When the SEC (Securities and Exchange Commission) filed an amicus brief with the U.S. Supreme Court in early 2007, arguing for a more stringent legal standard to plead and prove the element of intent in federal statutory investment fraud cases filed in court (under the Private Securities Litigation Reform Act of 1995 (PSLRA)), it took investors and their advocates by surprise. While the industry’s goal may be to protect big business from lawsuits, it shouldn’t be the overriding consideration when legitimate investment fraud claims are at stake, whether asserted in court or arbitration.

Making it harder for the public to assert investment fraud claims in either forum could turn out to have unintended repercussions. After all, in 1987 at the industry’s insistence (with SEC backing), the Supreme Court upheld mandatory securities arbitration as a way to reduce investment fraud cases filed in federal court. We represented the investors in that case, Shearson v. McMahon, who were required to file their fraud and other claims in a securities arbitration at the New York Stock Exchange. But it didn’t take long for the industry to back away from the exclusive jurisdiction of the securities arbitration venue, and instead turn to the courts to micro-manage various investment fraud claims filed in arbitration by the public. The industry’s courthouse litigation strategy resulted in the dilution or outright dismissal of many claims even before they reached an arbitration hearing.

Paradoxically, after McMahon the passage of so-called tort reform legislation such as the PSLRA illustrated that laws enacted with the supposedly “beneficial” goal of curtailing civil lawsuits could not prevent the kind of fraud that undermined market integrity and investor trust in the early 2000s. Prime examples were the accounting industry’s association with the Enron collapse and the analyst conflict of interest scandal that resulted in billion dollar fines against the major investment banks and brokerages. If anything, lax oversight coupled with the relaxation of standards governing the mechanisms to redress wrongdoing may even have encouraged some of the illegal activity that was so detrimental to the interests of investors and the public generally.

Since McMahon, securities arbitration claims are filed at the self-regulatory organizations such as the NASD pursuant to the brokerage industry’s mandatory arbitration clauses in their customer agreements and under the rules of the forum, not pursuant to federal statutes. Arbitrators should be made aware that the more stringent standard for pleading fraud under a specific statute that is currently working its way through the courts should not apply to investment fraud claims brought in securities arbitration. As triers of fact in an equitable tribunal, arbitrators should not impose a higher burden of proof that would make it harder for investors to prevail.