Since at least 1987, if you want to sue your stockbroker for investment fraud, the sale of unsuitable or other risky investments, breach of fiduciary duty, or for the sale otherwise defective financial products, including everything from reverse convertible notes to structured products, Real Estate Investment Trusts or even Ponzi schemes, investors are required to bring these claims in arbitration before Financial Industry Regulatory Authority ("FINRA")(formerly the National Association of Securities Dealers, Inc. and the New York Stock Exchange).
The Supreme Court’s decision in Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 226 (1987) fought for and celebrated by the securities industry, required all investors to bring their securities fraud and other claims, not in federal or state court, where civil juries may award injured investors their rightful due and punish outrageous conduct, instead investors would be forced to bring their claims before an arbitration panel, (comprised of substantially old, over-educated, conservative, white male, typically retired professionals, resume builders, or judge want-to-be’s, that have the time or inclination to sit for few hundred dollars per day, dispute between investors and their stockbrokers or brokerage firms), and at least one person from the "inside," an industry arbitrator, or a person associated with the securities industry, and for whom, perhaps puffery and overstatement may be a way of life.
Of the 35,486 arbitration cases from January 2002 through November 2008, investors lost more than half.
In 2008, the perceived unfairness of arbitration, (and particularly, the "unwillingness" of the judiciary to earnestly examine "egregious" arbitration awards), motivated Congress to seek to make these arbitrations "voluntary." On July 12, 2008, Congress introduced Senate Bill 1782, entitled the "Arbitration Fairness Act," based upon a Congressional finding that:
Mandatory arbitration undermines the development of public law for civil rights and consumer rights, because there is no meaningful judicial review of arbitrators’ decisions. With the knowledge that their rulings will not be seriously examined by a court applying current law, arbitrators enjoy near complete freedom to ignore the law and even their own rules.
Senate Bill 1872 at Section 2 (July 12, 2008, 110th Congress, First Session).
In January 2011, after a pilot program, FINRA amended FINRA Rule 12402 to allow customers in FINRA arbitration have the option to choose an all public arbitration panel in all cases. Regulatory Notice 11-05, Customer Option to Choose an All Public Arbitration Panel in All Cases (Eff. Feb.1, 2011; Securities Exchange Act Rel. No. 63799 (January 31, 2011), (File No. SR-FINRA-2010-053).
Under this New rule, customers had the right not to have any person on their securities arbitration panel that is, or within the past five years, was:
(A) associated with, including registered through, a broker or a dealer (including a government securities broker or dealer or a municipal securities dealer);
(B) registered under the Commodity Exchange Act;
(C) a member of a commodities exchange or a registered futures association; or
(D) associated with a person or firm registered under the Commodity Exchange Act;
(2) is retired from, or spent a substantial part of a career engaging in, any of the business activities listed in paragraph (p)(1);
(3) is an attorney, accountant, or other professional who has devoted 20 percent or more of his or her professional work, in the last two years, to clients who are engaged in any of the business activities listed in paragraph (p)(1); or
(4) is an employee of a bank or other financial institution and effects transactions in securities, including government or municipal securities, and commodities futures or options or supervises or monitors the compliance with the securities and commodities laws of employees who engage in such activities.
Data from the pilot program show that all-public panels awarded investors damages in 65 percent of the cases that resulted in awards, as opposed to 49 percent of the non-pilot program cases in 2009 and 48 percent of the non-pilot program cases in 2010.
Now some two years later, FINRA proposes to amend FINRA's Customer and Industry Codes of Arbitration Procedure to Revise the Public Arbitrator Definition, and is filing with the Securities and Exchange Commission ("SEC" or "Commission") a proposed rule change to amend the Customer and Industry Codes of Arbitration Procedure ("Codes") to revise the definition of "public arbitrator" to exclude persons associated with a mutual fund or hedge fund from serving as public arbitrators and to require individuals to wait for two years after ending certain affiliations before they may be permitted to serve as public arbitrators.
FINRA believes that the proposed amendments to the public arbitrator definition would improve investors’ perception about the fairness and neutrality of FINRA’s public arbitrator roster.
Certainly, the expansion of the definition of industry or non-public arbitrator include persons associated with a mutual fund or hedge fund is a welcomed event.
Under the new definitions to Rule 12200, FINRA proposes that he term "public arbitrator" means a person who is otherwise qualified to serve as an arbitrator and:
(1) is not engaged in the conduct or activities described in paragraphs above,
(2) for a total of 20 years or more;
(3) is not an investment adviser, or associated with, including registered through, a mutual fund or hedge fund;
(4) is not an attorney, accountant, or other professional whose firm derived 10 percent or more of its annual revenue in the past two years from any persons or entities listed above or
(5) is not an attorney, accountant, or other professional whose firm derived $50,000 or more in annual revenue in the past two years from professional services rendered to any persons or entities listed in paragraph (p)(1) relating to any customer disputes concerning an investment account or transaction, including but not limited to, law firm fees, accounting firm fees, and consulting fees;
(6) is not employed by, and is not the spouse or an immediate family member of a person who is employed by, an entity that directly or indirectly controls, is controlled by, or is under common control with, any partnership corporation, or other organization that is engaged in the securities business;
(7) is not a director or officer of, and is not the spouse or an immediate family member of a person who is a director or officer of, an entity that directly or indirectly controls, is controlled by, or is under common control with, any partnership, corporation, or other organization that is engaged in the securities business; and
(8) is not the spouse or an immediate family member of a person who is engaged in the conduct or activities described above.
Under the new proposed Rule "a person whom FINRA would not designate as a public arbitrator because of an affiliation under subparagraphs (3)-(7) shall not be designated as a public arbitrator for two calendar years after ending the affiliation.
FINRA claims that it prosed the amendment because it had discovered "In one instance, an individual applying to be a public arbitrator had retired one month earlier from a lengthy career at a law firm that represented securities industry clients."
However, it would appear that for example in house lawyers, formerly employed by a broker-dealer, would only have to wait 2 years, as opposed to five years following his or her termination, as required by the present rule, and that investment adviser, or a person associated with, including registered through, a mutual fund or hedge fund would also only also have to wait 2 years, under the proposed rule as opposed to the five year ban on persons associated with a securities broker-dealer or commodities firm.
Nicholas J. Guiliano, Esquire
Our practice is limited to the representation of investors in claims, for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost to unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.