Sunday, November 28, 2010

Can Behavioral Economics Inform Our Understanding of Securities Arbitration?

By Barbara Black (T/Y Securities Law Prof Blog). 

The classical economic approach assumes that parties take rational account of the effects of ADR on the likely disposition of their disputes and adopt predispute arbitration agreements (PDAAs) when they mutually benefit the parties. Accordingly, there should be a presumption in favor of enforcing PDAAs so long as the parties have entered into them knowingly and voluntarily, but there is generally no reason for the state to favor PDAAs. In contrast, critics of mandatory consumer arbitration believe that, as a practical reality, consumers cannot bargain over PDAAs and have little choice but to accept the deal offered by the business. In addition, relying on the behavioral economics literature, they assert that consumers typically are not as rational as classic economic theory supposes.
The opposing positions in this debate over consumer arbitration have been well fleshed out in the academic literature. This paper will focus specifically on securities arbitration in the FINRA forum, where there are unique differences in the FINRA process that add complexity to this issue. I pose three questions regarding the staying power of PDAAs and explore whether classic or behavioral economic theory can help answer them. I then explore what would happen if the SEC or Congress prohibited PDAAs in customers' agreements. I conclude that if Congress or the SEC prohibits PDAAs in securities arbitration, the effect on the FINRA arbitration forum may not be beneficial to investors withsmall claims.
In the context of brokerage relationships, investors consistently identify trust as the most important factor in the relationship, and brokerage firms advertise heavily on the basis of trust. Many brokerage firms, in particular discount and online firms, advertise on the basis of low commissions, so that all firms face competitive pressures to keep commissions low. Trust and commissions thus are salient terms, while PDAAs, for the reasons discussed above, are not. In addition, because regulatory and compliance requirements for the protection of investors increase firms’ costs of doing business, if firms achieve savings from PDAAs, they have good reason to resist competition on the basis of PDAAs; cost savings depend on keeping the term non-salient.

1 comment:

  1. I like that quote: "One of the things Wall Street does is while we're all looking over here, they're already onto the next thing."....goes hand in hand with the saying in law enforcement in regards to technology, schemes, etc. which is that the criminals are always 10 steps ahead of us.

    But I think society has already drawn the parallels between both.