SECURITIES

ARBITRATION

Actions Needed to

Address Problem of

Unpaid Awards

United States General Accounting Office

GAO Report to Congressional Requesters

June 2000

GAO/GGD-00-115

United States General Accounting Office General Government Division

Washington, D.C. 20548

Page 1 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

B-281372

June 15, 2000

The Honorable John D. Dingell

Ranking Minority Member, Committee on

Commerce

House of Representatives

The Honorable Edward J. Markey

House of Representatives

This report responds to your July 30, 1998, and September 23, 1998, requests that we evaluate

issues relating to the arbitration process in the securities industry. On the basis of your

requests, this report discusses (1) whether arbitration forums had implemented

recommendations made in our 1992 report, Securities Arbitration: How Investors Fare

(GAO/GGD-92-74, May 11, 1992) and assessed the effectiveness of the changes; (2) how

investors fared in securities arbitration award decisions; and (3) the extent to which investors

were paid the amounts awarded by arbitration panels. This report includes recommendations

to the Chairman, U.S. Securities and Exchange Commission, regarding regulatory actions to

address the problem of unpaid arbitration awards.

As agreed with your offices, unless you publicly release its contents earlier, we plan no

further distribution of this report until 30 days from its issue date. At that time, we will

provide copies to Representative Tom Bliley, Chairman, House Committee on Commerce;

Representative Michael G. Oxley, Chairman, and Representative Edolphus Towns, Ranking

Minority Member, Subcommittee on Finance and Hazardous Materials, House Committee on

Commerce; the Honorable Arthur Levitt, Chairman, U.S. Securities and Exchange

Commission; Mr. Frank Zarb, Chairman, National Association of Securities Dealers; Mr.

Richard Grasso, Chairman, New York Stock Exchange; and other interested parties. We will

also make copies available to others upon request.
B-281372

Page 2 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

If you have any questions on matters discussed in this report, please call me or

Michael Burnett at (202) 512-8678. Other major contributors to this report are acknowledged

in appendix VII.

Thomas J. McCool

Director, Financial Institutions

and Markets Issues
Page 3 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards
Executive Summary

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The securities industry uses arbitration to resolve disputes between

industry members and individual investors that involve hundreds of

millions of dollars each year. Congress, state regulators, and investor

groups have questioned whether an arbitration system that is administered

largely by securities self-regulatory organizations (SRO) is fair and

impartial. In a 1992 report on arbitration, GAO found no indication of a

proindustry bias, but concluded that SRO-sponsored forums lacked

internal controls to provide investors with reasonable assurance that

arbitrators were independent and competent.1

 GAO recommended ways

for the industry to improve arbitrator selection, qualifications, and

training.

Because of their continuing concerns about SRO-sponsored arbitration,

Representative John D. Dingell, Ranking Minority Member of the House

Committee on Commerce, and Representative Edward J. Markey asked

GAO to update its 1992 review of securities arbitration programs.

Specifically, they wanted to know (1) whether arbitration forums had

implemented GAO’s recommendations and assessed the effectiveness of

the changes; (2) how investors fared in securities arbitration; and (3) the

extent to which investors were paid their arbitration awards.

The securities industry SROs—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. NASD and

NYSE generally assessed arbitrator performance using methods such as

participant evaluations, focus groups, and discussions with arbitration

attorneys. They said that this participant feedback indicated that the

program changes have improved investors’ perceptions of arbitrator

performance and the fairness of the arbitration process.

GAO could not reach conclusions about the fairness of the arbitration

process from case outcome statistics. 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 June 1990, 59 percent. The percentage of the amount claimed

that was awarded also declined during this period, 46 to 57 percent,

compared with the earlier period, 61 percent. 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

 

1

 Securities Arbitration: How Investors Fare (GAO/GGD-92-74, May 11, 1992).

Purpose

Results in Brief
Executive Summary

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final arbitration award decision. For some of these cases, broker-dealers

may have chosen not to arbitrate because they reasonably expected to

lose. For this reason, the declining win rate could indicate little or no

change in the fairness of the arbitration process. GAO could not apply the

same technique it used in 1992 to determine whether arbitration results

implied anything about the fairness of SRO-sponsored arbitration because

the caseloads at an independent forum, the American Arbitration

Association (AAA), and at the courts were too small to make meaningful

comparisons.

More importantly, however, 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. GAO’s survey found that 49 percent of the awards rendered in 1998

were not paid at all and an additional 12 percent were only partially paid.

GAO estimated that the amount of unpaid awards was about $129 million,

or 80 percent of the $161 million awarded to investors during 1998. About

$13 million, or 8 percent of the unpaid awards, were still being disputed in

court through such actions as a motion to vacate or modify the award.

Nearly all of the unpaid awards were from cases decided in NASD’s

arbitration forum. When investors complained, NASD took action to

suspend nonpaying broker-dealers and had success in recovering awards,

but it did not monitor the payment of arbitration awards. In addition, most

of the unpaid awards resulted from broker-dealers that were no longer in

business. 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.

Ultimately, recovering losses caused by undercapitalized, financially

irresponsible, or unscrupulous broker-dealers is difficult—if not

impossible—for investors. Educating investors about the risks of doing

business with such broker-dealers could help them avoid situations that

may result in unpaid awards. In addition, investors’ arbitration attorneys

have suggested alternative approaches to address the problem of unpaid

awards.

This report contains recommendations to the Chairman of the U.S.

Securities and Exchange Commission (SEC) regarding regulatory actions

needed to address the problem of unpaid awards. SEC, NYSE, and NASD

generally agreed with the report’s recommendations, but expressed

concern about certain aspects of GAO’s analysis. They also suggested

several technical changes to the report, which GAO has included where

appropriate.
Executive Summary

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Arbitration, an alternative to suing in court, is a process that uses a neutral

third party to resolve differences between two parties in controversy. Most

broker-dealers require their customers to sign predispute arbitration

agreements that require disputes to be resolved through SRO-sponsored

arbitration. Investors can initiate arbitration proceedings by filing claims

with SRO-sponsored arbitration forums and paying filing fees. The forums

then provide both parties with a list of potential arbitrators from which

they can select who will arbitrate their dispute. The arbitrators’ decisions

are final and can only be appealed to the courts for narrowly defined

reasons, such as arbitrator misconduct or bias. Arbitration awards are to

be paid within 30 days from the date of the award, unless a party seeks

judicial review of the award.

The SROs, primarily NASD and NYSE, administer and oversee securities

arbitration programs. SEC is responsible for overseeing the SROs’

operations to ensure that they comply with securities laws and rules,

including those that pertain to arbitration.

NASD and NYSE have initiated new arbitration processes that respond to

GAO’s 1992 recommendations. For example, NASD no longer suggests

arbitrators for particular cases but produces a computer-generated list by

rotation of eligible arbitrators from which the parties are to select. NYSE

has also provided the parties more autonomy in selecting their arbitrators,

and both SROs periodically check arbitrators’ backgrounds and require

them to take training.

The SROs made these changes to improve the arbitration process and

participants’ confidence in arbitration. To assess arbitrator performance,

the SROs obtained participant feedback on various aspects of their

arbitration experience through evaluation forms. The SROs used the

results of these evaluations to identify the need for training programs, to

counsel arbitrators about deficiencies or problems, and to evaluate

arbitrator performance. However, many participants did not complete the

evaluation forms. SRO officials said that the forms that were completed

indicated improvement in participants’ perceptions of arbitrator quality. In

addition, these officials said that they periodically discussed arbitration

processes and specific program changes with various participants,

including focus groups, and conducted limited surveys of participants to

assess the effects of specific changes. These officials also said the results

Background

Principal Findings

SROs Have Made Program

Changes Consistent With

GAO Recommendations
Executive Summary

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of these processes have shown that perceptions of arbitrator performance

and the fairness of the arbitration process have improved.

The percentage of cases in which arbitrators’ decisions favored investors

has declined from the 59 percent GAO found for cases decided from

January 1989 through June 1990. The percentage favoring investors

averaged about 51 percent for the period of 1992 through 1996, then

increased to a high of 57 percent in 1998. The amount of awards made to

investors as a percentage of what they claimed also declined during 1992

through 1998, from the 61 percent that GAO previously found to an average

of about 51 percent of the amount claimed. However, the extent to which

arbitration cases were settled before reaching an award decision

increased. From 1989 to 1992 less than 50 percent of cases were settled,

while for 1993 to 1998, the cases settled ranged between 50 to 60 percent.

This increase in the percentage of arbitration cases settled may, in part,

explain the decline in the percentage of awards that favored investors.

GAO could not use the results of securities disputes at independent forums

to gauge the fairness of SRO-sponsored arbitration as it had in 1992. AAA’s

securities caseload declined significantly after 1991. The number of cases

AAA decided averaged only about 35 a year from 1992 through 1998,

compared with nearly 250 cases in the January 1989 through June 1990

period that GAO included in its 1992 report. The percentage of favorable

awards for investors at AAA declined from 1992 through 1998 from 88 to 50

percent, but these percentages are not statistically significant because of

the small number of cases.

GAO also could not compare arbitration results to those achieved by

investors who sued brokers in court because so few court cases were

decided. GAO found 121 securities-related disputes between individual

investors and their broker-dealers at 5 federal district courts. Of the 121

disputes, the courts decided 15 cases (12 percent), the parties settled 22

cases (18 percent), and the courts dismissed 85 cases (70 percent) for such

reasons as being remanded to arbitration or transferred to another district.

In the 15 decided cases, which were not enough to be statistically

significant, investors won 11 cases (73 percent). Information was not

available to determine the percentage of claimed amounts awarded.

GAO estimated that about 500 NASD awards to investors in 1998 either

were unpaid or were partially paid. GAO developed its estimates by

surveying a random probability sample of 247 of the 845 investors who

received monetary awards in cases decided in 1998. Nearly all of the

nonpayments involved NASD-decided cases.

Arbitration Award

Decisions Did Not Favor

Investors as Often as They

Did Before 1992

Many Investors Were Not

Paid Their Awards
Executive Summary

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NASD did not have procedures to monitor whether awards were paid, but

it did follow up when investors complained. In 1998, investors filed 142

such complaints. These complaints were the only source of information

NASD had on unpaid or partially paid awards. When it received written

complaints, NASD sent letters to the nonpaying brokers or broker-dealers

threatening to remove them from the securities industry. Although this did

not always help investors recover their awards, in total, NASD suspensions

or the threat of suspension resulted in about 40 percent of these unpaid

awards being paid or otherwise settled to the satisfaction of the investors.

Timely information about whether arbitration awards have been paid

could help NASD better assist investors who have not been paid awards.

Most of the unpaid awards resulted from broker-dealers that were no

longer in business. NASD had no procedures to address this problem, but

is considering changes to its arbitration program to help investors who

have disputes with these broker-dealers. These changes include notifying

the investors of their broker-dealers’ status when the investors file an

arbitration claim, limiting the ability of a defunct broker-dealer to enforce

a predispute arbitration agreement against a customer, and establishing a

rule to streamline the arbitration process when the broker-dealer is

defunct and fails to appear. Such actions may help investors obtain more

timely judgments against defunct broker-dealers, but these actions do not

help them avoid broker-dealers that might not pay. SEC and the SROs have

extensive investor-education programs, but these have not included data

on the extent of award nonpayment. Publicizing this information, along

with related investor-education information, might better focus investor

attention on the possibility of unpaid arbitration awards. Encouraging

investors to use the Central Registration Depository to more thoroughly

evaluate the background of broker-dealers and individual brokers that they

intend to do business with might help investors better make these

important decisions.

Some attorneys who have represented investors in securities arbitration

have proposed alternative methods to better ensure payment of awards.

These alternative methods include having the Securities Investor

Protection Corporation (SIPC) cover unpaid awards, establishing a

separate SRO-sponsored fund to pay awards, or increasing broker funds

that are available to pay awards through additional capital or bonding

requirements.2

 GAO did not assess the feasibility of these proposals but

obtained the views of SEC; NASD; and affected organization officials,

 

2

 SIPC is a nonprofit membership corporation of broker-dealers, which protects customers of failed

broker-dealers against loss of cash and securities up to statutorily defined limits.
Executive Summary

Page 9 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

including SIPC officials and those who represent arbitration attorneys and

broker-dealers.

GAO recommends that the Chairman, SEC, 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.

GAO recommends that the Chairman 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.

GAO also recommends that the Chairman 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.

Lastly, GAO recommends that the Chairman 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

this problem.

NASD Regulation, Inc., the NASD subsidiary with primary responsibility

for its arbitration program through the Office of Dispute Resolution; NYSE;

and SEC provided written comments on a draft of this report, which are

reprinted in appendixes IV, V, and VI. These organizations generally agreed

that the draft report revealed a potentially serious problem with the

nonpayment of arbitration awards by broker-dealers and individual

brokers that had left the industry and agreed with GAO’s

recommendations to address this problem. However, they expressed

specific concerns about some of the approaches GAO used and some of

the results of its analysis that are discussed in detail in chapter 5.

Recommendations

Agency Comments
Page 10 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Contents

Executive Summary 4

14

How Arbitration Is Designed to Work 14

SROs Administer and SEC Oversees Securities

Arbitration

15

Objectives, Scope, and Methodology 15

Chapter 1

Introduction

18

SEC Has Worked With SROs to Improve Securities

Arbitration

18

SROs Have Made Changes to Improve Their Arbitration

Processes

18

SROs Seek Participants’ Views to Assess Effects of

Program Changes

21

Chapter 2

SROs Have Made

Changes to Improve

Their Arbitration

Programs

23

Investors Have Not Fared as Well in Award Decisions as

They Did Before 1992, but More Cases Were Settled

23

Factors Affecting Awards for Investors 25

Other Comparisons in Arbitration Case Processing 28

Use of AAA Has Declined 29

Few Securities Disputes Are Litigated, Most Are

Dismissed

32

Chapter 3

Arbitration Awards

Favoring Investors

Declined, but More

Cases Were Settled

33

Over Half of Awardees Were Not Paid 33

NASD Did Not Routinely Determine If Arbitration Awards

Were Paid

36

NASD Is Considering Changes to Address Award

Nonpayment by Broker-Dealers That Are No Longer in

Business

38

Other Potential Solutions to the Problem of Unpaid

Awards

39

Chapter 4

Many Arbitration

Awards Were Not Paid

44

Conclusions 44

Recommendations 44

Agency Comments and Our Evaluation 45

Chapter 5

Conclusions and

Recommendations
Contents

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Appendix I: Methodology for Analyzing Arbitration

Results

50

Appendix II: Awardee Survey Methodology 60

Appendix III: Awardee Survey Questionnaire 64

Appendix IV: Comments From the NASD Regulation, Inc. 66

Appendix V: Comments From the New York Stock

Exchange

73

Appendix VI: Comments From the Securities and

Exchange Commission

75

Appendix VII: GAO Contacts and Staff Acknowledgments 78

Appendixes

Table 3.1: Percentage of Cases Decided in Favor of

Investors in 1998

26

Table 3.2: Size and Range of Investors’ Claim Amounts in

1998

28

Table 3.3: Average Processing Time for Cases Decided in

1998 (Days)

29

Table 3.4: Firms Requiring Predispute Arbitration

Clauses in Accounts for Individual Investors as of July

1999

30

Table 3.5: AAA Investor-Initiated, Securities-Related

Awards and Results for Investors, 1992 Through 1998

31

Table 4.1: Estimates of the Percentage of Monetary

Customer Arbitration Awards Issued by All Forums

and NASD in 1998 That Broker-Dealers or Individual

Brokers Paid Nothing, Paid Partially, or Paid Fully

34

Table 4.2: Estimates of Percentage of Award Cases Paid

in Full and Dollar Amounts Paid in 1998, by Size of

Award

34

Table I.1: Arbitration Cases Won and Lost, Odds on

Winning Derived From Them, and Odds Ratios

Indicating the Effects of Various Characteristics of

Arbitration Cases on the Odds on Winning

54

Table I.2: Arbitration Cases Won That Received Awards

That Were More or Less Than 50 Percent of the

Amount Claimed, and Odds Ratios Indicating the

Effects of Various Claim Characteristics on Winning

Sizable Awards

58

Table II.1: Disposition of Sample 61

Tables
Contents

Page 12 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Figure 3.1: Percentage of Decisions Favoring Investors

and Awards to Amounts Claimed, January 1989

Through June 1990 and January 1992 Through

December 1998

24 Figures

Abbreviations

AAA American Arbitration Association

ICS Investors Compensation Scheme

NASD National Association of Securities Dealers

NASDR NASD Regulation, Inc.

NYSE New York Stock Exchange

SAC Securities Arbitration Commentator

SEC Securities and Exchange Commission

SIA Securities Industry Association

SICA Securities Industry Conference on Arbitration

SIPC Securities Investor Protection Corporation

SRO self-regulatory organization
Page 13 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards
Chapter 1

Introduction

Page 14 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Arbitration is used to resolve disputes between broker-dealers or

individual brokers and their public customers (called investors). As an

alternative to suing in court, arbitration uses a neutral third party to

resolve differences between two parties in controversy. The arbitration

process in the securities industry has generally occurred in self-regulatory

organization (SRO)-sponsored forums that are overseen by the Securities

and Exchange Commission (SEC). The number of arbitrations in these

forums has averaged about 6,400 cases a year since 1992, after more

investors became involved in the markets and as broker-dealers required

them to arbitrate disputes in SRO-sponsored forums. In addition, the

Supreme Court ruled in 1987 that investors who had signed predispute

arbitration clauses could be compelled to resolve their disputes with

broker-dealers by arbitration.1

 Before 1987, arbitration caseloads were

fewer than 3,000 a year, but these caseloads increased in number between

1987 and 1992.

Customers’ experience with arbitration generally begins when brokerdealers require them, before opening an account, to sign a contract that

includes a predispute arbitration clause. If a dispute subsequently arises

between the customer and the broker-dealer, the customer can file an

arbitration claim with the forum indicated in the predispute agreement and

with any SRO of which the broker-dealer is a member.

In a customer-initiated arbitration case, the customer files a statement of

claim with the designated SRO-sponsored arbitration forum, along with a

filing fee that is based on the amount in controversy. The customer must

also submit a refundable deposit to cover the cost of the first prehearing or

hearing session. The forum’s director of arbitration serves the statement of

claim on the broker-dealer or individual broker (called respondents)

against whom the claim has been brought. The respondent has from 20 to

45 days, depending on the forum used, to answer the claim with any

defenses and related claims. A single arbitrator can be used to resolve

claims under $25,000, solely on the basis of the parties’ claims, when a

hearing is not requested. Unless otherwise requested by a party, a single

arbitrator can also be used to decide claims that are greater than $25,000

but less than $50,000. For all other cases, unless otherwise agreed to by the

parties, a panel of three arbitrators is appointed to hear the dispute. After

the filing process, the director of arbitration provides the parties with a list

of potential arbitrators, most of whom are public rather than industry

arbitrators, to hear the dispute. The parties indicate their preference and

may challenge specific arbitrators on the list.

 

1

 Shearson/American Express, Inc., v. McMahon, 482 U.S. 220 (1987).

How Arbitration Is

Designed to Work
Chapter 1

Introduction

Page 15 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Once the panel of arbitrators has been selected, the panel conducts

hearings that may last a day or more depending on the complexity of the

case. Arbitrators are to render their decisions after the presentation of the

evidence at the hearings. They are not required to provide a reason or a

written opinion when they make an award decision. The statement usually

provides the amount awarded and any other nonmonetary relief. The

award is final and is only subject to court review for narrowly defined

reasons, such as arbitrator partiality, fraud, or disregard of the law.

However, a court can confirm an arbitration award to establish a judgment

against the party owing the award. Unless a party files a motion to vacate

or modify the award, awards are to be paid within 30 days of the award

date. If the award is not paid within 30 days, interest will accrue at the

legal rate or the rate specified by the arbitrators in the award.

Securities arbitration proceedings are administered through arbitration

forums sponsored by various SROs, such as the National Association of

Securities Dealers (NASD) and the New York Stock Exchange (NYSE).

SEC is responsible for overseeing the SROs’ operations to ensure that they

comply with securities laws and rules, including those that pertain to

arbitration. The SROs are not-for-profit organizations that have primary

regulatory responsibility under the Securities Exchange Act of 1934 to

adopt and enforce standards of conduct for their members. The SRO

arbitration forums are funded from several sources, such as claim filing

fees, charges for the use of facilities, per case member surcharges and case

processing fees, and subsidies from SRO general revenues. SEC oversees

the SROs’ rulemaking regarding arbitration and inspects SRO arbitration

programs for compliance with the securities laws and SRO rules.

The American Arbitration Association (AAA) also administers securities

arbitration proceedings. AAA is an independent, not-for-profit organization

that handles dispute resolution for several industries and is not regulated

by SEC. AAA is funded fully from case processing fees. Parties in AAA

arbitration cases also must pay the arbitrators’ fee and other costs.

Because of their continuing concerns about how investors fare in SROsponsored arbitration forums, and whether investors are paid their awards,

Representative John D. Dingell, Ranking Minority Member, House

Committee on Commerce, and Representative Edward J. Markey asked us

to update our 1992 report on securities arbitration programs.2

 Our

objectives were to determine (1) whether securities arbitration forums had

implemented our 1992 recommendations and assessed the effectiveness of

 

2

 Securities Arbitration: How Investors Fare (GAO/GGD-92-74, May 11, 1992).

SROs Administer and

SEC Oversees

Securities Arbitration

Objectives, Scope, and

Methodology
Chapter 1

Introduction

Page 16 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

the changes, (2) how investors fared in securities arbitration award

decisions, and (3) the extent to which investors received the amounts

awarded by arbitration panels.

To obtain information on the changes to arbitration programs that NYSE

and NASD made to address our 1992 recommendations and any

assessments of those changes, we interviewed SEC and SRO arbitration

forum officials. We also analyzed the revised arbitrator application forms,

including arbitrator profile forms, and other background information the

forums use to select individuals for the arbitrator pool. We interviewed

forum officials about their verification of the information submitted. We

also reviewed the arbitrators’ manual and schedules of courses available

and attended a course given to chairpersons of arbitration panels. In

addition, we reviewed arbitration participant evaluation forms used by

NASD and NYSE and their analyses of evaluation results.

To obtain information on the use of predispute arbitration clauses, we sent

a questionnaire to the top 10 broker-dealers by numbers of retail sales

representatives listed in the Securities Industry Association’s (SIA)

Securities Industry Yearbook 1998-1999 and 2 broker-dealers that provide

on-line brokerage services. Nine of the 12, including both on-line brokerdealers, responded to our questionnaire.

To determine how investors fared in arbitration award decisions, we used

various statistical techniques to analyze arbitration awards for cases

involving investors in disputes with securities broker-dealers. We obtained

information on securities arbitration awards from a database maintained

by the Securities Arbitration Commentator, Inc., (SAC) of Maplewood, NJ.

This database includes information on arbitration awards decided at all

SRO-sponsored forums and AAA, and the database contained the only

comprehensive, consistent data available without reviewing case files at all

of the forums. However, because this database is limited to awards, we

were unable to provide a detailed analysis of investors’ claims that were

settled or withdrawn. We performed tests to assess the reliability of the

SAC database. Our methodologies and statistical procedures are discussed

in detail in appendix I. To determine how investors fared in court, we

reviewed court case records for five selected eastern U.S. districts—the

District of Columbia, Maryland, northern Illinois, southern New York, and

eastern Virginia. We chose these districts because of their proximity to

major securities markets and convenient locations.

To determine the extent to which arbitration awards were not paid, we

surveyed a random sample of 247 awards from the 845 monetary awards to
Chapter 1

Introduction

Page 17 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

investors that we identified in the SAC database as being decided in 1998.

Eighty-five percent of the sampled awardees responded to our survey.

Survey estimates made in this report, which are projected to the entire

population of 1998 awards, are subject to sampling error. Unless otherwise

noted, all percentage estimates from the survey have sampling errors of

plus or minus 5 percentage points or less, and all total dollar estimates

have sampling errors of plus or minus 10 percent or less. Our survey

methodology is discussed in detail in appendix II. Our survey questionnaire

is shown in appendix III. We obtained additional information on unpaid

1998 awards from NASD records of written complaints and records related

to its processing of those complaints. To obtain information on the status

of broker-dealers identified as not paying an award, we sent NASD a list of

those broker-dealers, and its staff determined the broker-dealers’ status.

To obtain information and views on possible solutions to the problem of

unpaid awards, we interviewed regulatory officials and officials of the

Securities Investor Protection Corporation (SIPC) and organizations that

represent arbitration attorneys and broker-dealers.

We requested comments on a draft of this report from the Chairmen of

SEC, NASD, and NYSE. Their comments are discussed in chapter 5. Our

work was conducted in Washington, D.C., and vicinity; New York, NY, and

vicinity; Boca Raton, FL; Baltimore, MD; Chicago, IL; and San Francisco,

CA, between October 1998 and May 2000. Our work was performed in

accordance with generally accepted government auditing standards.
Chapter 2

SROs Have Made Changes to Improve Their

Arbitration Programs

Page 18 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Since our 1992 report, SEC has worked with NASD and NYSE to

strengthen the arbitration process.1

 These SROs have made several

changes to improve their arbitration processes, many of which respond to

our recommendations. To assess the effectiveness of program changes, the

SROs sought participants’ views on their satisfaction with arbitrator

performance and the effectiveness of program changes. NASD and NYSE

officials told us that they believed the overall process has improved and is

fair for investors.

Since 1992, SEC has worked with the SROs to strengthen the securities

arbitration process through its rule reviews and inspections. SEC officials

told us that one of the most important rule changes they recently approved

involved NASD’s arbitrator selection process, which is discussed in the

next section. In addition, SEC has completed two arbitration program

inspections each at NASD and NYSE since 1992. SEC is currently

conducting an inspection of NASD’s program and plans to begin an

inspection of NYSE’s program in 2000. Since 1992, SEC also has inspected

arbitration programs at other SROs, such as the Chicago Board Options

Exchange and the Pacific Exchange.

According to SEC officials, SEC reviews SRO administration and

processing of arbitration cases in each inspection. In addition, they said

SEC examines SRO arbitrator pools, focusing on SRO’s recruitment,

training, and evaluation of arbitrators. In each inspection, SEC advises the

SRO of any deficiencies found and recommends that the SRO implement

remedial measures to correct the deficiencies. SEC also follows up with

the SRO to ensure that the SRO implements SEC’s recommendations. SEC

staff further noted that one of the purposes of their inspections is to

evaluate the impact of any changes in the arbitration process.

NASD and NYSE officials told us that they have made several changes to

improve their arbitration processes since our 1992 report. They said the

changes address each of the report’s recommendations, which were that

the SROs should develop standards for selecting arbitrators, verify

information submitted by arbitrators, and establish specific training for

arbitrators. NYSE and NASD have also sponsored a symposium and task

force, respectively, to address issues relating to the arbitration process.

NYSE’s Symposium on Arbitration in 1994 and NASD’s Arbitration Policy

Task Force in 1996 addressed the adequacy of SRO information on

arbitrators and the arbitrators’ experience. Both groups also identified

 

1

 Securities Arbitration: How Investors Fare (GAO/GGD-92-74, May 11, 1992).

SEC Has Worked With

SROs to Improve

Securities Arbitration

SROs Have Made

Changes to Improve

Their Arbitration

Processes
Chapter 2

SROs Have Made Changes to Improve Their Arbitration Programs

Page 19 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

needed changes in the arbitration selection process and the training of

arbitrators.

NASD officials told us that they have made significant changes to their

arbitration program in response to our recommendations addressing

arbitrator qualification, selection, and training. For example, NASD now

requires 5 to 8 years of professional or practical experience for applicants

to become NASD arbitrators. NASD also surveyed arbitrators in 1992 and

again at the end of 1998 to review and verify the accuracy of information

on their background. In addition, NASD officials said that they check

background information when arbitrators are selected to decide disputes.

NASD requires the arbitrators to sign an oath or affirmation indicating that

the information on their background is accurate.

NASD officials told us that one of NASD’s most significant changes has

been the change to its rules that provides for selection of arbitrators from

a list. Under the previous rules, NASD staff provided the parties with a list

of three arbitrators. The parties had one peremptory challenge and

unlimited challenges for cause to eliminate particular arbitrators. The new

rules provide for a list selection process that gives the parties a greater

role in choosing who will decide their cases. Under the new process,

NASD supplies a list of up to 15 names that are selected by computerized

rotation of the arbitrator roster. The parties can strike anyone from the list

and rank the remaining arbitrators according to their preferences. If the

parties cannot agree, they are assigned the next available arbitrator on the

computerized list to fill any remaining vacancies. NASD also revised the

list of arbitrators, eliminating names for various reasons, such as

unsatisfactory evaluations in previous arbitration cases, failure to

complete new training requirements, lack of interest, or conflicts of

interest that would prevent them from serving as independent arbitrators.

In January 1993, NASD began requiring all new arbitrators to complete

introductory training before becoming eligible to serve on a case.

According to an NASD official, the training program has been refined in

the past 5 years. One of the refinements, which began in March 1998,

requires arbitrators to pass a test on arbitration procedures to become

eligible to serve on a case.

NASD also has taken action to separate its arbitration activities from its

market and regulatory activities. In September 1999, SEC approved a new

NASD subsidiary—NASD Dispute Resolution, Inc.—which is to be

responsible for managing arbitration disputes. NASD reported that this

change, which should be operational by the summer of 2000, would make

NASD Made Changes to

Improve Its Program
Chapter 2

SROs Have Made Changes to Improve Their Arbitration Programs

Page 20 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

the arbitration process more independent. An NASD official also said that

NASD had made other changes to its arbitration program, including

encouraging parties to try mediation to resolve disputes before going to

arbitration, issuing a Discovery Guide to define which documents should

be exchanged among the parties in the arbitration process, streamlining

the claim process, and establishing a Web site on arbitration issues.

NYSE officials told us that NYSE, among other things, has established a

new arbitrator profile for maintaining information on arbitrators’

background and qualifications. NYSE also has developed procedures for

verifying this information and established training standards for

arbitrators. The profile serves as the initial disclosure of information about

arbitrators to the parties, counsels, or witnesses in a particular case. The

profile includes information on employment history, education,

professional and arbitration experience, brokerage affiliation, and

arbitration training. NYSE also requires potential arbitrators to have a

minimum of 5 years experience in their chosen profession or to have two

letters from members of their profession or the community that endorse

arbitrator nominees and address their experience and character. NYSE

officials said that this information assists them in selecting potential

arbitrators.

NYSE officials stated that NYSE continually checks arbitrators’

qualifications. The officials noted that each time arbitrators are assigned a

new case, NYSE asks the arbitrators to review, update, and sign their

profile information. They said that NYSE also verifies this information

annually for each arbitrator as well as checks arbitrators’ disciplinary

histories for past securities or criminal violations. As part of the arbitrator

profile, NYSE is to disclose any disciplinary history that does not warrant

the arbitrator’s removal from the pool. Arbitrators who receive poor

evaluations on more than one occasion may be removed from the pool. In

addition, arbitrators who are suspended or barred by a regulatory

organization or who fail to disclose their disciplinary history are also to be

removed from the arbitrator pool. In addition, NYSE may (1) temporarily

disqualify arbitrators if they are currently the subject of a complaint or

investigation and (2) permanently disqualify arbitrators for failure to

disclose material information or for being subject to a finding of fraud by a

court or arbitration.

NYSE is also trying a new process for selecting arbitrators. Under a pilot

program, NYSE permits the parties in arbitration to choose from two

options to select their arbitrators. NYSE either provides the parties with a

list of 3 arbitrators, allowing specific opportunities to remove an arbitrator

NYSE Made Changes to

Improve Its Program
Chapter 2

SROs Have Made Changes to Improve Their Arbitration Programs

Page 21 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

from the list, or the parties can request random lists of up to 15 arbitrators.

NYSE officials told us that they have received favorable responses from

the parties on the available alternatives.

NYSE has also conducted arbitrator training seminars on procedures,

issues, and ongoing developments concerning securities arbitration. It

requires all new arbitrators to attend the arbitrator-training program and

expects all arbitrators to periodically attend additional training. In

addition, NYSE officials said that NYSE has an arbitration Web site that

provides information to investors, including on-line access to all

arbitration awards issued since 1992. These officials said NYSE also has

pilot programs that encourage the use of mediation and more efficient case

processing through administrative conferences with the arbitrators to

resolve preliminary matters.

To assess the effects of their program changes, NASD and NYSE use

participant evaluations to obtain investor perceptions about arbitrator

performance on individual cases. Officials from these SROs said that their

review of the evaluations has shown a high level of participant satisfaction

with arbitrators’ performances. These officials said that they also use other

methods to evaluate the effects of program changes, such as focus groups

and meetings with individual arbitration participants. Overall, these

officials said that the arbitration process has improved and is fair for

investors.

The evaluation forms that the SROs use focus on arbitrators’ skills and

traits, such as display of professionalism and sensitivity during the

proceedings, whether the case was conducted according to prescribed

procedures, and whether arbitrators displayed knowledge of the securities

industry. Forum officials said that they use these evaluations to develop

training programs, counsel arbitrators about deficiencies or problems, and

determine if certain arbitrators should continue to be on the list of

arbitrators for the specific forum.

NASD officials told us that getting participants to complete the evaluation

forms has been extremely difficult for the forums over the years. The

January 1996 Arbitration Policy Task Force Report2

 recommended that

NASD make a greater effort to improve participants’ response rate. Shortly

after the report was published, NASD developed a new evaluation form to

elicit a higher participant response rate. An independent analysis of

 

2

 Securities Arbitration Reform: Report of the Arbitration Policy Task Force to the Board of Governors

National Association of Securities Dealers, Inc., January 1996.

SROs Seek

Participants’ Views to

Assess Effects of

Program Changes
Chapter 2

SROs Have Made Changes to Improve Their Arbitration Programs

Page 22 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

NASD’s participant responses by professors of the Department of Social

Sciences at the United States Military Academy at West Point found that

for 2,037 cases closed by hearing between December 1, 1997, and April 1,

1999, the response rate varied from 10 to 20 percent. NASD officials told us

that although they strive to have a greater degree of participation, West

Point professors told these officials that the response rate provided a valid

statistical sample. For example, the professors’ analyses showed that, of

the parties responding, 93 percent indicated that their cases were handled

fairly and without bias. An NASD official said NASD plans to continue such

analyses of the parties’ evaluations to identify overall trends in responses.

The participant evaluation forms have not included questions on process

changes. SRO officials said that this use of the evaluations to assess

program changes is inappropriate because investors rarely have more than

one experience in arbitration and, therefore, have no point of reference

from which to gauge the effect of specific changes to the program. SEC

officials noted that the sole purpose of the evaluations is to assess

arbitrator performance.

The SROs have also used other methods to assess participant satisfaction

and the effectiveness of program changes. During 1999, NASD conducted

focus groups with customer and industry participants to obtain feedback

and comments about its new list selection process. NASD also surveyed

selected attorneys who were frequent participants in arbitration to assess

the effectiveness of the arbitrator selection program. NYSE officials said

that they also met regularly with participant attorneys to assess overall

satisfaction with the NYSE program.

SEC officials also noted that NASD and NYSE arbitration program

officials, as well as those of other SROs, meet quarterly with

representatives of both public investors and the industry through the

Securities Industry Conference on Arbitration (SICA).3

 These officials said

that SICA has provided a useful forum for the SROs to assess the

effectiveness of specific arbitration program changes.

 3

 SICA, formed in 1977, is a cooperative effort of representatives of the securities industry; the SROs;

and the public to implement a uniform arbitration system, monitor that system, and change it as

appropriate or required. SEC staff said they also attend SICA meetings.
Chapter 3

Arbitration Awards Favoring Investors

Declined, but More Cases Were Settled

Page 23 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Our analysis of arbitration results from 1992 through 1998 showed that the

percentage of cases decided in favor of investors had declined compared

with cases decided before 1992. The awards investors received as a

percentage of the total amount that they claimed had also declined.

However, during this period, the percentage of cases settled without an

arbitrator’s decision has increased, which SEC officials said may explain

the declines in awards favoring investors. We reviewed several factors that

might affect award outcomes, such as representation by an attorney or size

of claim. The factors that affected case outcomes were similar to those we

identified in 1992.

In 1992, we also compared the results of arbitration in SRO-sponsored

forums with those in an independent forum, AAA, to provide an indication

of the fairness of SRO-sponsored arbitration. However, AAA’s securities

caseload declined significantly after 1990, and although AAA awards to

investors also declined from 1992 to 1998, its caseload is no longer large

enough to provide a meaningful comparison. Also, as in 1992, we could not

compare arbitration results to those achieved by investors in litigation

because the processes were different and so few cases were decided in

court. Without comparison to such benchmarks, statistics on case

outcomes and settlements provide limited information about the fairness

of the arbitration process.

In 1992, we reported that 59 percent of investors received favorable

decisions in cases arbitrated from January 1989 through June 1990. This

percentage declined to an average of about 51 percent for cases decided

from 1992 through 1996 and increased to 56 percent in 1997 and 57 percent

in 1998. (See fig. 3.1.) Similarly, we reported in 1992 that investors who had

favorable decisions received an average of 61 percent of the dollar amount

they claimed. This percentage declined to an average of about 51 percent

during 1992 through 1998, ranging from a low of 46 percent in 1994 to a

high of 57 percent in 1997.1

 (See fig. 3.1.)

 

1

 Our analysis did not calculate the percentages of claim amounts awarded separately for

compensatory and punitive damages.

Investors Have Not

Fared as Well in Award

Decisions as They Did

Before 1992, but More

Cases Were Settled
Chapter 3

Arbitration Awards Favoring Investors Declined, but More Cases Were Settled

Page 24 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Source: GAO analysis of arbitration award data.

Regulatory officials attribute the decline in arbitration results favoring

investors to a corresponding increase in the percentage of cases settled.

These officials said the higher percentage of cases that are settled tends to

reduce the percentage of arbitration award decisions in which investors

might receive favorable awards because broker-dealers are more likely to

try to settle cases that they think they might lose. We estimate that

between 1992 and 1998, the percentage of cases settled ranged from 43

percent in 1992 to 50 percent or greater for the years 1993 through 1998,

reaching a high of 60 percent in 1997. In 1992, we reported that settlements

occurred in 44 percent of SRO cases and 33 percent of AAA cases.

The NASD and NYSE arbitration forums decided most of the cases that

were arbitrated during 1992 through 1998. For example, NASD’s arbitrators

decided 1,428 cases, or 92 percent, of the total 1,552 customer-initiated

arbitration cases in 1998. NYSE decided 90 cases, or 6 percent of these

Figure 3.1: Percentage of Decisions

Favoring Investors and Awards to

Amounts Claimed, January 1989

Through June 1990 and January 1992

Through December 1998
Chapter 3

Arbitration Awards Favoring Investors Declined, but More Cases Were Settled

Page 25 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

cases. The other forums accounted for the remaining 2 percent of these

cases.2

We could not determine the reasons for the differences in overall case

outcomes from year to year. Each arbitration case has different

participants and varying circumstances relating to the claims and,

therefore, must be judged on its own merits. Attempting to evaluate these

factors would have involved time-consuming detailed reviews of case files,

extensive examination of the relationships among these variables, and

subjective judgments about the merits of individual cases. Also,

differences in the membership among SROs could affect the result, and the

investment products involved could be more complex and risky from one

year to the next. In addition, investors having similar claims could simply

be asking for higher amounts from one year to the next, which could

change the percentage of the claim awarded with no difference in the type

of case or the amounts awarded.

For arbitration cases decided from 1992 through 1998, we used a

multivariate analysis to evaluate how certain factors affected investors’

chances of winning an award and the size of the award relative to the

amount claimed. This analysis allows simultaneous evaluation of the

effects of several factors on a particular result and estimation of the

effects of any one factor by controlling or holding constant all other

factors. (See app. I.)

Without adjusting for differences in membership, our multivariate analysis

showed that when other factors are controlled, investors were 23 percent

more likely to receive a favorable decision at NASD between 1992 and

1998 than at NYSE. Investors received favorable decisions in an average of

about 54 percent of the cases at NASD during this time period as compared

with 45 percent at NYSE. For the most recent year, as shown in table 3.1,

the percentage of all cases decided in favor of investors in 1998 at NASD

was 57 percent compared with 50 percent at NYSE. Of the 34 cases

decided at the other forums, 15 favored investors.

 

2

 The other three forums were AAA, Chicago Board Options Exchange, and the Pacific Exchange.

Factors Affecting

Awards for Investors

Factors Affecting

Arbitration Results
Chapter 3

Arbitration Awards Favoring Investors Declined, but More Cases Were Settled

Page 26 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Forum Percent

Industrywidea 57%

NASD 57

NYSE 50

a

Includes SRO-sponsored forums and AAA.

Source: GAO analysis of arbitration award data.

SEC and NYSE officials told us these differences could be attributed to

differences in NASD and NYSE membership. Securities regulations require

every broker-dealer that has public customers to register with, and be a

member of, NASD. As a result, they said NASD members include the

newer, less established or less capitalized broker-dealers that may be more

likely to take actions or fail to exercise proper internal controls over

actions that could cause them to lose arbitration decisions. NYSE

members must be able to pay the cost of a seat on the exchange (one

recently sold for about $2 million); therefore, these members generally

include the larger, more established broker-dealers.

When adjusted for the differences in membership at NASD and NYSE, our

analysis showed an insignificant difference in the results of their

arbitration decisions. We compared the results of cases for large brokerdealers that were members of both NASD and NYSE and had multiple

awards in both forums. These awards accounted for over 31 percent of all

investor-initiated arbitration cases decided from 1992 through 1998. At

NASD, investors won 44 percent of the awards. At NYSE, they won 41

percent of the awards. NASD arbitrators awarded investors more than 50

percent of the amount they claimed 37 percent of the time, while NYSE

awards were more than 50 percent of the amount claimed 33 percent of the

time.

In addition to looking at different forums’ effect on cases decided by

arbitration, we also looked at other factors to determine whether they

could have affected case outcomes. These factors were (1) the type of

disposition (i.e., customer-member, customer-employee, or small claim);

(2) the year of arbitrator’s decision; (3) attorney representation; (4) claim

components, such as compensatory damages, punitive damages, or

attorney fees; (5) filing of counterclaim; (6) whether the process included a

hearing of the evidence or a review of written evidence; (7) the processing

time; (8) the total claim amount; and (9) the number of hearings. Our

analysis indicated that investors were 27 percent more likely to receive an

award if an attorney represented them. In 1992, attorney representation

did not affect whether investors received favorable decisions. The

Table 3.1: Percentage of Cases Decided

in Favor of Investors in 1998
Chapter 3

Arbitration Awards Favoring Investors Declined, but More Cases Were Settled

Page 27 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

components of the claim also were correlated to case outcome. Investors

filing claims that included more than compensatory damages, such as

punitive damages, interest, or various fees, were more than twice as likely

to receive an award. We did not address this factor in 1992.

Cases that involved a higher number of hearing sessions were also more

likely to be decided in favor of investors.3

 Investors who had between 5

and 10 hearing sessions were 27 percent more likely to receive favorable

decisions, and if they had 11 or more hearings, they were 113 percent more

likely to receive a favorable decision than claims involving fewer than 5

hearings. In 1992, we reported that investors were about 40 percent more

likely to receive an award if they had a hearing than investors whose cases

were decided only after a review of written evidence.

Whether a broker-dealer filed a counterclaim against an investor also

affected case outcomes. A broker-dealer may file a counterclaim against

the investor after receiving the investor’s claim. Investors were 43 percent

more likely to receive a favorable decision if the broker-dealer did not file

a counterclaim. In 1992, counterclaims were not factors in case outcomes.

Our analysis also shows that investors’ chances of receiving a favorable

decision in arbitration decreased from 1992 to 1995 but have increased

since 1995. In 1998, investors were 33 percent more likely to receive a

favorable decision than they were in 1995. Detailed results of our analysis

are shown in appendix I.

Without adjusting for differences in membership, our multivariate analysis

showed that investors who received a favorable decision at NASD were 45

percent more likely to receive an award in excess of 50 percent of their

claim than investors who received favorable decisions in other forums. In

1992, we found that forum did not affect the amount of award. In addition,

investors with attorney representation in cases occurring at any forum

were 30 percent more likely to receive an award greater than 50 percent of

the amount claimed. In 1992, investors represented by attorneys were 60

percent more likely to receive an award in excess of the average award

amount.

 

3

 Cases that required a large number of hearings may have many different characteristics that affect

their outcomes from those that required fewer hearings. We did not have information on these

characteristics, and they are not identified in our analysis. Therefore, our analysis should not be

interpreted as implying that prolonging cases will positively affect their outcomes.

Factors Affecting the

Amount Awarded
Chapter 3

Arbitration Awards Favoring Investors Declined, but More Cases Were Settled

Page 28 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

The size of the claim also affected award amounts and the odds of winning

a sizable award varied by the year they were awarded. Claims involving

$10,000 to $100,000 were only 60 percent as likely as claims under $10,000

to receive an award over 50 percent of the amount claimed. Claims

involving more than $100,000 were only 27 percent as likely to receive an

award over 50 percent of the amount claimed. We reported in 1992 that

claims under $20,000 were nearly 4 times as likely as larger claims to result

in an award greater than the average percentage of the amount claimed. By

1998, the odds of winning a greater than average award were 30 percent

higher than in 1992 and 50 percent higher than in 1995. We could not

determine from our analysis whether the amounts claimed were justified

or excessive. Unless the investor requests a hearing or the arbitrator calls

one, claims of $25,000 or less are decided by one arbitrator after a review

of written evidence. Our analysis showed that investors who had

arbitrators decide their cases on the basis of the written evidence were

about 40 percent more likely to receive an award over 50 percent of the

amount claimed than those that had hearings.

In addition to the factors that could have affected case outcomes, we also

analyzed differences in the size of investor claims, the processing times,

and the types of claims initiated by investors among SRO-sponsored

forums. For example, the median investors’ claim industrywide in 1998

was $64,000, and the median claim was higher at NYSE than at NASD.

Table 3.2 provides the range of claim amounts filed for the industry and for

NYSE and NASD in 1998.

Investors’ claim amounts

Forum Low High Mean Median

Industrywidea $200 $40,563,000 $320,000 $64,000

NASD 200 23,500,000 288,000 63,200

NYSE 700 7,500,000 384,000 75,000

a

Includes SRO-sponsored forums and AAA.

Source: GAO analysis of arbitration award data.

Table 3.3 shows the average time it took to decide a case at SROsponsored forums based either on reviews of written evidence or a

hearing. Decisions made after a hearing took considerably more time than

ones made only on the basis of the written evidence. Smaller claims can be

decided solely on the basis of the written evidence. To determine the time

it took, we used the dates from when the forum received an investor’s

claim to when the forum sent the arbitrators’ decisions to the parties.

Disputes decided at NASD took longer to resolve than those at NYSE.

Other Comparisons in

Arbitration Case

Processing

Table 3.2: Size and Range of Investors’

Claim Amounts in 1998
Chapter 3

Arbitration Awards Favoring Investors Declined, but More Cases Were Settled

Page 29 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

NASD officials told us that their cases took longer because of their larger

caseload and the parties’ increased involvement in the process.

Average processing time (days)

Forum Hearing

Written

submission

Industrywidea 504 281

NASD 519 289

NYSE 311 134

a

Includes SRO-sponsored forums and AAA.

Source: GAO analysis of arbitration award data.

Investors attempting to recover compensatory damages was the primary

reason that cases entered arbitration. An award of compensatory damages

may include the party’s actual dollar loss and any other damages, such as

interest or lost profits. A party in arbitration can also claim punitive

damages, or compensation in excess of actual damages, which are

intended to punish wrongdoers. In addition, a party may claim attorney

fees and other expenses of the arbitration process, such as forum fees.

Investors claimed punitive damages in about 20 percent (317 cases) of the

1,552 total cases decided in 1998. This percentage was less than the 28

percent we reported for cases decided by SRO forums in 1992. Arbitrators

awarded punitive damages in 107 cases, or about 34 percent of the 317

decided cases in which investors requested such damages. This was a

significant increase from the 12 percent we reported in 1992.

Investors claimed reimbursement for attorney fees in about 10 percent

(148 cases) of the 1,552 total cases decided in 1998. This percentage had

decreased considerably from the 30 percent we reported in 1992. Investors

received attorney fees in 100, or 68 percent, of the 148 cases in which they

claimed such fees. This percentage was considerably more than the 17

percent we reported in 1992. Arbitrators also awarded attorney fees in 44

cases in which investors had not requested such fees. We also obtained

information on lost interest and other costs associated with the claim that

we did not include in our 1992 report. Investors claimed these costs in 14

percent (211 cases) of the total cases decided in 1998. They received these

costs in 160 cases, or 76 percent of the 211 decided cases in which they

claimed these costs.

In 1992, we compared SRO-sponsored arbitration results to those at AAA,

as an indication of the fairness of the arbitration process. We found no

significant differences in case outcomes. We could not make the same

Table 3.3: Average Processing Time for

Cases Decided in 1998 (Days)

Use of AAA Has

Declined
Chapter 3

Arbitration Awards Favoring Investors Declined, but More Cases Were Settled

Page 30 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

comparison for this report because AAA’s securities caseload declined

significantly from what we reported in 1992 and, therefore, AAA’s results

no longer provided as meaningful a comparison to SRO-sponsored forums.

Since our 1992 report, large broker-dealers’ policies requiring predispute

arbitration agreements have expanded to include cash accounts in addition

to margin and option accounts. The nine broker-dealer firms that replied to

our survey required individual investors to agree to resolve their disputes

through SRO-sponsored arbitration as a condition of opening most types of

accounts.4

 The only exceptions were for investors who opened plain cash

accounts. As shown in table 3.4, six of the nine broker-dealers told us that

they require predispute agreements to open at least some retail cash

accounts; the remaining three broker-dealers did not require such

agreements. In 1992, we reported that eight of the nine large brokerdealers that responded to our survey did not require individual investors

who opened retail cash accounts as of December 1, 1990, to sign

agreements containing arbitration clauses. All nine of the broker-dealers

that responded to our survey and had margin accounts said they required

predispute agreements for customers who opened these accounts. For

broker-dealers having option accounts, eight of nine said they required

such agreements.

Predispute arbitration clause

Account types

Accounts that

did not use

Required for all

such accounts

Required for

some accounts

Not required for

such accounts

Retail Plain Cash 0 4 2 3

Retail IRA Cash 0 8 1 0

Retail 401 K Cash 2 6 1 0

Retail Margin 0 9 0 0

Retail Options 1 8 0 0

Institutional 1 5 2 1

Source: GAO analysis of broker-dealer survey data.

The large broker-dealers we surveyed did not offer their customers AAA as

a choice to arbitrate a dispute. Some of the reasons the large firms gave

for their policy of using SRO-sponsored forums were lower costs, a more

timely process than at the independent forums, and arbitrators’ knowledge

of the securities industry.

 4

 We surveyed the use of predispute arbitration agreements for the 10 largest broker-dealers by number

of retail representatives and 2 additional brokers that provide on-line brokerage services. We sent

questionnaires to the 12 broker-dealers and 9 responded.

Predispute Agreements

Require the Use of SROSponsored Forums

Table 3.4: Firms Requiring Predispute Arbitration Clauses in Accounts for Individual Investors as of July 1999
Chapter 3

Arbitration Awards Favoring Investors Declined, but More Cases Were Settled

Page 31 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

According to AAA officials, broker-dealer predispute agreements that

require investors to use SRO-sponsored arbitration forums have caused

AAA’s securities-related caseload to decline significantly. In our 1992

report, we analyzed the results of 248 AAA investor-initiated, securitiesrelated awards from the period of December 1989 through June 1990. As

table 3.5 shows, from 1992 through 1998, AAA averaged only about 35 such

awards a year, ranging from a low of 20 awards in 1998 to a high of 49 in

1996. Also, as shown in the table, investors received favorable decisions

and large percentages of their claims often in the early 1990s and then both

results declined through the years, until 1998 when investors received

favorable decisions in 50 percent of the cases and received 13 percent of

their claims.

Year

Investor-initiated,

securities-related

awards

Percentage of

favorable decisions for

investors

Percentage of

claims awarded

1992 24 88% 79%

1993 25 80 72

1994 43 72 52

1995 46 63 56

1996 49 53 48

1997 35 54 48

1998 20 50 13

Source: GAO analysis of arbitration award data.

AAA officials told us that they were still interested in deciding securities

arbitration disputes. In January 2000, SICA started a 2-year cooperative

pilot program to give brokerage customers the option to use non-SRO

forums to arbitrate disputes. NASD, NYSE, and other SROs are to

cooperate in the pilot program, and seven retail brokerages committed to

participate. Under the program, customers that have qualified claims with

one of the participating brokerages may have the option of having their

dispute heard at a non-SRO forum designated by the brokerage. The two

participating non-SRO forums are AAA and the Judicial Arbitration and

Mediation Service.

Few Results at AAA

Table 3.5: AAA Investor-Initiated,

Securities-Related Awards and Results

for Investors, 1992 Through 1998
Chapter 3

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Page 32 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

As in 1992, the results of arbitration and court cases are not comparable

because of the inherent differences in the processes5

 and their respective

outcomes and the small number of litigated cases. Most of the securitiesrelated court cases we reviewed were dismissed. We identified 817

securities and commodities cases that were terminated (decided or

dismissed by the court or settled by the parties before a court decision)

between January 1997 and December 1998, at the 5 federal district courts

we visited. The courts’ information systems did not distinguish securities

cases from commodity cases, but we reviewed the 817 cases and identified

121 to be securities-related disputes between individual investors and their

broker-dealers. Of the 121 disputes, 15 (12 percent) were decided in court;

22 (18 percent) were settled by the parties before a court decision; and 85

(70 percent) were dismissed for various reasons, such as they were

remanded to arbitration or were transferred to another district.

The 15 cases the courts decided, 11 in favor of the investor, were not

statistically significant. We could not determine what percentage of

investor claims the courts awarded because the claims often were not

quantified. For the 10 cases in which the claims were quantified, the

investors were awarded (1) the full compensatory amount claimed in 7

cases and (2) the full punitive amount in 5 of the 7 cases in which punitive

damages were requested.

The average time to litigate the 15 cases was 930 days and the median time

was 1,151 days. The average time to settle the 21 cases was 1,045 days; the

median time was 644 days. The average time to litigate the 23 cases we

reviewed for our 1992 report, was 744 days; the median time was 594 days.

The settlement time averaged 510 days, and the median time was 365 days.

 

5

 For example, the amount of discovery allowed and rules of evidence are different. See appendix I of

our 1992 report (GAO/GGD-92-74).

Few Securities

Disputes Are Litigated,

Most Are Dismissed
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Page 33 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

On the basis of our survey of investors who received arbitration awards

during 1998, we estimated that 49 percent of the awards were not paid, and

an additional 12 percent were partially paid.1

 Our estimates showed that

these investors did not receive nearly 80 percent of the $161 million that

they were awarded.2 Nearly all of the unpaid awards involved arbitration

cases decided in NASD’s arbitration forum. Investors who complained to

NASD had some success in collecting their awards when NASD initiated

suspension proceedings against the nonpaying broker-dealers after

receiving the complaints. However, NASD did not routinely monitor the

payment of awards to ensure that it took timely action against the

nonpaying broker-dealers. Such actions could provide some investors with

a better chance to collect their awards.

Better follow up on award payments, however, will not address the

primary nonpayment problem, because most broker-dealers that failed to

pay the awards were no longer in business. To the extent these brokerdealers may be insolvent, investors have little chance to recover their

awards. NASD’s arbitration program did not address this problem, but

after discussing our preliminary findings, NASD suggested some program

changes that might reduce costs and increase options for investors. In

addition, some investor arbitration attorneys have suggested other

approaches that might be considered to address the nonpayment issue.

As table 4.1 shows, an estimated 61 percent (±7 percentage points) of

investors who won arbitration awards in 1998 either were not paid or

received only partial payment. This percentage estimate rises to 64 percent

(±7 percentage points) if only NASD cases are considered. We developed

these estimates from a survey of a random probability sample of 247 of the

845 investors who received monetary awards in arbitration cases decided

in 1998.

 

1

 Our estimates are based on survey responses of claimants or their representatives regarding the

status of award payment from a representative random probability sample of awards favoring investors

decided in 1998. We did not follow up to validate the accuracy of the survey responses. Survey

estimates also are subject to sampling error. Unless otherwise noted, all estimates of percentages have

sampling errors of plus or minus 5 percentage points or less, and all estimates of total numbers (e.g., of

awards or dollars) have sampling errors of plus or minus 10 percent or less of those total values. This

percentage estimate (49 percent) has a sampling error of ±7 percentage points.

2

 In 3 percent of these cases, survey responses indicated that the award had been modified or vacated

by a court or such action was pending. If we exclude all of these awards from the sample because they

legitimately may no longer be owed to the investors, our estimate of the unpaid dollar amount of the

awards decreases to 72 percent. Our other estimates do not vary significantly when these cases are

excluded.

Over Half of Awardees

Were Not Paid
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Many Arbitration Awards Were Not Paid

Page 34 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Forum

Number of

monetary

customer awards

Percentage

paid nothing

Percentage

paid partially

 Percentage

 paid fully

All forums 845 49%a 12% 39%a

NASD 786 52a 12 36a

 aSampling error is ±7 percentage points.

Source: GAO analysis of awardee survey data.

On the basis of responses from investors who reported total dollars

unpaid, we estimated that unpaid awards amounted to $129 million, or 80

percent (±8 percentage points), of the $161 million total awarded in 1998.3

The unpaid awards included an estimated $55 million (±$8 million) of

unpaid awards for punitive damages. Table 4.2 shows that, in general,

larger awards were less likely to be paid than smaller awards. For

example, only 5 percent of awards of $1.15 million and over were paid in

full, compared with 44 percent (±9 percentage points) of awards under

$100,000. Also, only 17 percent (±6 percentage points) of the total dollars

owed in awards of $1.15 million and over were paid, compared with 43

percent (±12 percentage points) of the total dollars owed for awards under

$100,000.

Range of award

amount

Number of

awards

Percentage of

awards paid

 in full

Total dollars

awarded

Percentage of

total dollars

paid in part and

in full

$1.15 million and

over

22 5% $82,281,600 17%a

$277,000 up to

$1.15 million

73 20 39,350,600 24

$100,000 up to

$277,000

130 38b 21,858,900 37b

Under $100,000 620 44c 17,318,870 43d

a

Sampling error is ±6 percent.

b

Sampling error is ±17 percent.

c

Sampling error is ± 9 percent.

d

Sampling error is ±12 percent.

Source: GAO analysis of awardee survey data.

 3

 When the 3 percent of unpaid awards for which survey respondents said the award was modified or

vacated by a court or pending in court are excluded, the dollar amount of unpaid awards falls to $116

million, or 72 percent. Other estimates do not vary significantly when these cases are excluded.

Type heading here Table 4.1: Estimates of the Percentage

of Monetary Customer Arbitration

Awards Issued by All Forums and NASD

in 1998 That Broker-Dealers or

Individual Brokers Paid Nothing, Paid

Partially, or Paid Fully

Table 4.2: Estimates of Percentage of

Award Cases Paid in Full and Dollar

Amounts Paid in 1998, by Size of Award
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Many Arbitration Awards Were Not Paid

Page 35 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Our survey allowed respondents to cite one or more reasons for

nonpayment or partial payment of their awards, on the basis of their

knowledge of the cases. The most frequently mentioned reasons were

• the broker-dealer was out-of-business, estimated to be a reason in 53

percent (±9 percentage points sampling error) of all late or unpaid awards;

• the broker-dealer claimed to be financially unable to pay the award,

estimated at 32 percent (±8 percentage points);

• an individual broker (associated person) owing part or all of the award

could not be located, estimated at 28 percent (±8 percentage points); or

• the broker-dealer had filed for bankruptcy, estimated at 21 percent (±7

percentage points).

We also estimated that for 3 percent4

 of the unpaid awards, the award was

not paid because the award had been modified or vacated by a court, or

such a measure was pending, which are legitimate reasons for

nonpayment. In an estimated 8 percent5

 of the cases, nonpayment or

partial payment was in some way due to the occurrence of a postaward

settlement, a compromised award (in which the awardees agreed to accept

less than the full award), or an installment payment arrangement.

Most survey respondents with unpaid or partially paid awards reported

taking a variety of actions to collect their awards. Survey respondents said

they complained to the forum in an estimated 71 percent (±10 percentage

points) of the cases in which they received an award; 67 percent (±10

percentage points) said they complained to the broker-dealer, an

individual broker, or their attorneys; 67 percent (±11 percentage points)

said they took “further legal action”; and 34 percent (±11 percentage

points) reported filing a complaint with SEC about the unpaid award.

Forums in our sample, other than NASD, decided too few awards in 1998

to be projected with meaningful results. Of the 44 NYSE arbitration cases

decided in 1998 in which investors received monetary awards, we sampled

10 and received 8 responses. Seven of the eight respondents said their

awards were fully paid, and one said the principle amount of the award

was paid but the respondent declined to pay the forum fee, which he was

awarded.6

 Of the 10 AAA awards in 1998, we sampled 4 and received 

4

 The sampling error for this small estimate results in a 95-percent confidence interval around the value

ranging from 1 to 10 percent.

5

 The confidence interval ranges from 3 to 17 percent.

6

 NYSE officials said that a review of the award indicates that the forum fee, which was $15, was not

part of the award to the investor.
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Many Arbitration Awards Were Not Paid

Page 36 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

responses from 3. Two of the three respondents said their awards were

fully paid, and one said nothing was paid. We did not receive a response

from the one Pacific Exchange awardee in our sample.

The number of completely unpaid NASD awards was estimated to be 410

(±60 percentage points), representing nearly all (99.7 percent) of the 411

(±60 percentage points) unpaid awards in all forums. Partially paid NASD

awards numbered about 95 (±37 percentage points), comprising most (94

percent) of the 101 (±39 percentage points) partially paid awards for all

forums. After removing non-NASD awards from our analysis, we estimate

that 52 percent (±7 percentage points) of the 786 NASD customer awards

issued in 1998 were completely unpaid, 12 percent were partially paid, and

36 percent (±7 percentage points) were paid in full (see table 4.1).

Our estimates indicate that 504 (±60 percentage points) NASD awards

made in 1998 were either not paid or partially paid, but NASD records

showed that it only received written complaints of nonpayment in 142

cases.7

 These complaints were the only source of information NASD had

on unpaid or partially paid awards. When it received a complaint, NASD

initiated suspension proceedings against nonpaying broker-dealers and

often had success in compelling them to pay awards.

After an NASD arbitration panel renders an award, NASD is to send copies

of the award to the claimant and the respondent, including a cover letter

noting that all monetary awards are to be paid within 30 days of receipt.

NASD may suspend or cancel a broker-dealer’s membership or an

individual broker’s registration if they are the respondents in an arbitration

award and fail to comply with the award or an arbitration settlement

agreement. When NASD receives a complaint that a member firm or

individual broker failed to pay an award or settled amount, it sends a

warning letter indicating that the respondent’s membership/registration

will be suspended unless one or more of five conditions had been met. To

avoid being suspended, the respondent (or his/her attorney) must send

NASD documentary evidence showing that

• the award has been paid,

• the parties have agreed to installments or have otherwise agreed to settle

the matter,

 

7

 Our survey respondents said that they complained to the forum in an estimated 71 percent of the

cases, or about 360 awards. This number vastly exceeds the 142 cases in which NASD records

contained a complaint letter about a 1998 unpaid award. Similarly, SEC officials told us that they

received far fewer complaints than the estimated 34 percent reported by our sample respondents. We

do not know why the survey results and reported complaints received differed.

NASD Did Not

Routinely Determine If

Arbitration Awards

Were Paid
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Many Arbitration Awards Were Not Paid

Page 37 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

• the award has been modified or vacated by a court,

• an action to modify or vacate the award is pending in a court, or

• a bankruptcy filing is pending or a bankruptcy court has discharged the

award.

NASD revocation procedures also allow the respondent to request a

hearing on the matter to consider whether (1) the respondent was given

notification of the award, (2) the respondent satisfied the award, and (3) a

valid reason exists for the respondent’s failure to comply with the award.

NASD sent warning letters to all of its member broker-dealers and

individual brokers who were involved in the 142 investor complaint cases

about nonpayment of 1998 awards. In 49 cases, the NASD member paid the

award, agreed to an installment plan, or otherwise settled the matter

without being suspended. Members in 14 cases sought a court order to

vacate the award; 5 filed for bankruptcy, and 9 requested a hearing (3 of

which also filed a motion to vacate). The parties settled one of the nine

cases before the hearing. The hearing decisions for the other eight cases

resulted in two award payments, three suspensions, and two dismissals

because the members had terminated their NASD membership and were

no longer subject to NASD actions. The final case was dismissed because

the member filed a motion to vacate the award. NASD suspended the other

68 members because they failed to respond to the warning letter, 4 of these

members eventually paid the award and were reinstated. In total, NASD

action resulted in about 40 percent of the awards being paid or otherwise

settled to the satisfaction of the investors.

NASD officials told us they did not attempt to enforce the payment of

awards without receiving a complaint of nonpayment. They said that

attempts to enforce payment might give the appearance of favoring one

side in arbitration over the other. They also said that NASD members are

liable for paying interest on unpaid awards, which encourages prompt

payment.

Although remaining neutral is important to help maintain the credibility of

an SRO-sponsored forum, ensuring that investors are paid arbitration

awards is an important part of maintaining their confidence in arbitration.

Some proactive actions can be taken that would not affect NASD’s

position. For example, as we previously discussed, NASD sends letters to

both parties notifying them of the award and the 30-day payment

requirement, then takes no further action unless investors complain.

However, the large difference in our estimates of the number of investors

who reported that they did not get paid and the number of complaints on
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Many Arbitration Awards Were Not Paid

Page 38 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

which NASD took action, may indicate that many unpaid investors do not

complain to NASD or that NASD responds only to written formal

complaints. Thus, nonpaying brokers may continue to operate with no

action being taken. Taking action to monitor the status of award payments

and identify nonpaying brokers as soon as payment is due not only could

benefit investors but also could help preserve their confidence in the

arbitration process and thus benefit the entire securities industry.

NASD could determine the status of award payment by requiring both

parties to notify it when they have paid an award or received payment, at

least by the end of the 30-day payment period. Data developed through this

process could help NASD timely identify nonpaying broker-dealers or

individual brokers and limit their ability to continue to operate without

paying awards. This could be especially important because our survey

results showed that a few broker-dealers were responsible for several

nonpayments. For example, 10 broker-dealers were each responsible for 3

or more unpaid awards, which in sum accounted for 62 unpaid awards—

about 25 percent of the 247 awards in our sample.

The primary cause of unpaid arbitration awards was broker-dealers and

individual brokers who were no longer in business and had left the

securities industry. NASD’s arbitration program had no procedures to help

investors deal with these failed broker-dealers. As a result, investors had to

go through the arbitration process to obtain a judgment against these

broker-dealers whether or not they were still in business. This would have

been both expensive and time-consuming to the investors. NASD is

considering making several program changes that might help investors

better deal with failed broker-dealers.

Our survey respondents identified 65 broker-dealers that had failed to pay

at least 1 award. NASD officials reported to us that 13 of these brokerdealers were still active, while 52 went out of business after they had been

expelled, suspended, terminated, or canceled from NASD membership or

liquidated. According to NASD information, 25 of these broker-dealers

were known to conduct business in microcap stocks. All 25 of these

microcap broker-dealers were among the 52 identified as no longer in

business. Our survey also identified 15 individual brokers that respondents

indicated had not paid awards. We did not have enough information on

them to accurately identify the individuals and determine their status.

As the statistics show, investors who filed claims against broker-dealers

that were no longer in business had little likelihood of getting paid their

awards. SEC officials noted that to help recover all or part of their awards,

NASD Is Considering

Changes to Address

Award Nonpayment by

Broker-Dealers That

Are No Longer in

Business
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Many Arbitration Awards Were Not Paid

Page 39 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

these investors may confirm their arbitration awards in court. Doing this,

the officials said, gives investors the ability to convert awards into

judgments, which they then can try to enforce against any assets of the

failed broker-dealer or individual broker that can be located.

NASD officials said they are considering ideas for several program changes

to reduce costs and increase options for investors seeking to establish a

claim and judgment against defunct brokers. First, they would propose to

NASD’s Board and SEC a rule amendment that a respondent broker-dealer

that has been terminated, suspended, or barred from NASD, or that is

otherwise defunct, cannot enforce a predispute agreement against a

customer in an NASD forum. Second, they also would propose a rule

amendment to provide streamlined default proceedings for cases in which

the terminated or defunct broker-dealer does not appear, but the investor

affirmatively elects to pursue arbitration. Third, they would propose to

advise investors that make arbitration claims of the status of the brokerdealer (such as terminated, out of business, or expelled) so these investors

could better evaluate whether to continue with arbitration or to proceed in

some other forum, such as in court. Although the changes NASD is

considering may not ultimately result in investors receiving their

arbitration award payments from broker-dealers that are no longer in

business, they could reduce the costs of the process and increase the

options available for investors.

The broker-dealer or individual broker that an investor chooses might

ultimately influence the investors’ chances of recovering an arbitration

award because many nonpayments were caused by failed broker-dealers.

Regulatory officials told us that failed broker-dealers were often

undercapitalized, financially irresponsible, or unscrupulous. SEC and the

SROs have education programs to help investors understand the potential

risks of dealing with such broker-dealers, but these programs have not

included data on the extent of award nonpayment. Publicizing such data

might better focus investor attention on the possibility of unpaid awards.

In addition, encouraging investors to use the Central Registration

Depository8

 to more thoroughly evaluate the background of a brokerdealer or individual broker could help investors who are considering

opening brokerage accounts to avoid doing business with potentially

troublesome brokers.

 8

 The Central Registration Depository is a database that NASD maintains containing employment and

disciplinary histories of individual brokers as well as disciplinary actions taken against member

broker-dealer firms.

Other Potential

Solutions to the

Problem of Unpaid

Awards
Chapter 4

Many Arbitration Awards Were Not Paid

Page 40 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Some attorneys who have represented investors in securities arbitration

have proposed other methods to ensure that investors are paid their

arbitration awards. Their proposals include

• providing SIPC coverage of unpaid awards,

• establishing a separate SRO-sponsored fund for unpaid awards, and

• increasing the availability of funds from broker-dealers or individual

brokers to pay awards by raising net capital requirements or requiring

additional bonding or insurance to cover malpractice claims.

We did not assess the feasibility of these proposals but obtained the views

of SEC, NASD, and affected organization officials, including SIPC officials

and officials of organizations that represent arbitration attorneys and

broker-dealers.

The first proposal would provide for payment of unpaid arbitration awards

from SIPC funds. Congress enacted the Securities Investor Protection Act

in 1970, which established SIPC, after the failure of many broker-dealers

raised fears of a run on solvent broker-dealers. The statute’s purpose is to

encourage investors to leave their securities with broker-dealers by

protecting the firms’ custodial function. The act’s provisions are designed

to effect an expeditious return of all customer securities and cash held at a

failed broker-dealer. SIPC officials told us that changing SIPC’s mission to

include coverage of all unpaid arbitration awards would require amending

the Securities Investor Protection Act. The officials said coverage of

unpaid awards would increase SIPC’s caseload and require it to become

larger and increase its need for resources. For example, SIPC, which

protects only against broker-dealer insolvency in certain situations, had 29

employees at the end of 1998. In contrast, the United Kingdom’s Investor

Compensation Scheme (ICS) had over 115 employees as of March 1999.

ICS is similar in function to SIPC in that it protects investors against

insolvency, but ICS provides broader coverage of investor losses due to

fraud. SIPC officials also noted that many arbitration awards are granted

by default when a broker-dealer, that has gone out of business, fails to

contest a claim. Thus, they said, the validity of the claim was never tested.

Officials of SIA told us that expanding SIPC coverage to include all unpaid

arbitration awards, if funded by assessments on broker-dealers, could

increase costs for broker-dealers and investors. They also said that

expanded coverage might encourage frivolous arbitration claims and

reduce incentives for investors to carefully choose their brokers and

investments. SEC officials agreed that expanded coverage could create

moral hazards.
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Page 41 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

In addition, SEC officials noted that paying possibly $129 million (our

estimate of the amount of unpaid claims in 1998) a year to cover such

claims would quickly exhaust the SIPC fund ($1.1 billion), which is

intended as a reserve against the failure of a large broker-dealer. The fund

was built up over the last 3 decades by assessing broker-dealers a

percentage of their yearly gross revenues. SEC officials pointed out that

the majority of this funding came from the handful of broker-dealers that

consistently have yearly revenues far in excess of the vast majority of all

active broker-dealers. The task of replenishing the fund would again fall

largely on the shoulders of these few broker-dealers, which SEC said are

well capitalized, have adequate reserves to cover arbitration judgments,

and are not delinquent in paying such awards. We are reviewing SIPC

operations in detail at the request of the Ranking Minority Member, House

Committee on Commerce, and plan to report the results in a separate

report.

The second proposal made by the arbitration attorneys was to establish a

separate SRO-sponsored fund to cover the compensatory damages part

(actual investor losses) of unpaid arbitration awards. Arbitration attorneys

suggested that such a fund could be financed from either one or a

combination of (1) interest from the SIPC fund, (2) a charge on investor

transactions, (3) fees on broker-dealers and individual brokers, and (4)

funds obtained from NASD money penalties. These attorneys suggested

that the fund be limited to the payment of investor claims of compensatory

damages after an award is deemed “uncollectable,” that is, when the liable

party has left the securities industry. SEC and industry officials said that

establishing such a fund could pose the same disadvantages as expanding

SIPC coverage, including increased costs for broker-dealers and investors

and the discouragement of broker and investor diligence. SEC officials

also emphasized that the SIPC fund stands as a reserve against the failure

of a large broker-dealer, and that the interest from the fund pays for SIPC’s

operations and the costs of small firm liquidations, of which there are

approximately seven new proceedings each year. These officials said that

diverting the interest to satisfy unpaid arbitration awards would deplete

the fund’s principal and could create the funding problems previously

discussed. SEC officials noted that the level of the SIPC fund dropped from

about $1.196 billion to $1.129 billion during the 1999 calendar year.

The third proposal was to increase the funds available to brokers to pay

arbitration awards by increasing net capital requirements. Arbitration

attorneys suggested that additional broker-dealer capital could be set aside

in escrow for a period of time, such as 2 years after their membership is

terminated, so that these funds would be available to pay awards when the
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Many Arbitration Awards Were Not Paid

Page 42 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

broker-dealer leaves the industry. SEC officials said that the purpose of the

net capital rule is to require broker-dealers to maintain sufficient liquid

assets to be able to self-liquidate in an orderly manner. This benefits

investors by allowing insolvent broker-dealers to remain operating long

enough to transfer customer assets out of the firm. These officials said the

rule relies on accounting principles and, therefore, is not equipped to

create reserves against the potential for adverse arbitration awards that

might arise in a broker-dealer’s future. SEC officials said that to establish

reserves against the type of arbitration awards that go unpaid (such as

awards that are based on claims not covered by the Securities Investor

Protection Act, and which bankrupt a firm or cause it to close) would

necessitate a substantial increase in the minimum capital requirements.

These officials noted that investors obtaining arbitration awards would be

general creditors of the failed broker-dealer. Therefore, absent an

amendment to the U.S. Bankruptcy Code, the reserves would need to be

large enough to cover all creditor claims for this proposal to provide

meaningful assistance to investors.

SEC officials stated that, in their view, a sizable increase in the net capital

requirements would force many small broker-dealers out of the industry,

and unduly penalize those broker-dealers operating in a responsible

manner. Moreover, the costs of maintaining this additional capital could

eventually be passed on to investors, at least in part. SEC officials also

noted that effectively barring small broker-dealers from entering the

securities business by raising net capital requirements could hurt investors

by limiting their choice of broker-dealers. Industry officials said that they

did not know how much net capital requirements would have to increase

to cover investor claims.

In addition, SEC officials pointed out that, under the net capital rule,

broker-dealers must immediately book a liability after receiving an adverse

arbitration award. Therefore, to remain in business, the broker-dealer must

maintain sufficient capital to cover the amount of the award. Furthermore,

these officials said that under Generally Accepted Accounting Principles, a

broker-dealer must record a liability for a pending arbitration claim if it is

likely the broker-dealer will lose and if the amount of the pending award is

reasonably certain. They said this accounting principle requires brokerdealers to evaluate all pending claims and determine whether the claims

need to be booked as liabilities for net capital purposes. SEC officials

stated that they would determine whether this evaluation process should

be made more transparent to regulators by requiring thorough

documentation.
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Page 43 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Other methods suggested to increase the availability of funds from brokerdealers to provide for payment of awards were to place additional bond

requirements or have broker-dealers and individual brokers carry explicit

insurance to protect against malpractice claims. Industry officials said

these methods also could raise costs on broker-dealers industrywide and

ultimately on investors. Industry officials were uncertain how much

insurance would be needed and whether insurers would be willing to

underwrite the coverage without limitation on liability. NASD Rule 3020

already requires that member broker-dealers maintain a blanket fidelity

bond to protect against various losses, including fraudulent trading.

Coverage varies from $25,000 to $500,000 depending on the broker-dealers’

net capital requirement. However, the bond provides only first-party

coverage, meaning only the broker-dealer could file a claim. Also, the

required coverage, especially for small broker-dealers, might not be

enough to pay for multiple awards exceeding $25,000.
Chapter 5

Conclusions and Recommendations

Page 44 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

NASD and NYSE have made changes to their arbitration programs that are

consistent with our 1992 recommendations and intended to improve the

fairness of the arbitration process. These changes appear reasonable, and

NASD and NYSE evaluations have shown that the changes have improved

both the process and investors’ perceptions of its fairness.

We could not determine whether the decline in the percentage of awards

that favored investors indicated anything about the fairness of SROsponsored arbitration. An increase in the percentage of settled cases—

some of which broker-dealers may have chosen not to arbitrate because

they reasonably expected to lose—may have changed the mix of cases

going to arbitration. For this reason, the declining win rates may not

indicate a change in the fairness of the arbitration process. Unlike our 1992

report, we did not have sufficient cases from AAA to compare the results

of an independent forum to the SRO-sponsored forums. Also, we did not

find enough securities-related court cases to compare results with the SRO

forums. However, the high dismissal rate of securities-related court cases

may indicate that, in general, investors have not fared better in court.

The securities industry, its regulators, and Congress should be concerned

about the extent to which arbitration awards are unpaid. Regardless of

how effective and fair the arbitration decision process may be, unpaid

awards could negatively affect investors’ confidence in arbitration. A

timely NASD follow-up program on award payments would likely improve

the chances that some investors would be paid their awards. In addition,

investors would save time and money in establishing their claims if NASD

implemented the types of actions it is considering.

Ultimately, recovering losses caused by undercapitalized, financially

irresponsible, or unscrupulous broker-dealers is difficult, if not impossible,

for investors. However, data developed from monitoring award payments

should help educate investors about the possibility of unpaid awards

associated with doing business with these broker-dealers. In addition,

encouraging investors who are considering opening brokerage accounts to

use the Central Registration Depository to evaluate the background of a

broker-dealer or individual broker could help them make better decisions.

The arbitration attorneys’ suggested award payment alternatives raise

policy issues that warrant careful consideration and resolution before they

could be effectively implemented.

We recommend that the Chairman, SEC, require NASD to adopt

procedures for monitoring the payment of arbitration awards. Such

procedures should include requesting the parties in an arbitration to notify

Conclusions

Recommendations
Chapter 5

Conclusions and Recommendations

Page 45 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

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.

We recommend that the Chairman 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.

We recommend that the Chairman 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.

Lastly, we recommend that the Chairman 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.

NASD Regulation, Inc. (NASDR), the NASD subsidiary with primary

responsibility for its arbitration program through the Office of Dispute

Resolution; NYSE; and SEC provided written comments on a draft of this

report, which are reprinted in appendixes IV, V, and VI. These

organizations generally agreed that our draft report revealed a potentially

serious problem with the nonpayment of arbitration awards by brokerdealers and individual brokers that had left the industry, and they agreed

with our recommendations to address this problem. However, these

organizations expressed specific concerns about some of the analytic

approaches we used and the results of our analysis. Also, NASD provided

additional information on the actions it has taken to improve the overall

efficiency and fairness of its arbitration program and to evaluate the

effects of these changes.

NASDR noted that the problem of unpaid awards does not indicate a

problem with the NASD arbitration program but rather of bankrupt or

defunct firms. It said that the same collection problems against these firms

exist when investors take their claims to court or non-SRO arbitration

forums. Nonetheless, NASDR agreed that appropriate measures need to be

taken to encourage prompt payment of arbitrator awards and proposed

several initiatives to address award nonpayment. If effectively

Agency Comments and

Our Evaluation
Chapter 5

Conclusions and Recommendations

Page 46 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

implemented, these initiatives would comply with the intent of our

recommendations.

NASDR expressed concern about our conclusion that the statistics show

arbitration awards favoring investors have declined since before 1992.

NASDR cited data from SICA, both for all SROs and for NASD, that show

the recent trend has been more favorable to investors with the composite

figures from all SROs reaching higher levels in 1997 and 1998 than at any

time in the previous 17 years. They said this trend continued in 1999 when

investors won 61 percent of awards. The SICA data and the SAC database,

which we used for our analysis, were developed from different sources,

but produced similar results for the 1992 through 1998 period. However,

the data from our previous report, which we developed from an extensive

review of individual case files for cases decided over an 18-month period

from January 1989 through June 1990, show a considerably higher

percentage of favorable results for investors, 59 percent, than the yearly

SICA data show for either 1989 or 1990, 53 percent for both years. We did

not do any work during this review to attempt to explain these differences.

NASDR also discussed its attempts to follow up on the unpaid awards we

identified to determine whether current members were involved. This task

was difficult because our survey results were confidential, and we could

only provide NASDR with the names of broker-dealers and the number of

unpaid awards attributed to each. NASDR’s review of cases found only 21

that involved current member firms, and in 10 of those cases, NASDR

reported that the firm had no obligation to pay the award. Because we only

provided limited information, we do not know if the cases NASDR

included in its review were the same cases that we surveyed.

NASDR also questioned the methodology used to obtain the sample of

awards we surveyed to obtain estimates of their payment. It was

concerned that oversampling of the largest awards may have skewed the

survey to include a greater percentage of awards against broker-dealers

that are no longer in business. As described in appendix II, we sampled at

a higher rate for large and medium awards than for small awards to

provide more precise estimates for each stratum and across the entire

population. However, in producing the estimates, we weighted responses

to account statistically for all members of the population, including those

that were not selected or did not respond to the survey. For example, all 95

of the largest awards were sampled, so they were each assigned a weight

of 1 to represent only themselves. We assigned small awards larger

weights to represent other small awards not sampled. Thus, the

oversampling of large awards provided more precise estimates for those
Chapter 5

Conclusions and Recommendations

Page 47 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

awards but did not overrepresent those large awards in our estimates for

the entire population of awards.

NYSE had no objections to our findings and recommendations but

objected to our classification of one NYSE award as partially paid, solely

on the basis of the response provided to our survey. NYSE validated that

the award was fully paid, and we provided that information in our report.

We did not use these data to project our sample results for NYSE.

NYSE agreed with our finding that the decline in award decisions favoring

investors could indicate little or no change in the fairness of the arbitration

process. It further noted the information in the report that, in its view,

supports the fairness of SRO arbitration. However, NYSE expressed

concern about our analysis of factors affecting arbitration results with the

SRO being one of the factors. NYSE noted that it is difficult to compare the

results in arbitration unless similar claims and similar broker-dealers are

used. We provided a separate analysis of awards against a common set of

broker-dealers for NASD and NYSE but could not provide a similar

distinction among claims. Any analysis of this sort is limited to the

available data. We had information on several of the characteristics of

cases and claimants, which we analyzed in a rigorous and systematic

fashion. We acknowledge that more and better information might have

altered our results. Unless the information we were missing is significantly

associated with the characteristics we had available, our estimates, which

were based on hundreds to thousands of award observations, provide

unbiased estimates of the effects of those characteristics.

SEC stated that the report provides useful data to confirm the message it

has brought repeatedly to investors over the past 8 years: investors must

investigate before they invest. SEC suggested that we could have provided

more meaningful information about the fairness of SRO arbitration by

comparing the procedures used by the SRO arbitration forums against

independently developed standards for alternative dispute resolution. SEC

said such an analysis would show that the SRO procedures measure

favorably against the standards. Although measuring procedures against

standards may provide a useful indicator of the fairness of the arbitration

process, our requesters asked us to determine the outcomes of cases to

assess how investors fared in securities arbitration award decisions. We

could not comment on the fairness of the SRO arbitration process based

on the statistics alone unless they could be measured against the outcomes

of securities cases at an independent forum or the courts because these

are the only other venues for resolving securities disputes.
Chapter 5

Conclusions and Recommendations

Page 48 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

SEC also stated that our analysis of arbitration awards failed to distinguish

between the amounts of compensatory damages claimed and awarded and

punitive damages claimed and awarded. To the extent compensatory

damages represent the actual losses of investors, a separate analysis of the

awards for these damages may have provided useful information about

whether investors recovered their actual losses through arbitration. We

focused on the total amounts awarded because our objective was to

determine how investors fared overall in arbitration award decisions

rather than whether they recovered their actual losses. However, we

include in chapter 3 data on the frequency with which punitive damages

were claimed and awarded in 1998 that are comparable to data of our 1992

report.

SEC also requested that our report provide greater detail on the payment

of awards of less than $100,000 and from $100,000 to $277,000. It stated

that this information would be useful for average investors who might

decide to forego seeking restitution in the mistaken belief that arbitration

awards are not paid. We now show these data in table 4.2.

In addition, SEC asked that we clarify that broker-dealers that stay in

business have a good payment record. Although, the information presented

in our report suggests this may be true, we did not specifically analyze the

payment records of these broker-dealers.
Page 49 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards
Appendix I

Methodology for Analyzing Arbitration

Results

Page 50 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

To determine how investors fared in securities arbitration, we analyzed

arbitration award data. We used the award data to calculate rates

(percentages) reflecting the extent to which investors won awards,

damages investors’ claimed were awarded, and various factors influenced

arbitration outcomes.

The data we used to describe the characteristics of cases brought to

arbitration and their outcomes were obtained from Securities Arbitration

Commentator, Inc. (SAC), Maplewood, NJ. SAC is a commercial research

firm that maintains a database of information from publicly available

records on decided cases from all of the self-regulatory organization (SRO)

arbitration forums and the American Arbitration Association (AAA).

The SAC database contained information on arbitration awards that

resulted from (1) customer (investor) claims of damages against SROmember broker-dealers (called customer-member claims) or their

individual registered representatives (called customer-employee claims)

and (2) investors’ small claims cases of less than a specified dollar amount

(which only apply to customer-member claims), that SAC maintained as a

separate award category, covering the period from January 1, 1992,

through December 31, 1998. By definition, these data did not include

records of cases that were settled or dismissed before a decision was

reached. Estimates of the percentage of cases settled were from data

provided by SICA.

The 11,290 cases in the database included fields describing 113 variables

such as the following: the name of the forum; the parties involved in the

proceeding (customer-member, customer-employee, small claims, etc.);

type of claim; amounts claimed; and amounts awarded.

We analyzed the following cross tabulations to understand the data and

plan the analysis:

• the number of awards in favor of (won) and against (lost) investors, by

year and by forum;

• the difference between the amount awarded and the amount claimed, by

year and by forum;

• type of damages claimed,by year;

• amount of damages claimed, by year and by forum;

• type of award, by year and by forum;

• amount of award, by year and by forum; and

• processing time, by year and by forum.

Arbitration Case Data
Appendix I

Methodology for Analyzing Arbitration Results

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Our data reliability assessment included several steps. First, to assess the

reliability of the data we selected a simple random sample of 350

arbitration award records in the SAC database and compared them to the

corresponding hard-copy awards as issued by the forums that we obtained

from SAC. This analysis determined the percentage of records that

contained more than one inaccurate field and the percentage of inaccurate

fields. The analysis showed that 4.0 percent of the sample records had

errors in more than one field. Further analysis showed that the 95-percent

confidence interval for the percentage of records with more than one error

was 2.2 to 6.7 percent. The second analysis showed that 1.1 percent of the

fields were incorrect. The 95-percent confidence interval bounds for the

percentage of the fields that were incorrect ranged from 0.7 to 1.6 percent.

Second, SAC also verified the completeness of awards in its database of

closed awards through comparison to lists of closed awards at NASD

Regulation, Inc., annual arbitration reports published by the Securities

Industry Conference on Arbitration (SICA), and summary statistics of the

National Association of Securities Dealers (NASD) arbitration program.

Similar steps were taken to ensure receipt of all Municipal Securities

Rulemaking Board and American Stock Exchange awards. AAA awards

recorded in the SAC database were checked against AAA records by AAA.

Awards rendered by the Pacific Exchange, The Chicago Board Options

Exchange, Inc., and the Philadelphia Stock Exchange were routinely

reviewed and compared with forum reports to spot any discrepancies with

the SAC data. In 1998, SAC began the practice of checking with the New

York Stock Exchange (NYSE) to determine that the NYSE awards

contained in SAC’s database represented all of the public awards rendered

at the NYSE. However, because we could not be sure that any list or

records of awards included all awards issued, we could not ensure that the

SAC data included all awards issued from January 1992 through December

1998.

To account for differences in membership among forums we calculated

these percentages for a data set of awards involving major broker-dealers

that had multiple awards in both NASD and NYSE. We identified the major

broker-dealer cases as those involving the major broker-dealers in the

industry in terms of registered retail sales representatives. We also limited

our major broker-dealer analysis to those broker-dealers involved in

multiple arbitration awards at both NYSE and NASD. On the basis of this

definition, there were 3,502 major broker-dealer cases in the SAC database.

These cases represented 31 percent of all of the cases in the database.
Appendix I

Methodology for Analyzing Arbitration Results

Page 52 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

To provide descriptive information on the extent to which investors won

arbitration awards and the amount of damages claimed that was awarded,

we calculated percentages for the amount of awards in which investors

won and lost decisions and percentages for the amount claimed that was

awarded.

We analyzed these percentages by forum for all cases in the database. In

addition, we analyzed won and lost percentages by forum for the award

cases involving the selected major broker-dealers with multiple awards in

both forums. For all cases in the databases (before selection of cases

involving the major broker-dealers), percentages of investor-favorable

decisions were 45 percent at NYSE, 54 percent at NASD, and 53 percent in

all other forums. For only those cases selected as major broker-dealers,

these percentages were 41 percent at NYSE, 44 percent at NASD, and 53

percent for all other forums.

A significant number of investors received awards for less than half of the

amount claimed across all forums. At NYSE, 60 percent of investor awards

were for less than half of the amount claimed while at NASD, 50 percent of

investor awards were for less than half of the amount claimed. The

corresponding figure in all other forums was 40 percent.

Similar results were found for the subset of cases that involved major

broker-dealers with multiple awards in both NASD and NYSE. For

example, at NYSE, 62 percent of investor awards were for less than half of

the amount claimed while at NASD, 58 percent of investor awards were for

less than half of the amount claimed. The corresponding figure in all other

forums was 44 percent.

We also used the SAC data to determine the factors that affected the

outcome of securities arbitration in this time period. To characterize the

features of arbitration cases that are associated with certain outcomes, we

examined the influence of a number of factors in a multivariate model.

We analyzed the data on arbitration cases in two steps. First, we

investigated which characteristics of the claims of damages affected the

likelihood that cases were won (decided in favor of the investor) rather

than lost (decided against the investor). Second, we investigated, for

claims of damages that were won and in which a monetary award was

sought, which claim characteristics affected the likelihood that the amount

awarded was more than 50 percent of the amount sought. The claim

characteristics we considered included (1) the year of the claim (1992,

1993, 1994, 1995, 1996, 1997, or 1998); (2) the type of disposition

Loglinear Analysis of

Arbitration Outcomes
Appendix I

Methodology for Analyzing Arbitration Results

Page 53 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

(customer-member or customer-employee); (3) whether the claimant was

represented by an attorney; (4) whether the claimant was seeking

compensation only; (5) whether a counterclaim was made; (6) whether

there was a hearing; (7) the time it took to process the claim (less than 6

months, 6 to 11 months, 12 to 24 months, or more than 24 months); (8) the

forum in which the claim was brought (NASD, NYSE, or Other); (9) the

claim amount sought ($0, $1 to $9,999, $10,000 to $100,000, or more than

$100,000); and (10) the number of hearings (0, 1 to 4, 5 to 10, or more than

10).1

In these analyses, we determined the size and statistical significance of the

effect that each of these claim characteristics had on whether cases were

won, and on whether more than 50 percent of the amount claimed was

awarded. We first looked at the effect of each characteristic ignoring every

other, and then used multivariate logistic regression models to estimate

the net effect of each of these characteristics, or the effects they had on

these two outcomes when the associations between claim characteristics

were controlled and all characteristics were considered simultaneously.

Odds and odds ratios, which we describe below, were used to estimate the

size of the effects of the different claim characteristics, and chi-square

statistics and Wald statistics were used to determine whether they were

statistically significant (i.e., large enough that they could not be assumed

to be due to random fluctuations or chance).

Our primary results are summarized in tables I.1 and I.2 below. The first

table shows the effects of the various characteristics of arbitration cases

on the likelihood that cases were won. The second table shows the effects

of these same characteristics on the likelihood that cases that were won

were decided for more than 50 percent of the total amount claimed (or

sought) by the individual who filed the claim.

 

1

 Preliminary analyses (not shown) revealed that the categories we used to represent the processing

time, forum, claim amount, and number of hearings were suitable to capture the effects of these

variables. That is, the large bulk of the variation in the outcomes we were looking at is between the

categories we created, rather than within them.
Appendix I

Methodology for Analyzing Arbitration Results

Page 54 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

 Arbitration result

Variable/Category Win Lose Total

Odds on

win

Observed

odds

ratios

Predicted

odds

 ratios

Type of claim filed

 Customer-Member 5,754 5,194 10,948 1.11 - -

 Customer-Employee 191 151 342 1.26 1.14 0.85

Year

 1992 973 846 1,819 1.15 - -

 1993 782 754 1,536 1.04 0.90 0.88

 1994 669 645 1,314 1.04 0.90 0.84

 1995 771 808 1,579 0.95 0.83 0.76

 1996 986 919 1,905 1.07 0.93 0.85

 1997 886 699 1,585 1.27 1.10 1.02

 1998 878 674 1,552 1.30 1.13 1.01

Representation

 Attorney 5,435 4,698 10,133 1.16 - -

 No attorney 510 647 1,157 0.79 0.68 0.79

Claim components

 Compensation Plusa 2,242 1,004 3,246 2.23 - -

 Compensation Only 3,405 3,999 7,404 0.85 0.38 0.43

Counterclaim made

 No 5,743 5,128 10,871 1.12 - -

 Yes 202 217 419 0.93 0.83 0.70

Type of case

 Written 1,459 1,672 3,131 0.87 - -

 Hearing 4,286 3,489 7,775 1.23 1.41 Omitted

Processing time

 < 6mos. 474 616 1,090 0.77 - -

 6 mos. - 11 mos. 2,475 2,366 4,841 1.05 1.36 0.99b

 12 mos. - 24 mos. 2,413 1,918 4,331 1.26 1.20 0.99

 > 24 mos. 524 393 917 1.33 1.06 0.99

Forum

 NASD 5,082 4,411 9,493 1.15 - -

 NYSE 509 621 1,130 0.82 0.71 0.81

 Other 354 313 667 1.13 0.98 0.90

Total claim

 $0 374 354 728 1.06 - -

 $1-$9,999 1,640 1,944 3,584 0.84 0.79 0.75b

 $10,000 -$100,000 1,788 1,674 3,462 1.07 1.01 0.78

 >100,000 2,003 1,273 3,276 1.57 1.48 0.80

Number of hearings

 0 1,459 1,672 3,131 0.87 - -

 1-4 2,781 2,608 5,389 1.07 1.23 1.02

 5-10 1,094 712 1,806 1.54 1.77 1.27

 >10 411 168 579 2.45 2.79 2.12

Table I.1: Arbitration Cases Won and Lost, Odds on Winning Derived From Them, and Odds Ratios Indicating the

Effects of Various Characteristics of Arbitration Cases on the Odds on Winning
Appendix I

Methodology for Analyzing Arbitration Results

Page 55 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Note: Odds ratios in the next to the last column are derived from the observed odds and indicate the

effect of each claim characteristic when other characteristics are ignored. Odds ratios in the last

column are from a multivariate model and indicate the effect of each claim characteristic when the

effects of all other claim characteristics are statistically controlled.

a

Compensatory damages plus other damages, including punitive damages, attorney fees, and forum

fees.

b

Not significant.

Source: GAO analysis of arbitration award data.

The odds on winning in table I.1 tell us how many claims were won for

every claim that was lost. For the small number of customer-employee

claims filed between 1992 and 1998, for example, the odds on winning

(versus losing) were 191/151 = 1.26. This implies that 1.26 customeremployee claims were won for every one that was lost or, multiplying by

100, that 126 customer-employee claims were won for every 100 that were

lost. For customer-member claims, the odds on winning were lower and

equal to 1.11 (111 were won for every 100 that were lost). The odds ratio in

the penultimate column of the table, which equals 1.26/1.11 or 1.14, tells us

that the odds on winning were higher among customer-employee claims

than among customer-member claims, by a factor of 1.14. We can also

interpret this as meaning that the odds on winning were 14 percent higher

among customer-employee claims than among customer-member claims.

This odds ratio and the others in the same column indicate the effects each

factor and the other factors had on award outcome when each factor is

assessed while ignoring the others. The odds ratios in the final column of

the table are more appropriate for assessing the effects these factors had

on award outcome, since they are derived from statistical models that

estimate the effects of each factor net of every other.

Focusing on the predicted odds ratios in the final column of table I.1, our

principal findings with respect to the odds on arbitration cases being won

can be stated as follows:

• When the effects of other factors were controlled, the type of claim filed,

processing time, and amount claimed had no significant effects on whether

arbitration cases were won or lost.

• The year in which claims were filed had a significant effect. Between 1992

and 1995, the odds ratio declined gradually—in 1995 the odds on winning

were only 3/4 of what they were in 1992 (or in 1992 they were about 32

percent higher than in 1995). Between 1995 and 1997-98, the odds on

winning increased by 33 percent, so that, net of all other factors, the odds

on winning ended up at the end of the period precisely where they were at

the beginning of it.
Appendix I

Methodology for Analyzing Arbitration Results

Page 56 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

• Cases in which claimants were not represented by attorneys had lower

odds on being won, by a factor of 0.79. Stated differently, the odds on

winning were higher when attorneys represented claimants by a factor of

1.0/0.79 = 1.27, or by 27 percent.

• Claims seeking only compensation were less than half as likely—or less

likely by a factor of 0.43, to be precise—as other claims to be won.

Alternatively, claims involving more than compensation were more than

twice as likely (2.32 times as likely) to be won.

• Claims in which no counterclaims were filed were 1.0/0.70 = 1.43 times as

likely to be won, or 43 percent more likely.

• NASD claims, not adjusted for differences in membership, were more

likely than NYSE claims to be won, by a factor of 1.0/0.81 = 1.23, or by 23

percent. We found (in supplemental analyses not shown) this difference to

be similar across all years. The small number of claims that were filed in

other forums were somewhat less likely than NASD claims to be won and

somewhat more likely than NYSE claims to be won, but they were not

significantly different from either.

• Claims that involved no hearings were not significantly different in terms

of their odds on being won from those that involved between one and four

hearings. Claims involving 5 to10 hearings were 27 percent more likely to

be won, and claims involving 11 or more hearings were 113 percent more

likely to be won than written claims.

Table I.2 provides information pertaining to the second outcome we

considered, involving whether cases that were won were decided for more

than 50 percent of the amount claimed. Focusing on the odds ratios in the

final column of table I.2, our principal findings with respect to the odds on

arbitration cases that were won being decided for more than 50 percent of

the total claimed (henceforth referred to as “the odds on winning sizable

awards”) can be stated as follows:

• The size of the award was unaffected by whether more than compensation

was sought, whether a counterclaim was filed, and processing time.

• The type of claim filed had an immense effect on the odds on winning

sizable awards, which was impossible to estimate with the data at hand.

While slightly fewer than half of customer-member claims that were won

received sizable awards, none of the customer-employee claims did.

• The year in which claims were filed had a significant effect. Between 1992

and 1995, the odds on winning sizable awards dropped by roughly 10

percent. Between 1994-95 and 1998, the odds on winning a sizable award

increased gradually. In 1998, the odds on winning a sizable award were

roughly 30 percent higher than they had been in 1992 and 50 percent higher

than in 1995.
Appendix I

Methodology for Analyzing Arbitration Results

Page 57 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

• Cases in which attorneys did not represent the claimants had lower odds

on winning a sizable award, by a factor of 0.77. Stated differently, the odds

on winning were higher when attorneys represented claimants by a factor

of 1.0/0.77 = 1.30, or by 30 percent.

• NASD claims, not adjusted for differences in membership, were more

likely than NYSE claims to involve sizable awards, by a factor of 1.0/0.69 =

1.45, or by 45 percent. The small number of claims that were filed in other

forums were somewhat less likely than NASD claims, and somewhat more

likely than NYSE claims, to involve sizable awards, but they were not

significantly different from either.

• Larger claims were less likely than small ones to win sizable awards.

Claims involving $10,000 to $100,000 were only roughly 60 percent as likely

as smaller claims to win sizable awards, and claims involving more than

$100,000 were roughly 27 percent as likely as smaller claims to win sizable

awards.

• Claims that involved no hearings were more likely than claims involving

hearings to win sizable awards, though the number of hearings appeared to

make little difference. In general, written claims were between 30 percent

to 56 percent more likely than others to involve sizable awards (i.e.,

1.0/0.77 = 1.30, or 30 percent; 1.0/0.64= 1.56, or 56 percent; and 1.0/0.69 =

1.45, or 45 percent).
Appendix I

Methodology for Analyzing Arbitration Results

Page 58 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Percentage of claim

awarded

Variable/Category

< 50

percent

> 50

percent Total

Odds on

> 50 percent

Observed

odds ratios

Predicted

odds ratios

Type of claim filed

 Customer-Member 2,821 2,565 5,386 0.91 - -

 Customer-Employee 183 0 183 0.00

Year

 1992 506 397 903 0.78 - -

 1993 407 323 730 0.79 1.01 1.06

 1994 356 268 624 0.75 0.96 0.94

 1995 387 335 722 0.87 1.12 0.86

 1996 483 430 913 0.89 1.14 1.01

 1997 428 412 840 0.96 1.23 1.20

 1998 437 400 837 0.92 1.18 1.29

Representation

 Attorney 2,770 2,302 5,072 0.83 - -

 No attorney 234 263 497 1.12 1.35 0.77

Claim components

 Compensation Plusa 1,255 898 2,153 0.72 - -

 Compensation Only 1,744 1,659 3,403 0.95 1.32 0.94b

Counterclaim made

 No 2,888 2,494 5,382 0.86 - -

 Yes 116 71 187 0.61 0.71 0.80b

Type of case

 Written 487 934 1421 1.92 - -

 Hearing 2,454 1,546 4,000 0.63 0.33 Omitted

Processing time

 < 6mos. 158 293 451 1.85 - -

 6 mos. - 11 mos. 1,185 1,185 2,370 1.00 0.54 0.99b

 12 mos. - 24 mos. 1,355 892 2,247 0.66 0.66 0.99

 > 24 mos. 296 182 478 0.61 0.92 0.99

Forum

 NASD 2,553 2,254 4,807 0.88 - -

 NYSE 308 176 484 0.57 0.65 0.69

 Other 143 135 278 0.94 1.07 0.93

Total claim

 $1-$9,999 553 1,087 1,640 1.97 - -

 $10,000 -$100,000 966 822 1,788 0.85 0.43 0.59

 >$100,000 1,413 588 2,001 0.42 0.21 0.27

Number of hearings

 0 487 934 1,421 1.92 - -

 1-4 1,510 1,118 2,628 0.74 0.39 0.77

 5-10 684 316 1,000 0.46 0.24 0.64

 >10 260 112 372 0.43 0.22 0.69

Table I.2: Arbitration Cases Won That Received Awards That Were More or Less Than 50 Percent of the Amount Claimed, and

Odds Ratios Indicating the Effects of Various Claim Characteristics on Winning Sizable Awards
Appendix I

Methodology for Analyzing Arbitration Results

Page 59 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Note 1: The analyses above pertain only to arbitration cases that sought monetary compensation and

were won by the claimant.

Note 2: Odds ratios in the next to the last column are derived from the observed odds and indicate the

effect of each claim characteristic when other characteristics are ignored. Odds ratios in the last

column are from a multivariate model and indicate the effect of each claim characteristic when the

effects of all other claim characteristics are statistically controlled.

a

Compensatory damages plus other damages, including punitive damages, attorney fees, and forum

fees.

b

Not significant.

Source: GAO analysis of arbitration award data.
Appendix II

Awardee Survey Methodology

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To determine the extent to which monetary awards that arbitrators made

were actually paid to investors, we surveyed a representative random

probability sample of individual investors winning awards in 1998 cases.

We used survey data to estimate the proportion of awards completely and

partially unpaid, and the total dollar amount unpaid.

Our target population consisted of all arbitration cases brought by

individual investors against broker-dealers or their representatives that

were closed in 1998 with a monetary award being granted. Using the SAC

database to generate our sample frame, we initially identified an actual

study population of 852 such award cases.

We drew a stratified random probability sample of 250 awards. Three

strata were created on the basis of the dollar amount of the award, and

sample cases were selected at a relatively higher rate from the larger

awards. See table II.1 for the allocation of the sample across the strata.

With this statistically valid probability sample, each member of the study

population had a nonzero probability of being included, and that

probability could be computed for any member. The sample was designed

to provide us with acceptably precise estimates of the proportion of

awards paid and unpaid, and the total dollar amount of awards paid and

unpaid, across the entire population.

After drawing the sample, we discovered three pairs of duplicate elements,

and an additional four pairs of duplicate entries in the sample frame

derived from the SAC database that had not been randomly selected into

the sample. This resulted in a final working sample size of 247 and a

population total of 845.

Because the sample frame created from the SAC database did not contain

mailing addresses and telephone numbers of awardees or their attorneys,

we asked the SROs to provide that contact information for our sample of

247 awards. According to AAA officials, AAA’s policy is not to release

information that would identify claimants, so it was necessary to allow the

company to mail our survey questionnaires directly to the claimants or

their attorneys for the four AAA awards drawn into our sample.

We chose to mail our questionnaires to the attorneys identified as the

representatives for the awardees, rather than the awardees themselves,

except in cases in which awardees represented themselves. We did this

because the survey pretests suggested that attorneys were more likely to

be able to provide the necessary information, and since they often worked

Population and Sample

Design

Administration of

Survey
Appendix II

Awardee Survey Methodology

Page 61 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

for many clients, could sometimes answer for more than one of our

sampled cases.

For each sampled award, we prepared a questionnaire preprinted with the

short caption (title) of the case, the names of parties involved, the award

amount, and the date the arbitration decision was issued. The

questionnaire requested that attorneys on that case (or the awardees

themselves) indicate whether that particular award had been paid, how

much of the payment had been received, whether payment was timely,

reasons for nonpayment, and actions taken to collect the award. Appendix

III contains a copy of the questionnaire.

We mailed out the questionnaires on September 24, 1999, and asked AAA

to mail questionnaires to their awardees simultaneously. On October 22,

1999, we sent a follow-up mailing with another copy of the questionnaire to

the 116 sample elements from forums other than AAA who had not yet

responded.

On December 6, 1999, we began to make telephone calls to the 84

attorneys or awardees that had not yet responded, or for whom mailed

questionnaires had earlier been returned as undeliverable. If we were

successful in contacting nonrespondents by telephone, we conducted a

telephone interview to complete as many of the items from the mail

questionnaire as possible. On December 15, 1999, we ended fieldwork.

We received 209 usable responses, which was an overall unit response rate

of approximately 85 percent. Because not all respondents provided an

answer to each question they were eligible to answer, the item response

rates vary and are generally lower than the 85-percent unit response rate.

Disposition

Nonresponse Usable response

Stratum

Population

size

Sample

size Refusal Undeliverable

All other

nonresponse

Mail

response

Telephone

response

Response

rate

Large awards 22 22 0 0 1 15 6 95%

Medium awards 73 73 2 1 6 41 23 88

Small awards 750 152 1 5 22 104 20 82

Total 845 247 3 6 29 160 49 85%

Note: Large awards are those that are $1.15 million or greater, medium awards are $277,000 to less

than $1.15 million, and small awards are under $277,000.

Source: GAO analysis of arbitration award data.

Disposition of Sample

Table II.1: Disposition of Sample
Appendix II

Awardee Survey Methodology

Page 62 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

To produce the estimates from this survey, answers from each responding

case were weighted in the analysis to account statistically for all the

members of the population, including those that were not selected or did

not respond to the survey.

Estimates from sample surveys are subject to a number of sources of

error, which can be grouped into the following categories: coverage error,

sampling error, nonresponse error, measurement error, and processing

error. We took a number of steps to limit these errors.

Surveys may be subject to coverage error, which occurs when the

sampling frame does not fully represent the target population of interest.

We could not ensure that the SAC data from which our frame was

constructed included all awards (see app. I). We detected seven pairs of

duplicate elements in our sample frame, which were removed before the

survey was conducted.

Sampling error exists because we followed a probability procedure that is

based on random selections, and our sample is only one of a large number

of samples that we might have drawn. Since each sample could have

provided different estimates, we express our confidence in the precision of

our particular sample's results as a 95-percent confidence interval (e.g., ±7

percentage points). This is the interval that would contain the actual

population value for 95-percent of the samples we could have drawn. As a

result, we are 95-percent confident that each of the confidence intervals in

this report will include the true values in the study population.

Nonresponse error arises when surveys are unsuccessful in obtaining

some or all information from eligible sample elements. To the extent that

those not providing information would have provided significantly

different information from those that did respond, bias from nonresponse

can also result. Because the seriousness of this type of error is often

proportional to the level of missing data, response rates are commonly

used as indirect measures of nonresponse error and bias. We took steps to

maximize response rates, such as multiple mailings and telephone followup to convert nonrespondents to respondents.

Measurement errors are defined as differences between the reported and

true values of the characteristics under study. Such errors can arise from

the way questions are worded, differences in how questions are

interpreted by respondents, deficiencies in the sources of information

available to respondents, or intentional misreporting by respondents. To

minimize such errors, we asked subject matter experts to review our

Survey Error and Data

Quality
Appendix II

Awardee Survey Methodology

Page 63 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

questionnaire and pretested the questionnaire with several attorneys

representing cases in our sample frame. We did not, however, verify the

substance of answers given by awardees or their attorneys.

Finally, surveys may be subject to processing error in data entry,

processing, and analysis. We verified the accuracy of a small sample of

keypunched records by comparing them to their corresponding

questionnaires, and corrected errors found. Less than 1 percent of the

data items we checked had random keypunch errors that would not have

been corrected during data processing. Analysis programs were also

independently verified.
Appendix III

Awardee Survey Questionnaire

Page 64 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards
Appendix III

Awardee Survey Questionnaire

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Appendix IV

Comments From the NASD Regulation, Inc.

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Appendix IV

Comments From the NASD Regulation, Inc.

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Appendix IV

Comments From the NASD Regulation, Inc.

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Appendix IV

Comments From the NASD Regulation, Inc.

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Appendix IV

Comments From the NASD Regulation, Inc.

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Appendix IV

Comments From the NASD Regulation, Inc.

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Appendix IV

Comments From the NASD Regulation, Inc.

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Appendix V

Comments From the New York Stock

Exchange

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Appendix V

Comments From the New York Stock Exchange

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Appendix VI

Comments From the Securities and Exchange

Commission

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Appendix VI

Comments From the Securities and Exchange Commission

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Appendix VI

Comments From the Securities and Exchange Commission

Page 77 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards
Appendix VII

GAO Contacts and Staff Acknowledgments

Page 78 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards

Thomas J. McCool (202) 512-8678

Michael A. Burnett (202) 512-8678

In addition to the persons named above, Lamont Kincaid, Richard J.

Hillman, Carl Ramirez, Barry Reed (Retired), Michelle A. Sager, Sidney H.

Schwartz, Douglas M. Sloane, and David Tarosky made key contributions

to this report.

GAO Contacts

Acknowledgments
Page 79 GAO/GGD-00-115 Actions Needed to Address Problem of Unpaid Awards
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