obligation in making financial recommendations.
When you buy a suitable financial product, you own it. The broker makes a commission and you take all the risk. Are you savvy enough to know what is truly suitable for your level of risk? Most investors rely on their brokers to make that determination.
The overwhelming majority of brokers want to keep arbitration alive; this should give you a hint of whose interests they really care about.
In an October 18 poll by Investment News, brokers were asked if mandatory arbitration should be ended. About 30 percent responded "yes." But more than twice that number, 69.8 percent, endorsed arbitration.
In an interview yesterday, TD Ameritrade Trust Co. President Skip Schweiss told Investment News, "I see a lot of eyes widen when I talk about this one." This is hardly surprising. As long as arbitration stays on the books, the industry makes up the rules.
Like Forrest Gump's box of chocolates, each panel is different. You never know what you're going to get, let alone why you're getting it. Unlike a court of law, arbitration panels aren't bound to disclose their deliberations; evidence isn't openly vetted. On the other hand, if lose in court, you can appeal. There are no appeals from arbitration -- and this is perhaps the most devious devil in the industry's bag of tricks.
Former SunTrust Bank senior analyst Harwood S. Nichols comes down in the middle of the debate.
"An outsider is bound to assume that panels are stacked against them, given that some knowledge of the industry and the complexity of the products require a certain level of sophistication and results in insiders being on the panels," Nichols explains. "You could hardly have three guys from Joe's Bar & Grill sitting in judgment."
Nichols adds: "The best advice for investors is to avoid litigation and arbitration by knowing what they are getting into. I would think investors could always vote with their feet and just not do business with firms requiring arbitration."
The SEC will soon call for public comment. In the meantime, investors are advised to follow Nichols' advice: If you don't want to take a chance on being gored, avoid signing up with firms that insist on mandatory arbitration agreements. .