Client Alerts

FINRA Moves to Eliminate the Use of Public Arbitrators with Past Industry Experience from Customer Cases

By: Frances Floriano Goins

About: Financial Services Regulatory, Regulatory & Internal Investigations

Last week the Financial Industry Regulatory Authority’s (“FINRA”) Board of Governors approved a proposed rule that would effectively eliminate the use of arbitrators with any prior industry experience from serving on panels involving customer claims. The rule change is subject to final approval by the Securities and Exchange Commission (“SEC”) after a public comment period. Under the existing rule, persons with past industry ties can be designated as public arbitrators so long as the mandatory two-year “cooling off” period is satisfied. The new rule, however, disqualifies persons from public designation who have previously engaged in any industry activity, including lawyers who previously represented investors or firms, according to industry sources. Not surprisingly, the Public Investors Arbitration Bar Association (“PIABA”) applauds the proposed rule as a “big step forward,” but does not favor the rule change regarding investors’ lawyers, according to its President, Jason Doss.

Although FINRA has taken steps to reduce the perceived “industry bias” in recent years, such a move would be unprecedented. Of FINRA’s 6,400 arbitrators, more than 3,500 are designated as public arbitrators. And, while it is unclear what percentage of public arbitrators have engaged in past industry activity, some estimates show that the number is more than 1,000. Thus, this proposed rule change could have a significant impact on cases, but for all of the wrong reasons.

For starters, there is no concrete evidence to suggest that customers are being treated unfairly by arbitrators that have past (or current) industry experience. As the 2013 FINRA statistics bear out, the difference between awards from “all-public panels,” which consist of three public arbitrators as opposed to the traditional “majority-public panel,” which, by contrast, consist of two public arbitrators and one non-public arbitrator, is statistically insignificant. Customers fared slightly better with majority public panels:  43% (55 out of 128 cases) of cases heard by all-public panels resulted in a damages award to customers whereas 44% (47 out of 107 cases) of cases heard by majority-public panels resulted in a damages award to customers. (See FINRA Dispute Resolution Statistics, available at: http://www.finra.org/ArbitrationAndMediation/FINRADisputeResolution/AdditionalResources/Statistics/.) Yet, FINRA sought approval from the SEC in February 2013 to make the all-public option the default rule as opposed to requiring customers to affirmatively elect it. The SEC approved the measure on September 18, 2013.

Importantly, the exclusion of these arbitrators will have a detrimental impact on the ability of panels to understand complicated securities transactions and robs them of the opportunity to get the practical “real world” perspective of how things operate in the industry. That serves no one’s interest. Further, this change may result in an increased use of expert witnesses, even in routine matters, which, of course, drives up the costs of arbitration for both sides. Unfortunately, with the persistent drumbeat to remove the use of mandatory pre-dispute arbitration provisions altogether from customer agreements, these arguments will likely not carry the day as FINRA will no doubt continue to make concessions to PIABA and other groups like it.