Finra should seek to make the arbitration pool more diverse because diversity offers significant benefits

InvestmentNews (Nov 16, 2014 11:01 pm) -- Finra's arbitration process has come under attack yet again. Last month, the Public Investors Arbitration Bar Association released a study criticizing the composition of Finra's arbitration pool for, among other things, its general lack of diversity. The study found that 80% of the arbitrator roster is male and that the average arbitrator is 67.

About 40% of Finra's arbitrators are over 70, and about 17% are over 80. The pool also lacks social-class diversity: 73% of arbitrators have advanced degrees — predominantly law degrees, achievements strongly correlated with high social class. PIABA argues that more-diverse groups would make better decisions.

Despite these shortcomings, Finra's dispute resolution arm professes a commitment to improving. On July 17, Finra announced that it had formed a 13-member Arbitration Task Force “to consider possible enhancements to its arbitration forum to improve [its] transparency, impartiality and efficiency.”

The task force itself is a diverse group representing academic, industry, state regulatory and investor perspectives. It should place the arbitrator diversity issue on the agenda and recommend steps for Finra to take to improve arbitrator diversity, as well as measures designed to provide greater transparency about the pool.

Finra's reflexive defenders have discounted the study. Although conceding the need for more gender diversity, a recent InvestmentNews editorial seems to celebrate the study's age-related findings, contending that “with age comes wisdom based on experience.” By this logic, it would seem that an arbitration panel's wisdom directly correlates to its vintage.

This wine-bottle defense implies that introducing younger arbitrators into the pool would reduce the integrity of Finra's arbitration process. One wonders whether InvestmentNews supports raising the voting age to let citizens accumulate more wisdom before making important decisions.

MORE-ROBUST DEBATES

This logic does not persuade me. Finra should seek to make the arbitration pool more diverse because diversity offers significant benefits. People of different backgrounds experience the world in different ways.

Panels with greater diversity might engage in more-robust debates and reach fairer decisions. If all the empaneled arbitrators share the same backgrounds and demographic characteristics, it seems less likely that they will have differing views and vibrant arguments.

Similarly, limited diversity makes the panel-picking process less valuable. If all the options largely share the same characteristics, choices between them become less significant.

A more diverse roster will let parties make meaningful choices when selecting their arbitrators. Presumably, Finra appoints panels of three arbitrators for many cases instead of one arbitrator, to place different perspectives on the same panel. Though not all elderly male lawyers share the same perspectives, a more diverse pool would undoubtedly include a broader range of views.

At the very least, the arbitrator pool could benefit from more social-class diversity. The pool's high percentage of retirees with advanced degrees leaves many perspectives unrepresented. And the largely homogenous age, gender and social class of Finra's arbitrator pool is not the only diversity concern. Unanswered questions remain about racial diversity.

The PIABA study drew its data from Arbitrator Disclosure Reports, which do not disclose the racial identities of Finra's arbitrators. Although its response to the study indicated that it actively seeks to recruit minority arbitrators, it has not disclosed statistics showing that those efforts have produced success.

The pool's composition also presents a perception and legitimacy issue. Importantly, investors and brokers locked within Finra's arbitration forum have lost the right to bring their problems to a more diverse jury of their peers, their right to an explained decision of the sort a judge would render and their right to challenge errors in that reasoning on appeal. Many may chafe at the further indignity of being forced to submit their dispute to a panel likely composed of elderly male lawyers.

This is not to say that Finra's current pool predominantly made up of elderly, likely white, male lawyers does not seek to give the parties fair decisions. To be clear, the pool undeniably contains significant talent. There are many wise and dedicated arbitrators striving to make fair decisions on the cases before them. But greater diversity would improve both the pool and the process.

INCREASE DISCLOSURE

To move forward, Finra should provide the public with more information about its arbitrator pool and publicly commit itself to diversifying the pool. The regulator should make available demographic information about the pool annually. Continuing disclosures will enable public investors and other significant stakeholders in Finra's arbitration process to assess the success of its diversification efforts.

To prove its commitment, Finra should provide statistical information on the age, gender, racial identity, education, income and asset level of members of the arbitration pool. That increased transparency will let stakeholders assess whether Finra's stated commitment to diversifying the pool is real or empty rhetoric.

Given the current pool's demographics and Finra's continuing failure to make voluntary demographic disclosures, many may doubt its commitment to recruiting a diverse stable of arbitrators.

Finra recently claimed that it has an “aggressive recruitment campaign in place to seek individuals from diverse backgrounds to serve as arbitrators.” It does not disclose when this supposedly aggressive campaign began or information sufficient to measure its success. Further, the diversity recruiting efforts appear to be concentrated on minority bar associations. This may increase the pool's overall ethnic diversity but will not add socio-economic diversity.

If Finra does not make more information available, policymakers may want to consider options for reform. The PIABA study identifies a long slate of possible options. It asks the Securities and Exchange Commission to more closely supervise Finra's arbitration forum and empower an independent group to provide oversight and transparency. It also requests that Congress pass the Investor Choice Act to give investors the right to opt out of Finra arbitration and bring their claims to a judge and a jury of their peers.

If Finra does not respond swiftly to investor voices and concerns about its arbitration process, the Investor Choice Act should be seriously considered as a way to give investors the ability to seek justice elsewhere and to create a structural reform to make Finra more responsive. A meaningful exit option may introduce competition and create a steady pressure to improve the process.

As Harvard economist Albert O. Hirschman's seminal treatise “Exit, Voice and Loyalty” explains, introducing exit options will often prompt organizations to reform when they have become less responsive to the voices of their stakeholders. This analysis has been applied broadly in the corporate governance context; it should also inform decisions about Finra arbitration.

Moreover, giving investors the right to voluntarily exit the Finra forum for other arbitration forums or courts may provide societal benefits. It would allow courts to decide cases and make law responsive to the current environment.

Benjamin P. Edwards is director of the Investor Advocacy Clinic at the Michigan State University College of Law. He can be reached at ben.edwards@law.msu.edu