Wealth Management (June 29, 2022) - FINRA released a report from independent counsel Lowenstein Sandler, concluding there was no agreement between Wells Fargo’s counsel and the regulator to exclude certain arbitrators.

A law firm hired by the Financial Industry Regulatory Authority found “no evidence” of a secret agreement between an attorney for Wells Fargo and the self-regulatory organization to exclude certain arbitrators from a particular proceeding after a Georgia court overturned an arbitration award on that basis, according to a report released by FINRA.

In February, a Georgia Superior Court overturned an arbitration award previously decided in favor of Wells Fargo, arguing that counsel for Wells Fargo “manipulated the FINRA arbitrator selection process” and violated FINRA’s code for arbitration proceedings. Fulton County Superior Court Judge Belinda Edwards penned the decision vacating the award levied against petitioners Brian Leggett and Bryson Holdings for more than $80,000, saying they were denied the right to a computer-generated neutral list of arbitrators and that Wells Fargo counsel was able to have particular arbitrators removed as options for selection.

In the aftermath of the decision, FINRA’s Audit Committee hired Lowenstein Sandler to probe the existence of such an agreement and the agency’s arbitration process. Christopher Gerold, a partner at Lowenstein Sandler, former chief of New Jersey’s Bureau of Securities and former president of the North American Securities Administrators Association, led the investigation.

The committee accepted the report’s findings that there was no agreement and that FINRA personnel “generally adhered to (Dispute Resolution Service) policies and procedures and that FINRA is continually striving to make the arbitration process more transparent and uniform,” according to a statement from Audit Committee Chair Lance F. Drummond, and members Jack Ehnes, Linde Murphy and Eileen K. Murray.

“The Committee, however, recognized that there are nonetheless opportunities to improve the policies, procedures and training related to the arbitrator selection process, as the firm recommended,” the group wrote in a statement.

Upon reviewing the report, Michael Edmiston, president of the Public Investors Advocate Bar Association (PIABA), said the organization respected “the thorough and vigorous work” put into Lowenstein Sandler’s review.

“Lowenstein’s report brought sunshine into a very opaque decision-making process,” Edmiston said in an interview with WealthManagement.com. “I think that’s long overdue.”

Edmiston noted that the report found there were still multiple “touch points” in which FINRA staff wielded influence in deciding who was selected as an arbitrator, despite the regulator’s attempts to remove such influence from the process.

“What it means for practitioners who are familiar with the forum, we know how it works. For those unfamiliar with the process or new to the process, or people not represented by counsel, this sort of unwritten policy and procedure is a problem for FINRA,” he said. “So we welcome the recommendation to codify and make public the procedures for challenging an arbitrator’s name appearing on a strike list.”

But Bill Singer, a securities attorney and critic of FINRA’s arbitration process, had harsh words for the report, saying its results seemed “pre-ordained and will likely be received as little more than whitewash” for those pursuing reform. From his perspective, the report didn’t address the Georgia court’s ruling that the FINRA arbitration had been “fundamentally unfair.”

“This was not a mere allegation by a biased party or a claim made by a critic of FINRA; this was the finding, the conclusion of a judge sitting on a state court,” Singer wrote in an email to WealthManagement.com.

Leggett and Bryson Holdings originally alleged they lost more than $1.1 million in a misguided arbitrage investment strategy on the part of their Wells Fargo broker, according to the Georgia court decision. After FINRA supplied a list of potential arbitrators from its “Neutral List Selection System,” in July 2017 Wells Fargo counsel Terry Weiss argued that Fred Pinckney, one of the potential arbitrators, should be removed from the list, arguing Pinckney harbored “personal bias” against Weiss.

The accusation sprang from a separate arbitration proceeding from nearly a decade earlier, in which counsel Robert and Joan Postell filed a claim against Merrill Lynch. Weiss served as Merrill Lynch counsel and a three-person panel included Pinckney. At one point, Weiss argued that the arbitrators became unfairly biased against Merrill and demanded they recuse themselves from the case. After counseling with Dispute Resolution Service (DRS), the arbitrators deemed they could continue and eventually ruled against Merrill Lynch. 

But Weiss moved to vacate the award and called for FINRA to conduct its own investigation. Within months, the trio of arbitrators learned they’d been sidelined, according to previous WealthManagement.com interviews with Pinckney. The arbitrator was also quoted in a 2012 article in Bloomberg that was critical of FINRA's approach in the Postell case. (Weiss later cited the quotes as evidence of Pinckney's supposed bias against him.)

A federal judge eventually denied Merrill Lynch’s motion to vacate, and after the SEC opened an investigation into the arbitrators’ removal, they were reinstated as choices for FINRA arbitration.

But during the Leggett case in July 2017, Weiss sent a letter to FINRA claiming it had been “made clear to me verbally that none of the Postell arbitrators would have the opportunity to serve” on any cases in which he was involved. 

Whether Weiss had an agreement with FINRA to automatically remove certain arbitrators was the “primary question” at the heart of the investigation, and the only evidence of such an agreement was the July 2017 letter from Weiss to regulators, according to Lowenstein.

“All current and former FINRA personnel who could conceivably have been a part of such an agreement were interviewed and denied the agreement’s existence, noting that it would be contrary to DRS’s culture of neutrality,” the report read.

According to FINRA, Lowenstein conducted nearly 30 interviews, looked at more than 150,000 documents, emails and phone records, analyzed FINRA’s arbitrator database system and listened to recordings of arbitration proceedings to come to its conclusions. The firm recommended FINRA conduct ongoing, mandatory staff training, an update to the DRS training manual and a procedural review of the algorithm used to randomly determine arbitrators. 

Additionally, Lowenstein suggested FINRA require written explanations upon request about why arbitrators were approved or denied to serve on a proceeding or why they were removed from a list, and update its rules to reflect that the regulators conduct manual reviews of potential arbitrators.

Sander Ressler, a managing director of Essential Edge Compliance Outsourcing Services, said some clients who reviewed the report found the recommendations reassuring. To Ressler, if FINRA updated recommendations on what a conflict is, and required written rules on the process of how an arbitrator is manually stricken, this would be a “step up,” adding transparency.

“And that makes sense,” he said. “The more definitions you have around ambiguous terms, and the more the process is defined on how you strike an arbitrator, I think that is a good thing. How can that be a bad thing?”

Wells Fargo is in the process of appealing the decision to overturn the arbitration award, and while Edmiston noted he was not an expert in Georgia law, appellate courts must weigh the information gleaned during trial, making it unlikely FINRA’s investigation would impact the ruling. But he acknowledged that there was still uncertainty as to the understanding Weiss believed he had with the regulator, even if the firm found no evidence of an unwritten understanding between FINRA and the attorney.

“To the extent the Lowenstein report found there was no agreement between the parties, we don’t dispute the degree of research or effort they put into investigating that issue,” he said. “But I keep going back to that July 2017 letter; how does that fit in there?”

Singer found the language in the report to be unnecessarily strained, and believed it would ultimately be of no consequence.

“The larger question is how FINRA’s lackluster Board of Governors will receive the Report, which, as I anticipate, will be with a large rubber stamp,” he wrote.