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By Charles Gasparino
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Over the course of his long and prosperous life, 90-year-old Henry Hochman had amassed a fortune investing in WorldCom, the high-flying telecom company. As the stock rose and Hochman's net worth hit eight digits, he never gave much thought to the stack of paperwork he'd signed after he opened his Salomon Smith Barney brokerage account more than 20 years earlier. But when WorldCom plunged into bankruptcy amid massive accounting fraud in 2002, Hochman lost more than $13 million--and the fine print in that paperwork suddenly loomed large. Like many aggrieved investors, Hochman wanted to sue Salomon, where star analyst Jack Grubman had relentlessly touted WorldCom. But according to Hochman's brokerage agreement--a document similar to the one signed by every investor--his complaint can't go to court. It must go to arbitration--a forum where, as Hochman is learning, the judging can seem as conflict-ridden as an Olympic gymnastics event.
Arbitration is supposed to provide a streamlined way for investors to get justice if brokers do them wrong. Instead of a formal trial, industry-appointed "arbitrators" hear the facts and quickly render verdicts. In the wake of the tech bubble and accounting scandals, arbitration claims are surging: investors filed nearly 9,000 cases last year, up from 6,500 in 1993. Investors have long complained that arbitration is stacked against them because the arbitrators are too closely aligned with brokerages. They appear to have a point: in two cases reviewed by NEWSWEEK, the panelists who'll render the awards have industry ties that outsiders say constitute a clear conflict. In Hochman's case, the chairman of the arbitration panel, Robert Herschman, is working with Salomon's lawyers as a "mediator" on other cases involving Grubman. "There's no way [he] will hand a big award to an investor," says Jacob Zamansky, a lawyer who represents investors but isn't involved in this case. "He's not going to bite the hand that feeds him."
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That kind of conflict isn't as rare as you'd think. The rules say that one member of a three-person arbitration panel must work in the securities industry; investor advocates claim that often makes them overly sympathetic toward brokers. Meanwhile, defense lawyers claim that arbitrators often ignore their own code of conduct, which requires disclosure of any conflicts. In another case reviewed by NEWSWEEK, attorney Thomas Ajamie has filed a lawsuit claiming that arbitrator Robin Henry is conflicted because she failed to disclose that she heads a charity that accepts large donations from the securities industry. In Hochman's case, his attorney, Jeffrey Liddle, calculates that Herschman has heard cases in which investors claimed $117 million in losses--and awarded just $7 million in damages.
Herschman, Henry and Salomon declined to comment; both cases are still pending. New York Stock Exchange spokesman Richard Adamonis says there are no hard and fast rules prohibiting these types of conflicts, as long as they're disclosed to all parties. The NYSE has no problem with Henry's industry-charity connections, Adamonis says, but it's examining whether Herschman fully disclosed his conflicts in a timely fashion. Investor advocates, meanwhile, say that as clients seek compensation for their lost fortunes, it's time to level the playing field. Attorney Zamansky has been speaking with members of Congress about the issue. "Let's just say the people I've spoken to are aware of the problems," he said. He's hoping a system based on fine print and closed-door trials might soon find itself under the hot lights of a congressional hearing. For investors who await their day in arbitration, that scrutiny can't come too soon.
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