There was an interesting article in the Journal about two Senators (Feingold and Leahy) who have indicated an interest in making arbitration between investors and brokers voluntary. Right now investors almost all agree to mandatory arbitration as part of the account opening process.

I serve as an NASD arbitrator and view it as a privilege. Moreover, as someone not dependent upon billable hours, the amount of compensation is not a particularly important matter. Nonetheless, it is interesting to understand the compensation structure for arbitrators and some of the rational practices that this may induce.

Most cases are heard by a panel of three arbitrators. Arbitrators are paid an honorarium equal to $200 for each hearing session. A hearing session is any meeting between the parties and the arbitrators of four hours or less.  Thus, arbitrators receive $400 each full day the panel is in session (with an additional $75 paid to the chair). There is no honorarium paid for preparation (other than a $100 payment where the hearing is postponed within three business days of the scheduled date) and no honorarium paid for the decision making process. Honorariums may be paid when arbitrators convene for the prehearing conference, to decide discovery disputes, or to resolve a contested subpoena.

The compensation formula does not encourage preparation in advance of the hearing.  To the extent the case settles shortly before the hearing, arbitrators receive no compensation for the time expended.  Similarly, the compensation formula discourages lengthy deliberations.  To the extent the arbitrators deliberate outside of a hearing session, there is no compensation. 

It is a careful balance. To the extent the honorariums are too high, it will discourage investors from bringing actions.  At the same time, however, a system that pays a relatively small amount will likely discourage some qualified individuals from becoming arbitrators.  Moreover, the failure to compensate for preparation and deliberation could impact the quality of the proceedings and the decision making process. 

Whatever system is put in place to resolve disputes between investors and brokers, it should be designed to produce thoughtful, prepared decisions from highly qualified individuals.  It is not clear that the existing system of arbitration does so.