Substantive Fairness in Securities Arbitration

Abstract

Securities arbitration today is premised on the cliche that arbitrators will apply undefined fair and equitable standards of decision. We contend that fairness and equity cannot exist in a vacuum and that the rule of law provides the only sensible standard to guide securities arbitrators. Moreover, we argue that the rule of law provides the legitimizing foundation under which securities arbitration must occur.

We will develop two related propositions in this essay. The first is that to achieve fairness, securities arbitration needs procedures that apply substantive legal principles. We call this the need for substantive fairness. The second proposition, much more embedded in the real world, asserts that application of substantive law occurs sporadically and inconsistently in present-day securities arbitration.

We first set forth a theory of substantive adjudicatory fairness relying on mainstream modern legal philosophers such as John Rawls, Lon Fuller, Harry Jones, and Joseph Raz. In addition to unequivocally advocating a rule of law approach for adjudication, these theorists emphasize the relationship of the application of legal rules to notions of fair notice.

This essay next chronicles and critiques developments regarding standards of decision in modern securities arbitration. We examine the work of securities arbitration administrators and regulators as it relates to the goal of substantive fairness. We show that NASD has equivocated between allowing the arbitrators complete discretion to decide cases on any grounds they choose and providing directives for selected questions that only sometimes facilitate the application of legal principles. NASD has flirted with substantive law but intentionally avoided fully embracing it. We advocate a change in securities arbitration - that of publicly and systematically mandating application of the rule of law in NASD awards. Such a change is long overdue and would facilitate a shift to a fairer, less standardless arbitration of customer-broker dispute resolution.

Keywords: securities, NASD, arbitration, regulated industries, ADR

JEL Classification: K22, K23, K41, L84