AdvisorHub (January 11, 2023) - The Financial Industry Regulatory Authority’s proposal to tweak its arbitrator-selection procedures, making them more transparent, represents welcome progress, according to lawyers engaged in related practices. But, at the same time, the lawyers express the need for Finra to make additional modifications.
“FINRA gets credit where credit’s due; they have made meaningful strides in promoting transparency,” said Hugh Berkson, the president of the Public Investors Advocate Bar Association.
But Berkson, as well as a lawyer who often represents brokerages and brokers, want to see the industry’s self regulatory organization go further in its reforms to ensure that any potential biases or conflicts on the part of prospective Finra arbitrators is well documented and known by all participants, and even by future claimants who use the Finra forum.
On December 23, Finra had submitted its proposal for approval to the U.S. Securities and Exchange Commission, which posted it on January 6 and is seeking comments from the public for 21 days.
The Finra proposal calls for rule changes to “enhance the transparency of the arbitrator selection” and other tweaks aimed at improving the resolution services it provides for disputes among brokerages, brokers and customers.
Finra said its proposal is “addressing recommendations” made in a prior 37-page report issued in June 2022 by an outside law firm.
Finra’s audit committee had in February 2022 tapped that firm, Lowenstein Sandler, LLP, to review its arbitration processes after allegations arose in a Georgia state court case about an improper side deal that allowed a lawyer representing Wells Fargo to rig the regulator’s arbitrator selection process. The Lowenstein report rejected those allegations, but recommended Finra provide “greater clarity” to its arbitration process.
Under the proposal submitted to the SEC, Finra would codify its existing practice of using both an algorithm and “conducting a manual review for conflicts of interest prior to sending an arbitrator list” to disputing parties, it said in its filing.
In addition, the new proposal calls for a Finra director to “provide a written explanation” to those parties about any decision to grant or deny arbitrator removal requests. Under the proposal, Finra will also “clarify for forum users that parties may challenge an arbitrator for cause at any point after receipt of the arbitrator lists until the first hearing session begins,” the filing said.
Berkson found the timing of Finra’s filing somewhat troublesome. “None of us knew this was coming,” he said. “We were a little curious about why this came in on December 23 with no notice to any interested stakeholders. That’s a little odd. I find it a little ironic that the original intent of all this was transparency and this is how we were notified,” he added.
PIABA had previously demonstrated its interest in arbitrator-selection reform. After the Georgia trial court ruled to vacate an arbitration based on the allegations of the improper side deal, a decision later overturned at the appellate level, PIABA called for “an immediate investigation” by the SEC.
Following the Lowenstein report, the plaintiff lawyers’ organization issued a tweet welcoming its recommendations and, in the future, working with Finra to improve the arbitrator appointment process.While the review determined that Finra personnel “generally adhered” to the regulator’s policies in the underlying controversy, PIABA, whose members represent investors who file complaints against brokerages and brokers in Finra’s forum, said it remains “concerned about the lack of transparency in the process and the appearance of impropriety in that case.”
Substantively, “nothing” about Finra’s new proposal “struck me as offensive,” Berkson said. But, at the same time, he is uncertain if Finra had gone far enough. Specifically, his initial concern centers on the proposed requirement for Finra staff to issue reasoned opinions on their rulings concerning the challenges to arbitrators for cause. Although that requirement represents “a positive step forward,” Berkson wants to learn if those opinions will be publicly available as a database of precedents for future claimants to rely upon, he said.
Such a database would give claimants “insight that would help us understand what FINRA considers to be a legitimate ground for a challenge or not,” Berkson said. “That will help the participants decide whether to challenge a particular arbitrator or not. Or know that it’s just a waste of time.”
Tom Lewis, a lawyer in New Jersey who represents brokers and brokerages, welcomed the Finra proposal but is withholding a full-throated endorsement.
“It’s a great proposal, but Finra has to execute on it,” Lewis said.
He wants to ensure that Finra makes an effort to give litigants updates about arbitrators’ changing circumstances, as part of its new plans to embrace transparency.
“It’s sometimes perplexing, because after an arbitrator is selected, it could be a year or two years for a case to actually get started and then be completed,” Lewis said. “There are a lot of changes that occur in people’s lives during that time period.” Prospective arbitrators can become engaged in litigation, file bankruptcies, or have other events that were not reported in initial disclosures, Lewis said.
Finra’s transparency goals should mean it communicates with the parties often about its rulings as they relate to arbitrators’ conflicts and potential biases. “It’s really easy for Finra to communicate with the attorneys instead of keeping it secretive,” he added.