February 06, 2017

FINRA Update: Task Force Recommendations and Rule Changes

A summary of the key recommendations to enhance the efficiency, transparency, and fairness of the dispute resolution system

Daniel R. Korb Jr.

December 16, 2016, marked one year since the Financial Industry Regulatory Authority (FINRA) Dispute Resolution Task Force issued its final report and recommendations. Formed in July 2014, the 13-member task force, composed of individuals from the public and industry sectors, was charged with considering possible enhancements to FINRA’s dispute resolution system and making recommendations to improve the process. In June 2015, the task force published an interim summary of key issues, forecasting what was soon to come. The task force reportedly looked at every aspect of FINRA’s dispute resolution forum and ultimately made 51 recommendations for improving the existing system and alerting users of the forum, arbitrators, and the general public to the evolving needs of the dispute resolution process. The task force’s recommendations also in some instances responded to the Dodd-Frank Act’s grant of authority to the Securities and Exchange Commission (SEC) to prohibit or limit the use of arbitration clauses that offend public policy or fail to protect investors. The task force submitted its final report to FINRA’s National Arbitration and Mediation Committee (NAMC) for further review and consideration, and initial actions have commenced.

This article briefly addresses a few of the task force’s key recommendations to enhance the efficiency, transparency, and fairness of the dispute resolution system: arbitrator quality, explained decisions, an “intermediate approach” for small claims, mediation before arbitration, and mandatory arbitration.

Arbitrator Improvements
It is the task force’s unanimous and strongly held opinion that arbitrators are the “most important investment” for the future of FINRA. Not surprisingly, the final report concludes that attracting and recruiting professional arbitrators is critical to the quality of the dispute resolution process. To this end, the task force expresses concern with existing arbitrator compensation and recruitment efforts, suggesting that the below-market-rate compensation that exists acts as a disincentive to recruiting otherwise qualified arbitrators. While the task force proposes an increase in arbitrator compensation, it also recognizes that FINRA simply cannot match the compensation offered by non-self-regulatory-organization arbitration forums, like the American Arbitration Association, without imposing a substantial financial burden on participants in the dispute process. Nevertheless, because professionalizing the FINRA arbitrator pool was the task force’s “highest priority,” the task force urges a modest increase in arbitrator compensation (from $300 to $500 per session) and biennial adjustments based on the consumer price index.

In addition to increased consideration, the task force stresses the need to implement more aggressive recruiting strategies to expand the depth and diversity of the arbitrator pool, including, specifically, by reaching more minority and women candidates. The task force also was concerned about improved and early disclosure of potential conflicts by arbitrators so as to ensure that the parties have a true pool of 30 potential arbitrators to select from.

Explained Decisions as the Default
Currently, FINRA does not require an explained decision unless the parties jointly request one. It requires only that final awards be in writing and publicly available on FINRA’s website. The task force, however, acknowledges that a common complaint among the party participants, especially those who are dissatisfied with the outcome of the arbitration, is the absence of any explanation in the award. The task force concludes that the current structure hampers transparency and does a disservice to parties who have a legitimate interest in how a particular conclusion was reached. In analyzing how to deal appropriately with the concerns of dissatisfied parties, the task force emphasizes that any recommendation had to strike an appropriate balance between improving transparency and opening the doors to an increased number of appeals. However, after reviewing appeals in alternative arbitration forums where explained decisions are provided, the task force determined that explained decisions do not cause a real increase in the number of appeals.

Ultimately, the task force recommends amending the current rules to require that arbitration awards be accompanied by brief explanations of the panel’s reasoning and the nature of the award unless one party notifies the arbitration panel before the initial pre-hearing conference that it does not want it. Notably, in arriving at this conclusion, the task force cautions that “if it subsequently becomes clear that one party frequently blocks an explained decision, a different approach may be warranted.” It is also the task force’s opinion that an explained award should not have any precedential value.

An “Intermediate Approach” for Small Claims
FINRA Rule 12800 currently provides a simplified arbitration procedure for small claims, which are defined as arbitrations involving $50,000 or less. The purpose of the simplified procedure is to make the process less expensive and faster. Simplified arbitrations are decided by a sole arbitrator on the pleadings and other submissions filed by the parties (unless a hearing is requested by the customer). Based on its investigation, the task force formed a consensus that claimants whose cases are decided solely on the papers are the most dissatisfied group of those that use FINRA’s dispute resolution process. Accordingly, the task force recommends that the NAMC consider adopting an intermediate form of adjudication that would strike a balance between hearing small claims solely on the pleadings and conducting a full hearing. Under the proposed “intermediate approach,” the claimant and respondent would be afforded the opportunity to appear before an arbitrator to explain their positions and respond to their adversary’s positions, in a time-limited manner. The task force concluded that this proposal would provide parties to simplified arbitrations an opportunity to be heard without imposing the procedural requirements of a full hearing on small claim arbitrations.

Mandatory Mediation Before Arbitration
The task force also analyzed the issue of mandatory mediation to avoid the increasing adversity, cost, and time-consumption associated with the arbitration process. Securities Arbitration Reform: Report of the Arbitration Policy Task Force to the Board of Governors National Association of Securities Dealers, Inc. 47 (1996) (also known as the Ruder Report). According to statistics from FINRA’s mediation program, nearly 80 percent of mediated cases resulted in early settlements. The task force found that early settlements cut arbitration time, reduce costs, and promote forum efficiency. Based on the success of FINRA’s mediation program, the task force proposes that FINRA mandate mediation for all arbitrations, subject only to an opt-out by either party. Furthermore, parties that successfully mediate their dispute may receive up to 100 percent reimbursement of their mediation and arbitration fees. The earlier the parties mediate during the arbitration process, the greater the percentage of fee reimbursement.

No Consensus on Mandatory Arbitration
In an effort to address investors’ perceptions that they lack an alternative forum to arbitration, the task force considered the effect of granting investors another option. The task force recognized that critics of mandatory pre-dispute arbitration agreements (PDAAs) argue that their prohibition would improve investor confidence by affording investors multiple options to pursue their disputes—resulting in greater transparency. NASAA Letter to the FINRA Dispute Resolution Task Force: Key Points (May 15, 2015).

The task force identified and considered four possible recommendations: “allowing investors to choose, post-dispute, between arbitration and litigation; maintaining the status quo; requiring broker-dealers to offer at least some customers an agreement without a PDAA; and requiring broker-dealers to offer a non-[self-regulatory-organization] forum in their PDAAs.” Although the task force devoted a considerable amount of time debating these alternatives, it ultimately failed to reach a consensus. Further, because the Dodd-Frank Act empowers the SEC to prohibit PDAAs with respect to disputes arising under federal securities laws and the rules and regulations implementing them, the task force reasoned that this policy question is better left to Congress and the SEC to decide.

The task force’s recommendations reaffirm FINRA’s continuing effort to promote efficiency, transparency, and equity in its dispute resolution process. The recommendations and analysis highlighted above reflect the organization’s interest in meeting the emerging needs of all parties to the arbitration process. Members of the financial industry and their representatives are anxious to see which of the task force’s proposals are adopted by FINRA in the immediate future.

Keywords: litigation, securities, FINRA, task force, dispute resolution