Those in favor of out of court alternative dispute mechanisms may look at the Financial Industry Regulatory Authority’s (FINRA) track record of arbitration as a move in the positive direction to bypass the congested court system to hasten resolution of securities disputes. Though this may be the story that a facial glance at the issue may demonstrate, there are in fact many procedural flaws and shortcomings with this practice, which more often than not results in the detriment of investor-complainants. FINRA has only recently undertaken efforts to reform, in response to widespread criticism; it is only a matter of time before we see what changes take place and whether they will actually address the systemic problems of before.
FINRA is a self-regulating organization operating under the control of the Securities and Exchange Commission (SEC), responsible for regulating brokerage firms and securities markets in the US, with the goal of ensuring that investors receive basic protections via not only active regulation, but also dispute resolution. All FINRA arbitrations are overseen by a panel of arbitrators who are appointed after the claimant files a Statement of Claim and the securities firm responds. Depending on the claim amount, the composition of the panel may differ, ((FINRA Rule 13401(a), 13800 (stating that panels for claims of less than $50,000 will consist of one arbitrator); FINRA Rule 13401(b) (stating that panels for claims between $50,000 and $100,000 will consist of one arbitrator by default, but the parties can agree to three in writing); FINRA Rule 13401(c) (stating that panels for claims exceeding $100,000 will consist of three arbitrators, unless the parties agree in writing to one).)) along with the type of individuals the arbitrators may be. For instance, in situations with three arbitrators, two will be public arbitrators who have not worked in the securities industry and one will be a non-public arbitrator with strong ties to and a working knowledge of the industry. Once a computerized system generates a random list of 30 arbitrators from FINRA’s internal rosters of arbitrators, each party can exercise its power to strike and rank certain arbitrators, at which point FINRA compiles a final arbitration panel. ((FINRA Rules 12400, 12404; see FINRA Arbitration Process, Mitchell & Associates, http://www.mitchell-attorneys.com/legal-articles/finra-arbitration-process/ (last visited November 17, 2014).))
Ever since the 1987 case, Shearson/American Express, Inc. v. McMahon, in which the Supreme Court upheld the enforceability of mandatory arbitration clauses, virtually all agreements that investors sign to open a securities account with a firm have provided that FINRA arbitration ought to be the exclusive means by which disputes arising under the agreements are decided. ((Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 238 (1987); see FINRA Arbitration Process, supra note 2.)) Thus, this nearly universal application of arbitration as a dispute resolution mechanism makes the process by which it is carried out all the more critical.
The problems cited with FINRA’s approach have been manifold. One has been that claimants’ lawyers often find legitimacy in their claims that the arbitrators have conflicts of interest, which only delays the administration of justice through the process. ((Gretchen Morgenson, Is This Game Already Over?, N.Y. Times (June 18, 2006), http://www.nytimes.com/2006/06/18/business/yourmoney/18arb.html?_r=1&oref=slogin&.)) A roughly 93% win rate for the firms and brokerage institutions has created the image that this is a “rigged game,” leading many to presume a pro-industry bias. ((Jane Wollman Rusoff, FINRA’s ‘Total Warfare’ Against Brokers in Arbitration, ThinkAdvisor (May 20, 2014), http://www.thinkadvisor.com/2014/05/20/finras-total-warfare-against-brokers-in-arbitratio?page_all=1, May 20, 2014.)) Some have attributed the blame to FINRA’s poor maintenance of diverse and updated arbitrator rosters, leading to awkward situations of compiling panels of arbitrators, some of whom may have died. ((Peter Robison, Finra’s Arbitrators: Dubious, Asleep—Sometimes Dead, Bloomberg Bus. Wk. (Apr. 24, 2014), http://www.businessweek.com/articles/2014-04-24/finra-seeks-reform-for-broker-investor-arbitration-system#p1.))
Thus far, FINRA has responded with a proposed rule stipulating that public arbitration panels could no longer include people who once worked for securities firms. ((Dave Michaels, Finra Plans New Limits on Arbitrators with Wall Street Ties, Bloomberg (Feb. 13, 2014, 4:22 PM), http://www.bloomberg.com/news/2014-02-13/finra-proposes-new-limits-on-arbitrators-with-wall-street-ties.html.)) Despite FINRA’s approval of this rule, there are arguments on both sides that cloud the future of this proposed rule. One potential weakness of this reform is leaving FINRA’s arbitration process largely void of expertise and qualified arbitrators, seriously undermining its legitimacy as a dispute resolution forum. ((Suzanne Barlyn, Wall Street Arbitration Reform Proposal Faces Rocky Path, Reuters (July 31, 2014, 8:10 AM), http://www.reuters.com/article/2014/07/31/us-column-comply-finra-arbitration-idUSKBN0G01DF20140731.)) As much as this may be a resoundingly pro-investor measure, there are pro-industry experts that rightly point out that this proposed rule would also preclude investors’ lawyers and representatives from serving as arbitrators. ((Id.))
With SEC scrutiny soon to come, it is unclear how it will view FINRA’s proposal, and should it pass muster, what will be done to remedy the weaknesses that investors and industry insiders legitimately worry about. All that seems certain at this point is the fact that this system is in dire need of reform to have some semblance of legitimacy as a means of redress.
Ki Hoon Kim
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