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New York Times Spotlights Arbitrator Conflicts-of-Interest

Check out this article from the Sunday edition of the New York Times which examines potential flaws in the process in which arbitrators disclose their conflicts in securities arbitrations. The story focuses on a couple who lost $48 million of their $60 million stock portfolio, which they had invested primarily in Level 3 Communications and WorldCom. The couple sued their broker for allegedly failing to diversify their portfolio.

Although, at first glance, the case seems like another run-of-the-mill securities case in the wake of the tech bubble burst (albeit an expensive one), the interesting fact is that four days before the arbitration hearing was to scheduled to begin, plaintiffs’ counsel discovered that the chair of the arbitration panel had a significant conflict-of-interest. It turns out the chair’s firm represented  the broker on numerous occasions in the past 5 years. The NASD removed the chair and indefinitely postponed the hearing date until a new chair could be appointed.

Everyone can agree that arbitrators have a duty to disclose all potential conflicts. This case highlights the fact that some arbitrators may not be taking this duty seriously enough. In a court of law, when judges are deciding whether to recuse themselves based upon a conflict, they are required to guard against not only actual impropriety, but even the “appearance of impropriety.” Arbitrators, who wield as much or more power as judges over the cases they decide, must hold themselves to the same standard not only to be fair to the individual participants in the arbitration, but also to protect the integrity of the arbitration system as a whole. The New York Times article suggests that the self-regulatory organizations should adopt new rules to address conflicts issues, such as requiring defense counsel to investigate ties among its firm, its client and arbitrators assigned to a case and report them to the regulators. However, the most efficient way to address the issue of conflicts is for arbitrators to take seriously their duties and thoroughly examine and disclose at the outset any potential conflicts.      

Full post as published by OverRegd - Securities Regulation and Litigation Blog on August 14, 2007 (boomark / email).