In the past year, the Financial Industry Regulatory Authority (FINRA) has been active in working to fulfill its mission to provide investor protection and promote market integrity. Practitioners will note a number of recent developments in the FINRA Codes of Arbitration Procedure as well as other updates and changes to rules and regulations affecting arbitration practice.
Limitations as to Who Can Serve as a Public Arbitrator
On February 26, 2015, the Securities and Exchange Commission (SEC) approved FINRA-proposed limitations as to who can serve as a public arbitrator. The revisions (SEC Release No. 34-74383 (Feb. 26, 2015)) apply to both the FINRA Code of Arbitration Procedure for Customer Disputes (Customer Code) and the Code of Arbitration Procedure for Industry Disputes (Industry Code).
The revised definitions of a “non-public arbitrator” and a “public arbitrator” are to be set forth in amended Rules 12101(p)/13101(p) and 12101(u)/13101(u), respectively. No person can be classified as a public arbitrator who has ever worked for, or been associated with, or registered through (a) a broker or a dealer; (b) the Commodity Exchange Act or the Commodities Future Trading Commission or a member of the National Futures Association or the Municipal Securities Rulemaking Board; (c) an entity that is organized under or registered pursuant to the Securities Exchange Act of 1934, Investment Company Act of 1940, or the Investment Advisers Act of 1940; (d) a mutual fund or a hedge fund; or (e) an investment adviser. The former rules allowed individuals who have been out of the industry for at least 5 years, but who may have worked in it as long as 20 years, to serve as public arbitrators.
In addition, professionals who have devoted 20 percent or more of their professional time to the representation of investors or the financial industry in any single calendar year during the last five years are to be classified as non-public arbitrators. Such professionals may be attorneys, accountants, and expert witnesses, among others. Previously, professionals whose firms had not derived 10 percent or more of their income over the past two years from the financial industry could serve as public arbitrators. Unlike those who worked directly in the industry, the professionals above are eligible to serve as public arbitrators after the 5-year “cooling off period” unless they have provided at least 15 calendar years of service to financial industry entities or to representing parties in disputes with such entities, in which case they can never serve as a public arbitrator.
The new rules also provide that individuals may not be deemed to be public arbitrators who have been employed by banks or financial institutions within the last five years and (a) effected transactions in securities, or (b) supervised or monitored employees’ compliance with securities and commodities laws. As with professionals, these bank employees may serve as public arbitrators after the passing of 5 years unless their employment totals 15 years or more.
The revised rules also prohibit a professional from serving as a public arbitrator if his or her firm has derived $50,000 or more, or at least 10 percent of its annual revenue, in any single calendar year during the last two years, from a broker-dealer, the other entities listed above in subsections (b) through (e), or from a financial institution that effects transactions in securities. This prohibition expires two years after the termination of the employment.
Finally, individuals whose immediate family member cannot serve as a public arbitrator are not to be classified as public arbitrators. This prohibition includes a two-year sunset provision.
As noted above, the SEC has approved the amendments, which await implementation by FINRA.
Late Adjournment Fees
On May 22, 2015, the SEC approved a proposed rule change (SEC Release No. 34-75036) to amend Rules 12214 and 12601 of the Customer Code and Rules 13214 and 13601 of the Industry Code to require that parties give additional notice before adjourning an arbitration hearing or risk being assessed a higher late cancellation fee if they fail to provide such notice. FINRA recommended the proposed rule changes in an effort to address arbitrator complaints regarding issues surrounding the late cancellation of scheduled hearings.
The amendments to Rule 12601(b)(2) and 13601(b)(2) increase from 3 business days to 10 calendar days the deadline by which parties should request adjournment of hearings to avoid a late cancellation fee. The amended rules also change the amount of honoraria paid to arbitrators for late cancellation of a hearing to equal that of a two-session hearing day, increasing the amount from $100 to $600 per arbitrator. In addition, the amendments make clear that the arbitrators have the authority (1) to allocate all or a portion of the cancellation fee to the non-requesting party if the arbitrators determine that the non-requesting party caused or contributed to the cancellation, or (2) waive the cancellation fee when appropriate.
Updated Expungement Guidance
FINRA provided expanded guidance on expungement to parties and arbitrators in December 2014 to specifically address cases in which the only relief requested is expungement. FINRA, Notice to Arbitrators and Parties on Expanded Expungement Guidance (updated Dec. 2014). In such cases, where the associated person has named the firm as a party but not the complaining customer, FINRA directed arbitrators to order the associated person to provide a copy of the statement of claim to the customer. FINRA did so in an effort to give customers the opportunity to state their position on the expungement request to both the panel and the parties.
This guidance follows a pronouncement in late 2013 in which FINRA described expungement of a complaint as “an extraordinary remedy that should only be recommended under appropriate circumstances” and further stressed the importance of the Central Registration Depository disclosures and noted that expungement is appropriate “only when [the information] has no meaningful investor protection or regulatory value.” In recognition of these issues, FINRA directed arbitrators to review a current copy of the registered representative’s BrokerCheck report when considering expungement, further explained the importance of providing a written explanation for the recommendation of expungement, and ordered arbitrators to determine and consider whether a settlement between the parties had been conditioned on an agreement not to oppose an expungement request. The later adoption of Rule 2081 flatly prohibited firms from conditioning settlement of a claim filed by a customer on an agreement by the customer to consent to, or not to oppose, an expungement request.
Rule Additions Require Redaction of Confidential Information
FINRA has amended the Codes of Arbitration Procedure for both customer and industry disputes in an effort to protect parties’ confidential information. Specifically, it added subsections (g)(1)–(3) to Rules 12300 and 13300 to require the redaction of an individual’s Social Security number, taxpayer identification number, or financial account number from any document that a party files with FINRA. Moving forward, documents filed with FINRA must be redacted to include only the last four digits of these numbers. The redactions are not required of documents exchanged by the parties or entered into the record during an arbitration hearing, nor do the amendments apply to simplified cases. Any filing received by FINRA containing a full Social Security, taxpayer identification, or financial account number will be found deficient under Rule 12307 or, depending upon the type of pleading filed, otherwise improper, and the offending party given 30 days to refile the document.
Referral to FINRA Enforcement During Pendency of Case
In December 2014, FINRA’s extended odyssey to amend Rule 12104 of the Customer Code and Rule 13104 of the Industry Code finally concluded with the adoption of modified amendments first proposed in July 2010 (SEC Release No. 34-62930 (Sept. 17, 2010)). The amendments allow arbitrators to refer matters to enforcement at any time during the pendency of a case. Once such a referral is made, the director of arbitration is then required to notify all parties to the arbitration of that fact. A party then has three days from such notification to request the recusal of the arbitrator or arbitrators who made the referral. The amendments are silent as to whether a party may move for removal of the arbitrator or arbitrators by the director if the recusal motion be denied.
Under the prior rules, an arbitrator was not authorized to refer a matter to enforcement until the case had concluded. The amendments were proposed by FINRA in an effort to address its concerns that delaying arbitrators’ ability to make referrals hampered FINRA’s ability to take action against problematic brokers and that such delays could result in additional harm to the investing public and limit the enforcement division’s ability to collect evidence. The adopted amendments differ from the original 2010 proposal in that the original proposal would have required the recusal of all arbitrators appointed to hear the case if any of the arbitrators made a mid-case referral. Objections were lodged as to the initial proposal based on concerns that the withdrawal of the entire panel would prejudice the parties who would be required to re-litigate their case.
FINRA Dispute Resolution Task Force
Concluding a FINRA update with a brief discussion of the FINRA Dispute Resolution Task Force seems appropriate. FINRA Dispute Resolution states on its website that it formed the “task force to consider possible enhancements to its arbitration and mediation forum” in furtherance of its commitment “to providing a fair, efficient, and economical forum to resolve disputes among investors, securities firms, and individual brokers.” The individuals who comprise the task force represent a broad spectrum of interests in securities dispute resolution and include ABA Securities Arbitration Subcommittee cochair Sandra D. Grannum of Davidson & Grannum, LLP.
The task force has met in-person three times since its formation in July 2014 and has plans to meet again in October 2015. It has stated that it is open to examining “any issues that may affect the face of arbitration and mediation in the next 20 years and that no issue was off the table for discussion[,]” and has identified 11 broad topics for review and established numerous subcommittees to address them.
The task force seeks input from any interested party on any and all aspects of FINRA’s dispute resolution forum and related processes. FINRA staff maintains an email inbox (DRTaskForce@finra.org) on its behalf. All correspondence with the task force via the mailbox on FINRA’s website will be kept confidential.
FINRA continues to work to provide a fair and efficient forum for dispute resolution to the investing public and its member firms. The changes discussed above reflect its efforts to adapt to constantly evolving litigation needs and to address concerns raised by members, investors and their counsel, and arbitrators. Next year’s update will likely be of great interest given the forthcoming recommendations of the task force. One can only assume that more changes are in store.
Keywords: litigation, securities, FINRA, Codes of Arbitration Procedure, public arbitrator, late adjournment, enforcement referral, task force