By: James D. Knotter*

© 1998, 2000 Second Reprint Rights Reserved
First Published in Securities Arbitration Commentator, 10/98

In 1997, of the 865 customer vs broker claims moved by the parties from the arbitration process of the National Association of Securities Dealers to its mediation program, almost 80% were settled. Yet these 865 cases represented only 15% of the total number of claims filed with the NASD during that year. With such a high settlement rate, why are so few claims diverted to mediation? Since, by definition, a case is settled in mediation only when each party regards the settlement as better than the alternative of pursuing the case to a final arbitration award, the paradox of high satisfaction but low usage demands an answer.

 The gist of the answer is this: Whereas the arbitration rules are detailed and the procedures are uniform from case to case and from panel to panel, there are no detailed rules or procedures controlling the mediation process.  Mediators’ styles vary across a broad spectrum from “touchy-feely”  plenary sessions whose principal goal may be restoration of  a spoiled relationship to a settlement conference style in which the mediator shuttles proposals between the parties and may seek to impose a settlement based on his own evaluation of the case. Without knowledge of how a mediation will be conducted, attorneys find it difficult to recommend mediation for any particular case and are at a loss as to how to prepare themselves and their clients for mediation. This article describes a tried-and-true mediation plan that works well for customer-broker cases.

As every litigator knows, an effective prosecution or defense needs a central theory to give it focus and consistency. The same holds true for an effective mediation plan. The theory underlying the plan described below is as follows:

  Arbitration and mediation are two means of reaching the same result: namely, finding the true value of a given claim. In arbitration, attorneys and witnesses, employing an adversarial process, communicate information to the arbitrators who find the value and state it as their award. In mediation, the parties and counsel use a collaborative process, moderated  by a trained mediator, to find the value themselves. That value is then stated as their settlement agreement.

There are two fundamental reasons why mediation is a more effective value-finding mechanism than arbitration.

 The first reason is simple efficiency. The process of conveying information to the arbitrator(s) using the examination/cross-examination process is time-consuming and tedious. In mediation, the parties and their counsel can base their settlement decisions on the knowledge of the  facts and law which they bring into the mediation session, as adjusted and refined by what they learn from the other side. Communication of complete information to a previously uninformed third party is not necessary. A case that would require several hearing days before an arbitration panel can usually be settled in a single mediation session.  Moreover, mediations do not require expert witness testimony or the reproduction of volumes of documentary evidence.

The second reason is related to the first. Assume the true value of a case is $100,000 and that it would cost each side $30,000 to find that value through arbitration. Thus the respondent’s total outlay to find and pay that value would be $130,000 and the claimant’s net recovery would be $70,000. Thus, the total process cost of finding the value through arbitration is $60,000. On the other hand,  the process cost of finding the same value through mediation may be only $10,000 per party, yielding a  total process cost of $20,000 and a cost saving of $40,000 when compared to arbitration. The parties and the mediator can use all or part of this saving to facilitate a settlement.

Since the goal of mediation is to equal or better the result that would be produced by arbitration, the respondent will find it advantageous to pay up to $120,000 and  the claimant to accept as little as $80,000 to settle the case. Thus, from the perspective of each party, a mediated settlement within the range of $80,000 to $120,000 is as good as taking the case through to an arbitral award. This broad  range helps explain the high settlement rate achieved in securities mediation.

To reach the goal and reflect the theory stated above, an effective securities mediation passes through three stages. Each stage has its own goal, delivers its own beneficial results and lays the foundation for the next.

  1.  In the first stage, each party and attorney briefly describes the dispute from her own perspective. The claimant starts, followed by the principal on the other side, usually the broker. Their layman’s-view perspectives are followed by a summary by each attorney of  the legal basis of her client’s position and of the principal evidence and arguments she would make if the case were in arbitration. The mediator steers the speakers back on course if they go into too much detail or become overly contentious.  

 These descriptions achieve the following goals: the principals become engaged in the process and they begin to see that there are two sides to the dispute. The mediator develops a feel for the case and gathers the information necessary for the next stage. Additionally, each attorney is able to gauge the credibility of her opponent’s main witness and can directly communicate the strong points of her case to the principal (and attorney) on the other side.

  If it appears that anger or frustration will block constructive negotiation, a carefully mediated direct exchange between the principals is the first topic. When the mediator concludes that the air has been cleared sufficiently for constructive discussion to proceed, he then moderates a focused, collaborative discussion of disputed matters which, based on what he has heard from the principals and counsel, he believes are  central to the dispute. When the mediator is satisfied that he and the parties share a common identification of the central facts and legal issues in dispute and have sufficiently aired their positions on those issues, he moves to the next stage.

  2.  Unlike the first stage which is conducted as a plenary session (all participants in the room), the second stage is usually conducted through a series of alternating private or “caucus” sessions.  Here the mediator engages each side in a focused, confidential discussion of the central issues and the validity and strength of its positions. The mediator also determines the status of any prior settlement discussions. When he is satisfied that the private discussions of strengths and weaknesses has refined the parties’ respective settlement postures, he solicits a demand or offer which he can communicate to the other side. The offers and counter-offers that are exchanged at this stage should not be viewed by the mediator as amounts that the parties realistically expect to pay or receive. Rather, this exchange is the process by which the parties “bracket” the final settlement  or, to put it another way, establish the range within which, after taking process cost savings into account, the final settlement will occur.

3.  In the final stage, which may be conducted in a plenary session or through more shuttle diplomacy, the mediator’s function is to facilitate a negotiation which will result in agreement on a dollar settlement which is within the range established in the second stage and, thus,  is preferable to each party than the alternative of pursuing the case to final award.

  In summary, since almost 80% of mediated securities claims settle on terms that, by definition, are acceptable to both parties, the principal reason for trying meditation is clear. Moreover, even if settlement is not achieved, each party will have gained a better understanding of the strengths and weaknesses of both sides of the case. Each client will also have been a real participant in the settle/arbitrate decision and will more readily accept the outcome of the arbitration, whatever it may be. Finally, even if the case doesn’t settle during the mediation, the ground work will have been laid for settlement discussions or a final demand or offer before the arbitration hearing begins.

 A securities mediation whose structure and process is known to all participants before it begins and which is based on a coherent theory permits the attorneys and their clients to prepare for, and to participate effectively in, a mediation  which will be beneficial even if, contrary to the odds, their case doesn’t settle.

   * Mr. Knotter is a graduate of University of Michigan Law School with 25 years of corporate and transaction law experience. Mr. Knotter is an inactive member of the Ohio and California bars and is the principal of Mediation Solutions, an alternative dispute resolution practice based in San Diego, California. He is an arbitrator for the NASD, NYSE and the National Arbitration Forum and serves as a mediator for the NASD, the Superior Court of San Diego and the San Diego Mediation Center. Mr. Knotter has mediated more than 500 disputes in the last ten years.