Post Midterm Elections Effect On Consumer Arbitration

The Elections are over: What it means for Consumer Arbitration
Five things to look for in 2015
By George H. Friedman*

 

Back when I was Director of Arbitration at FINRA, we used to have a “Crystal Ball Contest” where the staff would weigh in on predictions for the coming year. I usually did pretty well. Maybe that’s because I belong to the World Future Society[1] and have a blog there, and love thinking and writing[2] about the future. Or maybe it’s because people can disagree with you, but they cannot state categorically that you are wrong, unless they claim to be time travelers. My colleagues at Arbitration Resolution Services call me “The Oracle of Teaneck.” For example, my followers may recall that about a year ago, I said “I have no doubt the Republicans will retake the Senate and add to their majority in the House in the mid-terms next year.” So, pay attention. Here are my views on what the election results mean for consumer arbitration:

 

  • The Arbitration Fairness Act is DOA; so is the Investor Choice Act
  • The Consumer Financial Protection Bureau will ban mandatory arbitration in many types of consumer financial contracts
  • The SEC will finally act on mandatory investor-broker arbitration; so will FINRA
  • SCOTUS will rebuke the National Labor Relations Board on its anti-arbitration policy
  • Web-based ADR will become much more prevalent

 

  1. The Arbitration Fairness Act is DOA; so is the Investor Choice Act

 

In 1925, what’s now called the Federal Arbitration Act (“FAA”) was enacted. It made mandatory predispute arbitration agreements (“PDAAs”) enforceable as a matter of federal law, and the Supreme Court in recent years has steadfastly supported the FAA. Legislation called the Arbitration Fairness Act (“AFA”)[3] has been introduced in both houses of Congress that would amend the FAA to ban PDAAs outright in consumer contracts. While Senator Franken held hearings on the Senate bill, nothing else of consequence has happened.

 

Prediction: The AFA bills will die when this Congress fades to black the end of this year. And there is zero chance they will be enacted in the next Congress. The same fate is in store for the Investor Choice Act (H.R. 2998) introduced earlier this year by Rep. Keith Ellison (D-MN). This legislation, would end the use of mandatory pre-dispute agreements by broker-dealers and investment advisers, and would guarantee class action participation.

 

Why these predictions? Several attempts were made over the years to amend the FAA to limit or ban use of mandatory arbitration in consumer contracts. These failed when the Republicans controlled the White House and Congress, and have met a similar fate under Democratic control of these institutions as well. For example, in 2009 the Democrats regained the White House and control of both houses of Congress. The capital markets tanked, there were the Madoff and other scandals, and the economy crashed. But the Arbitration Fairness Act didn’t make it out of the House Financial Services Committee, which at the time was chaired by Barney Frank, an avowed critic of PDAAs in consumer contracts. If it didn’t happen then, it’s not going to happen next year with a Republican controlled Congress. You can book that one.

 

  1. The Consumer Financial Protection Bureau will ban mandatory arbitration in many types of consumer financial contracts

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act addressed fundamental consumer protection issues involving securities, banking, and indeed the US economy. The Act, known as Dodd-Frank, contains language governing the use of predispute arbitration agreements in consumer financial and investor contracts.[4] Dodd-Frank created the Consumer Financial Protection Bureau (“CFPB”) and charged the new federal agency with studying the use of PDAAs in consumer financial transactions and addressing PDAAs “if the Bureau finds that such a prohibition or imposition of conditions or limitations is in the public interest and for the protection of consumers…” Note that the CFPB’s choices are not binary, “yes-or-no” decisions; it can ban PDAAs outright or limit their use or impose conditions for their use. For example, the CFPB could promulgate a rule that limited PDAA use to a class of transactions (limitation on use) or required that consumers separately initial or click a PDAA (condition for use).

 

The uproar earlier this year over General Mills’ decision to adopt and later retract a new policy by which consumers, by engaging in activities such as downloading a recipe, or participating in a contest, or “liking” the firm on Facebook, would unwittingly be agreeing to arbitrate, certainly refocused the spotlight on the prevalent use of mandatory, predispute arbitration in consumer transactions. Indeed arbitration clauses abound in the consumer context, showing up in a vast array of contracts for consumer goods and services. Applied for a credit card? You’ve likely agreed to arbitrate disputes with your bank. Got a new cell phone? Payday loan? Rented a car? Opened a checking or stock brokerage account? Arbitration is likely right there in your contract.

 

Prediction: CFPB has been busy this year, holding field hearings, issuing reports, and conducting surveys. It will very shortly be issuing the report to Congress required by Dodd-Frank. Based on what I have seen, there’s no doubt in my mind that the Bureau will promulgate regulations banning use of PDAAs in a range of consumer contracts, specifically credit cards, bank accounts, car loans and payday loans. At a minimum, CFPB will impose conditions on PDAA use. For example, I’ve proposed recently that CFPB write rules that impose conditions on the use of PDAAs in contracts for consumer financial products and services – but not ban PDAAs outright. Specifically, the rules should:

 

  • Give the individual a choice of agreeing to arbitrate, but at the time of contracting. My plan would state that no individual would be denied goods or services or employment if he or she declined the arbitration option. This would provide the consumer/employee a choice of whether to accept arbitration, but move it up to the time when the contract is signed to avoid the practical realities of getting a bi-lateral post-dispute agreement to arbitrate. This requirement would give the dominant party a reason to offer incentives to the weaker party to agree to arbitrate, and – dare I say it – sell the process. By following this approach, there would be meaningful choice, but in a practical way.

 

  • Ensure that there is a knowing and voluntary agreement to arbitrate by requiring that the consenting individual separately initial/click the arbitration agreement. The Friedman plan would deal with the problem of ensuring a truly “knowing and voluntary” agreement to arbitrate by requiring that the arbitration agreement be separately acknowledged. By so doing, we would eliminate any uncertainty that the weaker party didn’t know what they were getting into.

 

  • Ensure procedural fairness safeguards. We should also require that any consumer or employee arbitration system adhere to basic tenets of procedural fairness. These are not hard to find; the challenge if anything will be narrowing down the list.

 

While CFPB funding may be an issue in a Republican Congress (the agency is widely perceived to be anti-business), I don’t think Congressional animus will include the CFPB’s arbitration activities.

 

  1. The SEC will finally act on mandatory investor-broker arbitration; so will FINRA

 

Dodd-Frank takes a different approach to PDAAs used in securities customer-broker contracts. Although the operative language in Dodd-Frank provides similar guidance and direction to both the CFPB and SEC about what the agencies are to do about mandatory or forced use of PDAAs, there is a key difference: Dodd-Frank section 921 does not require the SEC to do anything about PDAAs in customer-broker contracts. Given the more than 90 mandatory study and rulemaking requirements the SEC has under Dodd-Frank, it is not at all surprising that arbitration is not high on the agency’s priorities list.

 

Prediction: In my view, it is politically untenable for the SEC to do absolutely nothing about PDAAs, especially in light of the pressure that’s been brought to bear on this issue by some in Congress, NASAA (the association of state and Canadian securities administrators), PIABA (the bar association for lawyers who represent customers in securities arbitrations), and others (for example the AFL-CIO). My view is that, at a minimum, the SEC will study the subject (it has since 2010 been accepting comments on the topic), and eventually require some changes (impose limits or conditions). It will not, in my opinion, ban PDAAs outright. Think about it. To ban PDAAs in customer-broker contracts, the SEC would have to find that doing so is “in the public interest and for the protection of investors.” Essentially, the SEC would be saying: “We’ve been supervising customer-broker arbitration for decades. But, you know, we just realized it’s a terribly unfair system.” On the other hand, a finding that says, “We’ve studied customer-broker arbitration and we’ve concluded that it’s a fair process. But, you know, these few changes will make it even better” is politically tenable. What might such changes be?

 

  • Give the investor a choice of agreeing to arbitrate, but at the time of contracting.

 

  • Ensure that there is a knowing and voluntary agreement to arbitrate by requiring that the consenting investor separately initial/click the arbitration agreement.

 

  • Ensure procedural fairness safeguards.

 

Sound familiar?

Et tu, FINRA?

During the summer, FINRA formed a Dispute Resolution Task Force to “suggest strategies to enhance the transparency, impartiality, and efficiency of FINRA’s securities dispute resolution forum.” The Task Force’s area on the FINRA Website already reports news of the group’s first in-person meeting, held October 10th. The Task Force “agreed that it would be open to examine any issues that may affect the face of arbitration and mediation in the next 20 years and that no issue was off the table for discussion.” It also identified the initial topics it will examine, and created subcommittees to “gather information and viewpoints” on the topics and to report back to the full Task Force. The Task Force is soliciting written comments and may, based on the written submissions, conduct interviews with organizations and individuals. The update also advises that the Task Force plans to wrap up its work next fall.

 

Prediction: I believe the group will finally tackle the remaining major criticism of FINRA’s arbitration: the mandatory use of PDAAs in investor-broker contracts. In fact, I predict they will adopt he plan I’ve already articulated twice in this blog post.

 

  1. SCOTUS will rebuke the National Labor Relations Board on its anti-arbitration policy

 

OK, this one involves employment arbitration and not consumer, but it’s close enough. What’s happening here? The Supreme Court has upheld class action waivers in consumer arbitrations, and at least one federal circuit – the Fifth – has ruled the same way as to the employment context. Specifically, the Fifth Circuit reversed the Board’s policy in D.R. Horton, Inc. v. NLRB, No. 12-60031 (5th Cir. Dec. 3, 2013). “[W]e disagree and conclude that the Board’s decision did not give proper weight to the Federal Arbitration Act….The NLRA [National Labor Relations Act] should not be understood to contain a congressional command overriding application of the FAA. The burden is with the party opposing arbitration, Gilmer, 500 U.S. at 26, and here the Board has not shown that the NLRA’s language, legislative history, or purpose support finding the necessary congressional command. Because the Board’s interpretation does not fall within the FAA’s ‘saving clause,’ and because the NLRA does not contain a congressional command exempting the statute from application of the FAA, the Mutual Arbitration Agreement must be enforced according to its terms.”

 

Strong stuff, but despite the fact that a federal circuit court, relying heavily on several Supreme Court holdings, has expressly overruled the NLRB’s take on class action waivers, some of the Board’s administrative law judges have apparently not gotten the message, issuing several rulings ignoring Horton.

 

Prediction: There’s not much I remember from civics class or law school, but I do remember this: Congress passes laws, the president signs laws, the courts interpret laws, and, federal administrative agencies carry out and apply federal laws. It is my view that the NLRB is having a bit of an identity crisis, and that sooner or later, the Supreme Court will – in “read our lips” fashion – deliver the message that class action waivers in PDAAs are enforceable under the FAA … and the NLRA. Specifically, sooner or later, the Supreme Court is going to hit the NLRB with a 2 x 4 over its rulings on class action waivers in arbitration clauses in employment agreements. Now, I’m not predicting violence toward a federal agency; the Supremes’ actions will be entirely legal.

 

  1. Web-based ADR will become much more prevalent

 

There’s a great scene in the classic 1967 movie The Graduate where a family friend of new college graduate Ben Braddock (played by Dustin Hoffman) gives some sage advice about the future to young Ben. With great fanfare, he leads up to a one word prediction: “Plastics!

 

Prediction: Here’s my one-word prediction on technology and ADR: “C-ODR” which stands for complete – online dispute resolution services.  This is a term developed by Arbitration Resolution Services, Inc., whose Board I chair. On what basis do I make this prediction? The dramatic and rapid advances in technology will make this choice an easy one for consumers, much like Amazon and other web-based entities have challenged brick-and-mortar shopping as the preferred method of commerce.[5] Put differently, why drag yourself to a hearing and wait around for snail-mail when you can accomplish the same things via the cloud in a fraction of the time and cost?[6] At a minimum, I see this as a breakthrough year for web-based ADR. Case administration, from filing to conclusion – including hearings – will be done online, and paper will become passé. It doesn’t take a Nostradamus to see that improving technology will drive this change.

 

In fact, I see changes happening even before arbitrations are filed. That’s right, before. Insurance companies, securities firms, credit-based companies, and just about any firm that processes claims online will start to build web-based ADR into their claims handling processes. For example, if a customer’s claim is denied in whole or in part, I can see the company offering cloud-based ADR on a voluntary basis as the next online step. Oh, wait, that one has already happened! ARS did that earlier this fall.

 

Conclusion

 

If nothing else, the arbitration world is constantly changing. No doubt there are some things that will happen this year that I just don’t see coming right now. And of course, some of my predictions may not come to pass, at least not yet. We can compare notes in a year. In the meantime, see you in the future!

 

 

 

————————

*George H. Friedman, an ADR consultant, retired in 2013 as FINRA’s Executive Vice President and Director of Arbitration, a position he held from 1998. In his extensive career, he previously held a variety of positions of responsibility at the American Arbitration Association, most recently as Senior Vice President from 1994 to 1998. He is an Adjunct Professor of Law at Fordham Law School. Mr. Friedman is Chairman of the Board of Directors of Arbitration Resolution Services, Inc. and serves on the Board of Editors of the Securities Arbitration Commentator. Friedman holds a B.A. from Queens College, a J.D. from Rutgers Law School, and is a Certified Regulatory and Compliance Professional (Wharton-FINRA Institute).

 

[1] I am also an environmentalist. Thus, I have recycled some material from my past blog posts and articles.

[2] See Friedman, George, Technology, Alternative Dispute Resolution, and the Insurance Industry: the Future Has Arrived (Really this Time), 2014:1 Journal of American Law 22 (Fall 2014), available at http://journaloflaw.epubxp.com/i/397972/22 <visited Nov. 17, 2014>.

[3] See Friedman, George, The Arbitration Fairness Act: a Well-intentioned but Potentially Dangerous Overreaction to a Legitimate Concern, 2013:1 Securities Arbitration Commentator 1 (June 2013), available at http://www.proffriedman.com/files/SAC_AFA_Article__final_06-2013_.pdf <visited Nov. 17, 2014>.

[4] For an in-depth analysis on what CFPB can and should do, see Friedman, George, What’s a Regulator to do? Mandatory Consumer Arbitration, Dodd-Frank, and the Consumer Financial Protection Bureau, 20:4 ABA Dispute Resolution Magazine 4 (Summer 2014), available at http://www.americanbar.org/publications/dispute_resolution_magazine/2014/summer/what-s-a-regulator-to-do–mandatory-consumer-arbitration–dodd-f.html <visited Nov. 17, 2014>.

[5] See Retailers, Are You Ready? Cyber Monday Overtakes Black Friday (Nov. 30, 2012), available at http://blogs.teradata.com/teradata-applications/retailers-are-you-ready-cyber-monday-overtakes-black-friday/ <visited 4/4/2014>. Also Cheng, Andria, UPS, FedEx Forecasts Suggest Black Friday Weekend will Again be Key for Retailers, Marketwatch.com (Nov. 17, 2014), available at http://blogs.marketwatch.com/behindthestorefront/2013/10/25/ups-fedex-forecasts-suggest-black-friday-weekend-will-again-be-key-for-retailers/ < visited 4/4/2014>, and Cyber Monday to be Busiest Day Ever for FedEx, CNN Money (Oct. 24, 2013), available at http://money.cnn.com/2013/10/23/pf/fedex-cyber-monday/ <visited Nov. 17, 2014>.

[6] See Friedman, George, “Road Trips” in Consumer Arbitration: there Must be a Better Way (Sep. 15, 2013) available at https://www.arbresolutions.com/road-trips-consumer-arbitration-must-better-way/#.VGo-x_ldX84 <visited 4/4/2014>.

 




Maybe, Like A-Rod, the NLRB Reads This Blog

Late last month in this blog, I wrote that the National Labor Relations Board (“NLRB”) was “cruisin’ for a bruisin’” on its arbitration policy. To review, and borrowing heavily from my own work, the NLRB had ruled previously in the D.R. Horton matter that a predispute arbitration agreement (“PDAA”) containing a class action waiver violated the National Labor Relations Act (“NLRA”) and was not enforceable because, among other things, the class action waiver unduly interfered with employees’ right to unionize. This case eventually found its way to the Fifth Circuit, which reversed this part of the Board’s ruling, in D.R. Horton, Inc. v. NLRB, No. 12-60031 (5th Cir., Dec. 3, 2013). “[W]e disagree and conclude that the Board’s decision did not give proper weight to the Federal Arbitration Act….The NLRA should not be understood to contain a congressional command overriding application of the FAA. The burden is with the party opposing arbitration, Gilmer, 500 U.S. at 26, and here the Board has not shown that the NLRA’s language, legislative history, or purpose support finding the necessary congressional command. Because the Board’s interpretation does not fall within the FAA’s ‘saving clause,’ and because the NLRA does not contain a congressional command exempting the statute from application of the FAA, the Mutual Arbitration Agreement must be enforced according to its terms.”

Fifth Circuit Holding Not Followed

But, despite the fact that a federal circuit court, relying heavily on several Supreme Court holdings, had expressly overruled the NLRB’s take on class action waivers, some of the Board’s administrative law judges had apparently not gotten the message. In Leslie’s Poolmart, Inc. and Keith Cunningham, No. 21–CA–102332 (SF Office, Jan. 17, 2014), an ALJ invalidated a PDAA that did not contain a class action waiver. The judge ruled in Poolmart that, by including a PDAA, the employer “violated Section 8(a)(1) of the [National Labor Relations] Act by maintaining and enforcing a mandatory and binding arbitration agreement which required employees to resolve certain employment-related disputes exclusively through individual arbitration and, though not expressly, but in practice, required them to relinquish any right they have to resolve such disputes through collective or class action.” What about the Fifth Circuit’s ruling in Horton? It doesn’t count until the Supreme Court says it does. “I find that the Supreme Court has not expressly overruled [the NLRB’s prior ruling in] D. R. Horton. Although the Court has upheld the enforcement of individual arbitration agreement in employment related matters, see, e.g., Concepcion, supra, and American Express Co. v. Italian Colors Restaurant … the Court has not addressed or resolved the issue of exclusive arbitration over class and/or collective actions. As such, D. R. Horton is the controlling law applicable in this case. Even in the face of other Federal circuit decisions to the contrary, D. R. Horton represents current Board precedent that I must follow.” As I wrote last month, wow!

Petition for Rehearing

Perhaps the full NLRB has rethought its strategy. Late last week it petitioned the Fifth Circuit for a rehearing en banc on Horton, arguing in its petition that the Court got it wrong when it relied on the U.S. Supreme Court’s holdings in Gilmer and Concepcion to uphold the PDAA. See D.R. Horton Inc. v. NLRB, (5th Cir., No. 12-60031, petition for rehearing 3/13/14). Said the NLRB, “Rehearing is warranted on this exceptionally important issue because the panel majority erred in finding Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20 (1991), and AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011), determinative of this case. Neither decision addressed nor decided the distinct NLRA issue presented here.” For those needing a fresher on appellate procedure, what the NLRB is essentially doing here is saying to the Fifth Circuit, “Did you really mean that? And if you did, can we have the entire Court, instead of a divided three-judge panel, decide the issue?” Courts usually decide issue en banc when there is a very important issue involved. And indeed, the NLRB in its petition calls this “exceptionally important issue.”

A Good Approach

I think the NLRB is taking the right approach in trying to get the issue before the full Court. If some NLRB administrative law judges are not going to follow Horton, they might as well know how strongly the Fifth Circuit feels about it.




NY Trial Court To Parties (and Arbitrators): Settled Means Settled

NY Trial Court to Parties (and Arbitrators): Settled Means Settled

I don’t often write about lower court decisions, but it’s not every day a court vacates a nearly $11 million arbitration award, and throws in some strong words to boot.  The case, Citigroup Global Markets, Inc. v. Fiorilla, No. 653017/2013 (Sup. Ct., N.Y. Cty., Jan. 9, 2014), arose out of a FINRA arbitration involving the same parties, case no. 10-03616.[1] On its face, the FINRA award is pretty straight-forward:  the arbitration panel unanimously awarded over $10 million to be paid by Citigroup to Fiorilla, after holding many hearings from October 2012 to July 2013 (the individual broker was ordered to pay $250,000 to the claimant).

The story becomes more complicated when Citigroup and the individual broker sought to challenge the award in state court on the grounds of manifest disregard of law, and bias because two of the arbitrators failed to make required disclosures.  It turns out the parties appeared to have settled their dispute before the arbitration was commenced.  This the court seizes on without addressing the arbitrator disclosure issue.

“In light of the fact that this matter was in fact settled and that all parties so advised the panel and FINRA in writing …there is no need to delve into the troubling allegations of misconduct by the arbitrators.  This award must be vacated.”  Although the FINRA award does not reference the settlement issue as one raised before the arbitrators, the court thinks it was and has some harsh words for the participants.  First, he counsels the panel, stating “Had the panel abided by the FINRA Rules, as FINRA did, and acknowledged that this matter had been settled, the parties could have avoided needless litigation.”  Then he addresses the respondents, stating  “The respondents’ refusal to abide by the settlement…has resulted in a frivolous waste of counsel’s time and efforts, as well as a waste of the scarce resources available to New York’s Unified Court System.”

My take.  Although it’s not clear whether the court applied the Federal Arbitration Act or New York’s Civil Practice Law and Rules, Art 75, I’m not sure it was correctly decided either way.  Deciding whether there has been a settlement in my view a factual determination to be made by the arbitrators and, as per U.S. Supreme Court holdings, is to be given great deference by the courts. Also, readers should bear in mind the court system structure in New York State.  The Supreme Court is a trial court.  There are two more levels of appeal beyond that (the Appellate Division and the Court of Appeals).  Given the stakes, it would be surprising if an appeal is not taken here.


[1] Both the court decision and the underlying arbitration award are available at http://finraawardsonline.finra.org/ (search by the FINRA case number).




The Future of Arbitration

Back in 1997, George Friedman, a member of the ARS Board of Directors, predicted and planned for the economic collapse of 2008, alternative energy needs, hybrid and electric cars, and now the future of arbitration.  Check out his predictions that were applauded at the 2013 Securities Experts Roundtable in Boston.

[slideshare id=24876769&doc=georgepptforsermeeting6-27-130802124737-phpapp02]




Mark Norych Submits Comments to SEC Regarding JOBS Act of 2012

The 2012 Jumpstart Our Business Startups Act (“JOBS Act”) is aimed at making it easier for small businesses to raise funds. The JOBS Act requires the SEC to perform studies and write rules to implement the law. Toward that end, the SEC solicited comments on Title III of the act, which concerns crowdfunding (a broad term used to describe a wide pool of small investors with few restrictions, usually networked by means such as the internet).  

On July 19th, Arbitration Resolution Services, Inc. (“ARS”) Executive Vice President and General Counsel Mark Norych submitted a comment letter urging the SEC to consider cloud-based arbitration as a way to resolve disputes between investors and crowdfunding portals. Norych points out that the nature of these disputes – which are expected to involve relatively modest amounts – makes them a perfect fit for streamlined online systems such as that used by ARS.

Click here to read the letter.




The Arbitration Fairness Act of 2013: A Well-intended but Potentially Dangerous Overreaction to a Legitimate Concern

Introduction

In early May, bills were introduced in the House and Senate, attempting to breathe new life into the concept of a federal Arbitration Fairness Act (“AFA”). The bills would amend the Federal Arbitration Act (“FAA”) by adding a new chapter invalidating predispute arbitration agreements (“PDAAs”) for consumer, investor, employment, or civil rights claims. The proposed legislation is similar to prior failed efforts to similarly amend the FAA going back at least to 2005.

This article analyzes the AFA of 2013 and concludes that, while a well- intended effort to address a legitimate concern – PDAAs imposed via an adhesion contract by dominant parties on weaker parties like consumers and employees – it in fact is a potentially dangerous overreaction that could end up harming those it intends to protect. The article closes with the author’s recommendation for a better way to address these concerns.

(The following article is written by George Friedman and is reprinted with permission of Securities Arbitration Commentator)

What the AFA Would Do and Why

The House version of the AFA was introduced on May 7 by Rep. Hank Johnson (D. Ga.). His press release announcing the AFA’s reintroduction provides the following purposes:

  • FAA by clarifying the scope of its application.
  • Amends the FAA by adding a new chapter invalidating agreements that require the arbitration of employment, consumer, or civil rights disputes made before the dispute arises (“PDAAs”).
  • Restores the rights of workers and consumers to seek justice in our courts.
  • Ensures transparency in civil litigation.
  • Protects the integrity of the Civil Rights Act, the Equal Pay Act, the Americans with Disabilities Act, and the Age Discrimination in Employment Act, among others.

The Proposed AFA Deconstructed

These are all noble intentions. But a closer look at the proposed statute reveals that not all the assumptions and entirely accurate. Indeed, most of the can be challenged or refuted:

1. The Federal Arbitration Act (now enacted as chapter 1 of title 9 of the United States Code) was intended to apply to disputes between commercial entities of generally similar sophistication and bargaining power.

Reality:  The Congressional Record from the FAA’s enactment in 1925 is not entirely clear on this point. Moreover, the FAA was enacted almost 90 years ago and for decades has been construed liberally by the Supreme Court to apply to a vast array of disputes, including consumer, securities and employment.

2. A series of decisions by the Supreme Court of the United States have interpreted the Act so that it now extends to consumer disputes and employment disputes, contrary to the intent of Congress.

Reality:  The broad statement is of course true – the Court has been liberally construing the reach of the FAA, but this has been going on for at least 30 years. And again, it is not entirely accurate to say that this has been against the will of Congress. After all, Congress at any time could have enacted legislation scaling back the reach of the FAA, and it didn’t. In fact, one can logically argue that the lack of legislation indicates, if anything, that Congress is evidently OK with the Supreme Court’s actions.

3. Most consumers and employees have little or no meaningful choice whether to submit their claims to arbitration. Often, consumers and employees are not even aware that they have given up their rights.

Reality:  The first part of this statement is true and, as proposed below, there is a better alternative than banning PDAAs outright and hoping that the parties will agree to arbitration after a dispute arises. After a dispute arises, one party or the other usually has a strategic or tactical interest in not agreeing to arbitrate. As discussed below, this would more often negatively impact the consumer or employee, even in the securities arbitration context.

The second part of the statement is not as accurate. Many employers and businesses make it very clear that the individual is agreeing to arbitrate. This is especially so in the securities industry: FINRA Rules 2263 and 2268 have very clear requirements about where the PDAA may be placed and what should be in it in both the employment and customer contexts, respectively. For example, among other protections for customers:

  • Contracts must contain a high-lighted statement immediately before the signature line indicating that there is an arbitration clause, and where in the document it may be found.
  • Investors must be given a copy of the PDAA.
  • The arbitration clause must inform the investor of key aspects of the arbitration, such as that they are giving up the right to go to court.
  • The PDAA cannot:  1) contradict the rules of an SRO; 2) limit the ability of a party to file an arbitration claim; 3) limit the ability of the arbitrators to make an award.

4. Mandatory arbitration undermines the development of public law because there is inadequate transparency and inadequate judicial review of arbitrators’ decisions.

Reality:  This statement overlooks some basic inconvenient truths. With apologies to former Vice President Gore, if the AFA were to be enacted, cases go? The American Arbitration Association had 2,031 employment last year and FINRA had 1,588 employment cases and 2,586 cases with customers as parties. As demonstrated below, if PDAAs are banned, more often than not, there will not be a post-dispute agreement to arbitrate. These cases will have to go somewhere to be resolved, and that somewhere is the court system. However, the courts are already overloaded, and, with criminal cases getting a priority, civil litigants will face long delays getting access to the courts. The delays will only worsen if thousands of formerly arbitrable cases are diverted into the court system in an age of diminishing resources and increasingly rare trials. Indeed, one new source of litigation might be the AFA itself, if enacted as written, since both Form U4 and FINRA Rule 12200 are arguably PDAAs, and could be challenged as such.

Also, to put it bluntly, litigation stinks and is no place to send consumers or employees. Cases take a long time, cost lots of money, and are subject to a long appeals process. Moreover, class actions, the subject of much angst of late, are not the weaker party’s best friend, with the typical payout being cents on the dollar or a discount coupon.

The second part of the finding (inadequate transparency) is also suspect. With the major ADR providers now subscribing to the due process protocols for consumer and employment dispute resolution, or having policies that mirror them, there is adequate transparency. And at FINRA, the process is very transparent.

  • FINRA is regulated by the SEC (rule approval process; inspections);
  • Rules are first approved by the National Arbitration and Mediation Committee, a majority of whom – including the chair – is not affiliated with the securities industry;
  • Rules are amended only after proposed rules are published in the Federal Register, the public is given a chance to comment, FINRA responds to the comments, and the SEC approves the rules as being consistent with investor protection;
  • Awards are public and available free of charge on FINRA’s Website, www.finra.org.

Moreover, the major ADR organizations now publish a wealth of statistical data on their consumer programs, either voluntarily or in compliance with state disclosure requirements.

The last part of the finding (inadequate judicial review) is also suspect, given that both the FAA and state arbitration statutes provide for what the Supreme Court says is adequate judicial review.

5. Arbitration can be an acceptable alternative when consent to the arbitration is truly voluntary, and consent occurs after the dispute arises.

Reality:  Really? Why is that? First, hoping and praying for all sides to agree to arbitrate after the dispute arises is a fool’s errand. Research shows consistently that one side or the other will generally have a reason not to agree to arbitration once a dispute arises. Also why is the process fair only if consent, presumably from the weaker party, comes after a dispute arises? I assert that the consumer arbitration programs as administered by the major ADR services such as the American Arbitration Association or FINRA are extremely fair by any objective measure, and in fact fairness, as discussed below.

But don’t take my word for it. FINRA’s arbitration program got high marks when measured against the “arbitration fairness index” created by Professor Tom Stipanowich, a leading authority in the arbitration field:

“FINRA has tried to make its operations more transparent and to promote greater public understanding of and access to arbitration. FINRA regulates the content and form of pre-dispute arbitration provisions in investor agreements, requiring highlighted language explaining to investors the implications of the arbitration agreement and ‘prohibiting agreements that would limit the claim in arbitration or that limits the power of arbitrators to make any award,’ including awards of punitive damages. It regulates fees to ensure that the securities industry bears the majority of administrative fees and waives hearing fees for investors FINRA assists investors in serving hearings at any of seventy-two cities nearest the investor’s residence. It provides expedited arbitration for senior or seriously ill parties [footnotes omitted].”

And Barbara Roper, Consumer Federation’s Director of Investor Protection, has spoken favorably about FINRA’s arbitration  system.

Why the AFA Would Be Harmful

The AFA if enacted would hurt the very individuals it was designed to protect: consumers, investors, and employees. First, as the author noted in an article appearing in this publication’s May 2013 issue, Customer in FINRA Arbitration: Time to Clear Things Up!,” (2012 SAC, No. 6), FINRA Rule 12200 – which requires brokers to arbitrate upon the demand of a customer disputes arising out of the broker’s business – would doubtless be attacked by the securities industry as unfair. The Securities and Financial Markets Association took this position when the AFA of 2007 was pending, stating: “Opponents of predispute arbitration agreements, however, seek neither fairness nor equality; rather, they seek an unfair strategic advantage. They want investors to retain their right This would lead to uncertainty and potentially years of litigation before the issue is resolved.

Second, if I am correct that arbitration case filings would dry up in an era of exclusively voluntary post-dispute, bi- lateral agreements to arbitrate, then arbitral institutions like FINRA and their fora in a time of greatly reduced Stated differently, when you break the glass and ring the fire alarm, you want to be sure there’s a fire brigade to respond.

Third, the proposed AFA as written would apply retroactively (it would invalidate existing agreements to arbitrate in millions of contracts), subjecting it to Constitutional challenge and uncertainty. For example, a legally tenable claim might be made that this aspect of the AFA runs afoul of the Fifth Amendment’s Takings Clause, which states in pertinent part: “No person shall … be deprived of life, liberty, or property, without due process of law.” There are property rights associated with contracts. Predispute arbitration agreements under the FAA are contracts, which stand on their own according to the Supreme Court. Thus, a statute such as the AFA that retroactively invalidated contracts such as PDAAs could be subject to challenge based on an impermissible governmental “taking,” absent a compelling governmental interest. While the Court in the past has allowed retroactive application of laws banning, for example, contracts containing racially restrictive covenants, I am not so sure banning PDAAs would be held in the same regard, even in the face of the AFA’s explicit language on retroactivity.

A Better Way?

During my long career as an executive, I usually approached naysayers with this retort: “OK, so what’s your plan?” Having demonstrated why the AFA is problematic, I do believe there are legitimate concerns Congress needs to address. For example, I believe it is unfair to require a consumer to agree to arbitration when a contract is signed as a condition of the dominant party providing goods or services. Ditto for employees. It’s not that the arbitration process is unfair, assuming basic standards of procedural fairness are maintained. It’s that perceptions of fairness require a choice for the weaker party.

Also, some of the arbitration systems imposed on consumers and employees – again not those of the established ADR providers – have aspects that are not fair. For example, requiring consumers to travel hundreds of miles for a hearing involving relatively small amounts of money is not fair. Allowing the dominant party to select a captive ADR provider isn’t fair. Burying the arbitration agreement in the midst of a dense contract is not fair. There are better approaches, which: 1) address perceptions that it is not fair for a dominant party to force a consumer or employee to agree to a PDAA as a condition of obtaining goods or services or employment; and 2) ensure procedural fairness:

The Friedman AFA

So, here’s my plan. At a very high level, I propose an AFA that provides:

  • in a consumer contract, any predispute arbitration agreement must be separately signed or clicked by the consumer;
  • a consumer cannot be denied goods or services if the consumer declines the arbitration option;
  • in an employment contract that is not individually negotiated, any predispute arbitration agreement must be separately signed by the employee;
  • a prospective or current employee cannot be denied employment if the employee declines the arbitration option; and,
  • clear procedural fairness guidelines be followed in any consumer or employment arbitration.

To avoid Constitutional challenges, the law should be prospective; it should apply to contracts entered into or revised after the effective date.

Ensure the individual has a choice of agreeing to arbitrate, but at the time of contracting.

My AFA would state that no individual would be denied goods or services or employment if he or she declined the arbitration option. This would provide the consumer/employee the choice the AFA proponents want, but move it up to the time when the contract is signed to avoid the practical realities of getting a bi-lateral post-dispute agreement to arbitrate. This requirement would give the dominant party a reason to offer incentives to the weaker party to agree to arbitrate, and – dare I say it – sell the process. Imagine a world where the dominant party says, in effect:

“We think arbitration is good for both of us. Here’s why … If you agree to arbitrate any disputes we have in the future, we’ll give you … If you agree to arbitrate now, you have a week to change your mind. And if you don’t want to agree to arbitrate, that’s OK.  We’ll still do business with you either way.”

By following this approach, the AFA would provide meaningful choice, but in a practical way.

Ensure that there is a knowing and voluntary agreement to arbitrate by requiring in the statute that the individual separately initial/click the arbitration agreement.

The Friedman version of the AFA would deal with the problem of ensuring a truly “knowing and voluntary” agreement to arbitrate by requiring that the arbitration agreement be separately signed, initialed or clicked by the consumer/ employee. The Supreme Court having held many times that the arbitration agreement is a separate contract, let’s treat it that way. By so doing, my AFA would eliminate any uncertainty that the weaker party didn’t know what they were getting into.

Ensure procedural fairness safeguards.

The new AFA would also require that any consumer or employee arbitration system adhere to basic tenets of procedural fairness. These are not hard be narrowing down the list.

The Friedman AFA would incorporate the best of:

The standards articulated by the Supreme Court in Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 30-31 (1991). There, the Court exhaustively laid out indicia of procedural fairness, among them: “… competent, conscientious, and impartial arbitrators;” limited discovery; written decisions; and the power to fashion equitable relief.

The Due Process Protocols for Consumer and Employment, as the case may be.  These standards were developed years ago to ensure procedural fairness and include requirements for independent administration, independent neutrals, reasonable cost, reasonable discovery, right to counsel, a reasonably convenient location for hearings, fair hearings (with the understanding that smaller claims can be accomplished or telephonic means or document review), the availability of the same relief as in court, and explained awards upon request.

The Arbitration Fairness Index:  As developed by Professor Stipanowich, the major elements are:  1) meaningful consent, clarity, and transparency; 2) independent and balanced administration; 3) quality and suitable arbitrators; 4) fair hearing; 5) fair outcomes (awards and remedies).  There are several more sub-elements under each heading that describe the standard in more detail:

Meaningful Consent, Clarity, and Transparency

  • Meaningful consent to arbitrate
  • Adequate notice and disclosure
  • Clear guidance for program users (“roadmap”) and access to helpline
  • Ease of court oversight
  • Published program statistics

Independent and Balanced Administration

  • Independent and impartial administration
  • Balanced input in rules and policies

Quality and Suitability of Arbitrators

  • Balanced input in roster of arbitrators
  • Diversity
  • Experience and training
  • Disclosure and challenge mechanism
  • Ethics standards and complain mechanism

Fair Hearing

  • Reasonable costs and fees
  • Legal counsel
  • Reasonable hearing location
  • Access to information and discovery
  • Limitations period
  • Fair hearing
  • Availability of class action

Fair Outcomes (Awards and Remedies)

  • Access to remedies available in court
  • Publication of reasoned awards
  • Outcomes

The arbitration rules of FINRA and AAA.  For example, FINRA’s rules are extremely investor-friendly.

  • FINRA serves the claim;
  • The fee structure favors the investor;
  • The hearing is cited where investor lived when underlying events occurred;
  • There are hearing locations in all 50 states (at least one in each);
  • A motion to dismiss rule that severely limits motions made prior to the claimant resting his/her case, and provides sanctions for frivolous motions;
  • Discovery Guidelines and codified discovery provisions in the April 2007 Code of Arbitration Procedure revisions;
  • A customer option of an all-public panel;
  • In close calls, if the investor wants an arbitrator removed for bias, he or she is removed; and,
  • Awards are public, and available free of charge on the Web.

The core procedural safeguards that were contained in the not-enacted Fair Arbitration Act of 2011 (S.1186).   For example, this bill required that, in order to be binding on the parties, a contract containing an arbitration clause had to:

(1) have a heading that reads printed in bold, capital letters;
(2) state explicitly whether participation in arbitration is man- datory or optional;
(3) identify a source where a regarding the arbitration program; and
(4) provide notice that all parties retain the right to resolve a dispute in a small claims court for a claim of $50,000 or less.

The PDAA also had to entitle each party under arbitration to:

(1) a competent, neutral arbitrator and independent, neutral administration of the dispute;
(2) representation by an attorney or other representative at such party’s expense;
(3) a fair arbitration hearing;
(4) a face-to-face hearing;
(5) the right to present evidence and cross examine witnesses;
(6) a written explanation of the basis for the arbitrator’s decision; and
(7) the right to opt out of binding arbitration and into the small claims court (for claims of $50,000 or less).

As stated above, the trick will be to narrow down the list, which is very long, overlaps in several areas, and conflicts in others.  What makes perhaps more sense is to establish model consumer and employment arbitration procedures that would pass muster under my proposed AFA. This would be an ambitious undertaking, but it’s been done before. Whether through model rules or established procedural standards, by so doing, my proposed AFA would address any potential issues process.

Conclusion

In the meantime, we should allow the Dodd-Frank approach to play out. The Act in sections 921(a) and evaluate PDAAs in customer-broker and investment adviser agreements. the Investment Advisers Act of 1940 to “… limit or prohibit use of pre-dispute arbitration agreements arising under the Federal securities laws, the rules and regulations thereunder, or the rules of a self-regulatory organization if it of conditions, or limitations are in the public interest and for the protection of investors.”

The law also established a new Consumer Financial Protection Bureau (“CFPB”), and requires it to study and services contracts (section 1028(a)), and authorizes it to limit or ban their use (section 1028(b)). Already, in February 2013 CFPB enacted regulations implementing Dodd-Frank’s ban on PDAAs in mortgages and home equity loans. More is sure to follow.

In short, we need to think, and think carefully, before we act.

[The preceding article by George Friedman, member of the Board of Directors of Arbitration Resolutions Services, Inc, originally appeared in the June 2013 issue of Securities Arbitration Commentator and has been republished with their permission.  For references and end notes, see Page 6 of the original article at this link.]