Financial Markets and Institutions:
Follow-up Report on Matters Relating to Securities Arbitration
GAO-03-162R: Published: Apr 11, 2003. Publicly Released: May 13, 2003.
Our June 2000 report Securities Arbitration: Actions Needed to Address Problem of Unpaid Awards revealed that, although investors had won a majority of awards against brokers, a high proportion of those awards had not been paid. Nearly all of the unpaid awards involved cases decided in the National Association of Securities Dealer's (NASD) arbitration program and most involved brokers that had left the securities industry. A year later we reported on limited data suggesting that the rate of unpaid awards had declined. However, we noted that given the short time period that the data covered, regulators needed to continue monitoring the payment of the awards to determine whether additional steps need to be taken. Arbitration attorneys and claimants have also expressed concern about the timeliness of NASD's updating of arbitrator disclosure information, which can be used by the parties in arbitration to judge the competence and objectivity of arbitrators, and with NASD's ability to remove arbitrators from cases if conflicts arise. In addition, arbitration attorneys also expressed concern about the use of motions to dismiss and motions for summary judgment to terminate NASD-administered arbitration cases. This report responds to requests that we review the status of issues relating to securities arbitration and award payment. Our objectives were to (1) describe NASD's procedures to ensure the timely updating of disclosure information that arbitrators provide and NASD's procedures for removing arbitrators from cases, (2) provide information on the use of motions to dismiss and motions for summary judgment in arbitrations, and (3) describe recent changes in the rate of unpaid awards and the number of arbitration claims filed with NASD.
NASD has made important changes to its arbitration program procedures, specifically in updating and entering arbitrator disclosure information and removing arbitrators from cases. To better manage the data entry process, in 2001 NASD centralized the arbitrator disclosure information function in its New York City offices. NASD also put a reporting form on line allowing arbitrators to submit new background information such as their education and training, employment, past arbitration experience, finances, and conflicts of interest. Also, in 2004 NASD plans to start a new computer system that would allow arbitrators to update their own records. Since November 2001, when the Securities and Exchange Commission (SEC) reported that NASD and SEC had not received any new complaints about the currency of arbitrator disclosure information, NASD has received one complaint. In addition, NASD has adopted a rule change that gives its Director of Arbitration and the President, NASD Dispute Resolution, indelegable authority to remove an arbitrator from a case after the hearing process has begun based on information not known to the parties when the arbitrator was selected. NASD has used this authority in nine instances since the change became effective in March 2001. Motions to dismiss were filed and granted in NASD-administered arbitration cases. Although NASD does not keep track of such motions, in 2001, for example, we determined that motions to dismiss or motions seeking summary judgment were filed in 55, or about 8 percent, of 719 investor-initiated, NASD-administered cases in which the investors won a monetary award. We identified 54 instances in which motions were denied and 28 instances in which the motions were granted. NASD rules do not prohibit either of the parties in arbitration from filing or the arbitrators from granting prehearing motions to dismiss. Further, the courts have consistently recognized the authority of arbitrators in NASD cases to grant prehearing motions to dismiss. Moreover, an NASD official told us that these motions can save time and resources by helping to weed out certain cases that, based on the facts set out in the parties' filings, clearly would not satisfy procedural requirements for cases in the arbitration forum. However, a member of the Securities Industry Conference on Arbitration said that such motions ought to be discouraged because discovery and appeal rights in arbitration are limited. In 2001, 236 or about 33 percent of the 719 NASD-administered monetary awards on claims filed by investors were not fully paid, down from 64 percent not fully paid in 1998, as we reported in June 2000. About 55 percent of the $100.2 million NASD arbitrators awarded to investors in 2001 was unpaid, down from 80 percent of the total $161 million awarded to investors in 1998. The majority of unpaid awards in both 1998 and 2001 resulted from brokers leaving the securities industry. For example, 192 of the 236 unpaid awards in 2001 involved defunct brokerage firms or individual brokers. Since 1998, NASD has introduced award-monitoring procedures that are designed to encourage payment. NASD also has introduced procedures for investors to avoid the problem of unpaid awards by defunct brokers by giving investors more options for handling claims against defunct brokers. The noted decline in the rate of award nonpayment also might be related to a difference in methodologies used to measure that rate. In 2000, we directly surveyed a sample of investors to determine if awards were paid in 1998, while for this report we used NASD data based on its monitoring of payment for the entire year 2001. The 5,974 arbitration claims that investors filed with NASD in 2002 have increased by 64 percent over the 3,637 claims filed in 2000.
Recommendation for Executive Action
Status: Closed - Implemented
Comments: NASD has updated its Website to disclose recent information about percentages of unpaid awards and the frequency with which awards against defunct brokers are unpaid.
Recommendation: The President, NASD Dispute Resolution, should make available on NASD's Web site current statistics showing the frequency with which arbitration awards against defunct brokers are not fully paid.
Agency Affected: National Association of Securities Dealers