Investors filing claims against brokerages would be able to request public arbitration panels without industry representatives under a proposal Finra announced Tuesday.
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Financial Industry Regulatory Authority Inc. said it will submit the rule in October to the Securities and Exchange Commission for the agency's approval. 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. Critics say that system hurts investors by denying them their day in court and subjecting them to a process unduly influenced by the industry. Supporters of arbitration argue that it saves investors money and allows them to avoid the delays and vagaries of the legal system.
David Massey, North Carolina's deputy securities administrator and newly appointed president of the North American Securities Administrators Association Inc., praised Finra's move, saying that it helps answer criticism that it is inappropriate to appoint industry panelists to parse cases involving other brokerages.
“This is a very good leap forward,” Mr. Massey said at NASAA's annual conference in Baltimore on Tuesday. “This is a tremendous benefit to investors, and it is a tremendous benefit to the arbitration program.”
Finra contends that the arbitration 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.”
A plaintiff's-side attorney said that investors believe that appointing an industry arbitrator to hear disputes is unfair.
“We've been working hard on this for several years, and it's nice to see it come to fruition,” said Scott Shewan, an attorney with Born Pape & Shewan LLP and president of the Public Investors Arbitration Bar Association, which represents plaintiff's attorneys. “The pilot was positive from the investor side. It's a good change. 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. I think Finra recognized that [perception problem].”
More than 60% of eligible investors — involving 560 cases — have participated in the two-year pilot program. They chose to have a non-public arbitrator on their panel 50 percent of the time.
Another industry group, the Securities Industry and Financial Market Association, was cautious about Finra's arbitration proposal.
“We would like to see the full details of the proposal before passing judgment,” said Andrew DeSouza, SIFMA's spokesman. “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. Shewan said the Finra rule won't eliminate industry arbitrators.
“The pilot still permits the parties to rank industry [non-public] arbitrators if they decide to do that,” Mr. Shewan 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.”
Investor advocates would like to see further reform making arbitration elective rather than mandatory.
“One of the problems with [arbitration's] being mandatory is that in product cases in particular, there's this risk that an industry arbitrator will go into deliberations and say, 'Well, we were all doing it. We can't nail just this guy.' The case might [involve] an industrywide problem,” Mr. Shewan said.
Marc Menchel, Finra's executive vice president and general counsel, speaking at the NASAA conference Sunday, argued that the Finra arbitration process allows plaintiffs to file some claims that they can't pursue in the courts.
“There are handcuffs,” he said of private rights of action.
