Unhappy with FINRA arbitration? Now's the time to recommend fixes

FINRA wants to know what it can do to improve its arbitration system used to resolve industry disputes.

And judging by the topics touched on in 61 questions posed in a notice earlier this month, almost any conceivable change to the regulator's arbitration rules are up for discussion. 

Officials at the Financial Industry Regulatory Authority, the brokerage industry's self-regulator, want to hear suggestions for everything from improving the selection of arbitrators who appear on its panels to whether punitive damages should be part of arbitration awards. In the most far-reaching question, they even ask if mandatory arbitration should be the default means of settling certain types of industry disputes. 

Because of contract clauses in almost all brokerage contracts, firms and clients alike are often required to resolve disputes in FINRA arbitration, rather than the courts. That's true whether the conflict is between two firms, a firm and one of its brokers, a client and a firm, or a client and individual broker.

Advocates of the system say it helps expedite resolutions and provides consistent interpretations of often-complex securities laws. Detractors contend it deprives ordinary investors of the protections of the regular court system, including various due-process safeguards and various avenues for challenging decisions.

READ MORE: Judge tosses UBS' attempt to have $1M arbitration award quashed

Recent changes to FINRA arbitration proceedings

FINRA has made various tweaks to its arbitration rules over the years. In June, for instance, it changed the criteria used to determine who can serve on its dispute-resolution panels. 

FINRA's previous requirement that arbitrators have at least two years of college-level education credits was revised to insist they have a four-year degree. A separate requirement that they have five years of "paid business and/or professional experience" was modified to specify the experience has to be in a profession such as teaching, the law or medicine. 

Those changes were followed this January by various tweaks used to determine who can be even up for consideration for serving on a FINRA arbitration panel and how potential members can be removed. 

All of those revisions are fairly small compared with what's apparently contemplated in FINRA's latest request for suggested improvements. Its latest push to improve its arbitration procedures comes as part of the FINRA Forward initiative, a broad push to "modernize" its rules for the entire industry.

Of 127 recommendations FINRA received in response to FINRA Forward, 13 had to do with arbitration, according to this month's regulatory notice. 

"As a result of the comments, as well as engagement outside of the comment process, FINRA has identified arbitration as an area of focus for its review," the notice states.

READ MORE: Arbitrators blast JPMorgan for 'pattern' of post-resignation firings

Firms, investors often want different things out of arbitration

Brian Rubin, co-head of the law firm Eversheds Sutherland's securities enforcement and regulatory investigations practice, said criticisms of FINRA arbitration proceedings tend to come from all directions. The difficulty for regulators will be finding reforms that appease certain groups while not making others more discontent than they are now.

Individual brokers or aggrieved investors, for instance, often complain of cumbersome discovery procedures — or rules determining when and how parties to a dispute must furnish documents to be used as evidence. The need to respond to requests for documents in response to discovery requests can add greatly to the costs of arbitration.

"From the claimant's perspective, discovery can sometimes be onerous," Rubin said. "The claimants are often looking for just quick resolution to their claims."

Meanwhile, some industry representatives believe disputes between two large firms belong either in court or before other arbitration groups like JAMS (formerly Judicial Arbitration and Mediation Services) or the American Arbitration Association (AAA). Contrary to what many individual claimants want, large firms sometimes look favorably on alternatives to FINRA because they offer a greater ability to obtain documents through discovery.

"Also, they think with large-dollar claims, they shouldn't necessarily be in front of arbitrators either, because there may be more complicated issues," Rubin said. "And since there's more money at stake, it may be more appropriate to have motions and discovery practice."

Elsewhere, industry advocates like the Securities Industry and Financial Markets Association have called for limits on arbitrators' ability to tack punitive damages onto award amounts. Punitive damages have become a flashpoint after a pair of arbitration panels imposed heavy punitive penalties on Stifel and UBS in separate cases involving investors aggrieved over complex investments.

READ MORE: What's next for reforms for mandatory RIA arbitration

PIABA: Firms already win 70% of investor disputes

Investor advocates are wary that any changes introduced amid the deregulatory push made under President Donald Trump will inevitably tilt the system toward the brokerage industry and its representatives. Michael Bixby, the president of the Public Investors Advocate Bar Association, noted such concerns in a statement released this month before he appeared in front of the U.S. House Committee on Financial Services to discuss the role of FINRA.

Bixby noted that firms already win the majority of disputes that go to FINRA arbitration. He's worried any proposed reforms would only tilt the playing field more toward industry interests.

Bixby Law

"In its arbitration forum where the industry already prevails in over 70% of the final arbitration proceedings, FINRA appears to be more interested in granting the industry's wish lists for industry protection to make the FINRA arbitration forum even more unfair for investors," Bixby said.

But Phil Waxelbaum, the founder of the advisor-recruiting firm Masada Consulting and a frequent industry expert in arbitration proceedings, said such statistics obscure an important fact: Most industry disputes are settled before going all the way to FINRA arbitration.

That's particularly true in cases in which a firm determines an aggrieved client has a strong claim to compensation. Most brokerages would rather quietly resolve such a situation rather than bear the additional legal costs of a dispute in arbitration.

"If you take the number of client outright wins in arbitration versus settlements, and you put that against the times that the firms prevail, we end up back with a very fair coin toss," Waxelbaum said.

Topics FINRA is seeking comment on by May 1

With so many competing interests, finding a way to appease them all may well prove impossible.

"I think both sides won't necessarily be happy with any change," Rubin said. "I think around the edges, they're looking to make them arguably more efficient, more fair."

Beyond the proper forum for hearing disputes, the topics touched on in FINRA's questions include:

• The six-year time limit for bringing claims: These questions concern FINRA's "eligibility rule," which bars claims that are more than six years old from being pursued. FINRA asks if the rule should be eliminated, clarified to make it clearer when the six-year time frame begins, or amended to allow older claims in cases of ongoing fraud or concealment.
• Punitive damages: FINRA asks if it should maintain its current system for allowing punitive damages to be imposed on claimants. Or should it allow parties to limit them using predispute contracts, or by imposing monetary caps. 
• U5 filings and defamation claims: These questions concern the public presentation of U5 filings — which firms must submit to FINRA whenever a broker is fired or leaves for another reason. Language from U5 filings often ends up on FINRA's massive BrokerCheck database, which investors can search to learn about a given broker's employment history. U5 filings are also frequently a source of defamation claims filed by advisors who feel they've been maligned by their former employers. FINRA questions if arbitrators should have to make specific findings, like a firm acted out of bad faith or malice, before making an award for a defamation claim. It also asks if arbitrators should undergo special training to hear these claims, and if brokerages should receive legal immunity for disclosures made on U5 forms.
• Explanations for decisions and awards: These questions ask if arbitrators should be required always to provide written explanations of their awards and about the specific details those decisions should include. Arbitration panels now frequently issue awards without providing any rationale.
• Recouping unpaid arbitration awards: FINRA seeks recommendations on how it can recoup unpaid arbitration awards, asking for regulatory, legislative or alternative solutions (such as setting up a national customer-recovery pool).
• Arbitrator qualifications and selection: These questions explore the appropriate composition of FINRA's arbitrator roster — its list of arbitrators qualified to serve on any given panel. In the interest of expanding the pool of potential panel members, it also asks if FINRA should modify its definition of a "public arbitrator" — or arbitrators with no ties to the brokerage industry. Three-member FINRA panels usually have at least two public arbitrators.
• Arbitrator training: These questions ask if FINRA should require arbitrators to have training in subjects such as securities law or complex investment products, and whether this training would compromise FINRA's neutrality.

Responses to FINRA's questions are due by May 1.