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Senators Russ Feingold, D-Wis., and Patrick Leahy, D-Vt., have recently called attention to problems with the private arbitration process imposed on investors making claims against members of the National Association of Securities Dealers. Others have now joined the cause. They deserve support. It has become impossible to invest in listed securities without agreeing to an arbitration clause submitting all of one’s future claims against the broker to a private panel, usually one designated by the association. Such panels are not accountable for their fidelity to laws enacted to protect investors from the many forms of fraud and abuse to which they are exposed. Under the Federal Arbitration Act of 1925 (FAA) or rules of most institutions promoting commercial arbitration, arbitrators may charge fees far exceeding court costs. They are free to apply their own moral standards in lieu of applicable law to any matter brought before them. They need not allow an investor to conduct discovery to investigate disputed facts. They are not obliged to explain their awards. And they need not allow investors to aggregate their claims to make them financially viable. These features of arbitration reflect the fact that the 1925 FAA was intended only as a means of enforcing private contracts, not claims arising under statutes enacted to protect claimants. In 1953, the U.S. Supreme Court heard the case of an investor suing his broker for an alleged violation of the Securities Act of 1933; it held that he was not bound by an arbitration clause found in his printed brokerage agreement. The court noted that the act had the purpose of protecting unsophisticated investors and concluded that “the intention of Congress concerning the sale of securities is better carried out by holding the arbitration clause invalid.” This was the position advanced by the U.S. Securities and Exchange Commission (SEC). In 1989, the Rehnquist Court reconsidered the issue and held that brokers may impose arbitration clauses on their clients. The court has proceeded also to weaken enforcement of many federal and state laws enacted to protect consumers, small businesses and workers. Confirming this judge-made federal policy, the 9th U.S. Circuit Court of Appeals held en banc in 2003 that it is a violation of the FAA for the parties to an arbitration clause to impose on courts the burden of reviewing an award to correct mere errors of law or fact. There is one exceptional federal statute that claimants are entitled to enforce in court without regard for any contrary term in a standard-form contract written by the defendant. This is so because Senator Orrin Hatch, R-Utah, in 2002 slipped a rider into an appropriation bill to secure an exclusion from the FAA for automobile dealers engaged in disputes with manufacturers. This reform restored dealers’ rights under the Automobile Dealers Day in Court Act and similar state laws. I was retained as counsel by the automobile dealers for the very limited purpose of writing an argument addressed to Congress. They directed me to be sure that my statement for them did not suggest that others, such as purchasers of automobiles, should be protected from mandatory arbitration clauses impairing their statutory rights. But they left me free to speak my mind separately, as I now do. An overextension of the FAA Congress must address the problems resulting from the high court’s overextension of the FAA. A comprehensive solution would be an amendment to the act assuring the right of a party to an “adhesion” contract written by a merchant, employer or franchisor to revoke the arbitration clause after a dispute arose with respect to any claim to enforce a statute enacted for the protection of consumers, investors, workers or small businesses. If a plaintiff then believes that arbitration would be economic and fair, it would be available, but he would know what he was getting into. That was familiar law until 1925. A lesser alternative would be to confirm the rights of parties in arbitrations brought under state or federal laws to conduct discovery, obtain a statement of reasons for any award, have the option of judicial review to set aside an award for a “clear error of law” and aggregate identical claims in class actions. These are the rights conferred on parties in court cases enabling consumers, workers, investors, small businesses or patients to enforce laws enacted for their protection. The FAA would then in statutory cases resemble the California law authorizing parties to hire a private judge to decide their case in accordance with statutory procedures and subject to the usual appellate review. Or, at the very least, Congress should explicitly allow the invalidation of mandatory arbitration clauses impeding plaintiffs from enforcing state laws. Five justices, but never five in the same case, have said that this is the present law. If Congress cannot repair private enforcement of the 1933 act, then it is time to invigorate the SEC with greater powers and resources. America has long depended on private plaintiffs to enforce many public laws. This was and is a good idea, but not if victimized investors can present their claims only to private arbitrators not bound by law. Paul D. Carrington is a professor of law at Duke Law School. His Web address is www.paulcarrington.com.

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