A Strategic Overview of FINRA Arbitration: Three I’s of Growth – Investment Advisers, Institutional Customers, and International Investors
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A Strategic Overview of FINRA Arbitration: Three I's of Growth

Investment Advisers, Institutional Customers, and International Investors

By Richard P. Ryder, Esq.*


When I first began thinking about the avenues of potential growth for FINRA's arbitration forum as the basis for an article, it was well before the COVID-19 virus shook to its foundations Wall Street's evident belief that this time, the bull market could continue without visible end. For longer than a decade, the stock market had soared ever higher, with few serious corrections and none that was long in duration. I believed, as did most of my arbitration colleagues, that there would be a natural end -- a cyclical eventuality -- that would ultimately alter the pace of case filings. That may well be happening, even now, but that's not the growth I write about in this article.

What I did begin to think about was the need for change to ensure securities arbitration's place at the center of a cohesive national investor protection program.[1] On my mind were the longer-term structural changes within the securities industry and the nation's markets that have been re-shaping how today's investor is served, who is doing the servicing, and even who that investor is. The markets have been evolving, each time rebounding in response to adversity -- after the '87 Crash, the Limited Partnership debacle, the Tech Crash, the Great Recession and now, wow, COVID.  My proposition holds that FINRA Arbitration hasn't changed in response to those structural shifts, and that success in its mission requires making those changes and stretching for growth.

Background: Past Articles

I have nibbled at the edges of this conundrum in earlier articles. In 2019 SAC #02, I argued that the material shift of the traditional wirehouse broker to the RIA space had displaced many investors from FINRA arbitration coverage. FINRA Dispute Resolution Services ("DRS") has reacted to this shift with some minor measures, but the upshot remains that investors dealing with independent RIAs generally face the Hobson's Choice of submitting their disputes to the lengthy gauntlet of litigation in the courts or weathering the often considerable expense of commercial arbitration. A solution, I wrote in "Is NASAA Short-Changing RIA Clients...,"[2]  surely lay in a confab between FINRA and the AAA -- which does offer an affordable Consumer Arbitration alternative for the retail investor -- mediated by NASAA.

NASAA was key, I reasoned, because (1) the forums had stopped making progress on an adequate solution; (2) the states have influential clout with the two forums; and (3) NASAA's (U.S.) membership oversees the very independent RIAs (up to $100M AUM) whose clients need more practical dispute-resolving solutions. If NASAA would see the problem as one of investor protection urgency, the job would get done. I also wrote for the SAC newsletter[3] on the subject of initial coin offerings -- potentially, a fourth "I" of growth(!) -- again positing that investors in BitCoin and other cryptocurrencies were purchasing instruments that were frequently "securities," that broker-dealers would be the ones selling them -- both in primary (ICO) distributions and in secondary re-sales -- and that FINRA should structure the nascent architecture to best protect ICO and crypto-investors with practical dispute resolution mechanisms.

Transitional Structural Changes

Back to long-term structural changes: Underlying the tumultuous migration of stockbrokers into the ranks of RIAs[4] has been a long line of regulatory and marketing changes that are transforming the role of the broker. They include the shift from point-of-sale compensation to fee compensation, the consequent giving way of transactional activity to asset-gathering, the proliferation of wrap-fee and other fee-based products, which precipitated the loss of the "broker-dealer exception" in Financial Planning Assn. v. SEC, 482 F.3d 481 (D.C. Cir. 2007), the subsequent registration of some 88% of brokers as investment advisory representatives, [5] and, most recently the launch of Regulation Best Interest.[6]

So, lasting changes have occurred in who is serving the customer today and how the customer is being served -- and, the investor, too, has changed. Today, we have sophisticated online research, execution and tracking services and record-low commission rates, all of which should encourage a proliferation of stock-pickers, but intermediation -- the imposition of an intermediary between the broker and the customer -- serves the desire of most individual investors to invest through a professional. RIAs are certainly part of that intermediation -- and we'll discuss them separately -- but hedge funds, corporate profit-sharing plans, pension/retirement plans, bank trusts, and 401(k) administrators and others represent the individual in the securities marketplace.

Today, people with savings have money in the market. Money can no longer sit in bank accounts -- it needs exercise to grow. Everybody we know lost money (at least on paper) when the Dow plummeted 10,000 points in March 2020 -- only a relative handful of investors actually chose the stocks whose prices plummeted. They were picked by RIAs or institutions that administer or manage the individual investors' savings. Besides these institutional intermediaries, this article will focus on the international investor who increasingly wants to access the U.S securities markets.  International investors seeking relative safety invest in our government securities and the American dollar. Those seeking dependable growth follow the Dow components or they dabble in liquid markets, trading tech securities, derivatives or a salad bowl of investment diversity. The COVID-19 crisis has only heightened awareness that money from all over the world flows into our nation's markets, because of the financial stability represented by our corporate and national wealth, the pricing fairness assured by massive volume and pervasive regulatory insight, and, important for our purposes, the ability to redress grievances within a framework that promises substantial justice.[7] The international investor is a growing and highly important component of today's stock and bond markets.[8]

Dispute Resolution as Investor Protection

Barriers exist, however, that block some institutional customers and international investors from taking advantage of the U.S. retail customer's unilateral right to demand arbitration under FINRA Rule 12200.  Most likely, the barriers were not intentionally erected to produce this result, but have evolved as barriers through practice, judicial interpretation or historical accident.  This article will discuss what can be done to remove or mitigate those barriers.

In the two articles previously mentioned -- the ICO and RIA articles -- we tried to offer practical suggestions for change. Inexplicably,[9] action on these suggestions did not follow. This round, after some prefatory discussion as to why they should, let's assume that FINRA management agrees that a need exists to expand its arbitration program. Proceeding on that premise, our suggestions will identify the sectors in which focus should be centered and measures that could maximize returns in those sectors. So, why should FINRA and FINRA-DRS be interested in growth? First, there's the practical concept that a robust arbitration program requires robust resources and institutional support. It's often the case in business that resources will flow to programs that are expanding, not contracting -- that have either consumer/public momentum or an aura of success. People need to believe that FINRA wants this outcome for growth to occur.

Why FINRA Needs to Grow

There used to be ten participating SROs in the Securities Industry Conference on Arbitration. Years ago, there were so many forums that SICA had to develop a Uniform Code of Arbitration.[10] Today, FINRA is, practically speaking, the sole self-regulator and the dominant arbitration forum for investors. With that exclusive position arises a heightened responsibility to maintain a viable, energetic program -- an implicit public duty that accompanies that status, which demands a persistent dedication to quality, fairness and access. To me, there's a regulatory imperative -- intensified by FINRA's position as sole self-regulator -- for adequate redress as a pillar of public confidence in U.S. markets, that should impel FINRA to modify its dispute resolution services as investor protection demands shift and evolve.

Is that dedication to a robust program apparent? The dedication of FINRA's DRS staff lies beyond question. But, does an institutional will exist to expand the DRS service as investor protection demands require? FINRA arbitration has been stuck in a trough for years now, processing about 3,500 new arbitration filings each year and, projecting forward, two of its mainstays are on a path to zero in the next year or two. Puerto Rico bond disputes have supplied a wave of cases -- thousands for the forum to administer in the past six years; that source will dry to a relative trickle this year. Expungement cases have provided hundreds of filings annually, perhaps more -- FINRA declines to report -- but procedural controls are planned that will reduce their number significantly. In fact, those anticipated controls are the cause of the surge. Thus, FINRA is on a path to negative growth, absent a new supply of cases from elsewhere.

FINRA releases only top-line information about the revenues that the FINRA forum generates for the sole self-regulator. FINRA doesn't report what the program costs each year, but, given the low case volume, the department will likely operate at a loss in 2020. NASD/FINRA officials have historically regarded the dispute resolution program as a strategic element in its investor protection mission. They have understood the connection between effective resolution of investor grievances, when they arise, and the public's confidence in the fairness of the markets. For example, arbitration case filing patterns and trends are often indicators of potential regulatory misconduct. Also, people are less likely to invest if they think the game is rigged or they are dubious about an effective path to justice, if cheated. Regulation can treat the former; effective dispute resolution alternatives are required to assure the latter.

Surely, the thought leaders at FINRA continue to make this connection between dispute resolution and investor protection. Still, a program that draws upon financial resources, instead of feeding them, and that is shrinking instead of growing, will tend to withdraw, rather than expand, as it focuses on reducing expenses, contracting its services, and conserving its resources. For a robust dispute resolution program to thrive, FINRA-DRS should be examining the scope of its investor protection coverage, assuring that the full panoply of investors in today's securities markets are well-served by its program, and re-structuring where necessary to assure full outreach. This may require some investment at first, but rule changes, combined with a re-examination of who is today's investor, will enable growth and, with growth, will come the stability needed to assure a truly healthy level of service.

How to Grow - What's the Path?

It's time then to look at where investors may be overlooked or under-served, in terms of their ready access to arbitration, in the event a dispute arises. They should not be denied arbitration by the existence of artificial or unnecessary barriers. They should find open doors and ready access when a grievance arises and redress is needed. I'm restricting my reference to three types of customer or investor in this article, but know that New York Stock Exchange arbitration rules, before the 2007 mergers with FINRA, permitted a demand for arbitration, similar to Rule 12200, that applied to "non-members" of the Exchange. Anybody with a grievance that drew into question conduct of the Exchange member constituting a regulatory concern[11] was permitted to demand arbitration of her dispute against the member. So, what are the opportunities for the forum to grow? I suggest the “Three I’s” are the leading growth avenues: 1) Investment advisers; 2) Institutional investors; and 3) International disputes. Read on for my thinking.

The First "I" of Growth: Investment Advisers

When the "client" of a registered investment adviser has a claim against the adviser, there is likely to be a broker-dealer involved who executed the trades in question. Often, that broker-dealer is affiliated from a control standpoint with that investment adviser, in which case FINRA-DRS customarily stands ready to arbitrate the dispute against both BD and RIA. These situations arise with increasing frequency, because so many registered brokers are also registered as, or with, investment advisers. But, the client-customer can get whip-sawed.

In a wirehouse setting, the broker may be dually-registered, in which case the customer will likely have both brokerage and advisory accounts. To our knowledge, the wirehouses have not tried to raise a jurisdictional distinction between these accounts and FINRA arbitrators have continued to adjudicate the full dispute, considering all of the customer's accounts as a whole. Some brokerage firms, though, utilize different pre-dispute arbitration agreements, depending upon whether the account is a brokerage account or an advisory account. By specifying AAA on the advisory account PDAA and FINRA on the brokerage account PDAA, the FINRA member compels the client-customer to fragment her claims. To proceed, she must either arbitrate in two forums -- a risky, clumsy and expensive choice -- or limit her claims to a single account, even though the representations made, the evidence available, and the underlying premises for investment decisions relate to both accounts.

Among some of the "independent" broker-dealers, which house brokers who operate as independent contractors, the mix of corporate relationships can be complex and confusing -- especially for the customer in arbitration (and even the arbitrators). In the FINRA Arbitration, Hansen v. ­­­­Allegis Investment Services, FINRA ID No. 17-00135 (Boise, ID, 12/19/17),[12] the Respondent brokers argued that the Arbitrators only had authority to arbitrate the customer's grievance, as it related to his brokerage account. The Arbitrators agreed, dismissing the claims against Respondents, as they related to the advisory account, for lack of jurisdiction after a 16-month proceeding. In the Panel's view, they could not rule, because the dually-registered individual respondents "were not acting in their capacity as associated persons of a member. It is the decision of the panel that the FINRA dispute resolution forum is not available for resolution of this dispute."

These legal barriers to ready justice should be addressed with regulatory counter-measures. Investors should have the option to arbitrate their entire dispute in a single arbitration forum and, to the extent feasible, FINRA should assure that all interested parties are at the table. That's how investor protection works. FINRA often arbitrates matters in which both annuities and variable annuities are part of the customer's portfolio, where commodities and securities transactions are in dispute, or where customers borrow investment funds from an affiliate bank. That these investments may be housed in different accounts and subject to separate regulatory regimes should not impede FINRA arbitrators from issuing a ruling on liability that adjudicates the customer's claims in full.

By the same token, the customer should not have to guess under what shell the hidden pearl lies.  If a member organization chooses -- for liability, regulatory or other highly rational business reasons -- to divide its business with a customer into a number of corporate "pockets," the customer should not have to negotiate those legal obstacles in order to arbitrate her full dispute at FINRA.[13] More than one way exists for fragmentation to be avoided; FINRA needs to alter its perspective and view the scope of the matter to be arbitrated from the investor's perspective, without regard to the regulatory umbrella Respondents were operating under that day. Fragmentation, by requiring a customer to arbitrate her related claims in different forums, costs the investor time and money -- oftentimes, a successful recovery. Arbitration has to meet its goals of being speedy, efficient and final. FINRA has a regulatory imperative to promote adequate redress for investors. These principles are consonant and each mandates a halt to tactics that result in jurisdictional fragmentation.

A Proposal

So how might FINRA proceed? It could implement rulemaking that would affirmatively require members to obtain undertakings from non-member affiliates, as a condition of doing business with its customers, that they will arbitrate at FINRA, upon the customer's demand. Another, perhaps simpler, approach might be for FINRA to engage in rulemaking that will allow the customer to opt out of FINRA arbitration with the member, absent consent from all named member affiliates, to participate in resolving the whole dispute at FINRA.[14] In either case, the objective would be to assure the customer-client-investor that her entire dispute will be addressed by the arbitrators with all interested parties participating.

What about the non-affiliated RIA? Growth here may not seem feasible, but there are measures available to FINRA that serve the advisory client, while promoting the forum. Many RIAs utilize the services of broker-dealers through custodial arrangements that make the broker-dealer a prime broker or clearing agent for all execution and back-office purposes. The advisory client is clearly the "customer" of the custodial broker-dealer in that framework and the client may, therefore, demand arbitration under FINRA Rule 12200. The RIA, on the other hand, may not have a PDAA with the client or may have a PDAA calling for arbitration at AAA or JAMS. The custodial broker-dealer finds itself in FINRA arbitration with the RIA as an "empty chair" Respondent and the advisory client has no way to join the RIA as a co-Respondent. Fragmentation looms.

In the custodial set-up, the custodial broker-dealer will generally have an agreement with the independent RIA and that agreement may permit the broker-dealer to third-party the RIA into the FINRA arbitration. FINRA-DRS has indicated that it will accept the RIA as a cross-Respondent in that instance, by dint of an "anchor BD" policy[15]. That's good to a degree. It may permit the arbitrators to allocate liability between the two, but it's an artificial fix. The advisory client does not have a direct claim against the RIA in that setting, which can limit its discovery options, examination rights at hearing, and collection rights post-Award. Were FINRA to require a provision in the custodial agreement between the RIA and the broker-dealer that would address this contingency, the advisory client, as an intended thirty-party beneficiary, could employ FINRA arbitration more effectively in arriving at a just disposition.[16]

Where independent RIAs prove open to using FINRA arbitration to adjudicate their disputes with clients, FINRA should arrange an inviting table. Currently, reports indicate that only 50% of state-registered RIAs employ PDAAs in their advisory contracts and only 15% of those name FINRA as a possible forum.[17]  Is that low percentage needlessly low, because of doubt that FINRA will accept their cases? The DRS forum is relatively inexpensive, specialized in the adjudication of securities disputes, and, to the advisory client, represents an alternative that makes feasible the resolution of disputes of all dollar sizes. Should FINRA affirmatively open its doors to these non-member RIAs and their clients, in the name of investor protection, independent RIAs using PDAAs would be more likely to include FINRA as an available forum[18]

FINRA first needs to address with the states -- and with the SEC, in the case of the larger RIAs -- a lingering historic belief among some SEC and state regulators that asking clients to sign a PDAA violates a duty to act in the client's "best interest" in all circumstances.[19] This dialogue among regulators gathers urgency with the effectiveness of Regulation Best Interest, as brokers now owe a "best interest" duty to their clients. An outreach to state-registered advisers could then ensue that acquaints RIAs with the benefits of arbitration at the Authority. FINRA should also clarify that, if the PDAA of a non-member RIA names FINRA and the court compels arbitration, FINRA will arbitrate the dispute.[20] FINRA could expand its service to RIA advisory clients by taking more proactive steps to encourage the use of PDAAs naming FINRA with non-member RIAs and to facilitate arbitration at its forum, when a party seeks it.

The Second "I" of Growth: Institutional Customers

"Institutional customers," broadly defined, include corporations that trade in the market or that utilize investment banking and brokerage services as issuers, as well as non-profits, pension plan managers, hedge funds, and others that manage portfolios on a fiduciary basis for individual government or corporate employees, trust beneficiaries, credit union members, and mutual fund investors. These intermediaries stand between the individual consumer, employee or investor and the broker-dealer who provides execution and clearing services. The investment adviser and portfolio manager who runs the investment corpus or pool of funds may not have the standing to pursue claims for market losses. They may even be conflicted and potentially to blame for the losses. A huge potential for FINRA's Dispute Resolution Services lies here.

In February 2009, a year after the auction rate securities blow-up that preceded -- and perhaps presaged -- the subsequent financial collapse, a corporate purchaser of auction rate securities, STMicro, won a rescission award of $400 million-plus from Credit Suisse in FINRA Arbitration. UBS lost an $80.8 million award in 2010 to a Maryland cell phone maker that had its cache of funds frozen in the ARS market: Kajeet, Inc. v UBS Financial Services. Goldman Sachs was ordered to pay $100 million to National Australia Bank in a 2015 Award resolving a dispute over CDO investments. Reportedly, NAB opted out of a class action regarding the Hudson Mezz-1 CDO investment, in order to pursue its claim individually in FINRA Arbitration.

At the same time as these corporate investors and banking clients were accessing FINRA arbitration as Rule 12200 "customers" and entrusting their multi-million-dollar disputes to FINRA Arbitrators, other institutional investors were having to fight in court for the same right -- and some were being denied access for not fitting the "customer" definition of Rule 12200. My colleague, George Friedman, covered these court cases and the confusion they have engendered very well in his article, Defining Who is a Customer in FINRA Arbitration: Time to Clear Things Up! published in 2012:6 SAC 1 (May 2013).[21] Whether an institutional customer who wants to arbitrate can readily do so is today still subject to unpredictability, as Mr. Friedman demonstrated in 2013. Some brokerage firms have even acted to bar institutional customers from arbitration through the use of forum selection clauses dictating litigation in a specific, convenient venue.[22]

FINRA has been vigilant in assuring that its member firms do not attempt to impede the right of associated persons or retail customers to access FINRA arbitration,[23] but, in the case of the institutional customer, it has neither clarified what "customers" can demand arbitration under Rule 12200, nor moved to admonish publicly those firms who use contractual provisions in "customer" agreements to drive institutional clients away from FINRA arbitration. FINRA, to my knowledge, has never staged public debate about whether issuers or municipalities in need of investment banking guidance or underwriting services qualify as Rule 12200 customers.

Why should FINRA not act here? Granted, the institutional customer can fend for itself better than the retail investor, but it should have equal access to the forum. Then, it can fend for itself. The decision to arbitrate or litigate a large-dollar dispute is difficult enough without having to weigh the unpredictability of one's gaining access to the forum of choice. How does that suit FINRA's goals for its dispute resolution program and how does it foster investor protection? Why, if brokerage firms have accorded the right under Rule 12200 to both institutional and retail customers to arbitrate on demand may a FINRA member contractually block that right for one, but not the other?

NYSE member organizations are historically accustomed to arbitrating at the demand of any "non-member." That right, vis-a-vis the institutional client, was compromised in the 2007 NASD-NYSE Consolidation through an omission, most likely one of corporate bias, not reason. FINRA's first move could be to clear the path for a broad band of institutional customers to arbitrate, should it choose to retrieve the "customer" definition from the courts and define the term with open debate. I'd suggest a broader regime, as the NYSE fostered, but the important objective is to clear the path, so that institutions with grievances are not in doubt as to their right to arbitrate.

Whether most institutions will want to arbitrate at FINRA is a separate issue. Those brokerage firms that have employed contractual provisions that bar FINRA arbitration evidently believe that, when the stakes are big, they are better-served elsewhere and that may be the view, too, of many institutions, as they review FINRA's selection procedures and its neutral roster. FINRA's Large Case Pilot, designed for application on a voluntary basis to disputes involving $10 million or more, recognizes that large-dollar cases demand more tailored procedures and benefit from arbitrators with special expertise. The most frequent use of the Pilot, reports tell us, comes from parties that seek to name their own arbitrators. Emphasis on this priority, outreach to parties, arbitrator training, together with the flexible procedural design potential of arbitration, will help parties to negotiate a course that enables them to select FINRA arbitration.

The Third "I" of Growth: International Investors

This may be the toughest nut to crack. We start with the realization that FINRA established a London hearing situs many years ago and, to my knowledge, it has never been used for an arbitration proceeding -- not one case! "Build it and they will come" simply has not worked. From one country to the next, there are cultural differences, varying attitudes about litigation and alternative dispute resolution generally, legal impediments to arbitration, differences in the governing law, and structural distinctions in the way customers and broker-dealers interrelate. But, we know that more and more foreign-based investors seek to invest in the U.S. securities markets. There's a new demand that will grow as technology and global commerce displace artificial barriers to long-distance trading. To the extent these international investors are operating in the U.S. markets -- whether they are retail or institutional -- they are a subject for investor protection, just as domestic "customers" are.[24]

The case of Citigroup Global Markets, Inc. v. Abbar, 761 F. 3d 268 (2d Cir. 2014), illustrates one of the major artificial impediments standing between international investors and FINRA Arbitration. Common practice among U.S. brokerage firms dealing in other countries is to incorporate in those foreign jurisdictions. There are many good legal, regulatory and even social reasons to do this. These separate entities are not FINRA members, because they don't operate in the U.S., but the overall corporate effort, of course, is to serve the full panoply of a client's investment needs. So, if a customer of the English subsidiary wants to make an investment in the U.S. securities markets, the English subsidiary and its American counterpart will work together to facilitate that investment. Win-win for the customer and the brokerage firm, at least until a dispute arises.

Ghazi Abbar was a wealthy Saudi Arabian businessman, who held major accounts with Citigroup in its London office. When investing in the U.S., he worked regularly with personnel from the firm's New York office and that was true in the instance that precipitated Mr. Abbar's effort to arbitrate at FINRA. Citigroup argued that Mr. Abbar was not a "customer" of the member. The District Court's first impulse was to see whether a "just" result could be reached by investigating the contacts and relationships between Mr. Abbar and the various personnel with whom he dealt in both the London and New York offices. It was clear substantial contacts existed with the New York office, but do you judge by weighing time involved, the importance of the contact to the transaction or to the overall investment plan -- what standard should apply? The District Court ultimately opted for a bright-line test, in the interests of judicial economy and to avoid delaying resolution of the central dispute. The accounts were held in London -- ergo, Mr. Abbar was not a "customer" of the USA-based FINRA member.

The Second Circuit affirmed and it ultimately developed a two-prong test, which has been adopted by other federal circuits at this point, that requires, to be a "customer" for FINRA Rule 12200 purposes, the putative claimant must either have an account with the FINRA member or have purchased goods or services from the member. That locks out internationally-based investors like Mr. Abbar. Of course, FINRA is free to disagree with the Second Circuit -- the term "customer" is FINRA's to define. However, it will have to act affirmatively and define the term from an investor protection perspective, where, thus far, the Authority has opted to leave that chore to the courts. That, then, distinguishes the international investors who invest in the U.S. securities markets from their domestic counterparts, in terms of their investor protection options should a dispute arise.

In my view, FINRA would do well to adopt "non-member" as the operative term for access to FINRA's Dispute Resolution Services and follow the NYSE example. That term is broad enough to cover Mr. Abbar and other international customers, who have grievances that relate to transactions in the U.S. securities markets -- plus, the term already has judicial gloss from the case law that tested its boundaries under NYSE Arbitration Rules. FINRA need not go that far, however. It could broaden the "customer" term to encompass international investors with assets held by the Respondent firm's affiliate(s) overseas and let the case proceed on the merits as against the member. FINRA might also permit the member to name, for liability allocation purposes, the non-member affiliate. There are other approaches, but, again, the issue is whether investors in the nation's markets should, in situations of equal relation to access, be subject to distinctions that limit their remedies? Answer that question and the appropriate solutions will illuminate readily.

Conclusion: Go For It!!

For those who doubt the fairness of FINRA arbitration for investors, this article will have little appeal. I proceed from the premise that FINRA arbitration serves well and fairly investors of all sizes and argue for modifications and measures that will bring more investors into arbitration. I think that, by and large, that works in the individual case and, from an overview perspective, it helps to assure a more robust forum, one the proudly promotes its virtues, that aims to grow and, with growth, invest in further improvements to the process. I think, to do that, FINRA needs to plug the holes in the system that invite fragmentation of investor disputes and it needs to adjust to the world of today's investor, restructuring and gearing up to meet the demands of groups that it insufficiently serves today.

This requires a more proactive outlook about arbitration at FINRA and an affirmative belief in arbitration as a dispute-resolving mechanism and the dispute resolution program it has built at FINRA-DRS.  It does not mean favoring the investor in the arbitral process -- that is not what I propose. Being pro-arbitration and party-neutral is perfectly feasible for this forum. To me, aggressively promoting the process makes not only good business sense, but also serves well the goals of investor protection. As the sole self-regulator in the securities business and as the operator of the dominant forum, FINRA needs to embrace a regulatory imperative that views a full plate of dispute resolution techniques as conducive to public confidence in the markets (by fostering means of adequate redress for investor grievances) and essential to a complete program of investor protection.

And Now, the Three R’s

With these predicates in place, FINRA-DRS needs to reconsider, retool and realign its program to deal more effectively with the disputes of today's investor. In this article, I cite three types of investor that FINRA-DRS should pursue. I selected these constituents, without regard to the difficulty of reaching them, but because they represent today's investor in the securities markets. To re-align, FINRA must move past the notion that its arbitral boundaries should be restricted to its regulatory jurisdiction. That approach creates confusion among arbitrators and parties alike, encourages fragmentation of investor disputes, and artificially limits FINRA-DRS' development of a robust and pervasive program. FINRA's more contained disciplinary jurisdiction should not dictate limits on the many ways in which it can promote DRS' services and thereby enhance investor protection.


*Richard “Rick” Ryder is the Founder and President, Securities Arbitration Commentator, Inc. (SAC), the publisher of Securities Arbitration Alert and Securities Online Litigation Alert. SAC also owns ARBchek, an online facility for searching Arbitrators' Award histories.


[1] FINRA proudly characterizes its facility as "the largest securities dispute resolution forum in the United States," its section of the FINRA Website appears on the Authority's Homepage under the "For Investors" Menu, signaling the forum's role in protecting investors, and the facility just changed its name from "Office of Dispute Resolution" to "Dispute Resolution Services" to stress its mission as a service provider.

[2] Subscribers are able to download a free PDF copy of this article by pasting the title into SAC's SBI-SAC search engine.

[3]Initial Coin Offerings (ICOs): Opportunities for Securities Dispute Resolution Systems, published in 2018:7 SAC 1 (Dec. 2018).

[4] This trend has been underway throughout the aughts; news stories indicate it continues today. See, e.g., Citi Latest to Leave Broker Protocol, by Janice Kirkel (CityWire, 1/2/2018); UBS Loses 109 Brokers to Competitors in Past Six Months -- Report, by Mason Braswell (AdvisorHub, 4/29/2019); 6 Key Reasons Why IBD Advisors Are Moving to the RIA World, by Howard Diamond (Diamond Consultants, undated).

[5] This statistic comes from p. iii of the "Executive Summary" of the SEC's 2011 Study on Investment Advisers and Broker-Dealers.

[6] The Dodd-Frank Act mandated a rule change that would raise the suitability standard under which brokers operate with customers to a fiduciary standard similar to those under which RIAs deal with their clients. Reg BI was the product of those efforts.

[7] Arbitration is particularly suited to resolving securities-related disputes, because it is relatively speedy, efficient and final. Recovering from a market loss and entering the markets again rely upon regaining confidence and understanding what went wrong. See, generally, AES International, "Four Tips for Moving On After a Financial Loss."

[8] The Federal Reserve published a study on this subject in 2008. That "working paper," entitled Why Foreigners Invest in the United States, reported that international investors had more than $2 trillion invested in the U.S. securities markets. By 2019, that figure had reportedly increased to $9.4 trillion!

[9] Would we authors write if we couldn't hope to move the needle of change at all? I had conversations about the article with a couple of state regulators. The intuitive connection between investor protection and PDAAs is just not there. On ICOs, search "cryptocurrency" or "Bitcoin" on FINRA's Arbitration Awards Online - 3 hits total.

[10] See, generally, SIFMA's 2007 White Paper on Arbitration in the Securities Industry.

[11] Actually, the Exchange did not define "non-member" as having regulatory concern restrictions. Like FINRA's "customer," NYSE's "non-member" acquired judicial gloss from some important litigation battles. See, e.g., Paine Webber, Jackson & Curtis v. Chase Manhattan Bank, 728 F.2nd 577 (2nd Cir. 2004); Spear, Leeds & Kellogg  v. Central Life Assurance Company, 85 F.3d 21 (2nd Cir. 1996).

[12] Theoretically, the Arbitrators' decision enabled Mr. & Mrs. Hansen to pursue a delayed action against the investment adviser entity in court, but regulatory action, fines and other collateral events had transpired, we understand from parties close to the case, to make pursuit impractical. In this case, claim fragmentation cost the Hansens, as aggrieved investors, precious time arbitrating at FINRA, only to find, 16 months in, that that remedy would be subject to a perceived jurisdictional limitation.

[13] Recently, a sole Arbitrator, considering a claim of elder financial abuse by a FINRA member, dismissed the case -- after the parties had answered and with no sign in the Award of a jurisdictional objection, because an insurance policy lay at the heart of the disputed conduct. The Arbitrator dismissed without prejudice, finding that "FINRA arbitration is not the appropriate forum for this dispute." Because the insurance policy was not a security, he ruled, "there ... is no subject matter jurisdiction." Sherman v. MSI Financial Services, FINRA ID No. 20-00307 (Boca Raton, FL, 7/10/2020). We understand that the McCarran-Ferguson Act might legitimately have been the basis for the Arbitrator's decision -- see, e.g., Legacy Consulting v. Gutzman (Ky. App. 2020) -- or, possibly, FINRA's "insurance business" exception in Rule 12200 -- see., e.g., Bazzone v. Nationwide Mutual, No. 03-4659 (3rd Cir. 2005). But. the fact that the Arbitrator held the product was not a "security" suggests that he felt FINRA's arbitral jurisdiction, like its regulatory jurisdiction, is restricted to securities. That's claim fragmentation at FINRA! One doesn't see this happening at other major arbitral forums. They take the whole dispute, absent a specific carve-out in the arbitration agreement.

[14] As an analogue, we'd point to FINRA's recent adoption of a rule that declines use of the forum, if the customer opts out of arbitrating with an "inactive" party. See, Regulatory Notice 20-11. If a non-member subsidiary is erroneously named, a demonstrable showing that it was "not associated with the account(s), security(ies), or conduct at issue" will permit an early pre-hearing dismissal. See FINRA Rule 12504.

[15] There was a great discussion on this subject at the 2017 Ass’n of the Bar of the City of New York "Hot Topics" Seminar, later summarized in Securities Arbitration Alert 2017-23 (Jun. 13).

[16] FINRA members would presumably welcome such a required clause. It would remove from contractual negotiations whether such a provision is reasonable and it would assure all interested parties have a role in resolving the advisory client's grievance.

[17] PIABA conducted a study of some 200 RIA advisory agreements in 2019 and Massachusetts did as well, with similar results. Anecdotally, we hear that "lots of" attorneys representing RIAs advise them to name AAA Commercial Arbitration Rules in their PDAAs, because the expense of conducting a AAA commercial arbitration will discourage clients from suing. Simplistic thinking, I would reply to such an attorney. Without addressing the short-sightedness of that advice, it begs the question: Why use a PDAA at all -- litigation is sufficiently expensive to achieve the same in terrorem effect? Moreover, these attorneys have not taken a close look at AAA's Consumer Arbitration Rules (CAR), which permit the AAA to designate a case for CAR Arbitration (where most fees are paid by the non-consumer party), even though the PDAA calls for application of the Commercial Arbitration Rules.

[18] I recognize that FINRA, in providing dispute resolution services to non-member RIAs and their clients, cannot provide collection support the way it does when members suffer an adverse Award. The client, though, is no worse position than if she won a monetary award at AAA or JAMS or a judgment in court against that RIA.

[19] This attitude goes back to the 1980s, when the SEC stated in a no-action letter that a mandatory arbitration clause in an RIA's client agreement might violate the Investment Advisers Act. While that view issued in 1986, the Commission has never retracted the opinion. In more recent times, SAC has reported official comments written by the Massachusetts securities chief, Frances Galvin (SAA 2013-07 (Feb. 20)): “... a clause binding an investor to arbitrate a dispute before its circumstances are established may not be in that client’s best interests, nor ... consistent with the fiduciary duty owed to the client by the investment adviser.”); informal cautions from SEC examiners to a Minnesota attorney; ban by Virginia's securities regulator against the use of PDAAs in Virginia-registered RIA advisory contracts. (SAA 2019-35 (Sep. 11).)

[20] In the days of NYSE arbitration, litigators, seeking an injunctive order in a raiding dispute, could point to a policy letter from the Exchange, known as the "Morris Letter," that assured the court arbitration of the dispute would follow expeditiously, should the court order preliminary relief. FINRA-DRS officials have often made public statements that it will comply with court orders compelling arbitration. A specific FINRA policy letter dealing with RIA disputes would serve the courts well as they consider such applications.

[21] A PDF copy of this article in SAC format is available online, with permission of the publisher.

[22] See, generally, Forum Selection Clauses in FINRA Arbitration, by Matthew W. Woodruff (NYLJ, 1/30/2014); Applied Energetics, Inc. v. NewOak Capital Mkts., LLC, 645 F.3d 522, 525 (2d Cir. 2011); See In re Am. Express Fin. Advisors Sec. Litig., 672 F.3d 113, 132 (2d Cir. 2011); Kidder, Peabody & Co. v. Zinsmeyer Trusts P'ship, 41 F.3d 861, 864 (2d Cir. 1994) (alterations in original)); see also Smith Barney, Inc. v. Critical Health Sys. of N.C., Inc., 212 F.3d 858, 862 (4th Cir. 2000). But see, UBS Finl. Svcs. v. Carilion Clinic, No. 12-2066 (4th Cir. 2013).

[23] See, e.g., Regulatory Notice 16-25.

[24] See, Morrison v. National Australia Bank, 561 US 247 (2010).