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It is often said that arbitration costs less than litigation. But what are the costs? Is arbitration really less costly than litigation?
Like the answer to virtually any legal question, the answer is that it depends. But no matter how you slice it, securities arbitration, like litigation, is expensive. Especially when you consider the nature of cases against financial advisors.
Compared, for example, to personal injury cases, financial cases are never simple. In injury cases, there was an accident. Take, for example, a car crash. It doesn't matter where the cars were coming from, or where they were going, or why they wanted to go there. The only question is "Why did they crash?"
But a securities case isn't about an incident, it's about a relationship. Where the investor was coming from and where he wanted to go (so to speak) will be the subject of detailed examination. There will be monthly statements for the lawyers to scrutinize, profit and loss analyses to create, prospectuses and SEC filings to read and pick apart and industry rules to study. And there are numbers, lots of numbers. This is specialized, detail-oriented stuff.
So it ought not to surprise anyone that the biggest cost is attorney's fees. Good attorneys--those with lots of experience--are expensive. Their fees are very high. We will cover those fees later. First, let's talk about the "expenses" of arbitration.
Starting a FINRA arbitration requires paying a filing fee. That fee is based on the size of the case. The scale starts at $50 for cases under $1,000, and rises after that. A case between $50,000 and $100,000 costs $975 to file. A case between $100,000 - $500,000 is $1,425. Cases over $1 million are $1,800, and that's the max. When an investor files a case, however, the responding brokerage firm must pay a "member surcharge" to FINRA; this surcharge is several thousand dollars per case -- more than the investor pays -- and the surcharges subsidize FINRA arbitration.
As a FINRA arbitration progresses, more "forum fees" are incurred--$1,200 per half-day hearing session. The average arbitration requires three days of hearings. That's six hearing sessions. So, if the parties do not settle in advance of the hearing, FINRA will have an outstanding bill of about $7,200. Complicated cases obviously take longer, and thus cost more. So do slow lawyers and arbitrators who only work from 10 a.m. to 4 p.m.
When the case is over, in the arbitration award, the arbitrators decide how these fees are to be divided between the parties. The usual division of hearing fees is 50-50. Sometimes, when the investor wins, all the forum fees are assessed by the arbitrators against the brokerage firm. In a very small percentage of cases (where the arbitrators thought the claim was frivolous), the forum fees are all assessed against the investor, but that is rare. The average forum fees for investors--the filing fee plus 50% of the hearing session fees--are thus $4, 000 to $5,000. FINRA uses part of these fees to pay the arbitrators, the rest to cover the cost of administration.
The other big expense in a securities case is retaining the services of an "expert witness" to analyze the account and testify on technical matters. The cost of an expert can range from a few thousand dollars to tens of thousands, depending on the kind of case and the kind of expert.
Some attorneys will advance all these case expenses, while others require their clients to pay the expenses as the case goes along. Either way, the client is responsible to pay these fees eventually, so these are real costs. But since the need to hire an expert witness (and pay other incidentals like copying and postage) exists both in arbitration and court, we can ignore those items in our comparison.
In litigation (or, in court), filing and service of process fees are smaller (about $500); there are no "hearing session fees." But, when in court, there is a different expense to be incurred--one not seen in arbitration--the cost of stenographic court reporters. In litigation, much of what happens must be transcribed for the record. Licensed court reporters, as they are known, are not public servants, and they charge about $2,000 per day to take down testimony at depositions and at trial. Extensive discovery--the hallmark of litigation--is thus very pricey. Just a few days of depositions, and the out-of-pocket expenses of litigation will quickly match or exceed those arbitration hearing session fees. Though maybe not by all that much. It depends.
So the cost is about the same, then? Not quite. We have not yet gotten to the real cost disparity--the cost of employing an attorney.
Hiring attorneys on an hourly basis is incredibly expensive. Whether the attorney charges $300 per hour or $600 per hour, those hours mount fast. Put that in the context of a securities case, and few folks can afford it.
Fortunately for victims of wrongdoing, there is the "contingent fee." A lawyer working on a contingency gets a percentage of the winnings; if there are no winnings, the lawyer earns no fee. The contingent fee arrangement thus enables alleged victims to hire a lawyer they could not otherwise afford. The lawyer takes the risk of not winning, but he's not working for free. His fee is a percentage of the recovery (usually one third).
A lawyer's willingness to accept a case on a contingency depends on not just the lawyer's perception of the merit of the case, but also its size. A lawyer can make only so much from a small case; the potential fee must justify both the work that must be done and the risk of getting nothing. And that's where the big difference between arbitration and litigation matters most.
Litigation involves so much more lawyer work than does arbitration. In court, there are motions to dismiss, interrogatories and depositions, motions for summary judgment, pre-trial briefs, post-trial briefs and the potential for appeals. Litigations can go on for five years (or more), and a contingent-fee attorney working on a litigation must "carry" that case for the entire duration. The lawyer won't see a nickel until it is all over, including the inevitable appeal.
Arbitration is much more streamlined. There are no motions to dismiss, no motions for summary judgment, no interrogatories, no depositions and no appeals. The whole process takes a little over a year (on average), beginning to end. There is a lot less paperwork and a lot less lawyer-work in arbitration.
The result is that it is relatively easy for an investor with a meritorious case to find a contingent-fee attorney to handle it, even if it is a small case. It would be much, much harder to find an experienced contingent-fee lawyer to take the same case to court (assuming court was allowed) because of the amount of work that the lawyer would need to do in court. Indeed, securities cases are especially susceptible to the most costly and time-consuming aspects of litigation, and an investor is usually up against a big corporation that can afford (and will not hesitate) to drive up the costs and delay everything with legal maneuvers and excessive amounts of paperwork.
Lawyers are in business to make a profit from the expenditure of their professional time. They would be less willing--and less able--to invest their time and take the risks of contingent fee arrangements if securities cases went to court. Only in the largest and best cases would experienced attorneys be willing to commit themselves to a contingent fee in such circumstances. Arbitration, as an alternative to litigation, thus enables attorneys to represent investors using the contingent fee in cases where they would not do so if the cases were in court.
So how much does arbitration cost? As I said, it depends on the case. But most securities cases would cost investors a lot more if they went to court--more in attorney's fees, that is. There's no arguing about that.
Seth E. Lipner is professor of law at the Zicklin School of Business, Baruch College, CUNY. He is also a member of Deutsch & Lipner, a law firm in Garden City, N.Y., that represents investors in arbitration. Professor Lipner is a member of the Forbes.com Investor Team.
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