Shortly, I hope to get around to drafting a blog post about FINRA’s latest demonstration of abasement to PIABA and claimants’ counsel everywhere, namely new Rule 4111. But, that rule is such a monstrosity that it will take a little time to parse, and a lot of work to get the post shorter than ten pages. Plus, my eyes roll so much every time I read the rule that I get dizzy and can’t type very well, which makes it hard to see the keyboard. For now, just enjoy the clever title of the piece-to-come: The 411 On Rule 4111.
With that said, there IS ample time today to discuss one of the central tenets of FINRA’s shiny new rule: do everything possible to ensure that any customer who files an arbitration – and, of course, the lawyer representing that customer on a contingency basis – gets paid. And note that I have chosen my words here quite carefully. I deliberately did not say “any customer who files an arbitration and then takes the case to a hearing and wins.” Nor did I say “any customer who files an arbitration and then enters into a settlement agreement that calls for installment payments over a period of time.” No, I said any customer who simply files an arbitration. Period. Regardless of the merits. For the simple fact is that FINRA – not Dispute Resolution, which, to its credit, doesn’t care who wins or loses, as long as the process is fair, but, rather, Member Supervision – will not rest until it is able to show the SEC, and, likely, Congress, all the things it is doing to address arbitration awards that do not get paid because the firm just goes out of business.
Let’s just take a minute here to discuss something important, yet widely overlooked: the size of the universe of cases at issue. From the amount of attention that FINRA devotes to the subject (which is only slightly less than PIABA), one would think that unpaid arbitration awards are rampant, affecting huge numbers of complaining customers. Not surprisingly, the actual number is really quite modest, by anyone’s definition. This is evident from FINRA’s own statistics, published here. According to the most recent data, from calendar year 2020, there were 2,145 arbitration cases closed in total that year. Of that total, 193 were closed as a result of an award following an evidentiary hearing. (As everyone knows, the overwhelming majority of arbitrations are closed due to settlement.) Of those 193, only 62 resulted in damages being awarded to the claimant. And, of those 62, only 23 had damages that were not paid. Of course, that is not particularly surprising when you consider that of those 23 cases, 17 of them were not even contested by the respondent(s). And what is the principal reason a firm would not contest an arbitration? Because it is inactive, and has no money to pay for a defense, let alone pay the award.
So, when you get to the bottom of things, you can see that there were a whopping six cases in 2020 where a respondent actually appeared and defended itself in an arbitration, lost, and then failed to pay the award. Not exactly the mountain of cases that FINRA, or PIABA, make it out to be.
Yet, as I said, FINRA sure acts like this is a massive problem. And it makes no effort to keep secret its efforts to address it. In Reg Notice 21-34, which attempts to describe how Rule 4111 works and why FINRA created it, FINRA flat out admits that a primary motivation for the rule is unpaid arbitration awards: “An added benefit of Rule 4111” – and let’s stop right there to insert sarcastic laughter, as that certainly suggests that there are any benefits to the rule – “will be important ancillary effects in addressing unpaid arbitration awards.” If that was all there was to it, it would be bad enough. I mean, as FINRA’s statistics amply demonstrate, the supposed issue concerning unpaid arbitration awards doesn’t amount to much. Six cases, big whoop.
But, sadly, that is NOT all there is to it. FINRA’s fixation goes beyond simply “addressing unpaid arbitration awards.” No, FINRA not only wants the customers in those six cases to get paid, it wants any customer who files an arbitration to get paid. As I said above, regardless of the merits, regardless of the facts, regardless of, well, anything besides the mere fact that the Statement of Claim was filed.
Here’s what I’m talking about. Consider that one factor in FINRA’s convoluted process of deciding under Rule 4111 whether a BD should be characterized as a “Restricted Firm,” i.e., one that may have to pay a big, fat deposit just for the privilege of remaining a member, is not just unpaid arbitration awards – which should result in a firm’s being summarily suspended anyway – but, as well, “Covered Pending Arbitration Claims.”
Under Rule 4111, a “Covered Pending Arbitration Claim” is an “investment-related, consumer initiated claim filed against the member or its associated persons in any arbitration forum that is unresolved; and whose claim amount (individually or, if there is more than one claim, in the aggregate) exceeds the member’s excess net capital.” The emphasis on “unresolved” is mine, to highlight the fact that FINRA is so focused on the six unpaid arbitration awards following contested hearings in 2020 that it is willing to make broker-dealers make huge deposits to address unadjudicated claims, i.e., claims that are pending and unresolved, which are altogether different than claims that have resulted in an award. That is really staggering, as it demonstrates that FINRA has completely lost sight of some basic, but important things.
Principally, FINRA appears to have forgotten (or maybe it just doesn’t care) that in arbitration, as in court, it is the claimant who bears the burden of proof. Respondents in arbitrations, like defendants in court, are presumed to be innocent. It is up to the claimant to prove otherwise. And, frankly (and statistically), claimants aren’t very good at that. As noted above, FINRA Dispute Resolution’s 2020 statistics reveal that claimants only win 32% of the time they go to hearing. Over two-thirds of the time they go to hearing, their claims are dismissed and they recover nothing. And that’s not because respondents’ counsel are such geniuses; it’s because a lot of these claims are silly and baseless. Indeed, on occasion, a hearing panel is willing to call out a claimant (and/or claimant’s counsel) for bringing a meritless claim by awarding attorneys’ fees to the prevailing respondent. FINRA, however, disregards all of this. As far as FINRA appears to be concerned, if a claimant simply files an arbitration Statement of Claim, it is presumptively valid, not the other way around, as the law and due process demand. And that is not just troubling, it’s frightening.
The same phenomenon manifests itself in connection with CMAs. Reg Notice 20-15 is all about changes FINRA made to its Membership Application Program, or MAP, rules in 2020. As with the promulgation of Rule 4111, FINRA represented that these edits were designed to reflect FINRA’s “effort to help further address the issue of customer recovery of unpaid arbitration awards.” But, just like Rule 4111, FINRA did not stop at unpaid arbitration awards. Just like Rule 4111, FINRA also baked into MAP’s consideration of a CMA a review of – you guessed it – “Covered Pending Arbitration Claims.” Indeed, it appears that Rule 4111 borrowed the definition for that awkward term from Rule 1011(c)(2), which reads the same as Rule 4111: “[a]n investment-related, consumer initiated claim filed against the transferring member or its Associated Persons in any arbitration forum that is unresolved.”
So, what this means is this, according to Reg Notice 20-15: “FINRA is concerned about prospective applicants for new membership hiring principals and registered persons with pending arbitration claims without having to demonstrate how those claims will be paid if they go to award or result in a settlement.” In other words, if you want to hire someone with a pending arbitration, you are required to show FINRA that you have the money to pay that claim IF it goes to hearing and claimant beats the odds and wins, or IF the case settles. Irrespective of its merits, irrespective of the facts, irrespective of the fact that it is the claimant’s burden of proof, irrespective of FINRA’s own statistics that show most arbitrations are without merit. And how much money will you need to show FINRA you’ve got? Well, that’s anyone’s guess, as it is entirely up to FINRA, which doesn’t publish a formula. Basically, it boils down to the more money, the better, and unless you can show you have enough money to pay 100% of the amount demanded in the Statement of Claim – despite the fact such figures are often grossly inflated – FINRA may very well conclude it’s not enough.
In sum, then, in its zeal to appease PIABA, and maybe Congress, by showing all the clever steps it is taking to address unpaid arbitration awards, FINRA has gone waaaay further than it needed to go by legislating language into at least two rules that it has the right to hold against member firms the mere existence of pending arbitrations. Ironically, even though the SEC approved the rules, this is well beyond anything the SEC itself does itself. Just consider the net capital rule, perhaps the granddaddy of customer protection rules. Remember that the net capital rule is an SEC rule, not a FINRA rule. In an interpretation that’s been around for over 30 years, the SEC has stated that a broker-dealer need not book even a contingent liability in its net capital computation to account for a pending lawsuit – and this reasoning has been extended to cover arbitrations – if it obtains an “opinion of outside counsel regarding the potential effect of such a suit on the firm’s financial condition.” In other words, from a net capital perspective, unlike FINRA, the SEC cares a lot about the merits, or lack of merits, of an arbitration. If a claim is so void of a factual or legal basis that a lawyer is willing to offer an opinion on that subject, the SEC says the amount of that claim need not be accounted for in the net capital computation. And if it’s not necessary to include it in the net capital computation, then, logically, there are no customer protection issues implicated.
As explained above (at length, sorry), FINRA has taken the opposite tack. In FINRA’s world, even utterly baseless claims have to be accounted for; for FINRA, all that matters is that they’re pending. That is not how this system is supposed to work.
 To its further credit, FINRA Dispute Resolution understands the problems a claimant faces when arbitrating against an inactive firm, but correctly notes that such claimants are fully advised by Dispute Resolution of the situation, and are given the chance to do something else, like go to court. When they don’t, and continue to pursue the arbitration and end up with a worthless award, well, that’s pretty much on them. As FINRA puts it, “FINRA also informs the customer that awards against such firms or associated persons have a much higher incidence of non-payment and that FINRA has limited disciplinary authority over inactive firms or associated persons that fail to pay arbitration awards. Thus, the customer knows before pursuing the claim in arbitration that collection of an award may be more difficult. . . . Accordingly, claims against inactive firms and brokers proceed in arbitration only at the customer’s option.”
 You want proof? Look at this award we obtained a month or two ago on behalf of a BD client. While Claimant ultimately dismissed his case voluntarily (presumably for the lack of supporting evidence), that only came after we pressured him to do so. In recognition of that, the arbitrator granted my client’s motion for its attorneys’ fees “as sanctions for . . . [claimant] continuing to pursue the claim after it was apparent there were no reasonable grounds for doing so.”