Securities Arbitration

What is FINRA’s Role in the Securities Industry?

FINRA is the largest, and currently the only, self-regulatory organization for all brokerage firms operating in the United States, overseeing approximately 4,700 brokerage firms, 167,000 branch offices and 635,000 registered securities representatives. FINRA is responsible for regulating the entire broker-dealer industry and devising standards of conduct and also administers an arbitration forum for securities disputes.

What is FINRA Arbitration?

Arbitration is a dispute resolution forum that serves as an alternative to traditional litigation. An arbitration proceeding is binding on the merits of a case as in a judicial proceeding. In fact, an appeal from an arbitration decision is more limited than an appeal of a judicial ruling.

Those appointed to decide both legal and factual issues in arbitration are called arbitrators, not judges. There are important differences between arbitrator and judicial decisions. While a judge is largely confined to analyze the facts under current law and precedential decisions, arbitrators are not bound to follow legal precedents and are free to fashion equitable remedies or to rely on non-traditional legal resources and considerations. Likewise, an arbitration hearing is similar to a court hearing but less formal and the rules of evidence are more relaxed and not strictly enforced.

The arbitration process begins when a customer files a statement of claim for arbitration with FINRA. The process is similar to a court complaint but less formal and the statement of claim does not need to be pled as particularly as a court complaint. After filing, the parties agree to select either one panelist or three panelists to serve as arbitrators to the dispute. If either one of the parties objects to a panelist that panelist is ineligible for selection. Once the panel is composed, deadlines are established to conduct the litigation.

FINRA arbitration usually takes nine months to a year and a half until trial and is almost always quicker than court litigation. One reason why FINRA is often a quicker forum is that in a court preceding a motion to dismiss is almost always filed in order to test the pleadings. However, in arbitration a motion to dismiss, under the FINRA Rules, is only appropriate in cases of misidentification or if the claim is duplicative of a case that has already been resolved. Thus, in arbitration, discovery commences immediately after the respondent files an answer. Another reason why arbitration is quicker is because depositions and interrogatories are generally not permitted under the rules.

Is there a Time Limit for an Investor to Bring a Claim in FINRA?

According to FINRA Rule 12206, an investor has six years “from the occurrence or event giving rise to the claim” to file an action with FINRA. If the arbitration panel assigned to a case dismisses the case as untimely, the investor may pursue the claim in court.

Who Decides the Case?

FINRA arbitrations are decided by a panel of arbitrators who are appointed after the investor files a statement of claim (which is similar to a complaint in court). For claims over $100,000, the panel will consist of three arbitrators. For claims between $50,000 and $100,000, one panelist will decide the case. Claims under $50,000 will be decided on the papers submitted.

What Happens After a Claim is Filed?

After a claim is filed, and a respondent answers, the arbitrators are selected from a list randomly generated by FINRA. In cases with claims over $100,000 three lists with ten names each is provided to all parties. Counsel for each respondent and each individually represented claimant can then strike up to four arbitrators from each list and rank the remaining names on the list. Counsel for each party submits the lists confidentially. Based on the rankings and strikes on each list, FINRA compiles a panel choosing the highest ranked arbitrators.

Once the panel is composed, FINRA schedules an initial prehearing conference. At the initial prehearing conference, the panel will set discovery, briefing and motion deadlines, schedule subsequent hearing sessions, and address other preliminary matters.

How Does Discovery Work in FINRA Arbitration?

Unless otherwise agreed to by the parties, within 60 days of the date that the answer is filed, the parties must produce the following documents or explain the specific documents that cannot be produced, or object to the production. Broker-dealers must produce:

1. The account record information for the customer parties, including all documents concerning the customer parties’ risk tolerance and all agreements with the customer.
2. All correspondence sent to the customer parties or received by the firm or associated persons relating to the claims, accounts, transactions, or products or types of products at issue.
3. All documents evidencing any investment or trading strategies utilized or recommended in the customer parties’ accounts.
4. All documents the broker-dealer or the registered representative used to establish that the customer authorized the transactions at issue.
5. All materials the broker-dealer or the registered representative gave to the customer relating to the transactions or products at issue.
6. All notes the broker-dealer or the registered representative made relating to the customer or the securities at issue.
7. All notes or memoranda evidencing managerial, supervisory, or compliance review of the customer parties’ accounts or the transactions at issue.
8. All recordings, telephone logs, and notes of telephone calls.
9. All writings reflecting communications between the registered representative and the firm’s compliance department relating to the securities at issue or the customer.
10. All Forms RE-3, U-4, and U-5 and Disclosure Reporting Pages, including all amendments, for the associated persons assigned to the customer parties’ accounts at issue during the time period at issue.
11. All sections for all of the firm’s manuals and all updates thereto relating to the claims.
12. All analyses and reconciliations of the customer parties’ accounts prepared during the time period at issue.
13. All exception reports, supervisory activity reviews, concentration reports, active account runs and similar documents produced to review for activity in the customer parties’ accounts related to the allegations in the Statement of Claim.
14. All internal audit reports relating to the registered representative at issue or for the securities at issue.
15. Records of disciplinary action taken against associated persons by any regulator (state, federal or self-regulatory organization) or employer for all sales practice violations or conduct similar to the conduct alleged in the Statement of Claim.
16. All investigations, charges, or findings by any regulator (state, federal or self-regulatory organization) and the firm/associated persons’ responses to such investigations, charges, or findings for the associated persons’ alleged improper behavior similar to that alleged in the Statement of Claim.
17. Those portions of examination reports or similar reports following an examination or an inspection conducted by any regulator that focused on the associated persons or the customer parties’ claims, accounts or transactions, or the product or types of products at issue or that discussed alleged improper behavior in the branch against other individuals similar to the conduct alleged in the Statement of Claim, for the period one year before the transactions at issue through the filing of the Statement of Claim.
18. All documents related to the case at issue that the firm/associated persons received by subpoena under Rule 12512 or by document request directed to third parties at any time during the case.
19. For all transactions at issue in the Statement of Claim, documentation showing the compensation, gross and net, to the associated persons for such transactions.
20. For claims related to solicited trading activity, a record of all broker compensation.
21. A record of all agreements pertaining to the relationship between the associated persons and the firm, summarizing the associated persons’ compensation arrangement or plan with the firm,
22. If the Statement of Claim includes allegations regarding an insurance product that includes a death benefit, the firm and/or associated persons must provide all information concerning the customer parties’.

The investor must produce the following documents:

1. All customer party and customer party owned business (including partnership, corporate) federal income tax returns the customer parties filed, limited to pages 1 and 2 of Form 1040, Schedules A, B, D, and E.
2. Financial statements covering the three years prior to the first transactions at issue in the Statement of Claim through the date the Statement of Claim was filed. Customer parties are not required to create financial statements in order to comply with this item.
3. All documents the customer parties received from the firm/associated persons and from any entities in which the customer parties invested through the firm/associated persons, unless the customer will admit that these were sent in the regular course of business.
4. All account statements for each non-party securities firm where the customer has maintained an account for the three years prior to the first transactions at issue in the Statement of Claim through the date the Statement of Claim was filed. However, in the alternative, the customer can provide a written authorization allowing the firm/associated persons to obtain the account statements directly from each non-party securities firm. If the customer parties elect to provide written authorization to the firm/associated persons to obtain the account statements, the customer parties must also provide all account statements in the customer parties’ possession, custody, or control containing handwritten notes or that are not identical to those the firm sent.
5. All documents, including agreements and forms, relating to accounts at the firm or transactions with the firm.
6. All account analyses and reconciliations prepared by or for the customer parties relating to the customer parties’ accounts at the firm or transactions with the firm during the time period at issue.
7. All notes, including entries in diaries or calendars, relating to accounts at the firm or transactions at issue with the firm.
8. All recordings and notes or logs of telephone calls or conversations about the customer parties’ accounts or transactions at issue that occurred between the associated persons and the customer parties.
9. All correspondence the customer parties (or any person acting on behalf of the customer parties) sent or received relating to the accounts or transactions at issue.
10. Previously prepared written statements by persons with knowledge of the facts and circumstances related to the accounts or transactions at issue, including those by accountants, tax advisors, financial planners, associated persons, and any other third party.
11. All complaints/Statements of Claim and answers filed in all civil actions involving securities matters and securities arbitration proceedings in which the customer parties have been a party, and all final decisions or awards or non-confidential settlements entered in these matters through the date the Statement of Claim was filed.
12. Documents showing the customer parties’ ownership in or control over any business entity,
13. All documents the customer parties received, including documents found through the customer, parties’ own efforts, relating to the investments at issue in the Statement of Claim.
14. For claims alleging unauthorized trading, all documents the customer parties relied upon to show that the customer parties did not know about or consent to the transactions at issue.
15. All materials the customer parties received or obtained from any source relating to the claims, transactions or products at issue.
16. The customer parties’ resumes.
17. Any existing description of the customer parties’ educational and employment background if not set forth in resumes produced under item 16.
18. All documents related to the case at issue that the customer parties received by subpoena.
19. To the extent that an insurance product that provides a death benefit is included in the Statement of Claim, the customer parties shall provide all information received from an insurance sales agent or securities broker relating to such insurance.

Under FINRA Rule 12507, the parties may make additional requests for the production of documents. If the parties have a discovery dispute, the FINRA rules require the parties to try to resolve the dispute in good faith. If the parties cannot resolve the dispute, either party may file a motion to compel the production of documents. Oral arguments on the motion are usually heard by the chair of the arbitration and decided after telephonic oral arguments.

What Happens After Discovery is Exchanged?

Pursuant to FINRA Rule 12514, at least 20 days prior to the first scheduled hearing date, all parties must provide all other parties copies of all documents and other materials in their possession or control that they intend to use at the hearing that have not already been produced. In addition, the parties must exchange lists of witnesses that they intend to call at the hearing. The parties may not present any documents or other materials not produced, or any witnesses not identified in accordance with FINRA Rule 12514.

Where is the FINRA Hearing?

Pursuant to FINRA Rule 12213, FINRA will select a hearing location closest to the customer’s residence at the time of the events that give rise to the dispute.

Who Can Attend the Hearing?

Pursuant to FINRA Rule 12602, the parties, and their representatives are entitled to attend the hearing. Absent persuasive reasons to the contrary, expert witnesses may attend as well. If a party does not attend the hearing, despite having notification of the hearing, the panel may determine whether they want to proceed to proceed with the hearing.

What Happens at the Hearing?

Arbitration hearings are similar to civil trials except that the rules of evidence are more informal. Each side is entitled to make opening statements, call witnesses, present evidence, and make closing arguments. Pursuant to FINRA Rule 12604, the panel can decide what evidence to admit. All witnesses are required to testify under oath and the proceeding is recorded.

What Happens After the Hearing?

Pursuant to FINRA Rule 12904, the award should be rendered within 30 days from the close of the hearing. The award must be in writing and signed by the majority of arbitrators. The award must contain: the names of the parties, the parties’ representatives, an acknowledgement that the arbitrators read the pleadings, a summary of the issues, the damages and relief requested, the damages and relief awarded, a statement of any other issues resolved, the allocation of the forum fees, the number and dates of hearing sessions, the location of the hearings, and the signature of the arbitrators. The parties may request an explained decision, which costs $400 in addition to the regular forum fees.

If the customer wins the case the respondent has 30 days to pay the award. However, if the customer loses, no appeal can be taken. The award can be confirmed or vacated in court.