Arbitration

What Is Arbitration?

Arbitration is a private process for settling disagreements without a court trial. The parties agree to present their dispute to one or more arbitrators, who review evidence, hear arguments, and then issue a decision called an award. In investing, arbitration most often comes up when an investor has a complaint against a brokerage firm or its representative, such as a dispute over unauthorized trades, unsuitable recommendations, or account errors.

How It Works

Arbitration is usually required by a provision in a contract the investor signed when opening an account. These arbitration clause provisions are common in brokerage account agreements and often specify that disputes will go to arbitration rather than to court. In the United States, securities-related disputes between investors and member firms are commonly handled by forums run by FINRA, the industry's self-regulatory organization.

The process typically involves filing a claim, selecting arbitrators, exchanging documents through a limited discovery phase, and holding a hearing that is less formal than a trial. The arbitrators then issue a written award, which is generally final.

Advantages and Disadvantages

Supporters point to several benefits. Arbitration is often faster and less expensive than court litigation, hearings are usually private rather than public, and parties may have some input into who serves as arbitrator.

The drawbacks are also significant. Discovery is typically more limited than in court, which can make it harder to gather evidence. Awards are binding and can be challenged only on narrow legal grounds, so appeals are rare. Many agreements also include class action waivers, which can prevent investors from joining group claims, and signing an arbitration agreement generally means giving up the right to a jury trial.

Why It Matters to Investors

Because arbitration clauses are often included in lengthy account paperwork, investors may agree to them without much attention. Reading the agreement helps clarify how disputes would be resolved and which rights, such as the right to sue in court, might be limited. Understanding the process can make it easier to know what to expect if a disagreement with a firm arises.