We continue here our analysis of FINRA’s recently-published Report, FINRA Perspectives on Customer Recovery, and share news that a Bill has been introduced in the Senate to require FINRA to implement one of the Report’s proposals.
We analyzed in SAA 2018-06 (Feb. 7) this new Report, which the Authority said “is intended to encourage a continued dialogue about addressing the challenges of customer recovery across the industry, while directly informing the further enhancement of recovery in FINRA's forum.” The amply-sourced 24-page Report “provides an overview of the FINRA arbitration forum, makes available additional data about unpaid awards in the forum, describes the steps that FINRA has taken to address those unpaid awards, and identifies additional measures that could be taken to either enhance the resources to pay such awards or provide greater incentives to pay such awards.”
Unpaid Awards Data
The Report notes that only 16% of FINRA cases are closed by award, and that the raw number of unpaid awards each year is low – 44 in 2016 – amounting to $14 million. About half these cases were uncontested, often by inactive firms or individuals who have left the industry. Moreover, the Report states that “unpaid customer arbitration awards against firms primarily involve smaller-sized firms.” It also stresses that a major tool used to encourage award payment is FINRA Rule 9554, which allows the Authority to suspend industry parties for non-payment, unless they raise a valid defense to non-payment: “In 2016, FINRA instituted expedited suspension proceedings against 20 active firms or associated persons in connection with 15 customer awards; 15 firms and associated persons paid the award or reached a post-award settlement.”
Past FINRA Changes to Address the Problem
The Authority points out that it has over the years implemented several other rule and procedural changes aimed at improving award payment, such as: 1) asking customers whether the industry party has paid the award; 2) requiring the industry party to confirm payment (or provide a valid reason for nonpayment, such as filing a motion to vacate); 3) warning customers filing new arbitrations against defunct industry parties that such respondents have a relatively high nonpayment rate; 4) allowing such customers to opt out of arbitration to pursue claims in court; 5) allowing customers to amend their pleadings to add parties against whom there’s a better chance at collection; and 6) allowing customers to invoke expedited default arbitration proceedings before a single arbitrator, where an associated person’s registration is terminated, revoked, or suspended and the AP hasn’t filed an Answer in the time allowed (for further analysis, see SAA 2017-41 (Nov. 1)).
Changes in the Works
The Report also lists several ongoing changes in various stages of completion (ed: excerpts taken verbatim; footnotes omitted): Giving investors additional options where respondents are unlikely to pay. In October 2017, FINRA issued a Regulatory Notice [17-33] seeking comment on proposed amendments to the Customer Code that would permit a customer to withdraw an arbitration claim against an inactive associated person, and file in court, despite the existence of a predispute arbitration agreement. Giving investors more information about unpaid awards. In May 2017, the FINRA Board approved proposed amendments to Form U4 to elicit information from registered representatives that do not pay arbitration awards, settlements, and judgments in full and in accordance with their terms. Enhancing the safeguards to prevent evasion of a payment obligation. [On February 8], FINRA also issued a Regulatory Notice [18-06] seeking comment on proposed amendments to create further incentives for the timely payment of awards by preventing an individual from switching firms, or a firm from using asset transfers or similar transactions, to avoid payment of arbitration awards while staying in business (see SAA 2018-06 (Feb. 7)).
The Problem Goes Beyond FINRA
FINRA asserts that the unpaid awards problem also exists in other ADR fora and the court system, and that some solutions go beyond FINRA’s authority and would require either federal legislation or SEC or other regulatory approval. These approaches include (ed: repeated verbatim): rulemaking by the SEC to require firms to raise or maintain additional capital; legislation by Congress to expand Securities Investor Protection Corporation (SIPC) coverage to include unpaid customer arbitration awards; legislation by Congress or rulemaking by the SEC or FINRA to require firms to carry insurance to cover unpaid arbitration awards; legislation by Congress or rulemaking by the SEC or FINRA to create a second brokerage industry fund, separate from SIPC; amendments to the SEC’s Form BD to require disclosure regarding unpaid awards by firms; legislation by Congress to amend the Securities Exchange Act of 1934 (Exchange Act) statutory disqualification definition to include more instances in which a firm or individual fails to pay an arbitration award; and legislation by Congress to amend the Bankruptcy Code so that arbitration awards cannot be discharged in bankruptcy.
A Call to Action
In sum, “a holistic consideration of how customer recovery is or is not addressed across related areas of financial services will better inform what steps to better protect customers would be appropriate in the context of each of these areas, and what consequences action in any one area may have for others.” After making public via the Web its own data on unpaid awards, identifying the problem, and identifying possible solutions, the Report states that, as a next step, FINRA “plans to organize discussions with other regulators and policy makers to further address this topic, identify additional data or analysis that may help inform effective decision-making in this area, and consider potential courses of action.”
Senate Bill Introduced
Shortly before we went to press, Sen. Elizabeth Warren (D-MA) on March 6th announced that she had introduced the Compensation for Cheated Investors Act (ed: not yet numbered) that would require FINRA to establish a fund for awards that have been confirmed in court but remain unpaid. According to a Factsheet: “This bill directs FINRA to establish a pool funded by penalties from member organizations that will provide adequate funds to pay unpaid final awards and track whether arbitration awards are paid.” The Bill would provide full restitution to investors for unpaid awards and requires FINRA to promulgate Regs establishing the fund within a year of enactment. If the Authority fails to accomplish this rulemaking, “FINRA shall use amounts made available to FINRA from its general budget to pay claims made to the relief fund.”
PIABA Weighs In
On the heels of the Bill’s introduction, PIABA on March 7th held a 30-minute Press Event, releasing a Report, Unpaid Awards: The Case for an Investor Recovery Pool. PIABA suggests three sources for funding an unpaid awards pool, in descending order: 1) fines; 2) FINRA’s profits; and 3) an annual assessment against all FINRA members. It estimates that the last option would average between $23 and $120 per broker. PIABA simultaneously issued a Press Release, As Unpaid Arbitration Awards Reach $200 Million, Congress Must Force Creation of "Arbitration Pool" if FINRA Does Not Act, observing: “Unpaid FINRA arbitration awards for 2012-2017 have ballooned to roughly $200 million and resulted last year in 36 percent of investors who won their cases getting nothing and 28 cents of each dollar awarded going unpaid, according to a new report from the Public Investors Arbitration Bar Association (PIABA). The solution? If FINRA does not act on its own to create an “arbitration pool” to cover unpaid awards, “Congress must take steps to establish one.” In response to a question, the PIABA reps said that some Republican members have expressed support for the concept. An audio recording of the event is available at
(ed: *Kudos to FINRA for taking the proverbial bull by the horns. **The FINRA Report has a nice navigation tool in the table of contents that allows users to click on links to sections of interest. ***We take issue with the part of the Senator’s Press Release and Factsheet accusing FINRA of not establishing procedures to address unpaid awards in the nearly 18 years following the GAO’s first Report on the problem in 2000. As detailed above, the Authority has made several changes to address the unpaid awards problem. PIABA, on the other hand, acknowledged that FINRA has acted to increase investor awareness about unpaid awards, but that “[u]nfortunately, FINRA continues to avoid addressing the GAO’s recommendation to improve award payments themselves if unpaid awards remained a problem.” ****Putting aside our overall conceptual reservations, we’re concerned that tying the pool’s funding to FINRA “profits” (FINRA after all is a not-for-profit organization) will lead to charges that the Authority is somehow tamping down investor wins so it’s not on the hook for unpaid awards. Former Director of Arbitration and current SAC Contributing Legal Editor and Board Member George Friedman raised this very point in the Q&A part of the PIABA call.) (SAC Ref. No. 2018-10-02)
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