FINRA Debates Rule Allowing Matters to Be Referred to Enforcement During Arbitration Cases

A recent InvestmentNews article highlighted a proposed rule change that the Financial Industry Regulatory Authority (FINRA) has proposed to the Securities and Exchange Commission (SEC) that would allow arbitrators to direct cases to FINRA enforcement during the pendency of the case.  FINRA enforcement is responsible disciplining brokers and brokerage firms for securities misconduct and fraud.  FINRA has the authority to suspend, sanction, fine, or bar individuals and companies from involvement in the securities industry based upon the findings of its investigation.

Under the current rules, arbitrators must wait until the case concludes before submitting a report of concerns to FINRA.  But FINRA believes that making arbitrators wait until the end of the arbitration could delay the regulator’s ability to take action against a parties and to collect evidence.

I believe there are pluses and minuses to allowing mid-litigation referral of customer claims to FINRA.  On the benefit side, FINRA would receive information faster and be able to protect more investors.  Although arbitrations are routinely completed within one year to a year and half after filing, a delay in submitting evidence of misconduct allows wrongful actors to continue to hurt investors.  In addition, sometimes counsel representing brokerage firms, on rare occasions, abuse the FINRA process in order to satisfy a demanding client.  However, brokerage firms, even in litigation, must conduct themselves fairly under the FINRA rules.  The power of an arbitrator to refer instances of repeated or significant abuse of the FINRA process will make firms think twice before simply ignoring panel orders.

Some minuses include whether or not the process will open up the arbitration to more scrutiny than the value of the referral of the case to FINRA enforcement.  First, FINRA already reviews all broker complaints to determine whether or not the matter warrants further investigation.  Second, for the vast majority of cases, very little evidence is provided to the arbitrators prior to twenty days before the hearing and at the hearing itself.  Thus, it is unlikely that arbitrators would refer many matters to FINRA until four to six weeks before the case is closed, not a significant improvement in getting information to FINRA enforcement from the current process.

Finally, and most importantly, any referral to FINRA enforcement will raise issues of arbitrator bias and increase the likelihood that any award will be challenged in court.  According to the proposal, arbitrators will refer claims to the director or president of FINRA enforcement who will then notify the parties that the referral had been made.  The parties would then have the opportunity to request that the arbitrator recuse themselves.  However, FINRA stated that an arbitrator’s referring a claim for disciplinary action should not be considered proof of bias and the decision to remain on the panel will be up to arbitrator.  Nonetheless, arbitrators that refer matters to enforcement are likely to cause claimants to face additional collateral attacks to the arbitration proceeding.  Brokerage firms have been known to raise issues of bias simply from arbitrators granting favorable discovery orders or allowing in disputed evidence.

Any action on the matter must first be approved by the SEC and made available for public comment before a final vote on approval.

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