In Focus: Case Cites Fraud as Reason for Court, Not Arbitration

American Banker  |  Friday, March 21, 2003

By Robert Julavits

As the debate over the brokerage arbitration process continues, some attorneys are coming up with alternative ways to push investor-broker disputes into court.

In a pending case in New York state court, attorneys argue that a client of Citigroup Inc.'s Citicorp Investor Services lost nearly $100,000 investing in WorldCom Inc. bonds that were recommended in "phony and conflicted" research provided to her by Salomon Smith Barney, a sister company.

The investor, Sylvia Bass, had agreed to arbitration with Citicorp. Salomon, the clearing agent for her investments, says it is covered by that arbitration agreement. But the attorneys say that since the dispute is about Salomon's research - specifically that of former telecommunications industry analyst Jack Grubman - the complaint properly should get a court hearing.

Ms. Bass' complaint, filed in late 2002, alleges "conduct constituting fraud by Grubman and Salomon in issuing phony analyst reports" and says she "would have the same claims against Salomon if she had been a client of Merrill Lynch." In other words, investors should get their day in court if fraud can be proved - especially if they are suing a third-party purveyor of research with whom they have no arbitration agreement.

Jeffrey S. Feinberg and Daniel R. Solin, the attorneys representing Ms. Bass, acknowledge the hurdles in dodging arbitration. But they use the same argument that critics of the process have long used: Arbitration inherently favors the brokerage industry, not individual investors. "There's a tremendous anti-investor bias built into the system," Mr. Feinberg said.

Emboldened by last year's research scandals and other investigations into how Wall Street firms treat individual clients, opponents of the arbitration process say the winds are shifting in their favor. During his Senate confirmation hearing in February, new Securities and Exchange Commission head William H. Donaldson pledged to look into the arbitration process.

One of the chief complaints has been about the central role of the National Association of Securities Dealers, which handles 90% of arbitration cases, according to a recent study by the law firm Hooper & Weiss. In arbitration, the investor and the broker are given lists of arbitrators from which to choose. They each rank their preferences and then the NASD makes the assignment. Some panels have three arbitrators. Disputes with claims under $50,000 have one.

Linda D Fienberg, the president of dispute resolution at the NASD, said both court and arbitration provide fair procedures, but arbitration has many advantages, such as greater speed, quicker resolution, and lower cost, she said.

Still, the NASD has come under fire. In a January decision, New York Supreme Court Justice Eileen Bransten upbraided the organization in a dispute over a panel member. In the case, attorneys for the investor said the chairman of an arbitration tribunal "omitted material facts" about his employment history and should have been removed from the panel. Though the judge denied the request, citing the language that the NASD "may" remove an arbitrator if information is not disclosed, she also questioned why the association would not do so.

"It is extremely disappointing and distressing … that the NASD has not as a matter of discretion disqualified [the chairperson]," Judge Bransten wrote.

Several attorneys who are not involved in the Salomon Smith Barney case said the strategy was a novel one but would likely fail.

Seth Taube, the chairman of securities litigation and business crimes at McCarter & English LLP in New York, said courts give "a tremendous deference" to honoring arbitration agreements. "There's tremendous public policy favoring broad enforcement of arbitration," he said. The process "is a major alternative."

The attorneys suing Salomon Smith Barney on behalf of Ms. Bass said they were optimistic that their main point would get noticed. Mr. Solin said, "Investors that rely on fraudulent research to invest have a direct claim against firms that produced it."

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