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The news that the U.S. Securities and Exchange Commission (SEC) is considering an initiative to allow arbitration as an alternative to shareholder litigation to enforce the federal securities laws should send shivers down the spines of all who care about the rule of law. Arbitration is often viewed as a cure-all for the shortcomings of our current system of litigation. Arbitration, however, has a dirty little secret � it is essentially lawless. Rather than apply settled rules of law to the facts of a dispute, arbitrators are free to use discretion to craft almost any solution they think appropriate. American companies spend billions of dollars to comply with U.S. corporate and securities laws. They expect this investment in the rule of law to pay off. Courts may make the occasional mistake but usually get it right when applying legal principles to a dispute. Arbitrators operate in the never-never land of equity in which the rule of law can be ignored. Wholesale arbitration of shareholder disputes would likely feature muddled compromise results, with shareholders receiving remedies based only upon vague and undefined notions of fairness. Critics of the current litigation regime point to the heavy burden that securities class actions now place upon U.S. public companies, including large settlements and the potential to generate costly attorney fees. Critics also point to the circularity of the remedy in shareholder suits: The defendant corporation and its insurers usually pay the settlement costs and attorney fees that are ultimately borne by the very shareholders the suit is designed to protect. Indeed, in response to similar concerns, in 1995 and again in 1998, Congress placed severe procedural restrictions upon shareholder securities class actions. Nonetheless, while the number of shareholder suits has declined, the average settlement amounts have significantly increased, leading to further calls for reform as the United States competes in the global market. No procedural protections Even accepting these concerns about our current litigation system at face value, arbitration is not the solution. First, the procedural protections against the most vexatious lawsuits against corporations would not operate in the world of arbitration. Plaintiffs’ attorneys, freed of the current constraints on pleading and discovery, would be free to harass companies with a multitude of arbitration claims. This danger would be intensified if “class action” arbitrations were allowed. Plaintiffs could file claims that would not pass procedural muster in court and hope for a compromise, split-the-baby award common in arbitration. Second, arbitrators apply notions of fairness and equity rather than legal rules. Decisions in modern securities arbitrations, such as those operated under the auspices of the National Association of Securities Dealers, are usually rendered by nonexperts who need not apply, or even understand, the securities laws. Such decisions, once made, are virtually insulated from judicial review. Historically, such a system made sense, as arbitration was utilized as an efficient dispute-resolution system whereby homogeneous members of trade groups employed experts to decide controversies according to industry norms rather than the rule of law. Modern securities arbitration, however, rarely takes place between those with any common understanding of applicable norms other than the law. Finally, arbitration today is no longer quick or efficient in that it has incorporated many of the procedural appendages such as discovery that are common in litigation. Arbitration is not the cure for whatever ills still plague securities litigation. Laws would atrophy There is a another hidden societal cost to moving from a judicial to an arbitration system to redress securities law claims. Experience teaches us that required arbitration causes the law to atrophy. For example, since the U.S. Supreme Court in 1986 validated the mandatory arbitration of disputes between investors and their securities brokers, the law in the area has virtually disappeared. Arbitral awards provide no substitute for judicial opinions. Arbitrators operate in secret proceedings, and their awards lack transparency and are not subject to scrutiny by Congress or the judiciary. Moreover, arbitrators usually fail to write opinions, and the few opinions that are published are not entitled to precedential deference. As the law disappears, the regulatory power of the SEC will increase. Perhaps that is why the SEC has jumped on the arbitration bandwagon. By supplanting the judicial interpretations of statutes, arbitration is likely to increase the reliance on SEC regulations. This is a perverse result that can still be avoided if the SEC backs away from this proposal to permit arbitration of shareholder claims. Precise dispute-resolution results derive from traditional case adjudication, not the rough, tumble and lawless realm of arbitration. Companies want predictable and certain results. These qualities will be lost if the SEC leads shareholder claims to the unpredictable and lawless land of arbitration. Edward Brunet and Jennifer J. Johnson are professors of law at Lewis & Clark Law School in Portland, Ore.

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