Leading state regulator sees arbitration reform gaining momentum

A NASAA model rule gives states the ability to yank the license of a brokerage or advisory firm that dodges an arbitration award or other judgment.

A leading state securities regulator is confident that arbitration reform will gain momentum at the state level.

The North American Securities Administrators Association, which is made up of securities regulators from all 50 states as well as Canada, Mexico and other jurisdictions, recently approved a model arbitration rule that would make it a dishonest or unethical practice for a broker or investment adviser not to pay an investment-related arbitration award to a customer.

The measure also sanctions the failure to pay a judgment, fine, civil penalty, restitution, disgorgement or similar penalty imposed by a state regulator, the Securities and Exchange Commission or the Financial Industry Regulatory Authority Inc.

Now that the NASAA membership has passed the model rule, NASAA President Melanie Senter Lubin expects individual states will begin taking it up, either through a legislative or regulatory process, depending on the state.

“This to me is the kind of rule where I would expect to see a lot of states move to adopt it,’ said Lubin, who is also Maryland’s securities commissioner.

The reason is that the model gives states another way to attack an ongoing problem — unpaid arbitration awards. It raises the stakes by allowing state regulators to yank the license of a brokerage or advisory firm that dodges such payments.

“A firm that wants to stay in business will have an additional incentive to pay judgments and awards because otherwise their license is at risk,” Lubin said.

Finra, the broker-dealer self-regulator, has the power to bar from the industry brokerages and registered representatives who don’t pay arbitration awards. Finra has been under pressure for years to solve the problem, which is getting worse, according to a recent study by the Public Investors Advocate Bar Association.

If states adopt the NASAA rule, it not only can address the problem when it occurs at brokerages but also would provide a means for targeting investment advisers who fail to pay arbitration awards, said Christine Lazaro, a professor of law at St. John’s University.

Investor advocates assert that advisers’ use of mandatory arbitration is more opaque and costly than the arbitration forum that Finra runs to adjudicate disputes between customers and reps and brokerages.

The NASAA model rule “is a good step, especially in the [adviser] space, to create accountability for arbitration awards to make sure they get paid,” said Lazaro, director of the St. John’s Securities Arbitration Clinic. “It will give the states something else to look at on the advisory side so that we don’t just have the bad actors shifting from one space [brokerage] to the other [adviser].”

The NASAA model rule received mixed reactions when it was open for public comment last fall.

“The goal of this rule is to help investors collect unpaid judgments and awards,” Lubin said. “This is a clean, direct way to get there.”

The extent to which the model rule will solve the problem will be determined over the next several months as state legislatures and regulatory agencies consider it.

“It’s going to depend on how many states adopt it,” Lazaro said.