Wall Street Panels for Settling Fights Draw Renewed Fire

Mar 2005 // The Wall Street Journal

He filed a securities arbitration claim with the New York Stock Exchange, which promises that two of the three members of its arbitration panel will come from the general public, not the securities industry. But Mr. Gimelson’s lawyer was surprised when he found out that one of the “public” arbitrators on the panel was Laurie Zeligson, who worked as a lawyer at Citibank for a dozen years through 1998 and later represented the bank and a securities firm in private practice. The panel ruled against Mr. Gimelson, while denying Waterhouse’s attempt to collect the $15,351 it said he owed.

Last year, Ms. Zeligson went to work for a Prudential Financial Inc. money-management unit but continued serving as a public arbitrator on a case that was already in motion, voting in favor of a securities firm in an NYSE employment-arbitration dispute. During her arbitration career, she voted in favor of Wall Street firms in all seven customer and employee cases she heard.

Ms. Zeligson said in a brief interview that she is no longer serving as an arbitrator. She later said in an e-mail that she believes she “brought the expertise necessary to serve as a public arbitrator.” While the NYSE says Ms. Zeligson was properly classified as public when she heard Mr. Gimelson’s case in 2000, it now says it should have reclassified Ms. Zeligson when she moved to Prudential. “We should have asked for more information,” says NYSE arbitration chief Karen Kupersmith. “Conflicts are important to us.”

Investors have been complaining for years that the arbitration system is stacked in favor of Wall Street. But the debate has intensified in recent years amid a swell of new arbitration claims following the burst of the Internet bubble in 2000. Now, some members of Congress and state officials are starting to turn up the heat on the industry. And the self-regulatory bodies that run the arbitration forum have started tinkering with the system to make it appear more fair.

“Combine a public arbitrator who has a long association with Wall Street with an industry arbitrator who works on Wall Street and the investor is not being served,” says William Galvin, the top securities regulator in Massachusetts. A subcommittee under the House Committee on Financial Services will hold public hearings on securities arbitration today.

Investors’ claims are heard either by panels at the NYSE or the National Association of Securities Dealers. The NASD handles roughly 90% of arbitration cases.

After receiving questions from The Wall Street Journal, the NASD recently said it is considering a rule change that would bar people such as Ms. Zeligson from serving as a public arbitrator. The new rule would remove people who work for firms that own or are owned by a NASD-registered firm such as Prudential from the public-arbitrator list.

The securities industry’s brand of justice took off after a Supreme Court ruling in 1987 allowed brokers to require customers to waive their right to sue in court as a condition of opening a brokerage account. Today such clauses are standard, which is why investors’ complaints usually end up in arbitration.

It has long been debated whether the securities industry should be permitted to police itself through an arbitration process that it controls. Wall Street has responded by requiring that two of the three arbitrators represent the public, which officials say helps ensure the system’s fairness. The third arbitrator must come from Wall Street, an effort to ensure knowledge of the inner workings of the brokerage industry. Big brokerage firms often encourage their employees to sign up as arbitrators.

In practice, though, even some “public” arbitrators have ties to Wall Street. Even if an arbitrator previously worked as a Wall Street broker, the NASD classifies the person as public if he or she held the brokerage job for fewer than 20 years and has been out of the business for at least five years. The NASD also counts accountants and lawyers as public if they get less than 10% of their income from brokerage clients. The NYSE has its own rules, including some similar to the NASD’s that leave the door open for former Wall Streeters to be classified as public.

Officials who run the arbitration system say it is fair and in recent years have even toughened the rules. For instance, the NASD last year changed its rules to force Wall Street insiders to wait five years instead of three before they can sit as public arbitrators. Linda Fienberg, the NASD’s head of arbitration, says a five-year break from the financial business is sufficient for an arbitrator to be classified as public. “That person will be knowledgeable and yet will be able to understand when firms engage in misconduct, and is as likely to find in favor of investors as someone who has no connection,” she says.

Jump in Cases

In 2004, 8,201 cases were filed with the NASD, a 47% jump from a decade earlier. Most involved aggrieved investors, although arbitration panels also hear complaints from brokerage employees against their employer and sometimes from one brokerage against another. In 2004, arbitrators ruled for investors 55% of the time, the NASD says. But an analysis by the Journal of about 1,000 cases ruled upon by around 40 of the country’s most-active arbitrators shows that arbitrators return a much smaller fraction of the total damages claimed by investors. The NASD doesn’t supply data on the size of damage awards relative to the amount sought.

Arbitrators, who typically make $400 a day, aren’t required to justify their decisions. That could change, though: The NASD’s board recently discussed requiring arbitration panels to provide a written decision if the complainant requests it in advance. The rule would require approval by the Securities and Exchange Commission.

 Jonathan and Mary Ann Smith took J.W. Genesis Financial Services Inc. to arbitration in 2000 after they lost nearly $67,000 investing in three small stocks. Two of the companies had warned in regulatory filings that their stock was only suited to those who could afford losing their entire investment, but the Smiths said their broker hadn’t told them this.

One of the arbitrators in the case was Patricia Bottoms, a former broker at Prudential Financial’s Prudential Securities unit as well as Lehman Brothers Holdings Inc. between 1984 and 1990. For years, Ms. Bottoms was classified as an industry arbitrator but she became a public arbitrator five years after leaving Wall Street, in accordance with NASD rules. The panel ruled unanimously against the Smiths.

“I don’t think someone who has spent years working on Wall Street should be standing as a public arbitrator,” says Mr. Smith, 50 years old, who installs computers for a living. “It has to prejudice them.”

Ms. Bottoms disagrees. “There is absolutely no benefit to the arbitrator to go about their business with that type of prejudice,” she says. She has served on five securities-arbitration panels involving employees or customers. She has voted in favor of Wall Street firms four times.

At both the NYSE and the NASD, the two parties in arbitrations have limited rights to strike arbitrators from a panel. At the NYSE, there are three methods of choosing a panel but the majority of panels are named by the exchange and lawyers get one automatic exclusion. After that, they’re stuck with the panel they get unless they can demonstrate a conflict. In the case of Mr. Gimelson, the investor who had a complaint against TD Waterhouse, his lawyer, Steven Caruso, was left with Ms. Zeligson because he used his exclusion to strike another arbitrator.

At the NASD, lawyers are presented with a list of 15 potential arbitrators and allowed to strike as many as they wish. But if the two sides strike so many people that there aren’t three left for the panel, the NASD returns to its database and picks a new panel of three by appointing the next available arbitrators that come up in the rotation. Neither side can exclude any of them. Lawyers can still appeal to the NASD to remove an arbitrator “for cause” but they must demonstrate a potential bias on the part of the arbitrator.

“I have been stuck with Ms. Bottoms twice with no say whatsoever in the matter,” says John J. Miller, a lawyer in Kansas City, Mo., who represented the Smiths.

‘I Was Not a Trader’

Some arbitrators with finance experience say it’s misleading to portray them as “Wall Street insiders.” Among them is James R. Greene, a former president of American Express Bank and of the Bankers Association for Finance and Trade, who is classified as a NYSE public arbitrator. He is now retired, but serves as a director at Israel’s Bank Leumi.

“Wall Street, as I use the phrase, is somebody in the brokerage business,” Mr. Greene says. “I lent money to people and collected it back. I was not a trader and did not have responsibilities for traders.”

In a rare challenge to the system, Tom Ajamie, a plaintiffs’ lawyer in Texas, filed a lawsuit against the NYSE in April 2004 in a bid to have arbitrator Robin Henry removed from a panel hearing his client’s $23 million claim against Prudential Financial.

Ms. Henry has long ties with Wall Street, Mr. Ajamie contends. She worked at Merrill Lynch in the early 1980s and now is chairwoman of a charity that receives donations from Wall Street firms including Citigroup and J.P. Morgan Chase.

In the suit, filed in New York state court, Mr. Ajamie says Ms. Henry fell asleep during hearings. At a court hearing related to the Ajamie case, Matthew Farley, a lawyer representing Prudential, said Ms. Henry closes her eyes from time to time but “I don’t believe she is sleeping.” The suit also says Ms. Henry has coached Wall Street witnesses by shaking her head to indicate which way they should answer.

The 75-year-old Ms. Henry doesn’t disclose her charity’s connections in the résumé she provides to the NYSE. An active arbitrator, she has ruled in favor of Wall Street firms about half the time, in line with the industry average.

In June, a judge rejected Mr. Ajamie’s request to have Ms. Henry removed from his client’s panel. The judge ruled that Mr. Ajamie failed to show a specific relationship between Ms. Henry and Prudential that would present a conflict.

Reached by phone, Ms. Henry referred questions to the NYSE. A spokesman for the exchange said that despite the allegations against Ms. Henry, “the court has found no evidence of impropriety or any disqualifying relationship.” He declined to comment on Mr. Ajamie’s specific allegations.

Charles Braisted worked for 30 years at law firm Davis Polk & Wardwell, which represents many top Wall Street firms, before setting up a private practice. He has since represented several Wall Street clients including Morgan Stanley and Prudential Securities. Nonetheless, the NASD recently reclassified him as a public arbitrator because of the five-year rule.

Mr. Braisted says he was slightly taken aback when he received the reclassification notice. But he thinks of himself as independent of Wall Street because most of his legal work in recent years has involved corporations, not brokerages. “I get upset when I see instances when a broker has ripped off a client or where a brokerage has not performed its compliance duties,” he says. Mr. Braisted has ruled for investors in each of the three arbitration cases he has heard involving client complaints.

Write to Susanne Craig at susanne.craig@wsj.com