Financial Industry Regulatory Authority Inc. has proposed a new rule to the SEC that would allow FINRA arbitrators to direct cases to FINRA’s enforcement division before the case has closed. As it stands now, FINRA arbitrators are required to wait until the arbitration case has concluded before they can report to FINRA’s Enforcement Department any wrongful conduct or concerns that they learn during the arbitration proceedings about a broker/registered representative or broker dealer. Pursuant to FINRA’s proposed rule change form filed with the SEC to amend Rule 12104 of the Code of Arbitration Procedure for Customer Disputes and Rule 13104 of the Code of Arbitration Procedure for Industry Disputes to broaden arbitrators’ authority to make referrals during an arbitration proceeding, “Finra is concerned that the current rule’s requirement that arbitrators in all instances must wait until a case is concluded before making a referral could hamper Finra’s efforts to uncover threats to investors as early as possible. . . Finra is proposing, therefore, to broaden the arbitrators’ authority under the Codes to make referrals during the hearing phase of an arbitration in those extremely rare circumstances in which investor protection requires that the referral not be delayed.”
Under the proposed new FINRA rule, “any arbitrator may refer to the Director any matter or conduct that has come to the arbitrator’s attention during a hearing, which the arbitrator has reason to believe poses a serious threat, whether ongoing or imminent, that is likely to harm investors unless immediate action is taken. Arbitrators should not make referrals during the pendency of an arbitration based solely on allegations in the statement of claim, counterclaim, cross claim, or third party claim. If a case is nearing completion, the arbitrator should wait until the case concludes to make the referral if, in the arbitrator’s judgment, investor protection will not be materially compromised by this delay.” In addition, “A party may request that the referring arbitrator(s) recuse themselves, as provided in the Code.” Notably, only the President of FINRA Dispute Resolution or the Director will have the authority to evaluate an arbitrator referral to determine whether to refer it to other divisions of FINRA. According to the proposed rule, “This means that the entire panel could remain after a party’s recusal motion, and the case could proceed as normal.” Further, “The investor would be less likely, therefore, to experience procedural disadvantages, significant delays, and increased costs” as the need for the arbitration to start over from scratch decreases.
Once the President of FINRA Dispute Resolution or the Director determine to refer the matter to the Department of Enforcement, that department will then determine whether the broker/registered representative’s or a broker dealer’s actions warrant suspension, sanctioning or other disciplinary action. The entire basis of FINRA’s proposed rule seems to be in line with FINRA’s goal of investor protection.
FINRA submitted two similar proposals in 2010 and 2011, but they were withdrawn or replaced after receiving significant opposition. In her 2010 speech at the Annual Securities Arbitration conference in New York, FINRA’s Assistant Chief Counsel, Margo Hassan, predicted that the benefits of the proposed rule change would ring loudly in the regulation industry following the Madoff Ponzi scheme. The detection of future Ponzi schemes at earlier points in their growth would help curb some of the rampant securities crimes that have plagued Wall Street in recent years. However, Hassan also warned of the lack of safeguards against any potential backlash that arbitrators might face should it become known that they referred matters to FINRA for investigation, or that they sat on a panel where such an occurrence took place. This could effectively chill the arbitrators’ desire to utilize these new powers once they become effective.
It is going to take some time before this proposed FINRA rule goes into effect. Now that the proposed FINRA rule change has been filed with the SEC, the rule change proposal will go before the SEC where it will be on display for public comment, and then it will be subject to additional review by the SEC before a final vote is made on whether to approve the rule change.
Lax & Neville LLP has nationally represented investors, brokers, investment advisers, financial services professionals and securities industry companies in regulatory matters and securities-related arbitrations. Please contact our team of attorneys for a consultation at (212) 696-1999.