I have often used this forum to complain about FINRA’s lack of backbone when it comes to dealing with PIABA, the group of lawyers who represent customers of broker-dealers, principally in arbitrations. Over the years, FINRA has amended its rules time and again in response to loud claims by PIABA that the arbitration process is biased in favor of the industry and against customers, each time making it more difficult for member firms to defend themselves. All-public arbitration panels, with no one from the securities industry there to provide real-world insight into the allegations of misconduct? Thank you, PIABA. No ability to file motions to dismiss clearly meritless claims? Thank you, PIABA.
As I’ve written about before, PIABA’s newest kick is to try and do something about the fact that when it prevails, sometimes the respondent is financially unable to satisfy the award, so the complaining customer – and, more important to PIABA, the customer’s lawyer – don’t collect any money. That has always struck me as a fact of life: doesn’t matter what the litigation is about, there is always a possibility that the defendant can’t pay. That’s why before a lawyer agrees to take on a client on a contingency basis (as PIABA lawyers do), they have to pose two questions: (1) Does the evidence suggest I will prevail? (2) If so, will I be able to collect from the defendant? This is as true in traffic accident cases as it is in commercial cases as it is in customer arbitrations. And, unless the answer to both is “yes,” the case will, generally, not go forward.
Yet, PIABA lawyers argue that their cases deserve special treatment, that something needs to be done to prevent the situation where they win the case but are unable to collect. Seems a bit presumptuous, doesn’t it?
Well, not to FINRA. Once again, FINRA is on the verge of capitulating to pressure from PIABA. In Reg Notice 18-06, FINRA is seeking comments on proposed amendments to its membership rules. Make no mistake about the point of these amendments. It is not to provide greater investor protection, or greater market integrity, which remain as FINRA’s two supposed overarching goals. Rather, as the title of the Reg Notice explicitly states, it is to “Incentivize Payment of Arbitration Awards.” Not just any arbitration awards, no, just awards against broker-dealers. FINRA doesn’t much care if a broker-dealer is unable to collect an award it receives against a customer with, say, an unpaid debit balance.
What do the new rules provide?
First, for applicants who are seeking FINRA’s permission to create a new broker-dealer, FINRA is proposing that it be allowed to “presumptively deny” the application if the applicant or any of the persons associated with applicant is the subject of a pending arbitration claim. Not an adjudicated claim, a pending claim, meaning a claim that has not yet gone to hearing and in which there have been no findings of liability. I guess FINRA has no respect anymore for the quaint old concept of “presumption of innocence.” Remember, in a FINRA arbitration, just as in court, the respondent/defendant is presumed innocent and the claimant/plaintiff has the burden of proof. Pish posh. So 1700s. Instead, let’s just presume that anyone named in an arbitration is guilty, right? So much easier. So, rather than presuming the respondent is innocent, let’s shift the troublesome burden of proof from the claimant, and, instead, make the respondent overcome the opposite presumption, i.e., that the respondent is guilty.
Oh, it’s not all bad. FINRA helpfully identifies the facts a new member applicant might include in its application “where there are concerns about the payment of those [customer arbitration] claims should they go to award or result in settlement.” In these cases, FINRA proposes to permit applicants to rebut the presumption of denial by proving that they could, in fact, pay the award “through an escrow agreement, insurance coverage, a clearing deposit, a guarantee, a reserve fund, or the retention of proceeds from an asset transfer, or such other forms that the Department may determine to be acceptable.” In other words, FINRA may let you become a member if you first prove you have a stash of money laying around specifically earmarked for one thing: to satisfy an arbitration claim that hasn’t even been proven and may never be proven.
And, more infuriating, what is missing from this list of facts that would allow an applicant to rebut the presumption that its application should be denied? How about a showing by the applicant that the customer claim is ridiculously and patently without merit (as, sadly, many are)? Shouldn’t that be enough to satisfy the MAP staff? Apparently not. Apparently, FINRA could actually care less about the actual merits of a customer arbitration, as its sole concern is on whether the applicant can pay the award. In a fair world, FINRA would at least pay some lip service to an evaluation of the merits of a pending arbitration, but, as this Reg Notice reveals, FINRA doesn’t even do that.
A couple of other observations about this rule proposal that give some insight into FINRA’s thought process.
First, it is interesting how FINRA is trying to make individual liability a problem for the firm. Follow me here. FINRA says that it is concerned “about new members onboarding principals and registered representatives with pending arbitration claims.” Ok, let’s play that string out. If those individuals take their arbitrations to hearing and lose, it is the individuals who have to pay the award, not the firm that they’ve registered with. Yet, FINRA states that the proposed rule amendment “[c]reating a presumption of denial in connection with” such pending arbitration claims “would shift the burden to the new member to demonstrate how its claims would be paid should they go to award.” How do the claims against the individuals magically become claims against the broker-dealer, for which the broker-dealer is financially responsible? Even PIABA hasn’t conjured up that requirement. Yet.
Second, it is almost funny how, despite the tellingly specific name it gave to the Reg Notice, FINRA attempts to make it seem like it’s not all just about getting customers and their lawyers paid. As FINRA sees it, creating a presumption of denial wouldn’t just provide greater assurances of an applicant’s specific ability to pay an adverse arbitration award, it would also “shine a spotlight on the individuals with the pending arbitration claims and the firm’s supervision of such individuals.” Specifically, FINRA wants to be able to assess “the nature of the anticipated activities of the principals and registered representatives with the arbitration claims; the impact on the firm’s supervisory and compliance structure, personnel and finances; and any other impact on investor protection raised by adding the principals and registered representatives.” If this was really an issue for FINRA, why did it take a complaint from PIABA to bubble it to the surface? I can assure you, PIABA isn’t interested in better supervision or tighter controls over new member applicants; it just cares about the escrow accounts, insurance coverage, guarantees, etc., i.e., the pots of money into which it can potentially dip. Anyway, isn’t it FINRA’s job to be shining this spotlight on potential problem areas in the industry?
The comment period for this proposed rule expires on April 9. Tell FINRA what you think about its plan. Unless you speak up, you lose the right to complain about it later.