Could Wall Street Reform Spell End of Mandatory Pre-Dispute Arbitration Clauses in Securities Disputes?

An important issue confronting Congress in the debate over Wall Street reform is the use of mandatory pre-dispute arbitration provisions in account opening forms between consumers and their broker-dealers and investment advisors.

In 1987, a sharply divided United States Supreme Court decided Shearson/American Express v. McMahon, 482 U.S. 220 (1987). In its decision the Court held that the mandatory arbitration provisions in agreements between investors and brokerage firms were enforceable. Since that decision, mandatory arbitration clauses have been adopted almost universally throughout the industry.

The arbitration provisions waive the investor’s right to go to court and require binding arbitration in a securities industry controlled forum (the Financial Industry Regulatory Authority – FINRA), in the event of any dispute regarding the investor’s account.

Congress has now recognized that such arbitration provisions have unfairly restricted the ability of defrauded investors to seek redress in the courts and the inequities of the mandatory securities arbitration system.

The Wall Street Reform and Consumer Protection Act, passed by the House of Representatives, could lead to the end of the use of mandatory pre-dispute arbitration in securities disputes. While the bill does not outright ban such clauses, the House version provides that the Securities and Exchange Commission (SEC) may restrict or even prohibit use of mandatory arbitration provisions by broker-dealers and investment advisors if the SEC finds that “such a prohibition, or imposition of conditions, or limitations are in the public interest and for the protection of consumers.”

The Senate version of Wall Street reform, the Restoring American Financial Stability Act of 2010, contains a similar provision with one key difference. The bill adds that the SEC could also “reaffirm” such mandatory pre-dispute arbitration clauses, as well as prohibit them or impose limits. The use of the word “reaffirm” would essentially allow the SEC to maintain the status quo – permitting broker-dealers to continue to insert these clauses into customer agreements with the SEC’s approval.

While Congress has now recognized some of the problems with the use of mandatory pre-dispute arbitration clauses, it is deferring any decision on this critical issue to the SEC. It is not clear how the SEC will deal with the use of mandatory pre-dispute arbitration clauses.