esm7i New research documents how arbitrators and companies compete to win companies’ business.
It may be in the boilerplate on your contract with a phone company, bank, or brokerage.
The “mandatory arbitrator” clause is found in contracts worth trillions of dollars. It says that if you ever have a dispute, you will agree to waive your right to sue the company and submit your complaint to a private arbitrator who is supposed to be neutral.
Nearly all financial firms insist on arbitration. But so do many other businesses: AT&T, Verizon, Apple and Amazon, Blue Cross, Blue Shield, and even Spotify and Shazam.
A new analysis of nearly 9,000 arbitrations cases from the Securities Industry confirms what many people have suspected for a long time: that the system is biased towards consumers, and not only because big companies can afford to pay more lawyers.
The study found that companies can have an informational advantage regarding arbitrators. They can discover arbitrators more likely to be in their favor.
Arbitrators know, too well, that being pro-business, in one case, increases their chances of being selected for future issues.
A Slanting Incentive
This is different from having judges who are paid the same regardless of what happens, says Stanford Graduate School of Business finance prof Amit Serut who worked on the study along with Mark Egan at Harvard Business School and Gregor Matvos at the University of Texas at Austin. You only get paid as an arbitrator if you are selected. They are motivated to lean toward the business side because they know those who do not will not be selected. “Everyone knows what’s going on.”
Researchers examined thousands of disputes between customers and stockbrokers or investment advisors. The Financial Industry Regulatory Authority oversees arbitration in the financial industry.
Researchers confirmed that certain arbitrators were more pro-business than others. The researchers compared cases apples-to-apples and found that more business-friendly arbitrators awarded their customers 12% less than those more consumer-friendly. This translates to approximately $90,000.
But that was only the beginning. The arbitrators chosen are randomly selected, but pro-business arbitrators have a 40% higher chance of being chosen. Their bias has a disproportionate effect. Researchers estimated that if arbitrators were chosen randomly, each customer’s average award would be $50,000 higher.
The Benefit of Experience
How can companies choose the right arbitrator?
The rules for selecting arbitrators appear fair at first glance. After FINRA has given the customer’s and company’s list of potential arbitrators, each party can “strike out” or veto a certain number.
It is a problem that companies know arbitrators’ records better than consumers and are, therefore, more likely to dismiss arbitrators more inclined to favor consumers. Each securities firm studied had averaged 81 arbitrations in disputes that were not securities-related, like those with cell phone carriers. An average of 133 hearings took place. On the other hand, most consumers have never participated in arbitration before, and they tend to choose arbitrators randomly. The informational advantage of the firms leads to biased results.
Seru says that the larger problem is that arbitrators are more biased in favor of the companies because their earnings — $300 for a 4-hour hearing plus expenses — depend on the companies’ choice.
Seru states that “this is a systemic problem.” If you examine the data over many years, it is clear that there are biases against consumers and firms. This may or may not have been intentional, but how the system is designed and the information that consumers and companies are provided leads to this outcome.
Look at Fixtures
Seru and his co-workers also found that reforms that seemed to be favorable could make things worse.
In 2016, FINRA, for example, proposed expanding the list of candidates to give both sides more chances to “strike out” those they dislike. Researchers argue that because companies are more informed, this would lead to lower awards being given to consumers. The proposal to raise arbitrators’ fees also seems like a good plan at first. Researchers show, however, that this change would lead arbitrators to be even more biased in favor of businesses, as the “prize” for being selected is higher.
Seru suggests that hiring a qualified arbitration lawyer is the best way to ensure a level playing field for consumers. The study showed that, on average, consumers who hired arbitration attorneys received arbitrators who were awarded almost 5% more.
A third way that consumers can reduce the advantage of corporations is by banding together with others who share the same complaint. Seru believes this would encourage arbitrators to show “more respect” to the consumer side and could act as a countervailing factor when deciding how pro-business to be.
The Consumer Financial Protection Bureau proposed a rule prohibiting financial companies from requiring customers to submit to mandatory arbitral proceedings. This would have allowed class-action lawsuits to be filed by customers. The Republican-led Congress repealed this rule in 2017.
