Gretchen Morgenson sees hope in a recent arbitration case that, incredibly, found in favor of actual human beings against Citigroup’s Smith Barney unit, which had sold as safe what was actually a risky and highly levered municipal bond arbitrage deal. What’s more, the three-member arbitration panel levied a serious penalty: $54.1 million, including $17 million in punitive damages. This is rare.

Morgenson succinctly lays out the stringent catechism of Wall Street defenses, which the plaintiffs had to overcome.

No. 1: We didn’t blow up your portfolio. The financial crisis did.

No. 2: If you’re wealthy and sophisticated, you should have understood the risks.

And, No. 3, the most common defense of all: The prospectus warned that you could lose your shirt, so don’t come crying to us if you do.

In this case, interestingly, the panel found that true disclosure in a prospectus isn’t good enough if you make false representations in sales material. That’s significant.

Well, it would be if this weren’t, well, an arbitration decision. What makes this award particularly surprising—but paradoxically less hope-inspiring—is that it didn’t come from a court, but from the industry-skewed arbitration system. A bit more on the quirks of arbitration would have been helpful here. For one thing, arbitration is mandatory by contract, meaning you can’t go to court even if you want to. Second, a third of the panel comes from the industry itself (I’m sure doctors would love it if a third of malpractice juries were made up of other doctors). Third, it’s actually designed to be one-off; there are no written opinions, and arbitration cases don’t establish precedent. Fourth, and worst of all, these are secret trials—testimony is behind closed doors and records are sealed. Who do you think that benefits?


This SmartMoney piece breaks down the not-great odds of winning a securities arbitration case.

The unfairness of the system aside, the spread of mandatory arbitration over the last 30 years poses a public policy problem. More arbitration means less public information. This is a companion to an even greater problem: sealing civil court records as a condition of settlement. More on that later.

Unfortunately, mandatory arbitration isn’t limited to the securities business but the clauses are found in all sorts of things, including many employment contracts and standard purchase agreements.

As this 2005 paper (pdf) by the consumer advocacy group the Center for Justice & Democracy reminds us, back in the ’90s, when women employees tried to sue what was then known as Salomon Smith Barney (hmm, a pattern? Nah) for sexual harassment and discrimination, but for a loophole, they would have have had to arbitrate their employment case, in secret, in front of the National Association of Securities Dealers, a mostly male outfit. Luckily for them, they managed to turn their claim into a class action—nearly 2,000 women joined—which are exempt from arbitration clauses. And of course , it was court-ordered discovery that broke the case open. Now, everyone remembers the “Boom-Boom Room” case.

It’s a whole ‘nother column, really, which Morgenson herself has written. But while she’s right that the decision represents a crack in Wall Street’s defenses, the actual breach will have to come from somewhere else.

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Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.