Binding arbitration has become a more common method of resolving disputes in the financial services industry, with providers often requiring it in the contract consumers must sign when an account is opened.
Critics say arbitration stacks the deck against customers, and since it’s almost impossible to open an account without agreeing to this process, investors are wise to take steps to make disputes less likely.
Financial services firms like brokerages generally use arbitration through the Financial Industry Regulatory Authority, the industry’s regulatory body, while consumer firms like credit card issuers typically rely on the American Arbitration Association.
“It’s very common to see arbitration agreements in both consumer and commercial financial transactions,” says Kenneth C. Johnston, director at the Kane Russell Coleman Logan law firm in Dallas. “While arbitration has been around for a long time, we definitely see it more these days.”
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Arbitration advocates describe this as a win-win alternative to lawsuits.
“Arbitration has generally been a good thing for both the investing public and the companies that serve them,” says William Stack, of Stack Financial Services in Steelville, Missouri. “The process often provides a faster resolution to client concerns by avoiding lengthy and expensive court proceedings.”
But others say the process is tilted in favor of the corporation over the aggrieved customer. Because the process is often opaque, it’s hard to evaluate.
“In matters of consumer contracts — credit cards, cell phones, cable television subscriptions, etc. — my opinion is that the consumer is at a material disadvantage. In more sophisticated transactions, arbitration can actually be very helpful to all parties,” says Gary Smith, partner in the Smith Paknejad law firm in Phoenix.
“The customer agreements of most financial services firms still contain pre-dispute arbitration agreements, or PDAAs, which are generally presented to clients on a take-it-or-leave-it basis,” says A. Ross Pearlson, co-chairman of the litigation group at Chiesa Shahinian & Giantomasi law firm in West Orange, New Jersey.
Many customers don’t focus on the implications of this requirement when they are opening an account and “will not be aware that they can be waiving their ability to recover punitive or consequential damages, or limiting their right to know the basis for the award or to appeal,” he says, noting that arbitrators, unlike judges, do not explain their reasoning.
“The imbalance in negotiating leverage and knowledge definitely affords the financial services firm the opportunity to stack the deck in its favor in drafting and presenting the PDAA,” Pearlson says.
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Federal regulators, such as the Consumer Financial Protection Bureau and Securities and Exchange Commission, have not acted to “redress this imbalance,” he adds.
“Although I have no empirical data, it is my general impression that arbitration results in a greater number of awards to customers that are smaller in size,” Pearlson says. “Financial services firms prefer arbitration because it limits their costs and exposure and resolves the dispute quickly and confidentially through individuals with industry knowledge and expertise.”
Johnston notes it is “increasingly common” for arbitration clauses to include a waiver of the customer’s right to file or join a class-action suit, which has long been the recourse for customers fighting over amounts too small to justify an expensive suit on their own.
“For example, Wells Fargo (ticker: WFC) asserted class-action waivers in the numerous class-action suits against it in the alleged creation of false consumer accounts,” Johnston says.
He adds, though, that arbitration often is fair to the customer.
The CFPB has proposed a rule banning class-action waivers, but it is unclear that this rule will be enacted by the new administration in Washington, he says.
Experts say the customer who does not want to agree to such terms has little option but to do business elsewhere, though it may be difficult to find a provider that does not requite arbitration.
Critics have long felt consumers should have the right to opt out of arbitration, and that the pool of arbitrators, many of whom are middle-aged white males, should be more diverse. And, they say arbitrators have too much incentive to curry favor with corporate defendants, which are more likely than consumers to hire arbitrators in the future.
But as a practical matter, consumers have little alternative but to live with the system.
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The best recourse is to minimize the risk of conflict by controlling your accounts yourself. The less authority you give the service provider, the less chance the firm will do something harmful. So avoiding arbitration involves some common-sense steps that make sense for many investors anyway:
— To avoid ugly surprises, refrain from giving your provider authority to trade on your behalf or make any other key decisions without your advance approval.
— Choosing your own investments will reduce the chances of being steered into something unsuitable. While individual stocks and bonds, and actively managed funds, can fall short of expectations, indexed products will provide market-matching performance.
— Know what fees you’ll be charged.
— If you do require advice, bone up on the subject so you can ask smart questions. Be sure to be clear about your goals and willingness to take risks, and ask for data and reasoning behind any suggestion you receive.
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Why Your Financial Service Agreement Includes Arbitration originally appeared on usnews.com
