Employment Disputes: Recommendations to Better Ensure That Securities Arbitrators Are Qualified
Published: 2003-08-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Employees in the securities industry must submit to binding arbitration in most employment disputes. The Securities and Exchange Commission (SEC) is responsible for overseeing these arbitration programs--the largest being run by NASD and the New York Stock Exchange (NYSE). The Congress asked GAO to examine (1) the circumstances under which NASD and NYSE will arbitrate employment and employment discrimination disputes, and their procedures for selecting and evaluating their arbitrators; (2) the characteristics and outcomes of arbitrated employment and employment discrimination disputes at NASD and NYSE over the last 10 years; and (3) how SEC oversees the arbitration programs at NASD and NYSE and the results of these oversight activities.
section_title: What GAO Found
paragraphs: Arbitration is generally required for most employment disputes, except those dealing with discrimination claims. NYSE will only arbitrate discrimination cases when parties involved agree to arbitrate after the dispute occurs. NASD will arbitrate employment discrimination cases based on agreements entered into between employees and firms before or after a dispute occurs. NASD has instituted additional requirements, however, for these cases, such as requiring that arbitrators not be affiliated with the securities industry. In addition, those chairing hearings for employment discrimination cases must hold a law degree, have 10 years of legal experience, have substantial familiarity with employment laws, and must not have primarily represented employers or employees in the last 5 years. To qualify to hear cases, NASD and NYSE require that arbitrators have at least 5 years of work experience, supply two letters of recommendation, and complete training in basic arbitration procedures. Arbitrators must also provide information on their complete employment history, including any affiliation with the securities industry, as well as information on whether they have any regulatory or criminal history. Neither organization independently verifies the qualifications for applicants not associated with the securities industry. In addition NASD and NYSE have standard procedures for ensuring that arbitrators selected to hear cases do not have conflicts and for evaluating arbitrator performance. However, evaluations of arbitrators by staff, parties in disputes and other arbitrators on cases are not always completed. Officials at NASD and NYSE noted that if they receive no information about an arbitrator's performance on a case, they assume that the arbitrator's performance was adequate. Over the last 10 years, 261 (17 percent) of the 1,546 employment disputes arbitrated at NASD or NYSE included a discrimination claim. Discrimination cases differed from cases with disputes that did not involve discrimination in the following ways: (1) discrimination cases required more hearing sessions; (2) employees won discrimination cases less often than cases not involving discrimination claims; and (3) in cases that employees won, the monetary award in discrimination cases was generally larger than in cases not involving discrimination. SEC periodically inspects NASD and NYSE arbitration programs. On the basis of its inspections, SEC has recommended improvements. In its most recent inspections of NASD and NYSE, SEC made various recommendations concerning procedures for ensuring that arbitrators are qualified. In addition, SEC recommended that one or both improve procedures for recording information on arbitrator performance in a central database and for disqualifying arbitrators who are poor performers.

section_title: Letter
paragraphs: Most employment disputes in the securities industry must be arbitrated— resolved by a neutral third party—because mandatory arbitration of such  disputes is often a condition for employment in the securities industry.  Arbitrators have the authority to make legally binding decisions that can  only be appealed on limited grounds. Their decisions can have serious  consequences for an employee’s career or livelihood since employee cases  can involve such issues as salary, performance evaluations, and alleged  discrimination. To resolve disputes filed by employees, the securities firms  rely on the arbitration programs run by self-regulatory organizations  (SRO), which regulate the firms in the securities industry that are their  members. Two SROs, NASD and the New York Stock Exchange (NYSE),  run the largest arbitration programs. While NASD and NYSE are  responsible for operating arbitration programs, the federal government,  through the Securities and Exchange Commission (SEC), oversees NASD  and NYSE to help ensure that arbitration procedures are fair and the rights  of all parties to the arbitration process are protected.
Recently you raised concerns about the fairness of the arbitration process  and the quality of arbitrators, especially in cases involving alleged  employment discrimination.
In response to your concerns about the arbitration of employment cases,  this report examines (1) the circumstances under which NYSE and NASD  will arbitrate employment and employment discrimination disputes and  each SRO’s procedures for selecting and evaluating their arbitrators;   (2) the characteristics and outcomes of arbitrated employment and  employment discrimination disputes at NYSE and NASD over the last   10 years; and (3) how SEC oversees the arbitration programs at NYSE and  NASD and the results of these oversight activities.
In response to your request, we conducted interviews with officials from  SEC, NYSE, NASD, and other established arbitration forums. In addition,  we analyzed existing rules and procedure manuals governing NASD and  NYSE. To determine how employees fared in securities arbitration, we  analyzed data on 10 years of arbitration cases filed by employees at NASD  or NYSE in which arbitrators had issued decisions (referred to as awards).  Specifically, we calculated the rates reflecting the extent to which  employees won awards, how much employees were compensated in  awards, and various factors that could influence arbitration outcomes.  Finally, to review SEC’s oversight activities, we reviewed a random sample  of complaint letters SEC received concerning arbitration and its inspection  reports for NYSE and NASD over the last 10 years, concentrating on issues  concerning arbitrator qualifications and arbitrator performance. Appendix  I contains a detailed description of our scope and methodology and  describes the reliability and limitations of our data. We performed our  work between August 2002 and June 2003 in accordance with generally  accepted government auditing standards.
subsections: section_title: Background
paragraphs: The arbitration of disputes first occurred at NYSE in the late nineteenth  century but eventually became the practice within the securities industry  in general. Arbitration was used to settle disputes over employee  contracts, and in 1991 the U.S. Supreme Court ruled that an age  discrimination claim brought forth by a securities industry employee could  be subject to mandatory arbitration. Subsequent court decisions  permitted the use of mandatory arbitration for resolving other  employment discrimination disputes, including sexual harassment.
Proponents of mandatory arbitration believe it is an efficient, cost- effective way to resolve conflicts between employers and their employees.  Opponents of mandatory arbitration believe that it puts employees at a  disadvantage. They argue that discovery, the process by which parties  exchange documents and other information relevant to their case, is  limited, hearings take place outside of public scrutiny, and arbitrators  favor employers, who are more likely to be “repeat users” than employees.
SROs include NYSE that operates and regulates its market, as well as  NASD, a private-sector provider of financial regulatory and dispute  resolution services. Their responsibilities include overseeing the  arbitration of claims brought in the securities industry by customers,  firms, and employees as required by the Securities and Exchange Act of  1934 (the Exchange Act). In 2000, NASD established a separate subsidiary  to administer its arbitration program. The subsidiary is headquartered in  Washington, D.C., and New York City, but also maintains staff in five  regional offices. NYSE administers fewer arbitration cases than NASD and  its arbitration program, which is administered by its Department of  Arbitration in New York, is much smaller. NASD’s subsidiary operates with  a staff of about 200 while NYSE maintains a staff of approximately 18. In  addition, NASD currently has approximately 7,000 arbitrators on its roster,  while NYSE has 1,905.
Arbitrators play a key role in resolving disputes brought forth in the  securities industry and their performance has a direct bearing on the  fairness of a hearing. Like judges, they oversee the administration of  proceedings, including determining the number of hearing sessions a case  requires and what evidence can be admitted. Unlike judges, arbitrators  are not required to base their decisions on legal precedent or to provide  any reasoning for their decisions. In addition, their decisions—unlike  those rendered in court—can only be appealed on limited grounds.
SEC is responsible for regulating securities market participants, including  SROs such as NASD and NYSE. In addition to overseeing SROs through its  inspections, SEC approves the rules they use to administer their  arbitration programs to ensure they comply with the Exchange Act and  other securities laws and rules. When SROs propose new rules or change  existing rules, they are required to file them with SEC for approval. SEC  then provides interested parties an opportunity to comment on proposed  rules or rule changes. In general, SEC is to approve certain new or  amended rules within 90 days after they are published or institute  proceedings to determine whether they should be disapproved.
section_title: Both NASD and NYSE Have Policies and Procedures Intended to Promote Fair Arbitration for all Cases
paragraphs: In most employment disputes, arbitration is mandatory, although for  discrimination cases NYSE rules strictly limit its use and NASD has  instituted additional requirements. For both customer and employment  disputes, both SROs require that all arbitrators have certain qualifications  in order to be on their rosters of available arbitrators. However, neither  SRO verifies the qualifications for all of the arbitrators on their rosters.  Both SROs have procedures designed to ensure that the arbitrators  selected to hear cases do not have conflicts and have procedures for  evaluating arbitrator performance. Yet, arbitrators who hear cases at both  SROs may not be receiving evaluations on a routine basis.
subsections: section_title: Most Employment Disputes, Although for Discrimination Cases NYSE Has Strictly Limited Its Use and NASD Has Instituted Additional Requirements
paragraphs: Prior to 1999, both NASD and NYSE rules required the mandatory  arbitration of all employment-related disputes, including discrimination  claims. In the 1990s, as discrimination claims filed at NASD rose, some  Members of Congress challenged the use of mandatory arbitration for  discrimination disputes. In 1997, the Equal Employment Opportunity  Commission (EEOC), which is responsible for enforcing the nation’s  employment discrimination laws, published a policy statement opposing  the use of mandatory arbitration agreements for these disputes.  Opposition to mandatory arbitration for these claims stemmed from  concerns that arbitration eliminated the role the courts played in deterring  discrimination and protecting employees. In addition, others believed that  many arbitrators were unfamiliar with antidiscrimination laws and,  therefore, could not provide a fair hearing on these claims.
NASD and NYSE took different approaches in changing their rules to  address these concerns. NYSE followed EEOC’s recommendation and only  arbitrates discrimination claims when all parties agree to arbitration after  the dispute occurs. NASD, on the other hand, no longer requires that  employees arbitrate employment discrimination disputes, but will arbitrate  these disputes, based on agreements employees have made before or after  the dispute occurs. The net result is that NASD will administer arbitration  cases that include discrimination claims if the parties have entered into an  agreement to do so. This includes policies employees sign as a condition  of employment.
According to NASD, in conjunction with this rule change, they assembled  a working group to consider recommendations contained in a document  known as “A Due Process Protocol for Mediation and Arbitration of  Statutory Disputes Arising out of the Employment Relationship.” This Due  Process Protocol was developed in 1995 by a committee of representatives  from a range of organizations, to provide arbitration procedures for  statutory employment claims. Following NASD’s review of this protocol  NASD introduced additional requirements for these types of claims.  Changes ranged from setting qualifications for arbitrators who chair  arbitrator panels to specifying how arbitrators documented their  decisions.
The arbitrator chairing a discrimination case at NASD must hold a law  degree, have 10 years of legal experience, have substantial familiarity with  employment law, and must not have primarily represented employers or  employees in the last 5 years. In addition to special chair qualifications,  all the arbitrators who hear cases with discrimination claims must also be  classified as “public”—that is, individuals who are not affiliated with the  securities industry either professionally or through their family  relationships. For employment discrimination claims of $100,000 or less, a  single public arbitrator is appointed, and for claims greater than this  amount a panel of three public arbitrators is selected.
In disputes subject to arbitration that arise out of the employment or  termination of employment of an associated person, and that relate  exclusively to disputes involving employment contracts, promissory notes  or receipt of commissions, a single “nonpublic” arbitrator—that is  someone who is affiliated with the securities industry—can only hear  nondiscrimination claims of $50,000 or less. In similar cases with claims of  $50,000 or more, a panel composed of three nonpublic arbitrators is  appointed. Currently, arbitrator chairs in cases without discrimination  claims need the same qualifications as any arbitrator. At NYSE, all  employment disputes, at the option of the employee, are entitled to a panel  of three arbitrators, and a majority of the arbitrators cannot be from the  industry unless the employee requests it.
NASD rules, adopted in 2000, also made two changes to procedures  concerning arbitrator decisions in cases with employment discrimination  claims. First, the rules specifically state that arbitrators can award  “reasonable” attorney’s fees for discrimination claims. This change also  creates an incentive for attorneys to take discrimination cases because it  provides greater assurance that they will be compensated for their work if  they are successful. Second, NASD’s rule change requires arbitrators to  document the disposition of discrimination claims, something not required  for the other claims. While this rule still does not require arbitrators to  explain their decisions, it requires arbitrators to specify for the parties  how they ruled on any statutory discrimination claim.
section_title: Both SROs Have Similar Qualifications for Arbitrators and Neither Verify the Qualifications of All Applicants
paragraphs: Both SROs require that all applicants for the arbitrator roster provide  information on their affiliation with the securities industry, have 5 years of  work experience, supply two letters of recommendation, and complete  training in basic arbitration procedures. Recommendation letters must  include particular information about the person writing the letter, the  prospective arbitrator, and an attestation as to the character and fitness of  the nominee. NASD also requires that applicants take a multiple choice  examination and receive a passing score of at least 80 percent. (See fig.1.)  After receiving arbitrator applications from applicants who work or  worked in the securities industry, the SROs check the Central Registration  Depository (CRD), a computerized database that contains the educational,  work, and disciplinary history for current and former securities registered  persons. Therefore, the CRD only covers arbitrators classified as  nonpublic. Currently, information from arbitrator applicants not employed  in the securities industry is not checked by the SROs, but NASD is  proposing a rule change that would require the verification of background  information on all new arbitrators.
NASD reported that verifying the background information on all new  arbitrators would enhance the reputation of its arbitration program. If SEC  approves its rule change, NASD will use an independent firm to conduct  the background checks and will pass the cost of this process—expected to  be between $60 and $85—onto the applicant. NYSE did not report any  plans to change its procedures at this time.
At NASD, once arbitrators’ applications are approved, they must take a  half-day introductory training course, be evaluated by the trainer, and pass  a 25-question multiple choice examination on arbitration procedures. Once  they pass the examination and evaluation by the trainer, they are included  on the NASD arbitrator roster. At NYSE, on the other hand, once an  application is reviewed and approved by staff, the applicant is considered  able to arbitrate any case once he or she participates in one training  course on arbitration procedures and conduct issues.
Ongoing training at both SROs is limited. NYSE requires that arbitrators  continue to attend at least one training course every 4 years. NASD does  not have such a requirement but does offer chairperson training for those  arbitrators wanting to chair cases. One SEC official raised concerns  about mandating ongoing training for arbitrators, arguing that it may  discourage the most experienced arbitrators from serving.
section_title: Both SROs Have Procedures for Selecting Arbitrators for Cases Intended to Ensure That They Are Unbiased
paragraphs: Both SROs, recognizing that arbitrators are one of the key factors to  ensuring a fair and efficient process, have developed procedures to help  ensure that the selection of arbitrators for a case is unbiased. Prior to  1998, NASD staff selected arbitrators based on the issues in the case and  the expertise the arbitrators held. In 1996, a NASD task force, organized to  review the securities arbitration process, reported that claimants and their  representatives were concerned that staff could be biased in selecting  arbitrators. To address this concern, NASD changed how arbitrators were  selected. Since 1998, NASD has allowed both parties involved in a dispute  to choose the arbitrators, which limited NASD staff involvement in the  selection process. NASD provides parties with a computer-generated list  of up to 15 arbitrators with profiles for each arbitrator. An arbitrator’s  profile includes a paragraph on the arbitrator’s background, a summary of  the arbitrator’s education and work history, the arbitrator’s experience,  the arbitrator’s disclosure and conflict information, and a list of all the  publicly available award decisions that the arbitrator has rendered. Each  party may peremptorily strike any arbitrator from the list, then ranks the  arbitrators who remain by order of preference. If the parties do not  mutually agree on an acceptable number of arbitrators after striking and  ranking, the list is extended by the computer and the parties are assigned  the next available arbitrator(s) on the computerized roster. While this  process reduces the potential for staff bias, some arbitrators have raised  concerns that a computer-generated list may not contain arbitrators with  substantial experience.
In 2000, NYSE also began giving parties three options for selecting  arbitrators: (1) choosing randomly from a list drawn from all available  arbitrators; (2) choosing from a list the staff compiles; or (3) having NYSE  staff attorneys select, the only procedure used prior to 2000. If all parties  cannot agree on one of these options, staff attorneys determine who will  arbitrate. According to NYSE, staff selection has remained the most  common method for selecting arbitrators, with parties using it for about   85 percent of the cases. Since this method is the default if parties cannot  agree, it is not possible to determine how often this method was actually  chosen by parties, or used as the default.
At both NASD and NYSE, arbitrators selected to serve on cases are asked  to review the case and determine if they have any possible conflicts of  interest. In addition, arbitrators must update their profile, which includes  information on their employment history and affiliation with the securities  industry. Both NYSE and NASD will remove arbitrators from their roster if  they misstate or fail to disclose information concerning conflicts of  interest.
section_title: Both SROs Have Procedures to Track Arbitrator Performance, Although Many Arbitrators May Not Be Evaluated
paragraphs: Each SRO has developed three types of evaluations for arbitrators:   (1) party evaluations, completed by either party or their attorneys;   (2) peer evaluations, completed by other arbitrators who hear the case;  and (3) staff evaluations. Both SROs summarize evaluation results and  input them into a centralized arbitrator database. According to NASD  officials, staff are required to summarize and input only negative  comments on an arbitrator, although SEC staff noted that in practice it  also often sees positive comments from NASD staff recorded in the files.  NYSE officials, on the other hand, reported recording a complete summary  of the evaluations. NASD conducts quarterly audits in which they check to  see if staff members are consistently entering information in the  centralized database and documenting actions taken concerning any  evaluations. In addition, the audits review how complaint letters have  been recorded, reviewed, and resolved.
Both SROs reported that it has been difficult for them to get parties to  return evaluations. Yet, NYSE reported that response rates have  increased since it began requiring that arbitrator chairs encourage parties  to complete the evaluations and reiterate that the evaluations are  confidential and will not affect the case outcome. NYSE said that peers are  very responsive with evaluations. NYSE said it requires that staff observe  new arbitrators for their first hearing at NYSE and said it sought to  evaluate all arbitrators, who serve on a case that goes to a hearing, at least  once a year. Although NYSE said that it had fulfilled this requirement in  2002, NYSE could not provide data on evaluations showing that arbitrators  had been observed. NASD could not report how often staff evaluate  arbitrators. Officials from both SROs said that if no information is received  about an arbitrator on a case, they assume the arbitrator performed  adequately.
To gain a better understanding of how often arbitrators were evaluated,  we reviewed the records of 124 out of the 494 arbitrators at NASD who  had heard discrimination claims and/or other employment claims between  January 2001 and June of 2002. On the basis of this sample, we estimate  that about 45 percent of arbitrators who heard cases during this time had  received some type of evaluation and of those only about 2 percent  received all three types of evaluations—peer, party, and staff. (See   fig. 2 for a breakdown of the types of evaluations arbitrators received.)
Although NASD supplements its evaluations by rating arbitrators on a  quarterly basis, our review showed that ratings are often based on little  or no information. Every quarter NASD rates those arbitrators who have  been active during that time, using a 3-point scale, with 1 being the lowest  and 3 being the highest. Staff bases the rating on evaluations and  complaints received that quarter and any notes recorded during that time  frame in the arbitrator database. In general, NASD reported that any  arbitrator who did not have any evaluations during the quarter is likely to  be rated adequate (“2”). We estimate that the majority of the arbitrators  that were rated received an adequate rating of 2, whether or not they  received any evaluations during this time, and 57 percent of arbitrators  with a 2 rating had not received any evaluations during this time frame.  (See fig. 3.) Some arbitrators without evaluations during this time frame  were also rated excellent, which could be a result of the rating from the  prior quarter.
Both NASD and NYSE have mechanisms in place to address poor  performance by arbitrators. If NYSE or NASD receives either a poor  arbitrator evaluation or complaints about an arbitrator on a case, staff will  take steps to respond. For example, the staff member assigned to the case  may be asked to corroborate the complaint or be asked to consult other  arbitrators assigned to the case to see if they support the allegation. A staff  member who confirms the complaint may then speak to the arbitrator and  suggest how he or she could improve his or her behavior. If the complaint  suggests no corrective action is possible, both SROs reported that the  arbitrator would be removed from the active roster immediately. All  complaints are recorded in the arbitrator database, and both SROs  reported that staff input how the complaint will be resolved.
In reviewing the records of NASD arbitrators, we found that staff did not  always document how they responded to poor evaluations and complaints.  We estimate that 10 percent of all 494 NASD arbitrators that heard cases  between January 2001 and June of 2002, received some kind of complaint,  either from a staff member, a party member, or another arbitrator. In our  sample, 6 of the 16 arbitrators that received negative complaints were  permanently dropped from NASD’s arbitrator list and 1 was temporarily  made unavailable pending further review. One arbitrator, who had been  permanently dropped in 2001, appeared to have complaints going back to  1993, yet the notes showed that no changes had been made to the adequate  rating of 2. For another permanently dropped arbitrator, staff noted they  were concerned that no negative comments were recorded on the  computer file since other staff and arbitrators had complained about this  arbitrator’s conduct. Of the 9 remaining arbitrators, information provided  by NASD indicated that staff had followed-up on the complaints raised for  5 arbitrators.
section_title: Over the Last 10 Years, Relatively Few Employment Disputes Involved Discrimination, and Some Variations Existed between These Cases and Other Employment Disputes
paragraphs: Of the 1,546 employment cases decided by arbitrators at NASD and NYSE  over the last 10 years, 261 (17 percent) included at least 1 discrimination  claim. Cases with discrimination claims required more hearing sessions  and took longer to complete than those with no discrimination claims. At  the same time, the compensatory damages claimed in all cases was  generally over $100,000, with claimed amounts generally higher at NYSE  than at NASD. In over half of all employment cases, employees won some  level of monetary compensation, although in cases with discrimination  claims employees were generally less likely to win. In most cases, when  employees won they received less than half of the compensatory damages  they claimed, with over 50 percent of the awards over the last 10 years  being $50,000 or less. When compensatory damages were awarded in cases  involving discrimination, it tended to be higher than compensatory  damages awarded in other employment cases, with just over 60 percent of  discrimination cases receiving more than $50,000. Appendix 1 describes  the reliability and limitations of these data.
subsections: section_title: Age and Sex Discrimination Were Most Prevalent in the Relatively Few Employment Cases That Included Discrimination Claims
paragraphs: Employment cases arbitrated at NASD and NYSE can contain 1 or more  claims, some of which might involve discrimination. Of all 1,546  employment cases heard (1,289 at NASD and 257 at NYSE) at NASD and  NYSE over the last 10 years, 261 (17 percent) included at least 1 type of  discrimination claim. NASD arbitrated 202 of the cases that involved  discrimination allegations. NYSE arbitrated the remaining 59. Given that  some cases involved more than 1 type of discrimination claim, in 261 cases  a total of 324 discrimination claims were made. As shown in table 1, the  majority of these 324 discrimination claims was either age (33 percent) or  sex-based (32 percent).
Over the last 10 years, the number of cases with discrimination claims has  generally decreased at NYSE. In more recent years, this has also occurred  at NASD, although prior to 2000 the number of cases at NASD involving  discrimination fluctuated. (See fig. 4.) NASD and NYSE officials reported  that the rule changes in 1999, which altered if and how discrimination  cases are arbitrated, might have reduced the arbitration of these types of  cases.
section_title: Cases That Included Discrimination Claims Required More Hearing Sessions and Took Longer to Complete
paragraphs: Over the last 10 years, the median number of hearing sessions in  discrimination cases ranged from 5 to 10 at NASD (see fig. 5) and from 8 to  15 at NYSE (see fig. 6). The median number of hearing sessions in cases  that did not involve discrimination ranged from 4 to 5 at NASD and 5 to   11 at NYSE.
Not surprisingly, cases requiring more hearing sessions also took longer to  complete. For example, cases requiring 1 to 2 hearing sessions took   438 days on average to complete, while those requiring 5 to 8 hearing  sessions took 490 days on average. According to NASD, discrimination  cases could require more hearing sessions and take longer to complete  because they are more complex.
section_title: Amounts Claimed in the Majority of Employment Cases Were over $100,000
paragraphs: In most cases arbitrated at NASD and NYSE over the last 10 years,  employees sought more than $100,000 in compensatory damages, whether  or not the case included a discrimination claim. (See fig. 7.)
Overall, employees in NYSE cases sought higher compensatory damages  than employees in NASD cases with the average compensatory damage  claimed at NYSE over $2 million and the average compensatory damage  claimed at NASD was under $1 million. These differences might reflect  differences in the membership of the two SROs. For example, members of  NYSE tend to include mostly the larger, more established broker-dealers,  whose employees may seek higher compensatory damages in arbitration  cases.
section_title: Cases Involving Discrimination Were Less Likely to Win Some Level of Compensatory Damages Than Cases with No Discrimination Claims
paragraphs: In general, in more than 50 percent of cases at NASD and NYSE,  employees were awarded some level of compensatory damages. (See fig.  8.)
Employees in cases involving discrimination, however, were less likely to  win some compensatory damages than employees in cases with no  discrimination claims. (See fig. 9.) Forty-eight percent of all NASD and  NYSE cases over the last 10 years that included a discrimination claim  won some level of compensatory damages compared with 61 percent of  cases with no discrimination claims.
section_title: While Most Employees Received Less Than Half of the Compensatory Damages They Claimed, Cases That Included Discrimination Claims Received Higher Awards
paragraphs: In cases where employees received a monetary award, over 60 percent of  employees received less than half of the compensatory damages they  claimed. In terms of the amount of compensatory damages awarded,  awards in cases at NYSE tended to be higher. (See fig. 10.) At NASD, just  over half of the cases won had awards of $50,000 or less, while at NYSE   70 percent of awards were over $50,000.
Compared with cases with no discrimination claims, employees in cases  involving discrimination were more likely to receive larger awards. (See  fig. 11.) Sixty-two percent of cases with discrimination claims that  received monetary awards had an award amount over $50,000, compared  with 48 percent of cases without discrimination claims.
In addition to receiving monetary compensation, employees sometimes  seek and receive nonmonetary awards. For example, an employee may  want defamatory language removed from his or her record. In the  employment cases that we analyzed, approximately 13 percent of  employees won some type of nonmonetary award without any monetary  award.
section_title: SEC Oversight Found SROs Could Improve Procedures to Ensure Arbitrators Are Qualified and Perform Well
paragraphs: To assess arbitration programs at NASD and NYSE, SEC conducts periodic  inspections and reviews complaint letters it receives. It has cited problems  at one or both SROs in the procedures used to (1) ensure arbitrators are  qualified and (2) track arbitrator performance. SEC generally reviews  arbitration procedures, arbitrator profiles, disclosure reports, and closed  cases and interviews staff during its inspections. Although SEC officials  indicated that complaint letters could affect the focus of an inspection, we  found that few of the letters SEC receives focus on employment  arbitration. In its most recent inspections, in addition to problems with  procedures both SROs used to ensure arbitrators are qualified, SEC found  that one or both SROs did not record information on arbitrator  performance in a central database or disqualify all arbitrators who were  poor performers from hearing cases. Both SROs have taken some steps to  address the problems.
subsections: section_title: SEC Conducts Systematic Inspections and Reviews Complaint Letters to Assess SRO-Administered Arbitration Programs
paragraphs: Since 1995, SEC has examined NASD’s and NYSE’s arbitration programs  three times each and has routinely responded to complaint letters about  the process. Most inspections have focused on either case processing or  recruiting and maintaining arbitrators. In general, inspections also  included reviewing problems raised in previous inspections to determine  whether they had been resolved. (See fig. 12.)
In conducting inspections, SEC reviews a variety of documents,  summarizes findings, develops recommendations, and provides SRO with  the opportunity to comment on both its findings and recommendations.  The documents SEC reviews generally include case files and arbitrator  profiles and disclosure reports. Some of the case files are chosen  randomly while others are selected based on risk factors that suggest  problems may exist, such as the length of time it took to complete a case.  In addition to reviewing documents, SEC interviews SRO staff to better  understand its operations. In its 2000 inspection of NASD, SEC reviewed  110 arbitrator profiles and disclosure reports and 89 arbitration case files.  In its 2001 inspection of NYSE, SEC reviewed 200 arbitrator profiles and  disclosure reports and 40 customer and employment cases in addition to  other documents. An SEC official noted that under the Exchange Act,  SEC has a broad range of authority to address deficiencies found in an  inspection.  As a practical matter, SEC staff and SROs discuss deficiencies  and document that necessary steps have been taken.
In addition to carrying out inspections to oversee SRO arbitration  programs, SEC reviews complaint letters from individuals employed in the  securities industry and other interested parties regarding SRO- administered arbitration programs. Of all the complaint letters SEC  receives, however, only a small percentage raise concerns about the  arbitration and an even smaller percentage deal with employment cases.  According to SEC’s complaint letter log, of the over 12,000 complaint  letters SEC received from January 1992 through October 2002,  approximately 500 contained a specific reference to arbitration. We  reviewed a random sample of 100 of the letters that referred to arbitration  and found 16 that discussed the arbitration of employment clams. Of the  16, 6 raised concerns about the use of mandatory arbitration to address  employment or employment discrimination claims. The other 10 letters  dealt with a variety of issues, including the amount of time allocated to  address a claim, the scheduling of hearings, and a proposal to limit  damages that can be claimed.
An SEC official with the division that approves SRO rules said the division  responds to all complaint letters it receives, which are tracked using the  database letter log. The official indicated that when letters register  general discontent with the arbitration process but do not contain a  specific allegation, parties are provided general information about  arbitration, including information on the narrow procedural mechanism  for challenging awards. When letters contain specific allegations, SEC  attorneys contact the SRO or use other means to investigate the allegation  before providing a response. SEC attorneys may also forward a copy of the  letter to the office that oversees periodic inspections, so it can assess the  allegation in its inspection activities. For example, an SEC official  reported that SEC had placed special emphasis in a recent inspection on  reviewing updates SRO staff made to arbitrator profiles and disclosure  reports in response to concerns raised in a complaint letter.
section_title: SEC Has Made a Variety of Recommendations to Improve SRO Procedures
paragraphs: In recent inspections, SEC staff identified a number of ways NASD and  NYSE could improve their procedures for ensuring that arbitrators are  qualified and for tracking arbitrator performance. For example, to ensure  that arbitrators are qualified, SEC staff recommended that one or both  SROs    ensure that they consistently conduct CRD checks of all industry  arbitrators and document those reviews in arbitrator profiles;    ensure that all arbitrator profiles are complete and reflect new or  updated information arbitrators submit about themselves;  lengthen training courses for new arbitrators;  include in arbitrator training manuals guidance on certain arbitration  procedures and certain problems arbitrators are likely to encounter;  and    develop policy on how often arbitrators must attend ongoing training,  the circumstances under which it can be waived, and documentation of  reasons waivers are granted.
On the basis of our review of SRO documents containing policies and  standard procedures and interviews with SRO officials, we found that each  SRO had taken steps to address SEC’s recommendations. One or both  SROs now require that CRD checks be recorded in arbitrator profiles; have  an online reporting form arbitrators can use to submit updated  information about themselves; and have a basic training course for new  arbitrators, more comprehensive training manuals, and a written policy  regarding ongoing arbitrator training.
In addition, in recent inspections, SEC staff found that the procedures in  place to track arbitrator performance could be improved. For example,  SEC staff recommended that one or both SROs    ensure that all pertinent information on arbitrator performance,  whether negative or positive, is recorded in a central database and    do more to address complaints of poor arbitrator performance,  including, if appropriate, removing arbitrators from the active pool and  better documenting actions taken in response to complaints of poor  performance.
SEC staff reported that it appears from recent ongoing and completed  inspections that the SROs have taken steps to address these  recommendations.
In general, to determine if any issues raised in past inspections remain  unresolved, SEC, at the beginning of each new inspection, reviews  recommendations from prior inspections. SEC is currently inspecting  NASD and will report on the results, including unresolved issues, if any,  within the next year. NYSE will be reexamined beginning in 2003, at which  time SEC will assess what additional steps, if any, NYSE has taken to  address the issues reported here.
section_title: Conclusions
paragraphs: SEC oversees NYSE and NASD, which regulate their member firms in the  securities industry. All three are responsible for ensuring that the  procedures for arbitrating discrimination and other employment disputes  are fair and the requirements of the Exchange Act are met. Although SEC’s  approval of rules governing arbitration programs and its periodic  inspections of these programs has resulted in improvements, there are  aspects of these programs that deserve closer scrutiny.
Currently, NASD and NYSE verify the qualifications for those arbitrators  who have worked in the securities industry and neither SRO verifies the  information provided by nonindustry arbitrators.  While we did not find  instances where arbitrators provided false statements of qualifications,  verifying the qualifications of all arbitrator applicants is an important step  in ensuring that employees and employers receive accurate information on  the arbitrators they select to hear their cases. Additionally, while SEC has  reviewed both SROs procedures for evaluating arbitrator performance, we  found evidence that arbitrators are not evaluated on a routine basis.  Although NASD has procedures for peer, party, and staff to evaluate  arbitrators and identify poor performers, these evaluations are not always  completed. While NYSE officials indicated that NYSE has similar  procedures and reported staff generally evaluate active arbitrators at least  once a year, we were unable to confirm this information. Securities  industry employees must use NASD and NYSE arbitration programs to  resolve most employment disputes. Therefore, more effort should be made  to verify that arbitrators meet the qualifications SROs require and to  encourage parties, other arbitrators, and staff to submit evaluations more  regularly, so that only arbitrators who perform adequately are maintained  on SRO rosters.
section_title: Recommendations
paragraphs: To help ensure that all NASD and NYSE arbitrators possess the  qualifications required by their SRO, we recommend that the Chairman of  SEC direct NASD and NYSE to verify basic background information of all  new applicants for their arbitrator rosters. We also recommend that SEC  continue to review the adequacy of procedures for evaluating arbitrator  performance in their next inspections at NASD and NYSE.
section_title: Agency and SRO Comments
paragraphs: We provided a draft of this report to SEC, NASD, and NYSE for their  review. A copy of their written comments is in appendixes II, III, and IV,  respectively. SEC, NASD, and NYSE also provided technical comments on  the draft report, which were incorporated as appropriate.
SEC agreed with the focus of our recommendation concerning the  verification of background information. However, SEC believed that in the  absence of any indication that the falsification of information is a problem,  it might not be necessary for NYSE, as a smaller arbitration forum than  NASD, to add this cost to the arbitration process. As a result, SEC  indicated that it should be up to NYSE to decide whether the independent  verification of basic background information of arbitrator applicants is  needed. NASD noted that although it has had no evidence that arbitrators  ever falsified information, it is planning to verify the background  information on all new applicants to increase party confidence in the  accuracy of arbitrator records. NASD reported that a one-time fee for  arbitrator applicants would cover the cost of this procedure. NYSE  reported that since it has found no proof of anyone providing false  information, there is insufficient justification for independently verifying  application information and adding costs to the process. In addition, NYSE  believes that it has already taken steps to ensure that its application  procedures are adequate, such as having applicants affirm that the  information they provide is correct and requiring two recommendation  letters. NYSE also indicated that counsel for employees can and do take  further actions to review the background of arbitrators.
Despite concerns raised by SEC and NYSE, we continue to believe that  verifying background information for all new arbitrators is an important  part of ensuring the integrity of arbitration, a process required for most  disputes.  While adding costs to the process is a legitimate concern,  NASD’s approach of instituting a one-time application fee of $80 would not  increase the expense of arbitration for the parties involved. Additionally,  the fact that lawyers representing parties are already sometimes verifying  information suggests that verification is valued and further supports the  need for it to be done independently and systematically for all new  arbitrators. Moreover, although our report has focused on the arbitration  of employment cases, a small percentage of all the cases arbitrated in the  securities industry, our recommendation will benefit all parties, since  NASD and NYSE arbitrators are available for both employment and  customer cases.
Concerning our recommendation that SEC continue to review evaluation  procedures at SROs, SEC, NASD, and NYSE, all indicated that they  understand the importance of evaluating arbitrators. Specifically, SEC  agreed that evaluating arbitrator performance is a fundamental element of  the arbitration process and reported that it will continue to review the  adequacy of procedures for evaluating arbitrator performance during its  inspections of SRO arbitration programs. NASD noted that it would strive  to provide better documentation of the actions it takes in response to  complaints or evaluations. NYSE reported it has a new computer system  that creates a centralized, easily accessible record of all feedback and  comments from arbitrator evaluations, which will allow staff to have a  more comprehensive view of an arbitrator’s performance.
As arranged with your offices, unless you announce its contents earlier,  we plan no further distribution of this report until 30 days after the date of  this report. At that time, we will provide copies of this report to the  Chairman of SEC, the President of NASD, and the Director of Arbitration  for NYSE, appropriate congressional committees, and other interested  parties. We will also make copies available to other interested parties,  upon request. This report will be available at no charge on GAO’s Web site  at http://www.gao.gov.
If you have any questions about this report, please contact me on   (202) 512-9889. Other contacts and staff acknowledgments are listed in  appendix V.
section_title: Appendix I: Scope and Methodology
paragraphs: This appendix provides a detailed description of the scope and  methodology we used to determine (1) the characteristics and outcomes  of arbitrated employment and employment discrimination disputes in the  securities industry; (2) who evaluates arbitrators and what performance  ratings they receive; and (3) how the Securities and Exchange Commission  (SEC) responds to complaint letters it receives concerning arbitration of  employment and employment discrimination cases.
subsections: section_title: Determining the Characteristics and Outcomes of Arbitrated Employment Disputes
paragraphs: To determine the nature and outcomes of employment and employment  discrimination disputes in the securities industry, we analyzed a database  containing employment disputes in which arbitration decisions had been  made by NASD or the New York Stock Exchange (NYSE) from January  1993 through June 2002. We obtained this database from Securities  Arbitration Commentator, Inc. (SAC), Maplewood, New Jersey. SAC is a  commercial research firm that maintains a database of information from  publicly available records on decided cases from all self-regulatory  organizations (SRO) arbitration forums, as well as the American  Arbitration Association.
The SAC database contained information on arbitration awards that  resulted from employee claims for damages against SRO member firms. By  definition, this database did not include cases that were settled or  withdrawn before an arbitration decision was reached. The 1,564 cases in  the database included fields describing a range of variables, such as the  name of the forum, the parties involved in the case, types of claims in the  case, amounts of compensatory damages claimed, and amounts of  compensatory damages awarded. Data on every variable we analyzed were  not available for all 1,546 employment cases arbitrated at NASD and NYSE  over the last 10 years. Our analyses of the median number of hearing  sessions were based on 96 percent of the total 1,546 cases. The amounts  claimed in discrimination and nondiscrimination cases, overall, were  based on 84 percent of the 1,546 cases. All other analyses presented in this  report were based on the total 1,546 employment cases arbitrated over the  last 10 years, unless otherwise noted.
To assess the reliability of the data we received from SAC, we reviewed  100 randomly sampled cases in the database, 50 with discrimination claims  and 50 without discrimination claims. To verify the accuracy of the  information for cases in the database, we compared this information with  information in copies of the original awards for the same cases as issued  by the forums or as reprinted by Lexis/Nexis. For most variables, data  reliability was adequate for the analysis we conducted. We did not use any  variables in the SAC database with high error rates. However, we were  unable to verify that the SAC database included all cases decided by NASD  or NYSE from January 1993 through June 2002.
section_title: Determining Arbitrator Performance
paragraphs: To determine who evaluates arbitrators and what performance ratings  they receive, we first generated a list from the SAC data file of all NASD  arbitrators who had decided at least 1 employment case that did not  include a discrimination claim. We stratified this list of 494 arbitrators into  two groups—those that had also decided at least 1 case involving  discrimination during this time and those that had not decided any cases  involving discrimination. We selected all 60 arbitrators from the group that  had heard at least 1 discrimination case and selected a random sample of  64 of those that had not heard any and obtained NASD’s files containing  evaluation and rating information for each of these 124 arbitrators. From  the files associated with the sampled arbitrators, we extracted data on the  number of evaluations, if any, these arbitrators received from the parties  and/or other arbitrators in the cases they had decided and on performance  ratings these arbitrators received.
Each arbitrator in our study population of 494 had a nonzero probability of  being selected for our sample. In analyzing data about the arbitrators in  our sample, we weighted each sampled arbitrator to account statistically  for all arbitrators in the study population, including those who were not  selected.
Because we followed a probability procedure based on random selections,  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 95 percent confidence intervals. These are intervals 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 value in the study population.  The width of a confidence interval is also referred to as the sampling error  associated with the estimate. Sampling errors associated with estimates  from our file review do not exceed plus or minus 15 percentage points.
section_title: Determining the Content of SEC Complaint Letters
paragraphs: SEC tracks complaint letters in a computerized database and has logged  over 12,000 from 1992 through October 2002. To determine how SEC  responds to complaint letters it receives concerning arbitration of  employment and employment discrimination cases, first we asked SEC  staff to search its database and identify those letters that mention  arbitration. SEC found that approximately 500 of the logged letters  mentioned arbitration. We reviewed the content of a random sample of  100 of these letters to determine how many dealt specifically with  arbitration of employment or employment discrimination claims. Out of  the 100 letters, we found 16 that dealt with the arbitration of employment  or employment discrimination claims. Twenty-five of the 100 letters in our  sample were missing from SEC files, and the issues raised in the remaining  59 letters were either unclear or unrelated to employment cases.
section_title: Appendix II: Comments from the Securities and Exchange Commission
section_title: Appendix III: Comments from NASD
section_title: Appendix IV: Comments from the New York Stock Exchange
section_title: Appendix V: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to those named above, Susan S. Pachikara, Joan K. Vogel, and  Sidney H. Schwartz made significant contributions to this report.