The FINRA Arbitration Process
©2007 Carlson & Dennett, P.S.
Since 1988 arbitration has become the almost-exclusive procedure for pursuing claims against brokers. Heavy use of the arbitration system is therefore very recent, and the rules are still evolving.
Federal law authorizes "Self-Regulatory Organizations" (SROs), to establish rules for arbitrating disputes between SRO members and customers. The Securities and Exchange Commission regulates the SROs.
In July 2007 the two largest SROs, the National Association of Securities Dealers (NASD) and the member regulation, enforcement and arbitration functions of the New York Stock Exchange (NYSE), merged to create Financial Industry Regulatory Authority (FINRA), This forum now handles most customer-broker arbitrations.
II. The Arbitration Rules–Background
FINRA has a Code of Arbitration Procedure, which sets forth the procedural rules for arbitrations.
The Uniform Rules aim to establish an economical and speedy system to resolve customer complaints. Economy and speed are inconsistent with the broad discovery, easy access to pretrial hearings, and complex evidentiary rules that characterize traditional litigation.
The Uniform Rules therefore greatly reduce the opportunity for prehearing discovery, abandon the legal system's rules of evidence, and make little provision for prehearing motions. As the result of criticisms, primarily by customer advocates, the Uniform Rules have been amended several times.
III. Role of FINRA Staff
The Code of Arbitration Procedure refers various decisions in the administration of an arbitration proceeding to "the Director". In practice, this means FINRA staff persons, who act in the stead of the Director.
FINRA will generally appoint a FINRA staff attorney as liaison with counsel on each case. Usually that staff attorney will attend the arbitration hearing itself, to advise the arbitration panel.
Before a date is set for the hearing, the parties have a great deal of flexibility to agree between themselves on matters of scheduling. If the parties agree to a particular step, then advise FINRA staff that they have agreed to proceed in a certain manner, the staff ordinarily will allow the parties to proceed as they wish. Once a hearing is scheduled, there is less flexibility.
FINRA arbitrations in Seattle are generally administered by FINRA's Los Angeles office. After the initial Statement of Claim is filed with the FINRA Director of Arbitration in New York, the case will most likely be assigned to the Los Angeles office for processing.
IV. Obligation/Election to Arbitrate
Customer agreement. If the customer agreement contains an arbitration clause it is binding and the customer must arbitrate. If the customer files a lawsuit in court, the broker can simply move to stay the court action pending arbitration.
FINRA rules. Even if the customer agreement does not contain an arbitration clause, FINRA rules require members (including all individual brokers affiliated with a member) to arbitrate disputes if the customer so elects. The customer may, however, choose instead to file a lawsuit in court. The broker has no election, and is controlled by the customer's choice.
V. Who Are the Arbitrators?
FINRA maintains lists of individuals who have applied, and qualified, to be arbitrators. The arbitrators are not employed by FINRA; they are volunteers who FINRA compensates once selected.
Individuals applying to be arbitrators must submit information about their professional experience, and the recommendation of a current arbitrator or FINRA staff member.
Anyone can apply to be a FINRA arbitrator. In practice, most arbitrators tend to be males presently or previously employed in the industry, businessmen or investors with some experience or interest in securities, and attorneys.
The arbitrators are categorized by whether they are "industry" or "public" arbitrators. An arbitrator is "industry" if a substantial part of their professional work involves the securities industry.
VI. Appointment of Arbitrators to a Case
When a Statement of Claim is filed FINRA staff review the parties involved in the claim, the locale in which the proceeding will be conducted, and the nature of the case. The staff checks with potential arbitrators about any apparent conflicts prior to appointment. Based on this information, the staff will select the arbitrator(s).
It is current FINRA practice to try to appoint the arbitrators very early in the process, and inform the parties of the arbitrator(s) selected.
For customer claims under $30,000, one arbitrator, "knowledgeable in but who is not from the securities industry", shall be appointed. Three arbitrators will be appointed upon request of the customer in the initial filing.
If the claim exceeds $30,000, or does not state a figure, a panel of between three and five arbitrators will be appointed. Three is typical. A majority will be public arbitrators, unless the customer requests that a majority be from the industry.
VII. Initiating an Arbitration Claim
A. Filing fees.
The claimant is required to submit, with the Statement of Claim, a filing fee, and a hearing session deposit. These fees are considerably more expensive than a court filing fee. The FINRA filing fee is $25-$600, depending on the amount of the claim. The hearing session fees are also graduated, and generally run between $450-$1,200.
The arbitrators may include in their decision an order that one party pays the other's filing fee and other hearing fees.
B. The Statement of Claim.
The Statement of Claim is the equivalent of a Complaint. The Code of Arbitration Procedure provides that the claimant "shall file"
(1) a "Statement of Claim" of the controversy, specifying "the relevant facts and the remedies sought",
(2) "together with the documents in support of the Claim".
The audience to whom the Statement of Claim is addressed is not a judge. It is a panel primarily of lay people, unaccustomed to legal claims, remedies, or jargon.
The party initiating the claim files the original documents with FINRA's Director of Arbitration.
VIII. The Role of Motions in FINRA Arbitrations
Motions practice is growing in securities arbitrations, as reflected by explicit reference to them in the most recent update of the FINRA Code.
The system in practice is extremely flexible. The parties can generally present any request to the arbitrators for resolution. Since there are few guidelines for processing prehearing requests for action, the arbitrators' response–or, whether there will even be a response–is hard to predict. The arbitrators can and often do duck an issue by deferring a decision until the conclusion of the hearing.
Hearings on Motions. Motions can be resolved without oral argument, or at one or more prehearing conferences. On request, the arbitrators will often allow motions to be argued by telephone conference call. Discovery motions can be referred to a single arbitrator for decision, without oral argument, on behalf of the entire panel.
A. In General.
The Code of Arbitration Procedure provides for the right to conduct limited discovery:
"Any party may serve a written request for information or documents upon another party."
The discovery rules further declare that "the parties shall cooperate to the fullest extent practicable in the voluntary exchange of documents and information to expedite the arbitration."
Despite this exhortation, and these seemingly simple procedures, brokers and firms frequently resist customer demands for documents.
A party is to respond or object to an "information request" within 60 days of service.
B. Objections to, and Enforcing, Discovery.
The parties are required to "endeavor to resolve all disputes regarding an information request prior to filing any objection to the request."
Written objections must be served upon all parties within 60 days of service of the requests.
The requesting party may then, "upon written request", ask Director to have a dispute resolved. A discovery dispute can be heard at a prehearing conference, or it can be ruled upon by a single arbitrator on behalf of the whole panel.
The primary incentive for both parties to cooperate in the production and exchange of documents and information is to look good to the panel, and avoid offending the non-lawyer arbitrators with "hardball" tactics.
Depositions are the exception rather than the rule in securities arbitrations. The Code of Arbitration Procedure makes no mention of depositions.
The parties may agree to conduct depositions. There are, however, no rules about the extent to which depositions may be used in an arbitration hearing; the matter is simply within the arbitrators' discretion.
The Arbitrator's Manual states that the arbitrators' power to issue subpoenas and direct appearances includes the power to order witnesses to appear for depositions
"when deemed appropriate by the arbitrators and where it is impossible to compel attendance [at the hearing itself] of the person to be deposed. Access to depositions should be granted to preserve the testimony of ill or dying witnesses, or of persons who are unable or unwilling to travel long distances for a hearing. . . as well as to expedite large or complex cases . . . .
Absent agreement to conduct depositions, it often is hard to persuade arbitrators to permit depositions.
X. The Prehearing Conference
FINRA will schedule a prehearing conference with the parties' counsel early in the process to pick an arbitration hearing date, and to set a discovery schedule. A party, an arbitrator, or the FINRA staff may also request a Prehearing Conference at any other time. The Director sets the time and place of the conference, and names the person who will preside. That person usually is the Chairperson of the panel, but can be another arbitrator or a FINRA staff person. There is usually such a hearing shortly before the arbitration itself, to finalize the structure of the hearing.
The hearing most often is by telephone, but it can be in person, or solely by written submissions.
The parties can request that virtually any matter be addressed at a Prehearing Conference, such as discovery disputes; motions on any topic; scheduling of the arbitration proceeding; whether prehearing briefs will be allowed and, if so, the schedule for submitting them; the number of witnesses and time allowed for testimony.
FINRA charges a fee to the party requesting each prehearing conference, depending on the size of the claim, ranging from $25-$450.
A. Power to Subpoena.
The arbitrators, and counsel of record, all have the power to issue subpoenas, to the extent provided by law. Under Washington law attorneys have broad authority to subpoena witnesses, and consequently attorneys can subpoena both witnesses and documents to the arbitration hearing to the same extent as they can subpoena witnesses to a trial.
FINRA arbitrations have no rule of evidence that addresses the use of expert witnesses. It is, however, common to offer expert testimony in securities arbitrations.
Since arbitrators are likely to have more expertise than juries in the technical aspects of the case, one will not need experts to educate the trier of fact in fundamental securities concepts. Still, an expert can help to explain securities law issues such as churning, control, supervisory standards and the like.
Claimants' counsel may want to call experts to express their opinions specifically on the ultimate issues in the case–such as whether certain securities were unsuitable for an investor with the customer's characteristics, or whether a pattern of trading appears to be excessive and without justification.
Accounting or economics experts may be helpful in larger cases to explain damages calculations.
In cases alleging improper supervision by a firm, it is important to call an expert with experience in supervision and compliance, to educate the panel on the standards applied, and to express an opinion on the quality of the supervision in the case at issue.
XIII. The Prehearing Exchange of Evidence
The parties are required to, at least twenty calendar days before the first scheduled hearing date (1) serve on each other copies of documents in their possession which they intend to present at the hearing, and (2) identify all witnesses they intend to call.
XIV. The Hearing Process
Arbitrations are dramatically different from trials. They are conducted in an office building conference room, and are much less informal than a trial.
A. Rules of Evidence. The rules of evidence adhered to in legal proceedings explicitly do not apply in arbitration hearings. The Arbitrator's Manual advises the arbitrators:
"The key consideration is fairness. . . .
While the Federal Rules of Evidence . . . often provide good, practical guidance on what evidence is probative . . . generally arbitration proceedings should be more informal and should permit more liberal introduction of evidence than would be permitted in court."
Arbitrators tend to be very lenient in admitting evidence.
B. Witness Examination. Witnesses are placed under oath, and examined by counsel in the same manner as in a trial. The Arbitrators can, and invariably do, ask questions of the witnesses.
C. The Hearing Record. The hearing is tape recorded. No court reporter is provided.
D. Arbitrators are not Jurors. It annoys arbitrators to be treated like a juror. The attorney should assume that the arbitrators have read the pleadings and that they know what the main issues are. One should also assume that the arbitrators are more knowledgeable about business and securities matters than are jurors.
XV. The Award; Appeal
The arbitration panel issues its award using a very basic format which identifies the parties and counsel, recites the claims asserted, then announces the decision. There is no explanation or justification for the decision.
FINRA requires that its members and associated persons pay arbitration awards within 30 days. FINRA has the power to sanction a party within its control who fails to pay.
Arbitration awards can also be filed in Superior Court. The judgment then can be enforced by the customer, using the traditional methods of collecting a civil judgment.