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Mid-Case Arbitrator Referral Rule Comment Period Ends. Few Comments But a Potpourri of Views
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The comment period for FINRA’s mid-case arbitrator referral rule expired on March 12th and, although there were not many comments, those submitted did reflect a wide range of views that were not split along “party lines.” We have previously covered the long and winding road this rule filing has traveled (see, e.g., SAA 2014-04 and SAA 2010-37). To review, the original July 2010 proposal (SR-FINRA-2010-036) came in the wake of the Madoff and Stanford scandals and was intended to address the admittedly rare circumstance where waiting until the end of a case poses a threat to the investing public. The proposal was amended a year later (Amendment No. 1) in response to mostly negative comments. On January 29th, FINRA withdrew the old rule proposal and refiled a new proposed rule (SR-FINRA-2014-005) that FINRA describes as having rule language identical to that in the one it withdrew. Although FINRA did not respond to the comments received to Amendment No. 1 prior to withdrawing the proposed rule, it addresses them on pages 23-32 of the new proposal.

Proposed Rule

The proposed rule would permit arbitrators to make mid-case referrals only in the exigent circumstances described above. FINRA would disclose to the parties the fact of the referral, but this would not automatically result in the arbitrator’s disqualification (although a party could challenge the arbitrator). Finally, the President of FINRA Dispute Resolution or the Director of Arbitration would have sole discretion to evaluate the referral and forward it to the regulatory or enforcement arms of FINRA for further review. The proposed rule also retains the current arbitrator authority to make post-case referrals, but broadens it a bit by permitting referrals of any matter or conduct (the current rule is limited to “matters”) and strikes “disciplinary” from the description of a referral. FINRA concludes that it “continues to believe that mid-case referrals would provide it with an important tool to protect investors by alerting FINRA to potentially serious wrongdoing earlier than is currently possible.”

Comments – An Overview

We first thought to analyze the comments along constituent lines, but it turns out the commenters do not speak with one voice. A total of ten comment letters were received, including one from Rick Ryder of this publication. At a very high level, they break down this way: three commenters urged approval, six opposed the proposal, and one supported the proposal in part and opposed it in part. Such a small sample does not lend itself to statistical analysis, but there were discernible trends. For example, almost all of those opposed expressed concerns that the cost of a mid-case referral would unfairly be passed on to investors, either directly or indirectly, while not adding realistically to investor protection. Almost all of those opposing the rule argued that it would increase the likelihood of a motion to vacate the Award based on referrals by arbitrators. And, some of the opposers suggested that arbitrators should not be asked to assume enforcement responsibilities. Those urging approval almost universally cited investor protection as of key importance to their support. Some commenters on either side proposed amendments to the proposal.

Strange Bedfellows

As noted above, the comments were by no means split along party lines. For example, former PIABA President Steve Caruso urges approval of the rule, while PIABA opposes it. SAC president Rick Ryder opposes the rule, while SAC Board of Editors member (and former FINRA Director of Arbitration) George Friedman supports it. The law clinics, too, were not uniform in their comments. Two (St. Johns and Georgia State) oppose the rule change, one (Pace-John Jay) urges approval, and one (Cornell) supports it in concept, but wants certain aspects amended. Both the sole securities industry commenter, also a SAC Board member (Bill Nelson), and an attorney from the other side of the aisle (Gary Berne), oppose the rule change.

(ed: So, what will the SEC do? We don’t like predicting the future, but George Friedman does. When reached for comment, without hesitating he said: “I have no doubt they will approve this rule. Read the close of my comment letter: ‘I agree this rule will hardly if ever be used. But if it more quickly terminates just one massive investor fraud, it will be worth it. Like Homeland Security, FINRA and the SEC cannot afford to be 99% effective. The investor protection mission of both organizations demands approval of this rule.’”) (SAC Ref. No. 2014-11-02)