By George H. Friedman, SAA Editor-in-Chief
The comment period closed December 13 on FINRA’s proposed rule to expand a customer’s arbitration options when firms or APs become inactive, with just a few comments, all supportive but with most urging further steps be taken.
We reported in SAA 2019-42 (Nov. 6) that FINRA had filed proposed rule, SR-FINRA-2019-027, on November 5, and in SAA 2019-44 (Nov. 20) that the SEC on November 13th had released that proposal for public comment in SEC Rel. No. 34-87557. 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 is aimed at expanding the customer’s options when an industry party becomes inactive before or during a case. It is an added measure for reducing the incidence of unpaid Awards. As reported in SAA 2019-45 (Nov. 27), the proposal was published November 22 in the Federal Register (Vol. 84, No. 226, Page 64581), making comments due December 13.
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.
Comments: Few, Supportive, But Most Say More Can be Done
Just five comments were posted on the Commission’s Website as of the comment period’s close on December 13. All were supportive, and four recommended additional investor protections. We commented in #44 that “it will be interesting to see if NASAA comments in its usual ‘this is a good step, but more can be done’ fashion.” No NASAA comment has appeared, but the three institutional commenters – PIABA, SIFMA, and the Financial Services Institute – generally support the proposed rule but urge that more be done. Footnotes have been omitted.
PIABA: “PIABA supports the amendments contemplated in SR-FINRA-2019-027 (hereinafter ‘the Notice’) that expand options for customers in pursuing and attempting to collect money awarded to them against industry respondents in arbitration proceedings. However, as set forth below, PIABA believes that the proposed rule changes set forth in the Notice are insufficient to remedy the longstanding problem of unpaid arbitration awards, which disproportionately involve customer claims against inactive FINRA members and associated persons.” The suggested changes (presented essentially verbatim)? Expand Customers’ Ability to Withdraw Claims Without Prejudice and Amend Claims; Expand Customers’ Ability to Adjourn Hearings and Obtain Refunds of Filing Fees; Streamline Default Proceedings; Do More to Solve the Problem of Unpaid Arbitration Awards (The letter concludes: "PIABA urges FINRA to establish a national investor recovery pool. While PIABA supports every measure taken to address the serious unpaid award problem, we reiterate our concern that FINRA’s current proposal will not address in a meaningful way the millions of dollars in unpaid awards that make a mockery of FINRA arbitration as a means of recovering investor losses").
SIFMA: “SIFMA’s support is predicated on FINRA’s stated purpose of the Proposal – namely, to facilitate ‘dealing with those member firms or associated persons who are responsible for most unpaid awards – firms and associated persons who are no longer in business either at the time the claim is filed or at the time of the award.’ We agree that the Proposal would probably help address the issue of unpaid arbitration awards. To that end, to better achieve the purpose of the Proposal (i.e., help address unpaid arbitration awards), we recommended that the Proposal be expanded to apply not only to customer cases but also to intra-industry Cases.”
Financial Services Institute: “FSI largely supports the Proposed Amendments as set forth in the Notice and the corresponding rule text.... However, as discussed more fully below, FSI is concerned that certain aspects of the Proposed Amendments have the unintended consequence of creating an unbalanced arbitration process and we make suggestions to address that concern.” The letter raises the following concerns (ed: presented essentially verbatim): 1) The Proposed Amendments Are Not Likely to Address the Issue of Unpaid Arbitration Awards, But Instead Create an Imbalance in the Arbitration Process. 2) Amending Pleadings to Add Parties Should Be Subject to the Arbitration Panel’s Approval.
Comments were also received from two individuals, Steven B. Caruso, Esq., Maddox, Hargett & Caruso, PC, and Professor Benjamin P. Edwards of the University of Nevada, Las Vegas William S. Boyd School of Law (in his individual capacity). Mr. Caruso’s letter supports the proposed change without qualification. Professor Edwards supports the changes, but is also harshly critical of its shortcomings: “The proposal simply does not do enough to address the problem. It does not recognize that the industry bears collective responsibility for allowing the business practices that result in unpaid awards. With FINRA unwilling to meaningfully address the problem through its own initiative, the Commission should require FINRA to propose meaningful reforms. Ultimately, self-regulation will only succeed if the Commission requires the self-regulating brokerage industry to somehow internalize the cost of unpaid awards. If the industry were liable for the harms it generates, it would have a more meaningful incentive to police its own conduct.”
(ed: *Wonder if FINRA’s response to comments will commit to further changes? **As we’ve noted before, 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.) ***Professor Edwards attached to his letter his article, The Dark Side of Self-Regulation, 85 U. CIN. L. REV. 573 (2017). ****We are surprised that NASAA so far has not commented. As noted in SAA 2019-47 (Dec. 11) and elsewhere in this Alert, NASAA on December 11 released a Report, NASAA Broker-Dealer Section E&O Insurance Survey Report, recommends requiring brokers to carry Errors and Omissions insurance as a way to address the unpaid arbitration awards problem. *****What’s next? Staff will analyze the comments and then send to the SEC a formal “response to comments” letter.) (SAC Ref. No. 2019-48-01)
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