The brokerage industry spent so much of its energy, capital and (in my opinion) bribery to derail the fiduciary issue and defang the various checks and balances that Congress was debating that it seems to have overlooked the possibility that it would lose one of its most brazenly anti-consumer, anti-advisor protections. And now the industry seems to be desperate to get it back.
I'm referring to FINRA arbitration, and FINRA's recent proposal that now, instead of having a brokerage executive involved in every arbitration panel, it is willing to experiment with all-consumer panels. I can easily envision FINRA's definition of a "consumer" as being somebody who has worked for brokerage firms in the past, but is not now employed there, and if they failed to get that past the SEC's smell test, then they could simply test out various consumers, and weed out those who seemed to be unsympathetic to the brokerage defenses.
But beyond this, I think would help if we recognize that FINRA's arbitration system is not only bad for consumers–it prohibits punitive damages against brokerage firms no matter how awful the fact pattern, and increasingly allows sophisticated delaying tactics that let the brokerage attorneys bleed clients–but it is also bad for the advisors who work in the industry. The arbitration forms basically give the brokerage firm total control over the defense, or lack thereof, of the defendant. The brokers are able to settle at their whim, throwing the broker under the bus, and if the broker loses an arbitration claim because of a weak or indifferent defense, then the brokerage firm severs ties with the broker and claims that the problem is fixed.
Having FINRA control the legal claims against brokerage firms serves only one constituent: the brokerage firms themselves, and it does a mighty good job of that. Its rulings tend to be opaque and not always in accordance with the fact pattern, nobody is put under oath, there is no possibility that the brokerage firm will ever have to pay more than the actual losses and there is no chance of appeal once a decision is rendered by a panel that includes somebody who works for the industry and knows how to watch out for its interests. To see how effective this barrier has been against the abuse of consumers, consider how many scandals the brokerage industry has sailed through these past 20 years, and then notice how few lawsuits have resulted.
You can argue, and I would agree, that the court system is imperfect, and that brokerage firms would enjoy an advantage there as well; they have a lot of money to spend on lawyers who understand how to use delaying tactics to wear down the average consumer. And, yes, there are undoubtedly cases where a jury will side against the big, bad large company in favor of one of their own, perhaps unfairly, and then throw in an unfair eight-figure punitive damage award for good measure.
So here's what I would propose to the brokerage industry, FINRA and the advisory community. Let's do away with the arbitration system owned and operated by the industry; that's an embarrassing conflict of interest that is transparently unfair to the consuming public. Let's acknowledge that you can never deter bad behavior by forcing people to give back no more than what somebody can prove was taken; it would be like enacting a court system for bank robbers, and then only punishing them by requiring them to give back whatever you can prove they stole–and that, only if they lose their case.
Let's also do away with the fiction that the broker/advisor's interests in these cases is the same as the firm's. They're not and never will be; the brokerage firm's easiest course is to simply blame the broker, and hide any systemic abuses.
Instead, let's allow clients to take their cases to the American Arbitration Association as a first step toward resolution. This wouldn't preclude either party from going to court if they can't arrive at an agreement, but it would answer some of the worst objections to the court system without precluding resolution in a court of law. The AAA wouldn't have the power to impose punitive damages, but the possibility that a jury might eventually hear the case would help brokerage executives think a few seconds longer before they embark on the next round of scandalous, predatory behavior. And I would suggest that the advisor–not the brokerage firm–be responsible for handling the arbitration hearing, and be fully empowered to negotiate with the end consumer.
Others may come up with improvements on this idea, and I'm all for that. In the weeks and months ahead, you're going to see the brokerage industry and FINRA both squirming hard to get out of this fix that they're in, the possibility of losing a powerful protection against the wrath of brokerage customers. The fact that both groups are voicing identical concerns should be enough evidence that they're deeply in bed together.
If the fiduciary community can point this out as clearly as possible, and offer a clear alternative to the shady industry-controlled alternative to our legal system, we might yet salvage something out of the recent investor protection act. While we're waiting for the SEC to decide whether advisors should act in the best interests of their clients, this will give us something to talk about with regulators and the press.