Securities Arbitration:

Actions Needed to Address Problem of Unpaid Awards

GGD-00-115: Published: Jun 15, 2000. Publicly Released: Jun 26, 2000.

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Pursuant to a congressional request, GAO provided information on issues relating to the arbitration process in the securities industry, focusing on: (1) whether arbitration forums had implemented recommendations made in GAO's 1992 report and whether the changes were effective; (2) how investors fared in award decisions; and (3) the extent to which investors were paid the amounts awarded by arbitration panels.

GAO noted that: (1) the securities industry self-regulatory organizations (SRO)--the National Association of Securities Dealers (NASD) and the New York Stock Exchange (NYSE)--implemented GAO's 1992 recommendations by giving arbitration participants a larger role in selecting arbitrators, periodically surveying arbitrators to verify background information, and improving arbitrator training; (2) NASD and NYSE generally assessed arbitrator performance using methods such as participant evaluations, focus groups, and discussions with arbitration attorneys; (3) NASD and NYSE believes that this participant feedback indicated that the program changes have improved investors' perceptions of arbitrator performance and the fairness of the arbitration process; (4) GAO could not reach conclusions about the fairness of the arbitration process from case outcome statistics; (5) investors did not receive as high a percentage of favorable arbitration awards during any year from 1992 through 1998, 49 to 57 percent, as they had during the period of January 1989 through 1990, 59 percent; (6) the percentage of the amount claimed that was awarded also declined during this period; (7) however, an increase in the percentage of cases settled during this period, generally 50 to 60 percent of the total cases concluded, may have changed the mix of cases going to a final arbitration award decision; (8) GAO's survey of investors who received awards in 1998 found that a number of broker-dealers that had left the securities industry often did not pay arbitration awards rendered against them; (9) nearly all unpaid awards were from cases decided in NASD's arbitration forum; (10) when investors complained, NASD took action to suspend nonpaying broker-dealers and had success in recovering awards; (11) most of the unpaid awards resulted from broker-dealers that were no longer in business; (12) NASD is considering changes to its processes to reduce costs and increase options for investors, but these changes still may not address the problem of defunct brokers not paying awards; (13) ultimately, recovering losses caused by undercapitalized, financially irresponsible, or unscrupulous broker-dealers is difficult, if not impossible, for investors; and (14) educating investors about the risks of doing business with such broker-dealers could help them avoid situations that may result in unpaid awards.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: On September 18, 2000, arbitration claimants and NASD member firms are to begin to certify the payment of awards.

    Recommendation: The Chairman, Securities and Exchange Commission (SEC), should require NASD to adopt procedures for monitoring the payment of arbitration awards. Such procedures should include requesting the parties in an arbitration to notify NASD, by the end of the 30-day payment period, about the payment status of any monetary award, so NASD can begin timely suspension proceedings against nonpaying broker-dealers, as appropriate.

    Agency Affected: United States Securities and Exchange Commission

  2. Status: Closed - Implemented

    Comments: Effective September 2000, NASD-Dispute Resolution (NASD-DR) began requiring NASD member firms to certify in writing that they have complied with awards against them or their individual brokers. A member must, within 30 days, notify NASD-DR that it paid an award, or that it has a valid basis for nonpayment, such as the filing of a notice to vacate the award. In addition, NASD-DR asks investors to notify it promptly if their awards have not been paid within 30 days of the date that they received the award.

    Recommendation: The Chairman, SEC, should require NASD to develop procedures addressing the problem of unpaid awards caused by failed broker-dealers to help reduce costs and increase options for investors, such as the changes NASD is considering.

    Agency Affected: United States Securities and Exchange Commission

  3. Status: Closed - Implemented

    Comments: SEC and NASD-DR have taken steps to make investors aware that awards may not be paid. SEC has revised its online publications to contain information about the potential for unpaid arbitration awards, and to underscore the importance of thoroughly investigating a broker's disciplinary history. SEC has also added language to the standard letter that it sends to investors who contact it about problems. SROs have also taken action to educate investors about the potential for unpaid awards, and have added detailed information to their websites.

    Recommendation: The Chairman, SEC, should work with the SROs to: (1) develop and publicize information to focus investor attention on the possibility of unpaid arbitration awards; and (2) encourage investors to more thoroughly evaluate the backgrounds of broker-dealers and individual brokers with whom they intend to do business.

    Agency Affected: United States Securities and Exchange Commission

  4. Status: Closed - Implemented

    Comments: SEC plans to periodically inspect NASD-DR's procedures for monitoring award payment and taking disciplinary action against member broker-dealer firms and individual brokers that have not paid awards. SEC agreed to consider the feasibility of other approaches to addressing the problem if unpaid awards remain a problem. SEC has identified options to explore with NASD and is monitoring award payment data. In the Follow-up report on Matters Relating to Securities Arbitration (GAO-03-162R), GAO found the rate of unpaid awards to have diminished since the June 2000 report, and that SEC and the SROs have taken steps to contain the problem of unpaid awards. In responding to the follow-up report, SEC agreed to continue to consider how SEC and NASD programs can continue to reduce the incidence of unpaid awards.

    Recommendation: The Chairman, SEC, should periodically examine the extent of nonpayment of SRO arbitration awards to determine the effectiveness of actions taken to improve the payment of awards. To the extent unpaid awards remain a problem, the Chairman should establish a process to assess the feasibility of alternative approaches to addressing the problem of unpaid awards.

    Agency Affected: United States Securities and Exchange Commission


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