Why You Should Hire a Lawyer for FINRA Arbitration

When investors hire the services of a financial advisor, they agree to litigate any disputes they may have with their broker via binding arbitration through an organization called the Financial Industry Regulatory Authority (FINRA). FINRA then provides arbitrators. These arbitrators are neutral, and they serve as a judge and jury to make an unbiased evaluation of a client’s allegations. Based on a study from Harvard Business School, however, there is plenty of reason to believe that these arbitrators are not as neutral as they are supposed to be, leaving uninformed clients at a distinct disadvantage. This makes sense, since according to FINRA’s own statistics, less than half of all investors who enter into arbitration end up receiving monetary awards.

Both parties get a say in who serves on the arbitration panel, but the Harvard study found that industry-friendly arbitrators are 40% more likely to get selected. When damages are awarded, the arbitrator decides exactly how much the claimant will receive. According to the study, arbitrators account for 60% of the variation in arbitration awards. When a client sought $175,000 in damages — the median amount — an industry-friendly arbitrator would award investors about $21,000 less than an arbitrator who favors clients. What’s more, the parties agree beforehand that the arbitration panel’s decision is final and binding; i.e., exceedingly difficult to have overturned in court.

Proponents of arbitration argue that it’s quicker, cheaper, and more informal (and therefore arguably easier) than a traditional court case. But if an arbitration case doesn’t result in a fair outcome, can we really argue that it’s more convenient?

These hearings regularly decide the fate of investors seeking six figures in damages. That’s simply too much money to leave up to pro-industry arbitration. Investors with an experienced securities attorney have a better chance at winning damages from firms who may have mishandled their investments.

How Do Parties Select Arbitrators?

FINRA provides a “Neutral List Selection System” (NLSS) for the parties to an arbitration. This algorithm comes up with a list of 10 to 15 potential arbitrators. Cases have either one or three arbitrators, depending on the size of the claim.

Each party receives a profile on each potential arbitrator. That profile includes a resume, along with a list of potential conflicts of interest. If a party spots something in an arbitrator’s record, like a financial interest in the outcome of the dispute, they can challenge their ability to arbitrate. Other “challenges for cause” include a previous business or personal relationship with any of the parties. Parties get to strike arbitrators from the list, and then rank the remaining arbitrators according to their preference. The arbitrators with the best scores from both parties are appointed to the arbitration panel.

It’s worth nothing that not all cases make it all the way to an arbitration panel — 84% of cases are resolved by some other means, and in 2019, 57% of customer disputes settled via a direct settlement, without any arbitration. Settlements occur when both parties voluntarily agree to resolve a case for a fixed sum of money. In most instances, the parties decide that settling is the cheaper and faster means of disposing of the dispute.

The Problem with Arbitrator Selection

Despite the “randomized” list of supposedly neutral arbitrators, the Harvard paper found that arbitrators with financial advisory experience have better chances of selection. Furthermore, firms enter into arbitration far more often than the average investor. With only so many arbitrators to choose from, firms are more likely have some familiarity with the potential arbitrators and their past decisions on arbitration panels.

Unfortunately, the inherent issues with the selection process eventually influence the outcome of cases. FINRA’s statistics consistently find that investors lose cases far more often than they prevail. In 2019, customers were awarded damages in only 45% of arbitrations. That number was even lower in 2018, when investors were only awarded damages 40% of the time.

Can FINRA Address Unfairness?

Investors have the option to present their own cases. But just like in a criminal court case, investors who choose to represent themselves are less likely to see the dispute settled how they want. Because the FINRA arbitration panel’s goal is to remain neutral, they can only provide procedural information — they can’t help out investors by offering legal advice. And if an investor decides to enter into an arbitration hearing without a lawyer, they should keep in mind that the brokerage firm will probably have hired an experienced attorney.

Informed clients, according to the Harvard paper, receive on average 6% more in damage awards. Unfortunately, most claimants don’t have all the information they need to increase the odds that FINRA arbitration hearings will work in their favor. For now, investors should rely on experienced securities attorneys to level the playing field with the firm.