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February 06, 2017 Articles

FINRA Update: Another Busy Year for the Financial Industry Regulatory Authority

The authority was active again in 2016, in working to enhance its arbitration and mediation forums

By Joshua D. Jones and Christy Boardman

The Financial Industry Regulatory Authority (FINRA) has been active again this year in working to enhance its arbitration and mediation forums. Many of these developments have been in response to concerns raised by the FINRA Dispute Resolution Task Force, which was formed in 2014 to consider possible enhancements to FINRA’s arbitration and mediation forums. Those developments are addressed in the accompanying article by our colleague, Dan Korb. 

The focus of this article are the changes being implemented by FINRA unrelated to the work of the task force. As you will note, FINRA is working on a number of fronts to improve its capabilities to deliver a fair and efficient forum for dispute resolution to its member firms and the investing public.

Offsetting Monetary Awards
On May 3, 2016, FINRA filed with the Securities and Exchange Commission (SEC) a proposed rule change concerning offsetting monetary awards. Rule 12904 of the Code of Arbitration Procedure for Customer Disputes (Customer Code) and Rule 13904 of the Code of Arbitration Procedure for Industry Disputes (Industry Code) require that all monetary awards be paid within 30 days of receipt unless a motion to vacate has been filed. Consequently, when arbitrators order opposing parties to pay each other damages but do not specify whether the party that owes the higher amount must pay the net difference, the party owing the lesser amount may be required to pay the counterclaim within 30 days even if the other party refuses or is unable to pay the larger amount. Otherwise, a party who does not pay within 30 days could be subject to FINRA disciplinary action, including membership cancellation or suspension. This lack of clarity in issued awards has resulted in parties asking arbitrators to revise an award after a case has closed or in post-award litigation. 

FINRA’s proposed rule change (SR-FINRA-2016-015) would amend FINRA Rules 12904(j) and 13904(j) to provide that, absent specification to the contrary in an award, when arbitrators order opposing parties to pay each other damages, monetary awards are offset, and the party that owes the larger amount pays the net difference. In addition, this proposed rule change would replace the bullets in Rules 12904 and 13904 with numbers to increase ease of citation of these rules. 

Efforts to Increase Number of Chairpersons
FINRA recently filed with the SEC a proposed rule change to amend Rule 12400 of the Customer Code and Rule 13400 of the Industry Code (SR-FINRA-2016-33). The changes, filed on August 18, 2016, would allow an attorney arbitrator to be eligible for the chairperson roster upon completion of (1) chairperson training and (2) service as an arbitrator through one arbitration award in which evidentiary hearings were held and were administered by a self-regulatory organization (SRO). The current rule requires service on at least two such panels plus training. 

FINRA proposed the rule change in an effort to expand the pool of arbitrators available to chair arbitrations. In part, the proposed change was in response to parties’ concerns relating to the use of out-of-town arbitrators and associated inconveniences. The use of such arbitrators became necessary due in part to the lack of available chairpersons in some localities. In addition, FINRA’s reclassification of roughly 14 percent of its public arbitrator roster as nonpublic (see “FINRA Update: Public Arbitrator Limitations, Adjournment, Task Force, and More,” in the Summer 2015 issue of this newsletter) worked to exacerbate the concerns regarding the lack of chairperson availability. Another factor cited by FINRA was a year-to-date increase in filings of 20 percent. FINRA estimates that adoption of the proposed rule change could result in an almost 30 percent increase in chairperson availability upon completion of the required training. 

Mandating the Use of the Party Portal in Arbitration Cases
On July 27, 2016, FINRA filed with the SEC a proposed rule change (SR-FINRA-2016-029) to require parties to use the FINRA Office of Dispute Resolution’s Party Portal to file initial statements of claim and to file and serve pleadings and other documents on FINRA or any other party. An exception would be made for pro se customers. This rule change would also require parties to use the Party Portal to file and serve correspondence relating to discovery requests; however, parties would not be permitted to file documents produced in response to discovery requests through the Party Portal under this proposed rule change. In addition, FINRA proposed permitting parties in mediation to use—on a voluntary basis—the Party Portal to submit and view their mediation case information and documents. 

Reminding FINRA Member Firms to Honor Pre-Dispute Agreements
On July 22, 2016, FINRA issued a notice (Regulatory Notice 16-25) reminding member firms that customers and associated persons cannot waive their rights to arbitration. If member firms do not honor FINRA rules relating to pre-dispute arbitration agreements with customers or pre-dispute agreements with associated persons, these firms may be subject to disciplinary action.

As explained in FINRA’s notice, “FINRA rules are not mere contracts that member firms and associated persons can modify.” Customers have a right to request arbitration at FINRA’s arbitration forum at any time. Under FINRA rules, customers cannot forfeit that right by signing an agreement with a forum selection provision specifying another dispute resolution process or arbitration venue. Similarly, member firms cannot require associated persons to waive their right to arbitration under FINRA’s rules in a pre-dispute agreement. 

Creating a Fund for Unpaid Arbitration Awards
On March 3, 2016, FINRA Chairman and Chief Executive Officer Richard Ketchum testified before the U.S. Senate Subcommittee on Securities, Insurance, and Investment. After Senator Elizabeth Warren questioned Ketchum about unpaid arbitration awards and referenced a study finding that over $60 million in arbitration awards from 2013 are yet to be paid, Ketchum acknowledged that unpaid arbitration awards are “a real concern” and that FINRA would like “to work with the SEC” on the issue. Ketchum explained that unpaid arbitration awards are often linked to insolvent firms or firms that leave FINRA, upon which FINRA loses its jurisdiction. He stressed that firms that do not pay awards are disbarred from FINRA membership. 

Ketchum also mentioned that FINRA is “looking at whether, one way or another, there should be a fund to try to at least address the small investors that are terribly harmed.” More recently, one of the members of FINRA’s Board of Governors confirmed that the board is considering creating of a relief fund for unpaid arbitration awards. The Public Investors Arbitration Bar Association has suggested establishing an unpaid arbitration awards fund that would require FINRA members to pay annual dues of around $100 per broker to a designated pool that would be dispersed annually to claimants who are unable to collect their FINRA awards. 

Merging FINRA Dispute Resolution, Inc., into and with FINRA Regulation, Inc.
On December 20, 2015, the SEC approved the merger of FINRA’s dispute subsidiary, FINRA Dispute Resolution, Inc., into and with its regulatory subsidiary, FINRA Regulation, Inc. According to FINRA, although this merger changed the corporate status of FINRA Dispute Resolution, it does not affect the services, benefits, and costs to use FINRA’s dispute resolution forum or the corporate governance and oversight of this forum. 

The dispute resolution office was established as a separate subsidiary in 1999 to strengthen the independence and credibility of the arbitration and mediation forums. FINRA now believes that maintaining its arbitration and mediation functions in a separate subsidiary is not necessary to provide a fair, neutral, and efficient dispute resolution forum. The merger is intended to reduce unnecessary administrative burdens that stem from maintaining separate legal entities. 

To implement the merger, FINRA made conforming amendments to the Plan of Allocation and Delegation of Functions by NASD to Subsidiaries (now titled the Plan of Allocation and Delegation of Functions by FINRA to FINRA Regulation, Inc.); amended FINRA Regulation by-laws to incorporate substantive and unique provisions from FINRA Dispute Resolution by-laws and made other conforming amendments; and made conforming amendments to FINRA rules. FINRA’s dispute resolution program now operates as a separate department within FINRA Regulation and is referred to as the Office of Dispute Resolution. In addition, FINRA increased the maximum number of FINRA Regulation board seats from 15 to 17 to enhance flexibility to manage its board committee assignments and to meet the compositional requirements under the FINRA Regulation by-laws. 

The developments discussed above reflect FINRA’s continuing effort to evaluate the efficiency of its operations and address concerns raised by members, investors and their counsel, and arbitrators. One can expect additional changes in the coming year as FINRA continues to implement some of the suggestions of the FINRA Dispute Resolution Task Force and to contemplate changes to enhance the effectiveness of its dispute resolution forum. 

Keywords: litigation, securities, FINRA, offsetting monetary awards, arbitrator qualifications, party portal, pre-dispute agreements, unpaid arbitration awards