In Disputes With Wall Street, Investors Face 'Rough Justice'

Jan. 27, 2010— -- As a veteran securities lawyer representing individual investors who say they were wronged by brokerage firms, Howard Rosenfield has seen his share of horror stories over the past 25 years.

There was the case a few years ago involving a disabled man whose broker placed half his entire inheritance in a single technology stock. The stock, JDS Uniphase, tanked monumentally, wiping his client out.

When it came time to seek some legal recourse, the client had one option: mandatory industry arbitration. A three-person panel of arbitrators who were paid by the industry to hear the case ultimately found that the broker in question did nothing wrong. Rosenfield's client was awarded nothing.

"It's Wall Street's system," Rosenfield added. "And it can be rough justice."

Complaints against brokers, which are on the rise again in the wake of financial turmoil, are not heard in civil court; instead, they are handled exclusively through the dispute resolution arm of the Financial Industry Regulatory Authority (FINRA), the brokerage industry's self-regulatory organization created in 2007.

FINRA's forerunner, the National Association of Securities Dealers (NASD), was set up more than seven decades ago specifically by the broker-dealer industry to police itself, and settle disputes. Mandatory arbitration has been the norm since 1987, when a Supreme Court ruling upheld the securities industry's position that customer agreements were sufficient means to prevent any cases from ever going to court.

According to securities lawyers who have handled hundreds of such cases, investors often overlook the fact that when they formally establish a brokerage account -- which requires signing the customer agreement -- they voluntarily stipulate to settle all disputes via an industry-run arbitration process.

But this may soon change.

Among the myriad of financial industry reforms currently being debated on Capitol Hill are some specific proposals, coming from the House, Senate and the Obama administration, which would prohibit or restrict mandatory arbitration, giving investors, finally, at least the option to take their brokers to court.

Rosenfield, who once sued FINRA, has been outspoken in calling for the need to reform the way Wall Street metes out justice. In the end, he stressed, the issue boils down to choice.

"It's time to end mandatory arbitration," the Farmington, Conn.-based lawyer said. "Give investors the right to decide if they want to go to a regular court, or to arbitration."

Jonathan Kord Lageman, another veteran New York securities lawyer, was more blunt: "FINRA arbitration is a sham."

Last year, FINRA logged 7,137 cases, up 43 percent from 2008. Three-fourths of the cases involved complaints made by individual investors; the rest of the cases were "intra-industry" disputes, such as a brokerage employee alleging unfair treatment by his employer.

The bulk of investor cases (or around three-fourths of them) are settled before ever going to a formal arbitration proceeding. Lageman and Rosenfield both stressed that most cases are settled primarily because securities lawyers know to avoid formal FINRA arbitration if at all possible.

Historically, going back decades, the securities industry used to prevail in roughly 60 percent of cases, according to the industry's own past studies. But in more recent years, that percentage has fallen. Of the 304 investor cases last year that went to arbitration, a slight majority, 55 percent, concluded with a decision favoring the industry. The industry win rate has come down from 58 percent in 2008, and 63 percent in 2007.