Finra proposal on public arbitration wins praise

But its decision to open up the process doesn't go far enough, some critics say

Oct 3, 2010 @ 12:01 am

By Mark Schoeff Jr.

Finra's efforts last week to open up its arbitration process have pleased — but not satisfied — critics who claim that the proposal doesn't go far enough to protect investors.

Investors who file claims against brokerage firms would be able to request public arbitration panels without industry representatives under a proposal announced last Tuesday by the Financial Industry Regulatory Authority Inc.

Finra plans to submit the proposal this month to the Securities and Exchange Commission. If approved, it would expand a pilot program started two years ago with 14 brokers that permitted some investors to use all-public panels in cases not involving individual brokers

The rule would apply to all investor disputes against any firm and any individual brokers, but not to those involving only industry parties.

Currently, arbitration panels comprise two public arbitrators and one industry representative. Clients who open accounts at broker-dealers must agree to mandatory arbitration conducted by Finra for any disputes that may arise.

Pat Huddleston, chief executive of Investor's Watchdog, said that the proposal — which he called a “good step” — doesn't go far enough in protecting investors. He said that the veil behind which arbitration operates would undermine the development of a universal fiduciary duty if one were imposed by the SEC. Unlike court rulings, there are no written explanations of arbitration decisions, and they can't be appealed to a higher level.

“Arbitration is not transparent,” Mr. Huddleston said. “Nobody but the parties understands what happens in that arbitration room.”

That argument is familiar to an investment adviser who serves as a non-public arbitrator for Finra.

“The plaintiff's bar has long wanted to have the industry folks off those panels,” said the adviser, who asked not to be identified because he is an adjudicator. The adviser, however, defended the presence of arbitrators from the profession on the dispute panels.

“We have a better understanding of the actual business,” he said.

Other investment advisers agree that authorities on a specific subject matter can be helpful.

“It's probably pretty important to have someone on the panel who has specific industry knowledge and past experience in that field to explain some of the complexities that may be at issue,” said Richard Jackson, a principal at Schlindwein Associates LLC, an advisory firm.

Mr. Huddleston, however, said that the need for an industry voice is mitigated by the fact that each side usually calls expert witnesses. And Finra contends that the proposed reform would help investors embrace the dispute resolution system.

“Giving each individual investor the option of an all-public panel will enhance confidence in, and increase the perception of fairness in, the Finra arbitration process,” Richard Ketchum, Finra's chairman and chief executive, said in a statement. “All investors will have greater freedom in choosing arbitration panels, and any investor will have the power to have his or her case heard by a panel with no industry participants.”

Indeed, a plaintiff's-side attorney said that investors think that appointing an industry arbitrator to hear disputes is unfair.

“If investors feel they have a stacked deck, they'll feel they're not getting a fair shake in arbitration, whether that's true or not,” said Scott Shewan, an attorney with Born Pape & Shewan LLP and president of the Public Investors Arbitration Bar Association.

The pilot program seemed to support that assertion. More than 60% of eligible investors — involved in 560 cases — participated in the two-year program. They chose to have a non-public arbitrator on their panels half the time.

Nevertheless, the Securities Industry and Financial Market Association is cautious about Finra's arbitration proposal.

“We would like to see the full details of the proposal before passing judgment,” said SIFMA spokesman Andrew DeSouza.

“We generally believe that the arbitration system is fair, cost-effective and works to protect investors. The empirical data from the Public Arbitrator Pilot Program reinforces this point and demonstrates that non-public arbitrators contribute to fair case outcomes,” Mr. DeSouza said.

The Finra rule wouldn't eliminate industry arbitrators, Mr. Shewan said.

“The pilot still permits the parties to rank industry [non-public] arbitrators if they decide to do that,” he said. “I think you'll see in many cases, claimants will still rank [i.e., pick via the selection system] one or more industry arbitrators, depending on the case.”

Marc Menchel, Finra's executive vice president and general counsel, speaking on Sept. 26 at the annual conference of the North American Securities Administrators Association Inc., argued that the Finra arbitration process actually allows plaintiffs to file some claims that they can't pursue in the courts.

“There are handcuffs,” he said of private rights of action.

David Massey, North Carolina's deputy securities administrator and newly appointed president of NASAA, praised Finra's move, saying that it helps answer criticism that it is inappropriate to appoint industry panelists to parse cases involving other brokerage firms. “This is a tremendous benefit to investors, and it is a tremendous benefit to the arbitration program,” he said.

Still, investor advocates are banging the drum for even greater reform. Mr Huddleston would like the Securities and Exchange Commission to follow through on the power given to it by the Dodd-Frank measure to limit or prohibit mandatory pre-dispute arbitration clauses in brokerage contracts.

“The SEC needs to give us a choice,” said Mr. Huddleston, a former SEC enforcement division branch chief. “But if arbitration is going to be one of those choices, I like the idea of the arbitration panel being three public arbitrators.”

Dan Jamieson contributed to this story.

E-mail Mark Schoeff Jr. at


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