Under a new FINRA pilot program starting this month, customers who bring arbitration claims against the firms of their financial advisors will be able to choose to have their cases heard by a panel of three of their peers, a switch from the current norm of two public panelists and one industry arbitrator.

The new program is aimed at quelling rising criticism that having even a single industry panelist unfairly biases the arbitration process against investors. Surprisingly, though, the new plan seems to have sparked opposition on both sides of the equation: Those in favor of empaneling the industry arbitrator are predictably against this new idea, but even longtime critics of the industry-panelist concept—including the Public Investors Arbitration Bar Association (PIABA) and the state regulators who belong to the North American Securities Administrators Association (NASAA)—have shown little enthusiasm for the plan. Both sides say the new system will take too long, and will likely produce inconclusive results. And attorneys who defend financial advisors, of course, worry the new rule will have long-term negative implications for their clients.

But FINRA says the goal here is to provide options. The two-year program will take 40 cases from the five major wirehouse firms—Merrill Lynch, Citi Global Wealth Management, UBS, Wachovia Securities, Morgan Stanley—plus 10 from Charles Schwab each year. In each case, the investor will choose whether or not to include an industry arbitrator as one of the panelists. "This pilot will give investors greater choice when selecting an arbitration panel," says FINRA Chief Executive Mary Schapiro. "Additionally, [we'll] see if a change in the way arbitration panels are selected is a better way to serve and protect the interests of investors."

FINRA will compare the results against existing metrics, such as the percentage of cases that settle before award, the length of the hearings, use of expert witnesses and the end results of the cases.

Executives at both PIABA and NASAA say the effort to address the issue is long overdue. Both believe that a mandatory industry panelist is inherently unfair and biased against the investor. "The basic problem is the industry arbitrator has a conflict of interest, and a built-in bias: an inclination to support the industry position," says attorney Larry Schultz of Driggers, Schultz & Herbst in Troy, Mich., and president of PIABA.

Pete Michaels, a Boston-based attorney who represents advisors, argues that the accusations of bias against industry arbitrators are flawed. Sure, he says, with two public arbitrators and one industry arbitrator, it's always two against one—but in number only. "It is false that the industry arbitrator is rigged for the industry. I sit as an industry arbitrator and I am incredibly skeptical of registered reps' claims. If you have one person [who always sided] for the industry and two for the clients, the registered reps would lose every single case. And that's not what happens. That's the fault of their logic."

But Schultz and other investors' attorneys contend that bias becomes a growing concern in the face of industrywide scandals.

"It's even more of a problem where we're seeing systemic fraud—auction-rate securities being the most recent example—because firms are dealing in the same types of products and the same type of misrepresentation," Schultz says. "The arbitrator who works for a firm selling a lot of variable annuities is going to have a hard time sitting on a variable annuity case," he says.

FINRA tacitly recognized this conflict, Schultz adds, when the regulator finally decided to ban from cases involving auction-rate securities any industry arbitrator whose firm had ever handled those products. That effectively eliminated arbitrators who worked for any major wirehouse. As far back as May, PIABA had objected to industry arbitrators sitting on these cases, but, Schultz recalls, FINRA had refused to step in, saying that its rules prevented any remedial action. But after a series of settlements in cases brought against the industry by state regulators, including New York State Attorney General Andrew Cuomo, FINRA changed its position.

Expertise: Helpful or a Hindrance?

But PIABA and NASAA don't simply want industry arbitrators pulled from the most high-profile system wide cases as well as the pilot program. Both groups say they'd rather see FINRA simply propose a new rule to the Securities and Exchange Commission to eliminate the industry arbitrator from the panels altogether.

Another contention is that the fluid employment market—and the takeovers of Dean Witter, Prudential Securities, A.G. Edwards, Paine Webber and Bear Stearns—opens another door to industry arbitrators' bias. "Yesterday's A.G. Edwards branch manager is today's Wachovia employee," says Brian Smiley, the incoming PIABA president and partner at Smiley Bishop & Porter in Atlanta. "That has to put pressure on industry arbitrators sitting in judgment of firms that could well be their future employer." He adds that there are many industry arbitrators to whom he doesn't object. His real concern, he says, is the industry panelist's mandatory presence. Finally, PIABA and other critics object on the grounds that even though industry arbitrators work in the business, they are not necessarily experts in the issue at hand.