CORPORATE LAW AND PRACTICE
Course Handbook Series
Number B-2117
Securities Arbitration
2014
Chair
Sandra D. Grannum
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4
Recent and Potential FINRA Rule Changes:
Summarizing Developments as to Arbitrator
Issues, Discovery Updates, Privacy Rule
and More
Joshua D. Jones (Guest Writer)
Joel M. Everest (Guest Writer)
Bressler, Amery & Ross, P.C.
If you find this article helpful, you can learn more about the subject by going
to www.pli.edu to view the on demand program or segment for which it
was written.
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BIOGRAPHICAL INFORMATION
Josh Jones is one of the founding partners of the Birmingham, Alabama
office of Bressler, Amery & Ross, P.C. In addition to a general litigation
practice, Josh regularly represents brokerage firms and other financial
institutions against claims asserted by their clients and employees. He
currently serves as the Co-Chair of the ABA Securities Arbitration
Subcommittee.
Joel Everest is an associate in the Birmingham, Alabama office of
Bressler, Amery & Ross, P.C. He also regularly represents brokerage firms
and financial institutions against claims asserted by customers and former
employees in state and federal court and in arbitration proceedings
throughout the country.
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FINRA has been busy of late. Practitioners will note a number of recent
developments in the FINRA Code of Arbitration Procedure as well as
other updates and changes to rules and regulations affecting arbitration
practice. Hot topics include the effect that changing panel compositions
have had on award outcomes and how the changing definition of public
arbitrators may affect the same moving forward. Discovery continues to
evolve as FINRA, firms, and counsel for all parties adapt to the amount
of electronic data generated by even the simplest brokerage relationship
as well as the staggering amount of such information potentially at issue
in “product” cases. Forthcoming changes to privacy rules and referral
procedures are also at the forefront of developments that one must
consider. The following will address these topics and more in an effort to
provide a concise examination of recent and upcoming FINRA arbitration
rule changes, potential amendments to the rules, and other developments
of interest.
I.
MODIFIED RULES REGARDING ALL-PUBLIC PANELS
Since February 1, 2011, FINRA has given customers the option to have
their cases decided by three “public” arbitrators (i.e. arbitrators with no
ties to the securities industry) instead of a panel comprised of two public
arbitrators and one industry-affiliated arbitrator. While customers were
able to request an all-public panel any time up to 35 days from service of
the Statement of Claim, the case defaulted to a majority-public panel if
no selection was made.
In the two years following the implementation of the all-public panel
option, customers chose an all-public panel in approximately 75% of
eligible cases.3 Of the cases in which the customer did not choose the allpublic option, 77% defaulted to a majority-public panel by making no
selection at all. This means that customers only affirmatively chose the
majority-public option in about 6% of cases.
Surprisingly, despite a majority of customers selecting all-public
panels, FINRA’s data shows that slightly more cases that have gone to a
final hearing since the all-public option was implemented have been
decided by majority-public panels. As of April 14, 2014, a total of 276
cases had been decided by majority-public panels, while only 268 cases
3.
As noted by FINRA President Linda Fienberg, the popularity (or lack thereof) of
the all-public option was “a bit surprising,” as customers chose an all-public panel
just 54% of the time during FINRA’s 27-month test program of the all-public option.
All data referenced in this article was provided by FINRA and is available on its
website: www.finra.org.
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had been decided by all-public panels. Of these cases, 47% (125) of the
all-public panels awarded damages to the customer compared to just 38%
(105) of the majority-public panels.
These results have led FINRA to comment recently that customers
are awarded damages “significantly more often” when an all-public
panel decides their case. However, recent award rates have been more
even. In fact, since 2013 majority-public panels and all-public panels
have awarded damages to the customer in the exact same percentage of
cases: 44%. This number is in line with historical award rates, which
have ranged from 37% to 47% on an annual basis since 2006.
Despite the award rates since 2013, FINRA recently noted its
concern that customers were defaulting to the majority-public option –
and thereby “significantly” reducing their chance at recovery – simply
because “they were not familiar with the Customer Code or because they
did not appreciate the significance of making an election.” Accordingly,
beginning September 30, 2013, FINRA modified its rules so that customers no longer need to affirmatively select the all-public option. Instead,
all parties have the option of choosing an all-public panel by striking as
many arbitrators as they wish from the non-public list of potential arbitrators. If the parties individually or cumulatively strike all non-public
arbitrators, FINRA will appoint the next highest ranked arbitrator from
the public list.
If, as FINRA feared, many of the customers who defaulted to a
majority-public panel over the past few years did so inadvertently, it is
very possible under the new rules that more than 90% of cases will
utilize an all-public panel. Cases proceeding under the modified rule
have not yet begun to reach final hearings, so the effects (if any) on
customer awards remain to be seen.
II.
LIMITATIONS AS TO WHO CAN SERVE AS A PUBLIC
ARBITRATOR
In another move meant to increase the perception of fairness in the
arbitration process, FINRA has proposed new limitations on who can
serve as a public arbitrator.4 On February 13, 2014, FINRA announced
proposed amendments that would prohibit anyone who has ever worked
in the securities industry from being classified as a public arbitrator.
4.
See Update: FINRA Board of Governors Meeting, February 13, 2014, available at
http://www.finra.org/Industry/Regulation/Guidance/CommunicationstoFirms/P4457
19.
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FINRA’s current rules allow individuals who have been out of the
industry for at least five years, but who may have worked in it as long as
twenty years, to serve as public arbitrators.
In addition, professionals who represent investors or the financial
industry as a “significant part of their business” would also be limited to
serving as non-public arbitrators. Current rules allow professionals whose
firm has not derived 10% or more of its income over the past two years
from the financial industry to serve as public arbitrators. Unlike those
who worked directly in the industry, these professionals would be eligible
to serve as public arbitrators after an unspecified “cooling off period.”
FINRA Chairman and CEO Richard Ketchum called the amendments “a
very balanced response to concerns on both sides” about how arbitrators
are classified. FINRA’s Board of Governors authorized FINRA to file
the proposed amendments with the SEC on February 21, 2014, but the
proposal has not yet been submitted.
While there is no data on the number of arbitrators who will be
reclassified as non-public if these amendments are approved, the number
of public arbitrators currently on FINRA’s roster – currently 3,557 – will
undoubtedly be reduced. Combined with the new all-public panel rule
outlined above (which will likely keep the majority of FINRA’s 2,839
non-public arbitrators off future customer-case panels), the effective size
of FINRA’s arbitrator roster will likely be substantially smaller.
III.
DISCOVERY GUIDE UPDATE: NOTICE TO MEMBERS 13-40
FINRA has once again updated its Discovery Guide. As outlined in Notice
to Members 13-40, the amended Guide will apply to all cases filed on or
after December 2, 2013. The amended Discovery Guide does not make
any changes to the previous Discovery Guide’s Document Production
Lists. Instead, the amendments add prefatory language to the Guide
dealing with three issues: (1) e-discovery disputes, (2) product cases, and
(3) affirmations.
With respect to e-discovery, the amendments outline several guidelines
regarding the production of electronic documents. Specifically, the amendments state that an arbitrator may allow a party to produce a document in
an alternative format if the original format will be too costly or burdensome to produce. In addition, the new language states that electronic files
must be produced in a “reasonably usable format,” which generally
means that the production should be made in the same format in which
the documents are ordinarily maintained or converted to a format that
does not raise the cost or burden of review for the requesting party. In the
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event that there is a disagreement over the proper format of production,
the arbitrator is to consider the totality of the circumstances when deciding
what is “reasonably usable.”
The amended Discovery Guide also highlights several ways in which
discovery in product cases can differ from other customer cases. For
example:
•
Documents requested/produced
voluminous;
•
Multiple investors may seek the same documents, and these
documents may have been produced to parties in many other cases;
•
Documents likely will not be client specific;
•
The product at issue may more likely be the subject of a regulatory
investigation;
•
Documents may be more likely the subject of a mandatory hold
because of regulatory and/or litigation issues relating to a specific
product; and
•
Documents are more likely to relate to due diligence done by
individuals and/or entities who did not handle the claimant’s account
and may not be a party to the arbitration proceeding.
may
be
significantly
more
Due to these unique circumstances, the amended Discovery Guide notes
that the Lists may not be fully equipped to cover documents requested in
product cases, and it reminds parties that they are entitled to seek other
relevant documents in accordance with the Customer Code.
Finally, the amended Discovery Guide adds certain requirements
related to party affirmations. The prior version of the Discovery Guide
only required parties to make affirmations if they did not have any
responsive documents in their possession, custody, or control. The amended
Discovery Guide now requires affirmations when a party produces some,
but not all, of the documents specified by the Lists. Specifically, the
customer or an appropriate person within the firm must affirm in writing
that a good faith search was conducted, describe the extent of the search
made, and state that the party does not have the requested document in its
possession, custody, or control. This section also adds that an arbitrator
may order an affirmation for documents not called for by the Lists.
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IV.
PRIVACY RULE REQUIRING REDACTION OF CONFIDENTIAL
INFORMATION
FINRA has proposed an amendment to the Codes of Arbitration Procedure for both customer and industry disputes in an effort to protect
parties’ confidential information.5 Specifically, the proposed amendment
would require the redaction of an individual’s Social Security number,
taxpayer identification number, or financial account number from any
document that a party files with FINRA. Under the proposed amendment,
documents filed with FINRA must be redacted to include only the last
four digits of these numbers. The redactions would not be required of
documents exchanged by the parties or entered into the record during an
arbitration hearing, nor would the proposed amendment apply to simplified
cases. Under the proposed amendment, if FINRA receives a filing containing a full Social Security, taxpayer identification, or financial account
number, the filing would be found deficient under Rule 12307 or,
depending upon the type of pleading filed, otherwise improper and the
offending party would be given 30 days to re-file the document.
FINRA decided to exempt documents exchanged by the parties,
those submitted during a hearing on the merits, and those in simplified
arbitrations in an effort to reduce the burden of the new requirements on
the parties to the arbitration. Of course, nothing presents the parties from
agreeing to redact confidential information or taking other steps to protect
the inadvertent disclosure of such information. In the proposal, FINRA
stated its belief that the proposed rule change is consistent with the
FINRA’s authority to adopt rules designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable principles
of trade, and, in general, to protect investors and the public interest.
Though the amendment is not yet effective, best practices would
seem to dictate that counsel implement the forthcoming requirements
immediately to the extent they have not already done so. This is particularly so given FINRA’s previously issued Information Privacy and Protection Policy, as well as its internal procedures for protecting confidential
information including the procedures governing the secure storage and
disposal of case materials. FINRA’s concern with protecting consumers’
confidential information is further evidenced in its 2010 Notice to Parties
in which FINRA requested that parties and their counsel take steps to
protect confidential information such as redacting such information from
pleadings and documents introduced into evidence.
5.
See FINRA Rule Filing 2014-0008.
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V.
MID-CASE REFERRAL TO FINRA ENFORCEMENT
FINRA is once again attempting to revise its standards governing when
an arbitrator may refer a matter to the attention of FINRA’s enforcement
division.6 Under current procedures, arbitrators may not refer a case to
enforcement until the case has concluded. Under a proposed rule change
filed in May 2014, an arbitrator would be able to refer matters to enforcement at any time during the pendency of the case. However, the Director
of Arbitration is then required to notify all parties in the arbitration that a
referral was made. At that time, any party could then request the recusal
of the arbitrator who made the referral. The terms of the proposed rule
change provide that a decision to refer a matter to enforcement will not
be considered evidence of bias for which removal would be automatically
warranted. Instead, the decision as to whether to recuse himself or herself
would remain with the arbitration.
The most recent revision to the proposed rule is one of several filed
since 2010. FINRA has made multiple proposed revisions in an effort to
address its concerns that delaying arbitrators’ ability to make referrals is
hampering FINRA’s ability to take action against problematic brokers.
FINRA believes that such delays could result in additional harm to the
investing public and limit the enforcement division’s ability to collect
evidence. The current proposal differs from the original 2010 proposal in
that the original proposal would have required the recusal of all arbitrators
appointed to hear the case if any of the arbitrators made a mid-case
referral. The original proposal was rejected after the claimants’ bar opposed
it on the grounds that the withdrawal of the entire panel would prejudice
claimants who would be required to relitigate their case. FINRA has sent
the rule change proposal to the SEC for public comment, additional
review, and potential approval.
VI.
BROKERCHECK UPDATE AND REVISED PROPOSAL
REGARDING LINKS TO SAME
In late 2013, FINRA released an updated version of BrokerCheck with “a
more user-friendly interface” designed to allow investors to “quickly find
information that can help them decide if an investment professional is
right for them.”7 The new format presents search results in a timeline
describing the broker’s employment history, registrations, and reportable
6.
7.
See FINRA Rule Filing 2014-0005.
See FINRA Press Release dated November 12, 2013.
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events. FINRA hopes the result is a more intuitive experience for users
of the system. In addition, the public can now search directly from
FINRA’s homepage both BrokerCheck as well as the IAPD record of
registered investment advisors.
The SEC has also approved two rule changes related to Rule 8312
that will affect BrokerCheck.8 The first amendment makes information
regarding investment-related civil action brought by regulators that eventually settled permanently available on BrokerCheck for any former associated persons registered on or after August 16, 1999. The second
amendment provides that information about member firms and their
associated persons acquired from any registered national securities
exchange that uses the Central Registration Depository (CRD) for registration purposes must be included on BrokerCheck.
In addition, FINRA is taking steps to increase awareness in the investing public regarding the information available on BrokerCheck. One such
step taken by FINRA has been to make the BrokerCheck widget available
to third-party websites, allowing visitors to those websites direct access
to BrokerCheck and IAPD reports without having to visit the FINRA or
SEC websites.
More controversially, and in response to comments on a prior proposal
to amend FINRA Rule 2267, FINRA has requested comment on a revised
proposal that would require a firm to include a readily apparent reference
and hyperlink to BrokerCheck on each website of the firm that is
available to retail investors.9 The revised proposal would also require
firms to include such a reference and link in “online retail communications with the public” which include both non-personal profiles of
associated persons and/or their contact information. In instances in which
the communication appears on a firm’s website, the BrokerCheck link
would be required to be near the profile and/or contact information.
Additional requirements are set forth governing third-party websites not
subject to a firm’s control. The revised proposal includes the following
exceptions: (1) e-mail or text messages, (2) posting to “online interactive
electronic forums” such as Twitter or message boards, and (3) a simple
directory or listing of associated persons’ names and contact information.
8.
9.
See FINRA Regulatory Notice 14-08.
See FINRA Regulatory Notice 14-19.
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VII. AMENDMENT TO SUPERVISION RULE REQUIRES FIRMS TO
CONDUCT BACKGROUND CHECKS ON APPLICANTS
Another approved FINRA rule amendment would expand the obligations
of brokerage firms to check the background of applicants for registration.10
These expanded obligations would apply to both first-time applicants and
transfers and would require firms to verify the accuracy and completeness
of the information contained in an applicant’s Form U-4. In addition,
FINRA announced plans to begin conducting searches of publicly available financial records as well as criminal records for all registered
individuals who have not been fingerprinted within the last five years.
FINRA also announced plans to conduct periodic reviews of public
records to confirm the accuracy of publicly-available information.
VIII. BONUS DISCLOSURE REQUIREMENTS
FINRA has proposed a rule change to adopt FINRA Rule 2243.11 The
SEC’s approval of the rule “would establish disclosure and reporting
obligations related to member recruitment practices.” Specifically, the
rule would require disclosure by registered representatives who receive
or will receive either upfront or future incentive compensation greater
than $100,000. This disclosure would have to be made to former customers who are considering transferring their accounts to the broker’s new
firm. In addition to the compensation disclosure, the rule would require
the disclosure of the potential costs, fees, product transfer concerns, and
tax ramifications associated with the client’s potential transfer to the new
firm. The method of disclosure may be oral or in writing depending on the
nature of the first contact between the broker and the client, though an
oral disclosure must be followed in writing within ten days.
In addition to the public disclosures discussed above, firms would
also be required to inform FINRA of an associated person’s receipt of
“significant increases in total compensation[.]” The final proposed draft
discusses the more than 50 comment letters FINRA reviewed in connection
with its initial proposal, the majority of which strongly opposed the initial
rule. The proposed rule now moves to the SEC where it may continue to
face opposition.
10. See FINRA Press Release dated April 24, 2014.
11. See FINRA Rule Filing 2014-0010.
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IX.
EXPUNGEMENT DEVELOPMENTS
On October 14, 2013, FINRA issued a notice to arbitrators and litigants
that provided expanded guidance on the expungement process by which
registered representatives may have customer complaints, including
arbitration claims, removed from their records with the CRD. The five
points of guidance provided in the notice included
1.
FINRA described expungement of a complaint as “an extraordinary
remedy that should only be granted under appropriate circumstances.” FINRA further stressed the importance of the CRD
disclosures and noted that expungement is appropriate “only when
[the information] has no meaningful investor protection or
regulatory value.”
2.
Given the importance of maintaining the integrity of the information
in the CRD system, FINRA described the role of arbitrators in the
expungement process as “unique” and “significant.” FINRA charged
arbitrators with ensuring that they have the information needed “to
make an informed and appropriate recommendation on expungement.”
3.
FINRA directed arbitrators to review a current copy of the registered
representative’s BrokerCheck report when considering expungement.
4.
FINRA further explained the importance of providing a written
explanation for the recommendation of expungement, including
citation to any documentary or other evidence relied on by the
arbitrator in reaching the decision.
5.
Finally, FINRA directed arbitrators to determine and consider
whether a settlement between the parties had been conditioned
upon an agreement not to oppose an expungement request.
Both parties and arbitrators should give careful consideration to the
expanded guidance when faced with a request for expungement. Though
the guidance provided is consistent with FINRA Rules 2080, 12805, and
13805 and not necessarily beyond the scope of what counsel would have
recommended to a requesting party prior to its issuance, the notice does
serve as a reminder to all involved of the importance of the issue to
FINRA and the continued diligence with which it will act to ensure the
continued integrity of what it views as one of the cornerstones of the
CRD system.
In addition to this supplemental guidance, FINRA is seeking the
adoption of Rule 2081 that would prohibit firms from conditioning
settlement of a claim filed by a customer on an agreement by the customer
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to consent to, or not to oppose, an expungement request.12 Given the
potential adoption of the rule and the manner in which this issue was
addressed in the supplemental guidance discussed above, parties should
proceed with particular caution as to any discussion of expungement
during the settlement negotiation process.
X.
DISPUTE RESOLUTION PORTAL
In what should certainly (and hopefully) be viewed as the continued
movement towards more efficient electronic filing and arbitration case
management, the previous calendar year saw the expansion of the availability of the FINRA Dispute Resolution Portal.13 Though the portal is
currently limited to use in select cases filed against a limited number of
brokerage firms, the use of the Portal is expanding and one expects to see
it as the primary means of document filing and FINRA case management
in the near future.
FINRA describes the Portal as “a web-based system that allows
invited participants to log into a secure section of our website for selfservice access to submit documents and view their case information.”14
After being provided access by either email notification or a claim
notification letter and registering with the system, parties may proceed
with filing documents electronically, view details regarding party representation and FINRA staff assignments, review pleadings filed to date,
review any outstanding deficiencies noted by FINRA, securely strike and
rank arbitrators, review scheduled hearing information, and even collaborate with both parties and arbitrators or mediators to find mutually
agreeable dates for scheduling purposes. The authors have found the
Portal easy to use, fairly well designed, and relatively intuitive for anyone
with experience in electronic case management systems. In our opinion,
and though it could be improved in several functionalities, it compares
favorably to Pacer and state court filing systems with which we are
familiar.
12. See FINRA Rule Filing 2014-0020.
13. The DR Portal contains both a Neutral Portal (for arbitrators and mediators) and a
Party Portal (for parties to an arbitration). The focus of this summary is the Party
Portal.
14. See FINRA DR Portal: User Guide for Arbitration and Mediation Case Participants.
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CONCLUSION
FINRA practice continues to evolve as FINRA, firms, and counsel on
both sides adapt to changing regulatory environments and to constantly
evolving litigation needs. The continued technological developments
may make it easier to file and manage cases through the Portal or review
more detailed information regarding your broker’s background, though
with these developments also comes increased risk of misappropriation
of personal information as well as unforeseen and ever growing costs
associated with storing, retrieving, and producing discoverable information. FINRA worked to address many of these issues and more in the
past year, and one can only expect more changes moving forward.
****
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