FINRA Arbitration: The Process, Some Advantages, and Some Disadvantages.
A brief introduction to arbitration before the Financial Industry Regulatory Authority (FINRA) for claimants seeking to recover losses from their stockbroker's or investment adviser's misconduct in handling their investments, and also for any financial professional faced with industry arbitration.
FINRA Arbitration-GenerallyVirtually every customer agreement with a brokerage firm or investment advisory firm will have a mandatory arbitration provision. For stockbrokers registered with FINRA, the arbitration provision will require arbitration through FINRA's dispute resolution protocol. Investment Advisers can include FINRA or other dispute resolution forums in their customer agreements, or none at all. As a public investor, you should read your customer agreements, including your new account agreement, margin agreement, and options agreement, and ask your broker to explain the key provisions. Also, both your Monthly Statement and Trade Confirmations will contain information that is important, and you should ask your broker to explain those terms and codes that relate to your style of investing. As a financial professional, don't just sign what is given to you, but read your compensation agreements carefully, as those agreements will certainly include arbitration provisions.
Generally, FINRA arbitration is heralded as quicker, less formal, less expensive, managed by selected and experienced arbitrators, and confidential, as contrasted to litigation before the Courts, which does not share many of those characteristics.
In FINRA arbitration, you can file a Statement of Claim based on any set of facts which you reasonably believe entitles you to compensation. Common claims include lack of suitable recommendations and investments, unauthorized trading, churning, misrepresentation or omission of risks, variable annuity and mutual fund switches, failed supervision, and even misappropriation and theft. Following service of the Statement of Claim, the Respondents will file an Answer and any counterclaims they may feel entitle them to a recovery. Of course, both parties will ask for reimbursement of fees and expenses. Following these initial pleadings, the parties will engage in discovery over the next 6 months, which is essentially and exchange of documents. Following discovery, many disputes are resolved through negotiation and mediation, and failing a resolution, the parties will prepare for the final arbitration. The final arbitration will generally be in a conference room, rather than a courtroom, and proceeds much like your courtroom TV drama, with the Claimant making an opening statement, followed by Respondent's opening statement, and then the parties call all of their witnesses, including any expert witnesses they believe will assist the arbitrators in understanding the facts, law, and damages. After all of the evidence is submitted, the arbitrators will deliberate, and render an award, which is usually a simple award without in-depth reasoning of why they ruled they way that they did. The award is delivered to the parties about 30-45 days following the close of the arbitration, and depending on the result, one party may owe the other, and/or one party may choose to contest the award in a separate lawsuit.
Some of The AdvantagesFINRA arbitration is designed to give the public investor/claimant a fundamental right to have their claim heard by the arbitrators. The various motions that are routinely encountered in court (Motions To Dismiss, Motion For Summary Judgement, etc.) are highly discouraged in FINRA arbitration, and in most instances, provided the filing is timely, the claimants will get to have their claims and requests for damages heard without risk to losing on a technicality.
Also, discovery in FINRA arbitration is more limited that litigation based discovery, and depositions, while permitted under the Rules, are rarely if ever granted. Thus, a claimant won't have their deposition taken, but a claimant won't be able to take the deposition of the broker or any of the firm's personnel. This more streamlined discovery saves both money and time.
Another advantage is that FINRA awards for damages can be based largely in equity, and are not dependent on technically prevailing on a state law or federal law cause of action. Thus, if you were treated unfairly, or if the broker violated certain rules and/or standards of conduct, the arbitrators can render a monetary award in your favor.
Another advantage is that a very high percentage of cases are resolved by agreement between the parties, often with the assistance of a professionally trained mediator. This high frequency of resolution may be due to a number of factors, including the unpredictability of the arbitrators, the limited discovery, and the inherent risk of ceding control of the outcome to arbitrators that don't have the same level of investment in the case as the parties. Further, in cases where the claimants have had a meaningful portion of their life savings is at stake, it is often in the claimant's best interest to take a bird in hand, rather than incur the time, expense, and risk of seeking the two (or more) birds in the bush.
Additionally, as contrasted with litigation, arbitrators' awards are provided great deference, and can't be easily attacked or overturned (like the appeal of a jury verdict), and thus when and if a claimant prevails in arbitration, the Respondents will generally pay the amounts in the award, rather than ask a court to overturn the award. Further, FINRA has rules that provide that a Respondent's license to do business can be at risk (terminated) if a broker or brokerage firm fails to pay an award (or settlement), thus enhancing the collectability of arbitration awards, as contrasted to Judgments rendered in court.
For registered investment advisers, you have the choice of whether to include an arbitration provision in your client advisory agreements, and also whether to utilize (and submit) to FINRA as your arbitration forum.
Some of The DisadvantagesWhile there is frequent debate among attorneys and industry professionals alike about this topic, I view one disadvantage to FINRA arbitration lies in the arbitrator selection process. Without getting into all of the details, FINRA discloses all final awards to the public. Thus, if an arbitrator renders an award that is perceived by either the claimant's counsel or the defense counsel as being too one-sided, then the odds are increased that the parties will strike that arbitrator and he/she won't be asked to serve in that particular case. For any arbitrator that does not want to be struck from the arbitrator lists on a routine basis, they may be (consciously or sub-consciously) inclined to gravitate toward the middle-of-the-road type of outcomes. Not too hot, and not too cold, thus insuring they will likely be ranked, and selected, in future arbitration. The obvious disadvantage to this is that there is a built-in reform, even in cases where a party should "win everything" or "lose everything."
Another disadvantage is that by signing the New Account Form with the binding mandatory arbitration provision, parties are divested of their constitutional right to a jury, and a judge. While some often argue that arbitration has sufficient advantages over litigation (and the US Supreme Court has so found), the fact remains that a public investor is giving money to someone who is requiring them to relinquish a right to a jury trial.