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Arbitration Financial Markets

Possible Changes Afoot for FINRA Arbitrations

Following is a guest post by JAMS panelist V. James Mann, who spent 25 years as an in-house attorney with Merrill Lynch, where he represented the broker-dealer, investment banking, institutional trading and sales businesses.

In 2008, the Financial Industry Regulatory Authority (FINRA) instituted a  pilot program whereby most of the larger retail broker-dealers agreed that, upon the request of a complaining retail customer, the hearing panel in an agreed upon number of investor arbitrations would consist entirely of arbitrators designated as “public arbitrators.”

This represented a departure from the long-standing arbitration rules first promulgated by FINRA’s predecessor, the National Association of Securities Dealers, Inc., whereby the typical customer-broker arbitrations would be heard by a panel consisting of two “public” arbitrators and one “industry” member.  This structure was intended to provide a balance where the majority of the panel - who presumably would have a natural affinity for the retail customer - would be joined by a non-interested brokerage industry panelist who would bring an understanding of products, prevailing industry standards and regulatory requirements to the dispute.

Interestingly, only 54 percent of investors eligible to participate in the pilot program elected to do so and, of those who chose to participate, approximately one-half ultimately picked a hearing panel which included an industry arbitrator. As of January 2011, the pilot program was made a permanent part of the FINRA arbitration regime applicable to all investor disputes.

At the annual meeting of the Public Investors Arbitration Bar Association in late October, Linda Feinberg, president of Dispute Resolution at FINRA, reported that 77 percent of eligible claimants are now electing to have their claims decided by a three person panel of public arbitrators. It seems clear that the days of the industry arbitrator in FINRA arbitrations are, if not numbered, becoming an endangered species.  One cannot help but feel the law of unintended consequences closing in on the process.

Under Section 921 of the Dodd-Frank Act, Congress has given the SEC authority to ban or limit mandatory arbitration of investor claims. An outright ban would constitute a complete reversal of the 1987 Supreme Court decision in Shearson v. McMahon upholding a pre-dispute arbitration provision in a customer account agreement.

Under existing FINRA Rules 12200, however, the customer would continue to have the unilateral option of bringing investment-related claims to a FINRA arbitration panel, rather than being required to file a lawsuit.  Were this scenario to develop, the right to arbitrate would belong only to the investor who could elect to have the case heard by a panel made up exclusively of public arbitrators. It is likely that the securities industry would view this as a “bridge too far” and would seek to repeal or significantly amend FINRA Rule 12200.

If the Rule were repealed under these circumstances, arbitration would virtually cease to exist as a venue for resolving customer disputes. The cases where the customer might prefer arbitration (e.g., a case with legal stumbling blocks or a case where the probable recovery is not likely to justify the expense of a lawsuit) are probably those where the broker-dealer defendant would take a contrary view.

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