Call it the Thunderdome of the securities industry.
For the 4,000 firms, 637,000 registered representatives and millions of investors in the U.S. brokerage industry, there’s practically only one way to settle disputes: Financial Industry Regulatory Authority arbitration.
Here, in part one of a series on FINRA arbitration, Law360 offers a primer on the forum.
Why FINRA Arbitration?
In 1987, the U.S. Supreme Court decided Shearson/American Express v. McMahon, which held that broker-dealers can enforce arbitration clauses in contracts when a customer brings a dispute over securities transactions. Since then, virtually all broker-dealers have made it mandatory for customers to bring claims to the dispute resolution forum run by FINRA.
Is It Fair?
It depends on whom you ask. Mandatory arbitration clauses have scores of critics because they bar consumers from going to court and having their claims heard by a judge and jury.
When it comes to FINRA arbitration, attorneys on both the claimant and respondent side of the aisle seem to think the process is by and large fair. Although FINRA is funded by the very firms it regulates, the regulator over the years has made a number of changes to formalize its arbitration proceedings and make them more independent from the securities industry.
Some of these changes are potentially helpful to investors. In recent years, for example, FINRA has allowed claimants to choose whether they want only so-called public arbitrators to decide their case, and it subsequently has narrowed the definition of who can count as a public arbitrator by excluding those who’ve ever worked in the financial industry.
“I think it’s a terrific system. I generally think they reach over time fair results,” said Jacob Zamansky, who represents investors in FINRA arbitrations through his firm Zamansky LLC.
Unlike federal court, where a case can be litigated for years and at great expense only to be thrown out on a motion to dismiss, FINRA arbitration claims will be resolved much more quickly and with less expense and uncertainty, Zamansky said.
“They can throw out a case that is absurd on its face, but short of drastic situations like that the customer is going to get a hearing,” he said.
Still, there are ongoing debates about the fairness of compelling investors into arbitration. And it is an open question whether the U.S. Securities and Exchange Commission will act on its powers under the Dodd-Frank Act to strike or limit the use of mandatory predispute arbitration clauses in future brokerage agreements.
It isn’t just investors who are bound to arbitration clauses. So are registered representatives who have a beef with their firm or want to expunge a customer complaint from their record. Firms themselves also have to go through arbitration if they want to claw back sign-on bonuses, which are typically given in the form of a promissory note, from brokers who flew the coop.
FINRA arbitration stretches across borders. Even though FINRA regulates U.S.-based broker-dealers and their representatives, overseas investors who feel they got ripped off by a member firm will have to bring their claim to the forum. Claims can also be brought against overseas brokers if they are associated with a FINRA-regulated firm.
Stats, Stats, Stats
Last year, FINRA arbitration closed a whopping 3,489 cases, and nearly the same number of new claims were opened as well. However, that’s nothing compared with the 9,209 cases it closed in 2004, and the 8,201 that were filed that year.
Arbitration cases have been on the decline over the past decade and a half, with 2015 marking the slowest year since 2000, according to FINRA data.
That will likely change, however, given the hot-button issues bubbling up in the markets, particularly in the wake of Puerto Rico’s bond fund crisis. At present, there are more than 1,000 arbitration cases in the hopper in the commonwealth, or more than double the number in New York City, the next largest center for dispute resolution requests, according to FINRA data.
Other FINRA data also reflects this trend. In 2015, municipal bonds and municipal bond funds were at issue in 559 and 607 claims served, respectively. In 2013, these securities were at the heart of 67 and 66 claims, respectively. By comparison, the most common claim last year involved common stock, which netted 610 new cases, while mutual funds made up just 373 cases.
In terms of win rates, investors face some odds getting an award if the matter is left up to a hearing panel. Last year, arbitrators awarded damages in just 42 percent of the cases brought by a customer. The rate was slightly higher in 2010 — 47 percent — and slightly lower in 2014 — 38 percent.
First and foremost, the statute of limitations for a case is six years from the event that gave rise to the dispute, although under certain circumstances that could be shorter, FINRA says.
From start to finish, though, FINRA arbitrations that were resolved last year on average took about 18 months if they went all the way to a hearing, according to the regulator’s data. Most cases, however, never make it that far. Just under 20 percent of cases last year were resolved after a hearing, as opposed to the 50 percent ended by a direct settlement between the parties.
Either way, once a claim has been filed, there is a certain order of proceedings before litigants get to the hearing stage. Once respondents have received a copy of a claim, they will have 45 days to research the matter and file a response, according to FINRA.
After that, parties select their picks for arbitrators, which are drawn from the pool of candidates available for the location where the hearing will be held. FINRA presents both sides with the same list of 30 randomly picked candidates, and both sides are given the opportunity to strike some candidates and favor the rest in order of preference. FINRA will choose the ultimate panel from the list.
At that point, the panel will hold an initial prehearing conference with the claimants to cover procedural issues, mediation alternatives and scheduling of the hearing. A discovery period is next. While FINRA publishes a list of documents it believes are presumptively discoverable, there are options to file motions to compel or seek subpoenas for information the other side refuses to give up.
Arbitration hearings are organized like normal trials in that there is a period for opening arguments, examinations and cross-examinations. But the rules of evidence are looser, as arbitrators have it within their discretion to consider things like hearsay. And because arbitration is an equitable forum, arbitrators don’t have to strictly follow the law when ruling on matters, attorneys say.
Hearings typically are scheduled for a few days, and panels generally return a decision on an award about 30 days afterward, FINRA said.
Public v. Private
When it comes to selecting an arbitration panel, there are a few things to keep in mind.
The size of the arbitration panel depends on the amount at issue. If the dollar figure at dispute in the case is $100,000 or more, then the matter will be heard by a panel of three arbitrators. Claims worth $50,000 to $100,000 are heard by a single arbitrator, while those for less than $50,000 can go through a “simplified” proceeding that is decided on the papers.
Arbitrators are categorized as public and nonpublic, with nonpublic referring to those with work experience in the financial industry or significant work on behalf of investors. Recent rule changes, however, have given more weight to public arbitrators. For one, arbitration panels must be chaired by a public arbitrator, while claimants have the right to select an all-public panel. The regulator also recently cut back on who counts as a public arbitrator and now excludes anyone who worked in the financial sector from meeting that standard.
Speaking of public, very little is ever published on the decisions of the arbitration panel. After a dispute has been resolved, FINRA will issue an order from the panel about its decision, and it identifies just basic information, such as the parties, the matters under dispute, how they were resolved and any compensation or relief awarded. Very seldom, however, do arbitrators explain their decisions, leaving it up to others to divine their reasons for ruling they way they did.
A task force that FINRA organized to explore potential changes to its arbitration program in December recommended changing the rules to require panels to explain their decisions, unless the parties request they don’t.
“A common complaint among parties, particularly customers who are dissatisfied with the outcome of arbitration, is the absence of any explanation,” the group wrote. “In the view of the task force, expanding the use of explained decisions is one of the most important things FINRA can do to increase transparency in the system.”
The decisions of panels are generally meant to be binding, and there is no internal appeals process at FINRA. Only in the most extreme cases can an arbitration decision be appealed to a higher court.