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Finra Board to Consider Arbitration Changes

4/11/2013

Dow Jones Compliance Watch

The Financial Industry Regulatory Authority’s board next week will consider proposed changes intended to simplify the rules for investors selecting an arbitration panel.

Finra, which oversees the arbitration forum, regularly contends with charges that the system favors brokerages, and has been making changes to help ensure a level playing field. The introduction in 2011 of an option to have all members of a hearing panel be from the “public” category of arbitrators–that is, those who aren’t involved in the securities business, as opposed to the “non-public” category–was viewed by investor advocates as a big step in that direction.

Cases brought by customers and involving disputes of more than $100,000 are heard by a three-member panel. Under the current rules, the customer can choose between a panel with three public arbitrators or a panel of two public arbitrators and one with industry experience.

However, an inexperienced investor without professional guidance from an attorney might not select an all-public panel at the outset, says Ryan Bakhtiari, a Los Angeles-based securities attorney who represents investors.

The proposed change would drop that initial choice from the process–and allow the parties to move directly to the stage of selecting arbitrators, where an investor can eliminate all candidates with industry ties, according to a notice posted on Finra’s website.

Under the proposed new rule, all parties would see lists of 10 chair-qualified public arbitrators, 10 public arbitrators and 10 industry-affiliated arbitrators. The proposal would permit four strikes on each of the public arbitrator lists. However, any party could strike all of the arbitrators on the industry-affiliated list, ensuring an all-public arbitration panel.

Mr. Bakhtiari, a former president of the Public Investors Arbitration Bar Association, believes most investors have elected the all-public option in the past year. The proposed rule change “recognizes that trend,” he says.

Finra data shows that investors fare better with all-public panels. Last year, in cases decided by three public arbitrators, customers were awarded damages 49% of the time. In cases decided by a panel including one person with industry ties, investors won only 33% of the time. However, securities attorneys caution that the sample size, of just a couple of hundred cases, is small and that the merits of a claim likely affect the outcome of a case more than the backgrounds of the panelist who hear it.

The proposed change, which Finra’s board will consider at its April 18 meeting, comes on the heels of other changes designed to draw a clearer distinction between public and industry arbitrators.

Those classified as industry arbitrators include those whose careers are or were directly involved in the securities business, such as brokers. Others whose businesses are related to the industry, such as lawyers who represent brokers, can become public arbitrators when they retire.

Last week, the Securities and Exchange Commission approved Finra’s proposal of a two-year “cooling-off period” before those with certain industry affiliations, such as lawyers, can serve as public arbitrators. Also approved was a change that excludes people associated with a mutual fund or hedge fund from the public category.

Finra believes the two-year wait “would improve its constituents’ perception about the neutrality of the arbitrators on the public roster,” according to its filing with the SEC. Some investors’ attorneys don’t think it’s long enough.

Jenice L. Malecki, a New York-based securities lawyer, is skeptical that an attorney who has spent his entire career representing the industry would be able to hear cases with a completely neutral view a mere two years after retirement. “It should be, at a minimum, ten years,” she says.

The SEC said that fourteen of the 45 comment letters it received suggested that the cooling-off period be at least five years. Eleven commenters felt that only individuals who have never had an affiliation with the financial services industry should be classified as public arbitrators.

Finra said it will further review the public and non-public arbitrator definitions, as well as the issues raised in the comment letters. But it declined to amend its rule, which is expected to take effect this summer.


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