PRIVATE JUSTICE
Can public count on fair arbitration?
Financial ties to corporations are conflict of interest, critics say
Reynolds Holding, Chronicle Staff Writer
Monday, October 8, 2001
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The notice that arrived in Darcy Ting's mailbox early last July was troubling enough.

AT&T, her long-distance phone company, was cutting off her right to sue. If Ting made one more long-distance call from her Berkeley home, the notice said, she would have to resolve claims of more than $5,000 against the company through the American Arbitration Association.

What the notice didn't disclose was that the association had invested $100, 000 in AT&T bonds the previous November.

"How can I possibly count on their being fair?" asks Ting, who has sued AT&T on behalf of California customers who received the notice.

In fact, the American Arbitration Association, the nation's largest arbitration firm, owns millions of dollars' worth of stocks and bonds in major corporations whose legal disputes its arbitrators have heard. Some of the corporations also buy "memberships" in the association, and their executives sit on the association's board of directors.

The association denies that any of these financial relationships affect its ability to provide fair and neutral arbitrators.

But critics say the arbitration industry is riddled with conflicts of interest that would never be tolerated in court.

"Virtually any lawyer who has had to use arbitration doubts the integrity of the system in a way we never doubted the integrity of the public courts," says Arne Werchick, a lawyer, arbitrator and former president of the California Trial Lawyers Association.

Over the past two decades, the U.S. Supreme Court has allowed corporate America to impose mandatory arbitration on the public so that companies can avoid lawsuits and judges can lighten their workloads. But the pressure to generate income and attract new clients has driven some arbitrators and their firms to engage in practices that cast doubt on the fundamental fairness of the process:

-- Financial investments. The American Arbitration Association and other arbitration firms own millions of dollars in stocks and bonds in some of the companies whose disputes the firms' arbitrators hear.

-- Undisclosed contracts. Large arbitration firms sell administrative and consulting services to many clients they provide arbitrators to, contracts that aren't revealed to people forced into arbitration.

-- Soliciting clients. Many arbitration firms court corporate clients by stressing the small awards and cursory procedures, sometimes asking ostensibly neutral arbitrators to help salesmen solicit new business.

-- Repeat players. Researchers have found that some arbitrators may succumb to the pressure of ruling for the clients who use their services repeatedly.

-- Captive operators. Some arbitration firms have such a close relationship with their clients that arbitrators may rule in the companies' favor to keep the business.

Last year, the American Arbitration Association's own arbitrators and mediators sharply criticized the firm for filing a legal brief that supported electronics company Circuit City's position before the U.S. Supreme Court. Circuit City wanted to enforce an arbitration clause against an employee, and American Arbitration didn't disclose that the clause named it to handle the dispute.

The association insists the brief merely explained how arbitration worked. But in a Sept. 15, 2000, letter to the association, American Arbitration mediator Elaine Leitner wrote that the brief "is not only unseemly, but destroys AAA's hard-earned neutrality."

Even arbitration's strongest supporters insist that an industry based on neutrality cannot tolerate the appearance of a conflict of interest.

"The only thing that keeps arbitrators in business is their integrity," says Arnold Zack, former president of the National Academy of Arbitrators.

Financial investments

AT&T is not the only corporate client in which American Arbitration has held a financial interest.

The association also has owned shares of Bank of America, Aetna, Cigna Corp. , General Electric and other corporations whose disputes its arbitrators have heard.

Several corporate officers of General Electric, Sprint and other companies that use the association's arbitrators have been directors of American Arbitration. And last year the association received more than $2.1 million in membership fees from Aetna, GE Industrial Systems and other corporations, institutions and individuals.

Kersten Norlin, spokeswoman for American Arbitration, said an outside investment firm manages all the nonprofit association's investments and the association's actual knowledge of the investments "is extremely limited." And whatever the affiliations of its directors or members, she explained, arbitrators are largely independent from the organization and usually selected from panels by the parties themselves.

"Our neutrals decide the outcome of cases. AAA doesn't," Norlin said.

But critics stress that the association has substantial control over the cases it resolves: American Arbitration Association sets the arbitration rules,

selects and trains the panels and chooses arbitrators when parties cannot.

"Do you honestly believe," says Alabama plaintiffs' attorney Charles Robinson Jr., "that a consumer has a fair chance when the company on the other side of the table pays yearly fees to AAA?"

Undisclosed contracts

Two years ago, several long-distance phone customers complained that MCI WorldCom Inc. had concealed a mandatory arbitration clause in documents filed with the Federal Communications Commission. The clause required customers to file all complaints with Irvine-based JAMS, formerly Judicial Arbitration and Mediation Service.

But JAMS, argued the customers, was financially beholden to MCI under side agreements that had never been made public.

One of the customers, a company owned by George Hopper of Lexington, Ky., said in legal papers supporting a complaint to the FCC that JAMS had earned more than $325,000 providing administrative and consulting services to MCI, had received free phone service from MCI, and, until 1999, was owned primarily by investment firm Warburg, Pincus & Co.

As a result, Hopper argued, the arbitration rules were "unjust, unreasonable, unlawful and unenforceable."

JAMS President Steve Price says MCI never paid for JAMS' long-distance service, the investment firm "never attempted to influence JAMS" and "any claim that this program was biased is just not true."

In 1998, a federal appeals court upheld the contract with MCI.

Another major arbitration firm, National Arbitration Forum in Minnesota, cited the MCI decision in a paper presented to the American Bar Association last year.

"Irrespective of allegations of bias," the company said, "the fact remains that the arbitration administrator -- and its employees -- cannot affect the outcome of an arbitration hearing any more than courthouse employees can affect the outcome of litigation."

But critics point to the overwhelming success of First USA N.A., one of the forum's biggest clients.

The bank has filed more than 50,000 collection cases with the forum and paid it several million dollars in fees, according to deposition testimony. And since 1998, First USA has won 99.6 percent of the cases, according to figures produced in a class-action lawsuit.

The forum's managing director, Edward Anderson, rejects the figures, saying the bank might have done as well in federal court.

"The forum is neutral, the arbitrators are neutral and the system has all sorts of protections against any claimant getting a leg up," Anderson says.

But on Sept. 30, 1999, a federal judge in Florida refused to enforce a mandatory arbitration agreement against a First USA credit cardholder because the card company had "failed to demonstrate . . . that the National Arbitration Forum is a neutral, inexpensive and efficient forum."

On June 1, the U.S. Court of Appeals reversed the decision, saying First USA was not required to demonstrate the forum's neutrality.

Soliciting clients

Formed in 1926, the American Arbitration Association had little competition for decades. But in the late 1980s and early 1990s, the Supreme Court dramatically expanded the role of mandatory arbitration, and the demand for arbitrators soared.

JAMS, National Arbitration Forum and other competitors commanded an increasing share of the market, and the association was forced to fight for business.

American Arbitration arbitrators began to accompany the firm's salesmen on calls to potential clients -- helping to solicit business from companies whose disputes the association hoped to resolve, say former association employees.

In a Jan. 14, 2000, memo, Regional Vice President Paul Van Loon in San Francisco asked arbitrators for introductions to corporations and to "indicate . . . if you would like to make the call with us."

Van Loon declined to comment, but association spokeswoman Norlin says he was referring to phone calls rather than personal calls, which, she says, arbitrators are barred from attending.

Although American Arbitration stresses that it does not tell potential clients they will prevail over employees, consumers and other individuals more often in arbitration than in the courts, that is the message the companies receive.

On the sales calls, often with arbitrators, "we would educate people on how arbitration was a less expensive, faster and confidential process," says one former salesman.

On a videotape played for workers at Red Lobster restaurants, American Arbitration arbitrator Bruce Chapin advised that a workplace dispute "is not a matter that would be best tried in front of a jury."

And the association's brochures have stressed "more rational outcomes than (in) the jury system."

Repeat players

Even reputable arbitrators are vulnerable to what has come to be known as the "repeat player" problem.

The problem arises because parties that frequently use arbitrators tend to have an advantage over individuals who go to arbitration once or twice. A repeat player who chooses an arbitrator and wins is more likely to select the same arbitrator in future cases. The prospect of more business gives the arbitrator a financial incentive to rule in the repeat player's favor.

In a 1997 study, Lisa Bingham, director of Indiana Conflict Resolution Institute, found that employees won just 16 percent of their cases against repeat players, defined as employers in arbitration at least twice a year. But the employees won 71 percent of their cases against nonrepeat players. Even when employees beat repeat players, the employees generally won no damages, the study found.

Last year, Bingham presented a revised study that accounted for new industry standards designed to make arbitrations fairer. Employees still won only 29 percent of the cases against repeat players compared with 51 percent against nonrepeat players.

Michael Young, co-chair of JAMS' Committee on Professional Standards and Public Policy, said in a recent article that "the risks of the repeat player advantage are real and can be disturbing," although he noted many arbitrators "take seriously their ethical obligations to be impartial."

By trying to reduce arbitration costs, the courts may have aggravated the repeat player problem.

In 1997, the U.S. Court of Appeals in Washington said an employee can't be forced into arbitration and then charged fees he wouldn't have incurred in court. The California Supreme Court reached a similar conclusion last year.

But making one party pay the fees skews the system, says Zack, who argues that parties should split the bill.

"I would like to think that if I did these cases, I would do what I think is fair regardless of where the chips fall," he says. "But I do have a gnawing feeling that if I hadn't had any cases for a while, and I saw the possibility of a lot of cases coming in from an employer, it might influence my decision."

Captive operators

Outside the major arbitration firms, thousands of arbitrators ranging from individual lawyers to company-controlled panels operate beyond scrutiny or industry guidelines.

And in some cases, the close relationship between these independent operators and their clients has cast doubt on the fairness of their proceedings.

"It's the unregulated, cowboy arbitrators," says Bingham, "and the private panels that employers set up below the radar that you really have to worry about."

In March, a federal judge in Indiana ruled that a chain of restaurants called Ryan's Family Steak Houses could not enforce an arbitration agreement imposed on two waitresses who accused their manager of sexual assault.

The agreement required employees to resolve disputes before Employment Dispute Services Inc., a private company the restaurant paid to provide arbitration whenever the need arose. Employees made no comparable payment, which the court found disturbing.

Employment Dispute Services "clearly has an incentive to maintain its contractual relationship with Ryan's," said the court. And since Employment Dispute Services also made the rules and picked the arbitrators, the court ruled there was "a strong potential for bias," and threw out the agreement.

It is rare, though, for a court to consider the fairness of an arbitration process before an award is issued. It is even rarer for a court to overturn an award -- even when the process is fraudulent.

In a lawsuit filed four years ago, for example, three Los Angeles landlords say they agreed to a commercial tenant's demand for an arbitration clause that named the Southern California Arbitration Association to resolve any disputes.

Unknown to the landlords, said the complaint, the tenant's officers were business associates of the arbitration firm's principals.

Within a few months, the tenant fabricated complaints that the association then resolved in their favor, costing the landlords hundreds of thousands of dollars in bogus awards, the complaint said.

Other victims of the association had failed to overturn similar awards because judges are essentially powerless to disturb arbitration decisions. But last year, a Los Angeles Superior Court judge slapped the now-defunct association and related businesses with a $5.1 million fraud and racketeering judgment.

Legal experts acknowledge that arbitration scams may be common -- but are very difficult to detect.

"The lack of oversight in this (arbitration) business creates a giant loophole," said Gregg Martin, an attorney for the landlords. "It's not going to take a rocket scientist to figure out how to do this again and again."

New ethical codes

The financial pressure to get new business also can influence whether an arbitrator discloses information that might keep him off a lucrative case.

The U.S. Supreme Court acknowledged the problem as early as 1968. In a case involving an arbitrator who had failed to disclose $12,000 in income from one of the parties, Justice Hugo Black stressed that a judge or jury foreman in that position would have been kicked off the case.

"We should, if anything, be even more scrupulous to safeguard the impartiality of arbitrators than judges," Black wrote for the court, "since the former have completely free rein to decide the law as well as the facts and are not subject to appellate review."

In 1994, several instances of egregious conflicts of interest persuaded the California Legislature to require that arbitrators, like judges, disclose certain potential conflicts.

But judges and arbitrators face different financial considerations.

"In court, if a judge recuses himself, nothing happens," explains William Cahill, a mediator and arbitrator and former San Francisco Superior Court judge. "But if you recuse yourself in the arbitration world, it's more complicated, because you might have to refund money. Some people don't easily do that."

In June 2000, a commission sponsored by Georgetown University Law Center and the CPR Institute for Dispute Resolution drafted a code of ethics for arbitrators and arbitration firms.

The code calls on the firms to disclose "any interests or relationships" that "might reasonably create the appearance" of bias.

In a comment to that provision, the code's drafters say "it is essential to hold (the firms) . . . to the highest standards of quality and competence."

William Slate, president of American Arbitration Association, is a member of the commission. But the firm has declined to say whether it will ever comply with the code.

About the series

Yesterday: Lost Rights. Mandatory arbitration clauses tucked into the fine print of bills, bank statements and other documents deprive people of their legal rights -- with the approval of the U.S. Supreme Court.

Today: Conflicts of Interest. Some arbitration firms have financial interests in their clients, creating the appearance of conflicts that would never be tolerated in court.

Tuesday: Compromised Judges. The lure of potentially high-paying jobs as arbitrators prompts some judges to try to impress arbitration firms in ways that undermine confidence in the courts.

Chart:

Apparent conflicts of interest between arbitration firms and clients

Some arbitration firms have undisclosed financial relationships with their corporate clients. Critics of mandatory arbitration say the relationships create conflicts of interest that raise questions about the fairness of the mandatory arbitration process.

As of Dec. 31, GE Senior Counsel Arthur E. Joyce was a member of the association's board of directors.

GE Industrial Systems, a GE business unit, is a "sponsoring member" of the association, meaning it has contributed $10,000 or more and receives services such as advice on handling disputes. .

A case study: GE and AAA

General Electric ..... American Arbitration Association

General Electric requires its employees to resolve any disputes with the company before arbitrators with the American Arbitration Association.

General Electric pays the arbitrators and American Arbitration fees to conduct the hearings.

As of Dec. 31, American Arbitration owned $680,000 in bonds of GE Capital Corporation, a GE subsidiary that accounts for almost half of GE's sales.

E-mail Reynolds Holding at rholding@sfchronicle.com.

Mandatory Arbitration Takes Another Huge Hit As Obama Signs New Law
Erin Geiger Smith, Dec. 22, 2009
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When a former employee of defense contractor Kellogg Brown & Root sued the company after reporting she was raped by co-workers in Iraq, company owner Halliburton tried to force the case into arbitration.
The woman, Jaime Lee Jones, has been "the public face for arbitration opponents" ever since.
President Barack Obama signed a bill into law on Saturday that forbids most military contractors from enforcing mandatory arbitration clauses in employment provisions, The National Law Journal reported.
The arbitration provision is included in the 2009-2010 spending bill for the U.S. Department of Defense.
There are some exceptions -- the law does not apply to contracts and subcontracts with less than $1 million and the defense secretary can grant a waiver if doing so is "necessary to avoid harm to national security interests in the United States." The waiver will be public.

Mandatory arbitration clauses, long a target for consumer-rights activists, have been in the spotlight this year.

In June, Obama's Financial Regulatory Reform Plan suggested one of its newly-created agency would have broad authority to review the propriety of mandatory arbitration agreements. In July, lawsuits brought against National Arbitration Forum for allegedly favoring the companies over consumers resulted in a quick agreement by the NAF to no longer hear disputes between credit card companies and their clients. The next week the American Arbitration Association voluntarily agreed to do the same until further guidelines are developed.

Last month, a similar lawsuit against bank credit card units resulted in J.P. Morgan Chase agreeing to drop arbitration clauses from it credit-card agreements.

Obviously, there is a difference between the consumer-related arbitration clauses and those included in employment contracts, but when the most prominent arbitration provisions -- those included in credit cards -- seem on their way to extinction over only one calendar year, larger changes could be afoot.
Nothing, of course, will ever prevent contracting parties to agree to arbitration; the focus of these arbitration attacks are on contracts where the terms are effectively non-negotiable for one of the parties.