We reported in SAA 2019-42 (Nov. 6) that FINRA had filed proposed rule, SR-FINRA-2019-027, on November 5. The SEC has now released that proposal for public comment in SEC Rel. No. 34-87557, dated November 13, 2019.
This proposal, which would amend the FINRA Code of Arbitration Procedure for Customer Disputes, in order to “...Expand the Options Available to Customers if a Firm or Associated Person is or Becomes Inactive,” was first floated in an October 2017 Reg Notice, Regulatory Notice 17-33, after FINRA Board approval in May 2017. As the name implies, the proposal was aimed at expanding the customer’s options when an industry party becomes inactive before or during a case. Fewer than ten comments were received by the December 2017 due date. Since then, the exact language has presumably been under review by the FINRA and SEC staff as an added provision for reducing the incidence of arbitration Awards that go unpaid by defunct broker-dealers and brokers leaving the industry.
FINRA’s Statement of Purpose
The amendments, if adopted, will require revisions to FINRA Rules 12100, 12202, 12214, 12309, 12400, 12601, 12702, 12801, and 12900, so a relatively simple conceptual change requires a great deal of textual modification. FINRA’s Statement of Purpose in the SEC Release starts by mentioning unpaid Awards and asserting that most non-payments can be ascribed to “firms or individuals whose FINRA registration has been terminated, suspended, cancelled, or revoked, or who have been expelled from FINRA.” FINRA terms these individuals and firms “inactive,” for purposes of its arbitration rules, while making the oblique observation that, while no longer associated with a broker-dealer or a member firm, these parties “may continue to operate in another area of the financial services industry where FINRA registration is not required.” FINRA explains that, at times, firms or individuals become “inactive,” because of FINRA taking disciplinary action against them; other times, the action is voluntary. Its current approach under Rule 12202, where inactive parties are involved, is to alert the complaining customer when the claim is first filed, advise her of the inactive party and the chances of non-payment, and extend the option to amend “his or her claim to add other respondents from whom the customer may be able to collect should the claim go to award.” The customer must then agree in writing to proceed; in other words, FINRA will not go forward solely on the basis of a pre-dispute arbitration agreement.
Expanding the Customer’s Options
Under the new proposed rule, customers with claims against inactive parties would be provided additional options in an expanded set of situations “where a firm becomes inactive during a pending arbitration, or where an associated person becomes inactive either before a claim is filed or during a pending arbitration.” In those situations, the customer would have the option to amend the pleadings, as under the current rule, and also to postpone the proceedings, request default proceedings, or to withdraw the claims and receive a refund of the filing fees. Under the new provisions, the customer would also have the option to proceed in court, rather than filing a FINRA claim. FINRA would now advise the customer of the inactive party’s “status change” and the customer would have 60 days to withdraw the claim “with or without prejudice.” (ed: why would one withdraw the complaint “with prejudice”? Doesn’t this option just create confusion?)
More Specifics on Customer Options
If the customer does not withdraw, FINRA believes that s/he should be able to adjust strategy based on the status change news. Although Rule 12309 will not permit the adding of parties between ranking and appointment stages, customers in this situation will have that privilege. Similarly, the customer may amend a pleading during a 60-day window from notification. Rule 12601 does not permit postponements without arbitrator approval, absent mutual agreement; here, customers will have the right to postpone, if the notification of the status change comes within 60 days prior to hearing. Finally, the right to default proceedings under Rule 12801 will be broadened under a technical change, so that any terminated associated person who fails to file an answer will trigger the request privilege.
(ed: *Several other small changes regarding arbitrator honoraria and filing fees are included in the proposal. It runs 34 pages and will soon be published in the Federal Register, at which time the period for comment will be set for 21 days thereafter. We will be sure to advise readers in the next Alert, which is scheduled for November 22. **The rule filing presumes throughout that any PDAA exercised by an inactive party will be invalidated by virtue of the inactivity -- so, for instance, the customer can now go to court. Actually, FINRA can’t invalidate a PDAA. FINRA is “jawboning” a bit here; it can only deny its forum. It’s perfectly feasible that a court might compel arbitration at an alternative forum under FAA section 5, for instance. ***FINRA has taken a lot of flak on the subject of unpaid Awards from Congress and consumer advocates, so we wonder about the remark regarding these delinquents still operating in the financial industry. They may be operating in the construction industry, too! So, what’s the point? Is FINRA suggesting that state regulators (or even the SEC), who regulate registered investment advisors -- or the bank authorities -- should be adjusting their policies to get these Awards paid? It will be interesting to see if NASAA comments in its usual “this is a good step, but more can be done” fashion (see, e.g., our coverage in SAA 2017-27 (Jul. 19) of NASAA’s comments during the FINRA 360 Review: “NASAA would also like to work with FINRA on the issue of unpaid arbitration awards, describing the efforts of FINRA’s Board to date as having the ‘best intentions,’ but offering no solution to the core problem.”).) (SAC Ref. No. 2019-44-01)
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