Arbitration Favors Firms Over Investors

They will also use up challenges that might have been needed for other reasons, such as bouncing an arbitrator whose awards consistently skew in favor of the industry. Arbitrators can also be challenged for cause -- meaning direct and definite bias or interest in the outcome -- though that's hard to show.

What makes this especially unfair is that arbitration issues have changed, says Brian Smiley of Smiley Bishop & Porter in Atlanta. "The cases used to be about isolated broker misconduct," he says. "Now we're seeing institutional misconduct -- the perversion of Wall Street research during the tech bubble, selling fraudulent and unsuitable variable annuities, abuses in the securitization of subprime products and, lately, auction-rate securities." All the big firms are involved.

Say that you have an auction-rate case against UBS and get stuck with a Merrill Lynch branch manager as your required industry panelist. How can that Merrill manager bring in a large award, or indeed any award? His own firm is up against the same charges. He might worry that if he finds for you, it could cost him his promotion or even his job.

Whatever the reason, the win rate for consumers has been spiraling down. They won 53 percent of their arbitrated cases in 2001 but only 36 percent in 2007, according to the Securities Arbitration Commentator in Maplewood, N.J., which tracks awards. (So far this year, they're running at 47 percent, says SAC managing editor Richard Ryder.)

Even with wins, you don't get much money back. In a study of arbitration covering 1995-2004, attorney Daniel Solin and financial expert Edward O'Neal combined win rates with awards to create an "expected recovery" rate. It peaked in 1998, at 38 cents on the dollar, falling to 22 cents in 2004.

More cases settle than go to arbitration, but those low recovery rates "knock down the settlement offers you get," says New York attorney Theodore Eppenstein.

When trying to remove Wall Street's thumb from the scale during arbitration, "you're up against some of the best-funded lobbying in the country," Aidikoff says. "Where are the people who speak for individual investors?" Where, indeed.

Jane Bryant Quinn, author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist.