George Friedman’s Latest Rebuttal To New Criticism of FINRA by Dan Solin

We welcome you to judge for yourself …

My reaction to Dan Solin’s latest broadside against FINRA, “FINRA’s Executives Prosper While Investors Suffer,” (US News; 7-11-2013) was similar to Ronald Reagan’s reaction to Jimmy Carter back in the 1980 presidential debates: “There you go again!”  Once again, we have an article making broad criticisms about FINRA’s arbitration program that aren’t backed up by substantial analysis or proof.  I’ll leave the debate about compensation to others, but as the recently retired FINRA Director of Arbitration, I have to set the record straight about the arbitration program.

The article calls the FINRA program unfair.  Really?  Let’s examine the facts, which I’ve backed up with links to sources.  And by the way, the offending statements in the article would still be wrong even if the FINRA folks were volunteers:

Predispute Arbitration Clauses

The article gives the impression that FINRA makes brokers put predispute arbitration clauses (“PDAAs”) in their customer agreements.  This simply is not true.  But, if a firm does want to use an arbitration clause, then FINRA rule 2268 has very clear requirements about where the PDAA may be placed and what should – and should not — be in it.  For example, among other protections for customers, contracts must contain a highlighted statement immediately before the signature line indicating that there is an arbitration clause, and where in the document it may be found.  Also, the PDAA cannot: 1) contradict the rules of a self-regulatory organization like FINRA; 2) limit the ability of a party to file an arbitration claim; or 3) limit the ability of the arbitrators to make an award.

Fairness of FINRA’s Arbitration Program

This paragraph in particular got me to thinking of “Dutch” Reagan:

Don’t confuse FINRA mandatory arbitration with arbitration by impartial administrators like the American Arbitration Association. Arbitration administered by these agencies can offer savings in time and cost to the participants. In contrast, FINRA-administered arbitration falls into an entirely different category. It’s the securities industry sitting in judgment of itself, with predictable results…

Not impartial?  Really?  Compared to what?  Having spent 22 years at the American Arbitration Association, I can attest that it is a very fair, impartial arbitration administrator.  But AAA does not regulate the securities industry.  Also, the only cases FINRA arbitrates are securities-related, while AAA has a very broad mission and handles all sorts of cases.  There are things FINRA can do because it regulates the securities industry that AAA simply cannot do.

Echoing points I made in an article I authored earlier this month in the Securities Arbitration Commentator, and without meaning to denigrate the AAA, below are some important facts your readers might want to know.  Where appropriate I’ve noted important differences between FINRA’s arbitration program and AAA’s:

• FINRA is regulated by SEC (rule approval process; inspections, responding to investor complaints).
• Rules are first approved by the National Arbitration and Mediation Committee, a majority of whom – including the chair – is not affiliated with the securities industry.  In fact, the past several chairs have been former presidents of PIABA – the bar association for attorneys who represent customers in the FINRA arbitration forum!
• Rules are amended only after proposed rules are published in the Federal Register, the public is given a chance to comment, FINRA responds to the comments, and SEC approves the rules as being consistent with investor protection.
• FINRA serves the claim on the broker under rule 12301(a); AAA does not serve the claim.
• FINRA’s fee structure favors the investor; AAA’s does not.  In fact, the industry parties pay an overwhelming portion of arbitration fees under FINRA’s program.
• Under FINRA Rule 12213, FINRA has the hearings at the hearing location closest to where the investor lived when the underlying events occurred.  AAA’s rules do not have a similar provision.
• FINRA has hearing locations in all 50 states (at least one in each).
• FINRA has a motion to dismiss rule that severely limits motions made prior to the claimant resting their case, and provides sanctions for frivolous motions.  AAA has no such rule.
• FINRA has Discovery Guidelines and has codified discovery provisions in the April 2007 FINRA Code of Arbitration Procedure revisions; AAA does not have a comparable guide.
• FINRA‘s rule 12403 gives the customer an option of an all-public panel.  So much for the article’s claim that the forum is “the securities industry sitting in judgment of itself.”  There’s no such rule at AAA (the parties must agree on an all-public panel).
• FINRA rule 12407(a)(1) provides that in close calls, if the investor wants an arbitrator removed for bias, he or she is removed; AAA has no such rule.  
• FINRA’s awards are public, unredacted, and available free of charge on the Web. The same can’t be said of AAA.
• Finally, FINRA enforces awards against industry parties under rule 9554; AAA has no authority to enforce the award.  FINRA also enforces settlements.

Then there’s the article’s statement about results.  Query: what is the right result?  Also, looking at the outcomes reported on the FINRA web site, we see that “in 2012, approximately 78 percent of customer claimant cases resulted, through settlements or awards, in monetary or non-monetary recovery for the investor.”  Is that a bad thing?  Just asking.

Also, the old fairness study cited in the article, published in early 2008 – more than five years ago — is based on data from cases processed from 2002-2006, and thus does not reflect participant views of the current program.  For example, the study most certainly doesn’t reflect the 2011 rule establishing a customer’s right to require an all-public panel.  Further, the article fails to mention that the two law professors who administered the study, Barbara Black and Jill Gross, speak favorably of FINRA’s program. For example, in a 2011 paper Professor Black stated:

People who have studied the FINRA arbitration forum closely (including myself) give it high marks on most of the recognized fairness  standards for dispute resolution; the outstanding fairness concerns relate to the presence of an industry arbitrator on every three-person arbitration panel and lack of reasons for the arbitration panel‘s award.  While the system is not perfect, FINRA, under SEC oversight, has enacted major reforms in recent years to improve the fairness of the forum [footnotes omitted].

Finally, the canard that somehow the industry rigs the arbitration program is absurd and outrageous.  Just because brokerage firms have to be registered with FINRA, and pay fees, assessments, and fines to FINRA, doesn’t equate to the securities industry being in control of FINRA.  This is kind of like saying that because we pay to the IRS taxes, assessments, and fines, the IRS is a taxpayer advocacy group controlled by the taxpayers.  To quote the late New York Mayor Ed Koch: “Ridiculous!”

In closing, fair, objective criticism is always appropriate.  Unfair, slanted criticism is not.