Auction Rate Preferreds (August 9, 2008) — Securities regulators have created a special process for resolving claims related to auction-rate securities, a move that was welcomed by some who have been pressing for change in the arbitration process.

The Financial Industry Regulatory Authority — created by the merger of the National Association of Securities Dealers and the enforcement arm of the New York Stock Exchange — said that qualifying investors will have the option of having their claims heard by a three-person panel of arbitrators, none of whom are affiliated with a firm that recently sold auction-rate securities.

The new process stems from one Finra developed for the Securities and Exchange Commission’s settlement with Citigroup Inc., in which the bank agreed to buy back about $7.3 billion in illiquid auction-rate securities, and pay $100 million in civil penalties, with $50 million going to the state of New York.

“The auction-rate securities matter is more widespread than other issues that have developed in the arbitration forum, and we wanted to make sure that any investor, whether in the Citigroup settlement who elects to have a three-person panel, or any other case related to ARS, all got the same treatment,” said Linda Fienberg, president of Finra Dispute Resolution. “This will apply to all auction-rate securities cases that are in our forum whether it’s part of a settlement or not.”

She said Finra will put the process in place as soon as possible.

Thus far, Finra has confirmed that more than 170 cases involving auction-rate securities have been filed in its Dispute Resolution forum, but there may be as many as 200, Ms. Fienberg said.

The announcement was welcomed by Laurence Schultz, president of the Public Investors Arbitration Bar Association, a national association of attorneys that represents investors in securities disputes, and that has been pressing for change in the arbitration process.

“This is precisely what we’ve been asking for,” said Mr. Schultz, of Driggers, Schultz & Herbst in Troy, Mich. “We’re pleased that they have stepped up to this problem and recognized that arbitrators who are associated with firms that were issuing auction-rate securities cannot participate in these panels.”

But Mr. Schultz believes that industry-connected arbitrators should be banned in all cases.

Typically, for claims of more than $50,000, the three-member panel of judges must include two public members, who may have limited industry connections, and an industry representative.

In the process announced Thursday, arbitration panels will continue to have that makeup, but individuals who since Jan. 1, 2005, have either worked for a firm that sold auction-rate shares or supervised someone who sold them won’t appear on the lists of nonpublic arbitrators from which panel members are selected for auction-rate arbitration cases.

Ms. Fienberg said Finra works to eliminate conflicts of interest in all arbitration cases. It will exclude an arbitrator if it identifies a conflict, an arbitrator may recuse themselves or an attorney or investor may bring a challenge if they feel there is a conflict, she said.

Finra plans to undertake a two-year pilot project, which will begin Oct. 6, in which some cases will be heard before an all-public panel if an investor chooses. The pilot will involve at least 466 cases, but Finra hopes to include more, Ms. Fienberg said.

The regulator will gather data to determine possible future options for arbitration, she said.