United States General Accounting Office GAO Report to Congressional Requesters August 2003 EMPLOYMENT DISPUTES Recommendations to Better Ensure That Securities Arbitrators Are Qualified GAO-03-790 August 2003 EMPLOYMENT DISPUTES Recommendations to Better Ensure That Highlights of GAO-03-790, a report to Securities Arbitrators Are Qualified congressional requesters Employees in the securities Arbitration is generally required for most employment disputes, except those industry must submit to binding dealing with discrimination claims. NYSE will only arbitrate discrimination arbitration in most employment cases when parties involved agree to arbitrate after the dispute occurs. disputes. The Securities and NASD will arbitrate employment discrimination cases based on agreements Exchange Commission (SEC) is entered into between employees and firms before or after a dispute occurs. responsible for overseeing these arbitration programs—the largest NASD has instituted additional requirements, however, for these cases, such being run by NASD and the New as requiring that arbitrators not be affiliated with the securities industry. In York Stock Exchange (NYSE). The addition, those chairing hearings for employment discrimination cases must Congress asked GAO to examine hold a law degree, have 10 years of legal experience, have substantial (1) the circumstances under which familiarity with employment laws, and must not have primarily represented NASD and NYSE will arbitrate employers or employees in the last 5 years. employment and employment discrimination disputes, and their To qualify to hear cases, NASD and NYSE require that arbitrators have at procedures for selecting and least 5 years of work experience, supply two letters of recommendation, and evaluating their arbitrators; (2) the complete training in basic arbitration procedures. Arbitrators must also characteristics and outcomes of provide information on their complete employment history, including any arbitrated employment and employment discrimination affiliation with the securities industry, as well as information on whether disputes at NASD and NYSE over they have any regulatory or criminal history. Neither organization the last 10 years; and (3) how SEC independently verifies the qualifications for applicants not associated with oversees the arbitration programs the securities industry. In addition NASD and NYSE have standard at NASD and NYSE and the results procedures for ensuring that arbitrators selected to hear cases do not have of these oversight activities. 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 To help ensure that only qualified arbitrators hear employment and the arbitrator’s performance was adequate. employment discrimination cases at NASD and NYSE, GAO Over the last 10 years, 261 (17 percent) of the 1,546 employment disputes recommends that SEC direct NASD arbitrated at NASD or NYSE included a discrimination claim. Discrimination and NYSE to verify the background cases differed from cases with disputes that did not involve discrimination in information provided by all the following ways: arbitrator applicants. In addition, GAO recommends that SEC, during • Discrimination cases required more hearing sessions. its next inspections, continue to • Employees won discrimination cases less often than cases not involving review the adequacy of NASD’s and NYSE’s procedures for evaluating discrimination claims. arbitrator performance. SEC, • In cases that employees won, the monetary award in discrimination NASD and NYSE all expressed cases was generally larger than in cases not involving discrimination. support for the second recommendation, but SEC and SEC periodically inspects NASD and NYSE arbitration programs. On the NYSE raised concerns about basis of its inspections, SEC has recommended improvements. In its most requiring verification at NYSE. recent inspections of NASD and NYSE, SEC made various recommendations concerning procedures for ensuring that arbitrators are qualified. In www.gao.gov/cgi-bin/getrpt?GAO-03-790. addition, SEC recommended that one or both improve procedures for To view the full report, including the scope recording information on arbitrator performance in a central database and and methodology, click on the link above. for disqualifying arbitrators who are poor performers. For more information, contact Robert Robertson at (202) 512-9889 or firstname.lastname@example.org. Contents Letter 1 Results in Brief 2 Background 4 Both NASD and NYSE Have Policies and Procedures Intended to Promote Fair Arbitration for all Cases 7 Over the Last 10 Years, Relatively Few Employment Disputes Involved Discrimination, and Some Variations Existed between These Cases and Other Employment Disputes 17 SEC Oversight Found SROs Could Improve Procedures to Ensure Arbitrators Are Qualified and Perform Well 28 Conclusions 32 Recommendations 33 Agency and SRO Comments 33 Appendix I Scope and Methodology 36 Determining the Characteristics and Outcomes of Arbitrated Employment Disputes 36 Determining Arbitrator Performance 37 Determining the Content of SEC Complaint Letters 38 Appendix II Comments from the Securities and Exchange Commission 39 Appendix III Comments from NASD 41 Appendix IV Comments from the New York Stock Exchange 47 Appendix V GAO Contacts and Staff Acknowledgments 51 GAO Contacts 51 Staff Acknowledgments 51 Page i GAO-03-790 Employment Disputes in the Securities Industry Table Table 1: Types of Discrimination Claims in Employment Cases at NASD and NYSE, 1993 through 2002 18 Figures Figure 1: Application Process 11 Figure 2: Types of Evaluations Arbitrators Received at NASD 15 Figure 3: How NASD Arbitrators Were Rated 16 Figure 4: Number of Cases Involving Discrimination at NASD and NYSE, 1993 through 2002 19 Figure 5: Median Number of Hearing Sessions for Discrimination and Nondiscrimination Cases at NASD, 1993 through 2002 20 Figure 6: Median Number of Hearing Sessions for Discrimination and Nondiscrimination Cases at NYSE, 1993 through 2002 21 Figure 7: Percentage of Discrimination and Nondiscrimination Cases at NASD and NYSE from 1993 through 2002, by Amount Claimed 22 Figure 8: Percentage of Cases at NASD and NYSE in Which Employees Were Awarded Compensatory Damages, 1993 through 2002 24 Figure 9: Percentage of Discrimination and Nondiscrimination Cases at NASD and NYSE in Which Employees Were Awarded Compensatory Damages, 1993 through 2002 25 Figure 10: Percentage of Cases Won at NASD and NYSE from 1993 through 2002 by Amount Awarded 26 Figure 11: Percentage of Discrimination and Nondiscrimination Cases at NASD and NYSE from 1993 through 2002, by Amount Awarded 27 Figure 12: Focus of SEC Inspections of NASD and NYSE, 1995-2002 29 Page ii GAO-03-790 Employment Disputes in the Securities Industry Abbreviations CRD Central Registration Depository EEOC Equal Employment Opportunity Commission NYSE New York Stock Exchange SAC Securities Arbitration Commentator SEC Securities and Exchange Commission SRO self-regulatory organization This is a work of the U.S. Government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. It may contain copyrighted graphics, images or other materials. Permission from the copyright holder may be necessary should you wish to reproduce copyrighted materials separately from GAO’s product. Page iii GAO-03-790 Employment Disputes in the Securities Industry United States General Accounting Office Washington, DC 20548 August 29, 2003 The Honorable John D. Dingell Ranking Minority Member Committee on Energy and Commerce House of Representatives The Honorable Edward J. Markey Ranking Minority Member Subcommittee on Telecommunications and the Internet Committee on Energy and Commerce House of Representatives 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)1, which regulate the firms in the securities industry that are their members. Two SROs, NASD2 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. 1 SROs have an extensive role in regulating the U.S. securities markets, including ensuring that members comply with federal securities laws and SRO rules. SROs include all the registered U.S. securities exchanges and clearing organizations, NASD, and the Municipal Securities Rulemaking Board. 2 NASD was formerly known as the National Association of Securities Dealers, but now goes solely by the acronym. Page 1 GAO-03-790 Employment Disputes in the Securities Industry 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. Both NASD and NYSE have policies and standard procedures intended to Results in Brief ensure fair arbitration in all disputes, but the circumstances under which they will arbitrate employment and employment discrimination cases differ. Arbitration is required for most employment disputes in the securities industry, except for discrimination cases. 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 Page 2 GAO-03-790 Employment Disputes in the Securities Industry familiarity with employment laws, and must not have primarily presented employers or employees in the last 5 years. NYSE, on the other hand, will only arbitrate if both parties agree after a discrimination claim has been asserted. To qualify to hear cases, NASD and NYSE require that applicants provide information on their employment history, including their affiliation with the securities industry as well as information on whether they have any regulatory or criminal disciplinary history, have at least 5 years of work experience, supply two letters of reference, and complete training in basic arbitration procedures. Neither organization verifies the qualifications submitted by 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, for evaluating arbitrator performance, and for removing poorly performing arbitrators from their rosters. As an indication of how well an arbitrator conducts hearings and makes decisions, NASD and NYSE rely primarily on the evaluations of arbitrators by staff, parties in disputes, and other arbitrators on cases. However, since some of these evaluations are voluntary, not all NASD or NYSE arbitrators are evaluated for every case they hear. Officials at each SRO reported 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 by NYSE and NASD involved one or more discrimination claim(s), most often related to age or sex, and the characteristics and outcomes of discrimination cases were somewhat different from those cases not involving discrimination. Disputes involving discrimination required more hearing sessions and took longer to complete than cases with no discrimination claims. The compensatory damages claimed for the majority of cases, whether or not it included a discrimination claim, was over $100,000. Although the majority of employees were awarded some compensatory damages, employees in discrimination cases were less likely to be awarded any compensatory damages. Most employees in discrimination cases who were awarded compensatory damages, however, received more than their counterparts in cases not involving discrimination. Based on periodic inspections of NASD and NYSE and reviews of complaint letters, SEC has found problems with procedures that one or both SROs used to oversee arbitrator qualifications and track arbitrator performance. SEC inspections generally include a review of arbitration procedures, interviews with staff, and a review of arbitrator profiles and closed cases, including both employment and employment discrimination Page 3 GAO-03-790 Employment Disputes in the Securities Industry cases. According to SEC officials, complaint letters can affect the focus of an inspection, but we found that SEC receives relatively few letters concerning employment arbitration. 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 improving procedures for recording information on arbitrator performance in a central database and for disqualifying arbitrators who are poor performers. For example, SEC recommended that arbitrators’ files be updated to reflect changes submitted by arbitrators that affect their qualifications. Both NYSE and NASD have taken steps to implement SEC’s recommendations. To help ensure that all NASD and NYSE arbitrators possess the qualifications required by their SRO, we recommend that SEC direct NASD and NYSE to verify the basic background information provided by all new applicants for their arbitrator rosters. We also recommend that SEC, during its next inspections, continue to review the adequacy of NASD and NYSE procedures for evaluating arbitrator performance. SEC, NASD, and NYSE all expressed support of the second recommendation, but SEC and NYSE raised concerns about requiring verification of information for arbitrator applicants at NYSE. We continue to believe the value of authenticating basic background information of arbitrator applicants outweighs these concerns because it will increase party confidence in arbitration, a process that is required for the majority of disputes. NASD indicated the steps they have taken to begin verifying the background information for all new arbitrator applicants. The arbitration of disputes first occurred at NYSE in the late nineteenth Background 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.3 Subsequent court decisions permitted the use of mandatory arbitration for resolving other employment discrimination disputes, including sexual harassment.4 3 Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20 (1991). 4 Alford v. Dean Witter Reynolds, Inc., 939 F. 2d 229 (5th Cir. 1991); Cremin v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 957 F. Supp. 1460 (N.D. Ill. 1997); andCircuit City v. Adams, 532 U.S. 105 (2001). Page 4 GAO-03-790 Employment Disputes in the Securities Industry 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.5 SROs include NYSE that operates and regulates its market, as well as NASD, a private-sector provider of financial regulatory and dispute resolution services.6 Their responsibilities include overseeing the arbitration of claims brought in the securities industry by customers, firms,7 and employees as required by the Securities and Exchange Act of 1934 (the Exchange Act).8 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 5 According to NYSE, the overwhelming majority of employees in arbitration are represented by attorneys who specialize in employment law. 6 Although NASD and Nasdaq are in the process of separating, as of this date NASD is the SRO and Nasdaq is a subsidiary of NASD. Nasdaq’s application for Exchange Registration status as a registered securities exchange under Section 6 of the Exchange Act is still pending before SEC. NASD delegates to NASD Regulation, its wholly owned subsidiary, SRO responsibilities as its regulatory arm. 7 Firms must register with an SRO to operate within the securities industry and must abide by its rules. 8 Customers bring the majority of arbitration cases in the securities industry. For example, in 2002, 78 percent of all decided cases at NASD were customer cases. Similarly, in 2002, only approximately 9 percent of all cases filed with NYSE were filed by employees. Page 5 GAO-03-790 Employment Disputes in the Securities Industry requires and what evidence can be admitted.9 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.10 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. 9 At both NASD and NYSE, arbitrators are classified as either public or nonpublic (NYSE uses the term industry). A nonpublic arbitrator is someone from the securities industry, retired from or has spent a substantial part of their career in the securities industry, or is an attorney, accountant, or professional who devoted more than 20 percent of his or her professional work to securities industry clients in the last 2 years. Public arbitrators then are those arbitrators who do not fall into the industry category and in addition do not have a spouse or a household member (referred to as an immediate family member at NASD) who is associated with someone in the securities industry. In June 2003, NASD filed proposed amendments to rules contained in its Code of Arbitration Procedure regarding the classification of public arbitrators. The purpose of proposed rule amendments was to further ensure that individuals with significant ties to the securities industry may not serve as public arbitrators. 10 Certain rules proposed by SROs that deal with a narrow list of topics, such as rules that establish or change dues, fees, or other charges that can become effective upon filing with SEC without action by SEC. SEC is required to publish notice of the proposed rule changes filed by the SRO and the rule change is subject to a 21-day comment period that begins when the notice of the filing is published. Within 60 days of SRO’s filing of a rule that is effective upon filing, SEC can annul the rule change and require that the rule be refiled under the normal notice and comment period. Page 6 GAO-03-790 Employment Disputes in the Securities Industry In most employment disputes, arbitration is mandatory, although for Both NASD and NYSE discrimination cases NYSE rules strictly limit its use and NASD has Have Policies and instituted additional requirements. For both customer and employment disputes, both SROs require that all arbitrators have certain qualifications Procedures Intended in order to be on their rosters of available arbitrators. However, neither to Promote Fair SRO verifies the qualifications for all of the arbitrators on their rosters. Both SROs have procedures designed to ensure that the arbitrators Arbitration for all selected to hear cases do not have conflicts and have procedures for Cases evaluating arbitrator performance. Yet, arbitrators who hear cases at both SROs may not be receiving evaluations on a routine basis. Arbitration Is Required for Prior to 1999, both NASD and NYSE rules required the mandatory Most Employment arbitration of all employment-related disputes, including discrimination Disputes, Although for claims.11 In the 1990s, as discrimination claims filed at NASD rose,12 some Members of Congress challenged the use of mandatory arbitration for Discrimination Cases discrimination disputes. In 1997, the Equal Employment Opportunity NYSE Has Strictly Limited Commission (EEOC), which is responsible for enforcing the nation’s Its Use and NASD Has employment discrimination laws, published a policy statement opposing Instituted Additional the use of mandatory arbitration agreements for these disputes. Requirements 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.13 The net result is that NASD will administer arbitration 11 Associated persons of broker-dealers accept the rules of SROs by signing the U-4, the application they must complete to become registered with a SRO. Within the U-4, applicants agree to arbitrate any dispute claim or controversy that is required to be arbitrated under the rules, constitutions, or by-laws of the SRO. 12 Discrimination claims filed rose from 4 in 1991 to 109 in 1996 (see Federal Register, 62, 242). 13 As approved by SEC, effective January 1, 1999, NASD’s Code of Arbitration Procedures were amended so that registered persons were no longer required to arbitrate claims of statutory employment. Page 7 GAO-03-790 Employment Disputes in the Securities Industry 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 group14 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,15 to provide arbitration procedures for statutory employment claims. Following NASD’s review of this protocol NASD introduced additional requirements for these types of claims.16 Changes ranged from setting qualifications for arbitrators who chair arbitrator panels17 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 primarily18 represented employers or employees in the last 5 years.19 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 14 The working group included attorneys representing employees, general counsels of member firms, and arbitrators with expertise in employment matters. 15 Organizations represented were involved in labor, employment law, and alternative dispute resolutions. 16 NASD has also adopted rules to allow claims to be consolidated in one case, meaning if someone chooses to take a discrimination claim to court they will also be allowed to combine nondiscrimination claims in that case. 17 Arbitration cases are heard by one or three arbitrators, depending on the size of the claim. In discrimination cases where there is only one arbitrator, that arbitrator must also meet these requirements. 18 Primarily is defined as 50 percent or more of the arbitrator’s business or professional activities. 19 Arbitrators who qualify to serve as chairs on discrimination disputes are asked to provide a summary description of their qualifications for discrimination disputes, which is presented to the parties in the case. This summary is in addition to the narrative summary that all arbitrators must provide regarding their general arbitrator qualifications. Page 8 GAO-03-790 Employment Disputes in the Securities Industry single public arbitrator is appointed, and for claims greater than this amount a panel of three public arbitrators is selected.20 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.21 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.22 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. 20 Parties may agree to have the case determined by a single arbitrator. 21 NASD is now considering expanding the qualifications for arbitrator chairs by requiring them to take the chair-training course and to have participated in a certain number of arbitration cases. According to NASD officials, having chairs be more familiar with the legal process would help the arbitration process. 22 SEC stated in its order approving NASD’s rule that it approved “the specific provision governing attorneys fees in cognizance of the special attention to them under the civil rights laws” and that “awards of attorney’s fees by arbitrators remain available to all parties in other cases administered under the Code of Arbitration Procedure, if applicable law permits such an award.” Self-Regulatory Organizations; Order Approving a Proposed Rule Change by the National Association of Securities Dealers, Inc., Relating to the Arbitration Process for Claims of Employment Discrimination, Release No. 34-42061 (Oct. 27, 1999). Page 9 GAO-03-790 Employment Disputes in the Securities Industry Both SROs Have Similar Both SROs require that all applicants for the arbitrator roster provide Qualifications for information on their affiliation with the securities industry, have 5 years of work experience, supply two letters of recommendation, and complete Arbitrators and Neither training in basic arbitration procedures.23 Recommendation letters must Verify the Qualifications of include particular information about the person writing the letter, the All Applicants 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.24 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.25 23 On the application form arbitrators are also asked to answer a series of questions on whether they have engaged in criminal activities and provide information on their affiliation to the securities industry—something arbitrators are required to update on an ongoing basis. For more information on arbitrator disclosure requirements, see U.S. General Accounting Office, Follow-up Report on Matters Relating to Securities Arbitration, GAO-03-162R (Washington, D.C.: Apr. 11, 2003) and Michael A. Perino, Report to the Securities and Exchange Commission Regarding Arbitrator Conflict Disclosure Requirements in NASD and NYSE Securities Arbitrations (Nov. 4, 2002). 24 NASD and the North American Securities Administrators Association established the CRD in 1981 and its use allows individual brokers and firms to meet both state and federal reporting requirements. NASD has instituted a statistical quality control process to measure the accuracy of disclosures and has periodic examinations done of the data by data quality professionals. 25 In August 2003, NASD filed a rule proposal with SEC, which would require that new arbitrator applicants have background information verified for federal and county criminal records, employment information, and professional licenses (SR-NASD-2003-122). Page 10 GAO-03-790 Employment Disputes in the Securities Industry Figure 1: Application Process Basic information applicant Verification of background Arbitrator training requirements must provide information NYSE & NASD: NYSE & NASD: NASD: Work experience and Check CRDa for those Applicants attend training and education. applicants who worked in the pass a written test before being Information on all affiliations with securities industry. placed on the roster. the securities industry. Neither checks background NYSE: Information on all regulatory and information of applicants who did Arbitrators attend training within criminal activities. not work in the securities 1st year on the roster and before industry. Two letters of reference. arbitrating a case. Source: NASD and NYSE. a A computerized database that holds the educational, work, and disciplinary history for current and former securities registered persons. 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.26 Ongoing training at both SROs is limited. NYSE requires that arbitrators continue to attend at least one training course every 4 years.27 NASD does not have such a requirement but does offer chairperson training for those 26 Arbitrators can fulfill their training requirement by reviewing the arbitrator conduct and procedures with NYSE staff prior to a hearing. In addition, NYSE reported that many of their new applicants have experience and training from other arbitration forums. 27 NYSE can waive this requirement. Page 11 GAO-03-790 Employment Disputes in the Securities Industry arbitrators wanting to chair cases.28 One SEC official raised concerns about mandating ongoing training for arbitrators, arguing that it may discourage the most experienced arbitrators from serving. Both SROs Have Both SROs, recognizing that arbitrators are one of the key factors to Procedures for Selecting ensuring a fair and efficient process, have developed procedures to help Arbitrators for Cases 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 Intended to Ensure That the expertise the arbitrators held. In 1996, a NASD task force, organized to They Are Unbiased 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.29 NASD provides parties with a computer-generated list of up to 15 arbitrators with profiles for each arbitrator.30 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 28 In mid-2003, NASD Chairperson training was converted to an online interactive program. 29 At that time, NASD reviewed all arbitrators on its roster and sent out letters to all arbitrators requesting that they update their profiles; in the process, NASD removed 800 to 1,000 arbitrators on its roster. 30 The composition of the lists depends on the size of the claim and the nature of the dispute. For example, in employment discrimination cases being heard by three arbitrators (claims of more than $100,000), the list will contain the names of 10 public arbitrators, plus the names of 5 public arbitrators who meet the special additional requirements to chair discrimination cases. Page 12 GAO-03-790 Employment Disputes in the Securities Industry 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. Both SROs Have Each SRO has developed three types of evaluations for arbitrators: Procedures to Track (1) party evaluations, completed by either party or their attorneys; Arbitrator Performance, (2) peer evaluations, completed by other arbitrators who hear the case; and (3) staff evaluations. Both SROs summarize evaluation results and Although Many Arbitrators input them into a centralized arbitrator database. According to NASD May Not Be Evaluated 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.31 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 31 NASD reported that it is currently working to allow parties and arbitrators to complete and return evaluations online and that this feature would increase the number of evaluations completed. Page 13 GAO-03-790 Employment Disputes in the Securities Industry 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 2002.32 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.) 32 We did not review arbitrator records at NYSE because its current computer system did not allow NYSE to provide us with the data we sought, within the time frame for this report. Page 14 GAO-03-790 Employment Disputes in the Securities Industry Figure 2: Types of Evaluations Arbitrators Received at NASD Percentage of arbitrators 45 40 40 35 30 25 20 15 14 14 14 11 10 5 4 2 0 Peer Party Staff Peer Peer Party All only only only and and and three party staff staff Type of evaluations Source: NASD. Although NASD supplements its evaluations by rating arbitrators on a quarterly basis,33 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. 33 NYSE reported that it does not have a numerical rating system and did not think it would add anything to the evaluation process it has in place. Page 15 GAO-03-790 Employment Disputes in the Securities Industry Figure 3: How NASD Arbitrators Were Rated Percentage of NASD arbitrators 100 90 79 80 75 70 60 50 40 30 21 20 17 10 8 0 0 Arbitrators Arbitrators Arbitrators rated 1 rated 2 rated 3 Arbitrators with evaluations Arbitrators without evaluations Source: NASD. 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 Page 16 GAO-03-790 Employment Disputes in the Securities Industry 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. Of the 1,546 employment cases34 decided by arbitrators at NASD and NYSE Over the Last 10 over the last 10 years,35 261 (17 percent) included at least 1 discrimination Years, Relatively Few claim. Cases with discrimination claims required more hearing sessions and took longer to complete than those with no discrimination claims. At Employment Disputes the same time, the compensatory damages claimed in all cases was Involved generally over $100,000, with claimed amounts generally higher at NYSE than at NASD. In over half of all employment cases, employees won some Discrimination, and level of monetary compensation, although in cases with discrimination Some Variations claims employees were generally less likely to win. In most cases, when Existed between 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 These Cases and being $50,000 or less. When compensatory damages were awarded in cases Other Employment involving discrimination, it tended to be higher than compensatory damages awarded in other employment cases, with just over 60 percent of Disputes discrimination cases receiving more than $50,000. Appendix 1 describes the reliability and limitations of these data. 34 Our analysis was conducted on cases decided by arbitrators and does not include cases that were settled or withdrawn. According to NASD, in recent years, parties agreed on a resolution in nearly 60 percent of all cases. 35 The data analyzed spanned from January 1993 through June 2002—the most current data available. Page 17 GAO-03-790 Employment Disputes in the Securities Industry Age and Sex Employment cases arbitrated at NASD and NYSE can contain 1 or more Discrimination Were Most claims, some of which might involve discrimination. Of all 1,546 Prevalent in the Relatively 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 Few Employment Cases discrimination claim. NASD arbitrated 202 of the cases that involved That Included discrimination allegations. NYSE arbitrated the remaining 59. Given that Discrimination Claims 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).36 Table 1: Types of Discrimination Claims in Employment Cases at NASD and NYSE, 1993 through 2002 Sex discrimination/ Race/national Age harassment origin Disability Religion Unspecified Total Year NASD NYSE NASD NYSE NASD NYSE NASD NYSE NASD NYSE NASD NYSE 1993 1 7 2 6 2 1 0 1 0 0 0 0 20 1994 6 8 11 6 3 2 1 0 2 1 1 0 41 1995 15 4 9 2 4 0 2 0 1 0 0 2 39 1996 9 2 10 2 2 1 3 2 0 0 0 1 32 1997 8 2 15 5 6 0 6 2 3 1 3 1 52 1998 18 2 13 2 5 0 7 3 1 2 2 0 55 1999 3 2 9 0 5 0 2 1 2 0 0 1 25 2000 8 0 5 0 5 0 4 0 2 0 5 0 29 2001 7 1 6 0 2 0 1 1 1 0 3 0 22 2002 4 1 1 0 1 0 0 0 0 0 2 0 9 Total 79 29 81 23 35 4 26 10 12 4 16 5 324 Source: Securities Arbitration Commentator. Note: Year 2002 includes cases decided in January through June. 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 36 Sex discrimination includes sexual harassment claims. Page 18 GAO-03-790 Employment Disputes in the Securities Industry cases are arbitrated, might have reduced the arbitration of these types of cases.37 Figure 4: Number of Cases Involving Discrimination at NASD and NYSE, 1993 through 2002 Total number of cases (n = 261) 40 30 20 10 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002a NASD NYSE Source: Securities Arbitration Commentator. a Includes only those cases decided in January through June 2002. Cases That Included Over the last 10 years, the median number of hearing sessions in Discrimination Claims discrimination cases ranged from 5 to 10 at NASD (see fig. 5) and from 8 to Required More Hearing 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 Sessions and Took Longer 11 at NYSE. to Complete 37 We were unable to determine what factors caused this decrease. Page 19 GAO-03-790 Employment Disputes in the Securities Industry Figure 5: Median Number of Hearing Sessions for Discrimination and Nondiscrimination Cases at NASD, 1993 through 2002 Median number of hearing sessions 12 10 8 6 4 2 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002a With at least 1 discrimination claim With no discrimination claim Total number of cases (n = 1,236) With at least 1 4 19 26 19 28 35 16 26 18 8 discrimination claim With no discrimination 31 68 92 138 153 145 110 105 133 62 claim Source: Securities Arbitration Commentator. a Median number of hearing sessions based only on cases decided in January through June. Page 20 GAO-03-790 Employment Disputes in the Securities Industry Figure 6: Median Number of Hearing Sessions for Discrimination and Nondiscrimination Cases at NYSE, 1993 through 2002 Median number of hearing sessions 20 15 10 5 0 1993 1994 1995 1996 1997 1998 1999 2000 2001a 2002b With at least 1 discrimination claim With no discrimination claim Total number of cases (n = 252) With at least 1 12 11 7 7 8 7 4 0 1 1 discrimination claim With no discrimination 29 26 24 34 14 24 14 8 12 9 claim Source: Securities Arbitration Commentator. a Too few cases with at least 1 discrimination claim were decided in 2001 to calculate the median number of sessions per case for that year. b For 2002, only cases decided in January through June were included in this analysis; however, not enough cases with at least 1 discrimination claim were decided during that time to calculate the median number of sessions per case for cases with at least 1 discrimination claim. 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. Page 21 GAO-03-790 Employment Disputes in the Securities Industry Amounts Claimed in the In most cases arbitrated at NASD and NYSE over the last 10 years, Majority of Employment employees sought more than $100,000 in compensatory damages, whether Cases Were over $100,000 or not the case included a discrimination claim. (See fig. 7.) Figure 7: Percentage of Discrimination and Nondiscrimination Cases at NASD and NYSE from 1993 through 2002, by Amount Claimed Percentage of cases 40 35 30 25 20 15 10 5 0 $1-$9,999 $10,000- $50,001- $100,001- $500,001- >$1 million $50,000 $100,000 $500,000 $1 million Award amounts With at least 1 discrimination claim With no discrimination claim Total number of cases (n = 1,295) With at least 1 3 9 17 64 39 80 discrimination claim With no discrimination 111 169 124 317 122 240 claim Source: Securities Arbitration Commentator. Note: For 2002, analysis based only on cases decided in January through June. 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 Page 22 GAO-03-790 Employment Disputes in the Securities Industry NYSE tend to include mostly the larger, more established broker-dealers, whose employees may seek higher compensatory damages in arbitration cases. Cases Involving In general, in more than 50 percent of cases at NASD and NYSE, Discrimination Were Less employees were awarded some level of compensatory damages. (See fig. Likely to Win Some Level 8.) of Compensatory Damages Than Cases with No Discrimination Claims Page 23 GAO-03-790 Employment Disputes in the Securities Industry Figure 8: Percentage of Cases at NASD and NYSE in Which Employees Were Awarded Compensatory Damages, 1993 through 2002 Percentage of cases 100 80 60 40 20 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002a NASD NYSE Total number of cases (n = 1,546) NASD 36 97 124 159 188 189 138 135 153 70 NYSE 42 38 31 42 22 32 19 8 13 10 Source: Securities Arbitration Commentator. a For 2002, analysis based only on cases decided in January through June. 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.38 38 Because of data limitations, in cases with both discrimination and other employment claims, we could not determine what proportion of the award, if any, was awarded for a discrimination claim. Page 24 GAO-03-790 Employment Disputes in the Securities Industry Figure 9: Percentage of Discrimination and Nondiscrimination Cases at NASD and NYSE in Which Employees Were Awarded Compensatory Damages, 1993 through 2002 Percentage of cases 100 80 60 40 20 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002a With at least 1 discrimination claim With no discrimination claim Total number of cases (n = 1,546) With at least 1 17 30 33 26 38 42 21 26 19 9 discrimination claim With no discrimination 61 105 122 175 172 179 136 117 147 71 claim Source: Securities Arbitration Commentator. a For 2002, analysis based only on cases decided in January through June. Page 25 GAO-03-790 Employment Disputes in the Securities Industry While Most Employees In cases where employees received a monetary award, over 60 percent of Received Less Than Half of employees received less than half of the compensatory damages they the Compensatory 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 Damages They Claimed, over half of the cases won had awards of $50,000 or less, while at NYSE Cases That Included 70 percent of awards were over $50,000. Discrimination Claims Received Higher Awards Figure 10: Percentage of Cases Won at NASD and NYSE from 1993 through 2002 by Amount Awarded Percentage of cases 35 30 25 20 15 10 5 0 $1-$9,999 $10,000- $50,001- $100,001- $500,001- >$1 million $50,000 $100,000 $500,000 $1 million Award amounts NASD NYSE Total number of cases with monetary awards (n = 784) NASD 147 199 89 158 29 18 NYSE 7 36 29 49 10 13 Source: Securities Arbitration Commentator. Note: For 2002, analysis based only on cases decided in January through June. Page 26 GAO-03-790 Employment Disputes in the Securities Industry Compared with cases with no discrimination claims, employees in cases involving discrimination were more likely to receive larger awards.39 (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. Figure 11: Percentage of Discrimination and Nondiscrimination Cases at NASD and NYSE from 1993 through 2002, by Amount Awarded Percentage of cases 35 30 25 20 15 10 5 0 $1-$9,999 $10,000- $50,001- $100,001- $500,001- >$1 million $50,000 $100,000 $500,000 $1 million Award amounts With at least 1 discrimination claim With no discrimination claim Total number of cases with monetary awards (n = 784) With at least 1 11 34 23 38 5 6 discrimination claim With no discrimination 143 201 95 169 34 25 claim Source: Securities Arbitration Commentator. Note: For 2002, analysis based only on cases decided in January through June. 39 On average, the amount claimed in discrimination cases was also higher. Page 27 GAO-03-790 Employment Disputes in the Securities Industry 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. To assess arbitration programs at NASD and NYSE, SEC conducts periodic SEC Oversight Found inspections and reviews complaint letters it receives. It has cited problems SROs Could Improve at one or both SROs in the procedures used to (1) ensure arbitrators are qualified and (2) track arbitrator performance. SEC generally reviews Procedures to Ensure arbitration procedures, arbitrator profiles, disclosure reports, and closed Arbitrators Are cases and interviews staff during its inspections. Although SEC officials indicated that complaint letters could affect the focus of an inspection, we Qualified and Perform found that few of the letters SEC receives focus on employment Well 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. SEC Conducts Systematic Since 1995, SEC has examined NASD’s and NYSE’s arbitration programs Inspections and Reviews three times each and has routinely responded to complaint letters about Complaint Letters to the process. Most inspections have focused on either case processing or recruiting and maintaining arbitrators. In general, inspections also Assess SRO-Administered included reviewing problems raised in previous inspections to determine Arbitration Programs whether they had been resolved. (See fig. 12.) Page 28 GAO-03-790 Employment Disputes in the Securities Industry Figure 12: Focus of SEC Inspections of NASD and NYSE, 1995-2002 Year SRO Focus of inspection Enrollment, training, selection, and 2001 NYSE evaluation of the performance of arbitrators in NYSE’s arbitrator pool. Processing customer and industry claimsa 2000 NASD and maintaining arbitrator pool by the Midwest Regional Office. 1998 NASD Recruitment, enrollment, training, and evaluation of arbitrator performance. Administration and procesing customer 1998 NYSE and industry claims. 1995 NYSE Administration and procesing customer claims. Processing of customer claims and 1995 NASD selection and retention of arbitrators. Source: SEC inspection reports. a Customers’ claims are claims made by investors while industry claims are made by members of the securities industry. 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 files40 and arbitrator 40 Prior to 1998, SEC limited its review to customer cases. In its 1998 inspections, SEC began to also review employment cases. An SEC official reported that because relatively few employment discrimination cases are arbitrated, typically all cases alleging employment discrimination closed during the inspection review period are selected for review. Page 29 GAO-03-790 Employment Disputes in the Securities Industry 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.41 An SEC official noted that under the Exchange Act,42 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.43 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.44 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. 41 SEC was unable to provide the total number of closed cases their sample was drawn from. 42 Securities Exchange Act of 1934 Section 19(h), 15 U.S.C. § 78s(h). 43 In the event deficiencies were not adequately addressed, SEC has authority under Section 19(h) of the Exchange Act to institute administrative proceedings to remove SRO officials, limit or suspend SRO activities, or revoke SRO registration. 44 Twenty-five of the 100 letters in our sample were missing from SEC files. The issues raised in the remaining 59 letters were either unclear or dealt with issues unrelated to employment cases. Page 30 GAO-03-790 Employment Disputes in the Securities Industry 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.45 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. SEC Has Made a Variety of In recent inspections, SEC staff identified a number of ways NASD and Recommendations to NYSE could improve their procedures for ensuring that arbitrators are Improve SRO Procedures 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. 45 The official reported that although other SEC divisions receive complaint letters, the division that approves SRO rules receives the most letters dealing with employment issues. Page 31 GAO-03-790 Employment Disputes in the Securities Industry 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;46 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.47 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. SEC oversees NYSE and NASD, which regulate their member firms in the Conclusions securities industry. All three are responsible for ensuring that the procedures for arbitrating discrimination and other employment disputes 46 GAO-03-162R (Washington, D.C.: Apr. 11, 2003). 47 In GAO-03-162R, we report that one SRO has implemented procedures making it easier to remove arbitrators from ongoing cases. Page 32 GAO-03-790 Employment Disputes in the Securities Industry 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. To help ensure that all NASD and NYSE arbitrators possess the Recommendations 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. We provided a draft of this report to SEC, NASD, and NYSE for their Agency and SRO review. A copy of their written comments is in appendixes II, III, and IV, Comments 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, Page 33 GAO-03-790 Employment Disputes in the Securities Industry 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 Page 34 GAO-03-790 Employment Disputes in the Securities Industry 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. Robert E. Robertson Director, Education, Workforce, and Income Security Issues Page 35 GAO-03-790 Employment Disputes in the Securities Industry Appendix I: Scope and Methodology Appendix I: Scope and Methodology 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. To determine the nature and outcomes of employment and employment Determining the discrimination disputes in the securities industry, we analyzed a database Characteristics and containing employment disputes in which arbitration decisions had been made by NASD1 or the New York Stock Exchange (NYSE) from January Outcomes of 1993 through June 2002. We obtained this database from Securities Arbitrated Arbitration Commentator, Inc. (SAC), Maplewood, New Jersey. SAC is a commercial research firm that maintains a database of information from Employment Disputes 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 1 NASD was formerly known as the National Association of Securities Dealers, but now goes solely by the acronym. Page 36 GAO-03-790 Employment Disputes in the Securities Industry Appendix I: Scope and Methodology 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. To determine who evaluates arbitrators and what performance ratings Determining they receive, we first generated a list from the SAC data file of all NASD Arbitrator arbitrators who had decided at least 1 employment case that did not include a discrimination claim. We stratified this list of 494 arbitrators into Performance 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.2 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 2 Our initial list contained 496 arbitrators, but we later learned that 2 of the 62 arbitrators we believed had decided a discrimination case had not, in fact, decided any cases during this time. We removed the arbitrators from the population and from the sample. Therefore, the actual study population was 494 arbitrators, from which 124 arbitrators were sampled. Page 37 GAO-03-790 Employment Disputes in the Securities Industry Appendix I: Scope and Methodology 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. SEC tracks complaint letters in a computerized database and has logged Determining the over 12,000 from 1992 through October 2002. To determine how SEC Content of SEC responds to complaint letters it receives concerning arbitration of employment and employment discrimination cases, first we asked SEC Complaint Letters 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. Page 38 GAO-03-790 Employment Disputes in the Securities Industry Appendix II: Comments from the Securities and Exchange Commission Appendix II: Comments from the Securities and Exchange Commission Page 39 GAO-03-790 Employment Disputes in the Securities Industry Appendix II: Comments from the Securities and Exchange Commission Page 40 GAO-03-790 Employment Disputes in the Securities Industry Appendix III: Comments from NASD Appendix III: Comments from NASD Page 41 GAO-03-790 Employment Disputes in the Securities Industry Appendix III: Comments from NASD Page 42 GAO-03-790 Employment Disputes in the Securities Industry Appendix III: Comments from NASD Page 43 GAO-03-790 Employment Disputes in the Securities Industry Appendix III: Comments from NASD Page 44 GAO-03-790 Employment Disputes in the Securities Industry Appendix III: Comments from NASD Page 45 GAO-03-790 Employment Disputes in the Securities Industry Appendix III: Comments from NASD Page 46 GAO-03-790 Employment Disputes in the Securities Industry Appendix IV: Comments from the New York Stock Exchange Appendix IV: Comments from the New York Stock Exchange Page 47 GAO-03-790 Employment Disputes in the Securities Industry Appendix IV: Comments from the New York Stock Exchange Page 48 GAO-03-790 Employment Disputes in the Securities Industry Appendix IV: Comments from the New York Stock Exchange Page 49 GAO-03-790 Employment Disputes in the Securities Industry Appendix IV: Comments from the New York Stock Exchange Page 50 GAO-03-790 Employment Disputes in the Securities Industry Appendix V: GAO Contacts and Staff Appendix V: GAO Contacts and Staff Acknowledgments Acknowledgments Clarita A. Mrena (202) 512-3022 GAO Contacts Margaret A. Holmes (202) 512-3283 In addition to those named above, Susan S. Pachikara, Joan K. Vogel, and Staff Sidney H. Schwartz made significant contributions to this report. Acknowledgments (130174) Page 51 GAO-03-790 Employment Disputes in the Securities Industry The General Accounting Office, the audit, evaluation and investigative arm of GAO’s Mission Congress, exists to support Congress in meeting its constitutional responsibilities and to help improve the performance and accountability of the federal government for the American people. GAO examines the use of public funds; evaluates federal programs and policies; and provides analyses, recommendations, and other assistance to help Congress make informed oversight, policy, and funding decisions. GAO’s commitment to good government is reflected in its core values of accountability, integrity, and reliability. 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Employment Disputes: Recommendations to Better Ensure That Securities Arbitrators Are Qualified
Published by the Government Accountability Office on 2003-08-29.
Below is a raw (and likely hideous) rendition of the original report. (PDF)