Finra wants to make clear how arbitrators are chosen to preside over brokerage industry legal disputes following a court decision last year that vacated an arbitration award over alleged manipulation of the arbitration panel.
On Dec. 23, the Financial Industry Regulatory Authority Inc. filed a proposal with the Securities and Exchange Commission that would make changes to the arbitrator selection process.
The proposal would codify the current Finra practice of manually reviewing arbitrator conflicts that are not identified by the selection algorithm that Finra uses. If an arbitrator is conflicted out of a case, the algorithm would select a new arbitrator.
Under the proposal, the Finra arbitration director would provide a written explanation whenever a challenge to remove an arbitrator is granted or denied.
The proposal also would make changes related to pre-hearing conferences and hearing sessions as well as to initiating, responding to and dismissing claims and cases and providing a hearing record. The proposal also would allow arbitrations of $50,000 or less to be conducted via video conference.
The reforms are in response to a report last year by the law firm Lowenstein Sandler, which reviewed Finra’s arbitrator selection process following a decision in a Georgia court that scuttled a Finra arbitration award because of alleged arbitrator tampering. The firm found no evidence of improper agreements to remove certain arbitrators from industry cases, but it did make recommendations for improving the selection process.
“Finra is proposing to amend the codes to provide greater transparency and consistency regarding the arbitrator list selection process, and to clarify the application of certain procedures and include expressly these procedures in various rules in the codes,” the rule proposal states. “The proposed rule change would enhance the transparency of the arbitration forum administered by Finra Dispute Resolution Services.”
Finra runs the arbitration system that adjudicates disputes between customers, registered representatives and brokerages.
The Public Investors Advocate Bar Association has been a leading proponent of arbitration reform. The organization had a positive initial reaction to the proposal.
“PIABA’s pleased that Finra is apparently taking the Lowenstein report seriously and making efforts to incorporate its suggestions into the rules,” said PIABA President Hugh Berkson.
Christine Lazaro, a professor of law at St. John’s University, said that the proposal essentially codifies existing Finra procedures.
“It’s small reforms,” said Lazaro, who also is director of the Securities Arbitration Clinic at St. John’s. “It’s a bigger reform in the context of transparency, less so in practice.”
Arbitration experts were just beginning to review the proposal this week, after it was filed with the SEC just prior to Christmas. The SEC must approve Finra rule changes.
Lisa Braganca, a Chicago securities attorney, took issue with Finra going straight to the SEC with the proposal rather than opening it to a public comment process first.
“I find it interesting Finra did not want to hear from investor advocates before they put the proposal in front of the SEC,” said Braganca, owner of an eponymous law firm and former president of the PIABA Foundation.
The SEC may seek public comment as it reviews the proposal.
“It is a little odd that [Finra] did not seek any input from anyone,” said Berkson, a principal at McCarthy Lebit Crystal & Liffman.
Finra said it is following its normal rulemaking procedure.
“Filing a proposal with the SEC — where there will be opportunities to comment — is one of the standard paths clearly spelled out in Finra’s rulemaking process,” Finra spokesperson Rita De Ramos wrote in an email. “Before this proposed rule change was submitted to the Finra Board of Governors for approval and then to the SEC for filing, it was reviewed by several Finra advisory committees, including the Investor Issues Committee, which includes consumer advocates, as well as the National Arbitration and Mediation Committee, which makes recommendations to Finra regarding recruitment, qualification, training, and evaluation of arbitrators and mediators.”
Braganca also criticized Finra for not revealing more about its arbitrator selection algorithm.
“Finra keeps that super secret,” she said. “That algorithm is really something that should be transparent. Arbitrator selection goes to the heart of the Finra dispute resolution process.”
The timeline for SEC review of the proposal is not clear.
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