The Financial Industry Regulatory Authority (FINRA) is actively working to improve its capabilities to deliver a fair and efficient dispute resolution forum to its member firms and the investing public. As explained in detail below, FINRA has taken steps to offer virtual hearings and mediations in the midst of the COVID-19 pandemic. Recently, FINRA also implemented several rule changes to assist prevailing parties in collecting their arbitration awards. Other recent rule amendments include changes to the fees applicable to expungement proceedings and rules affecting senior and vulnerable investors, as well as third-party discovery.
Response to COVID-19 Issues
FINRA has made significant changes to the arbitration and mediation processes in response to the COVID-19 pandemic. On March 25, 2020, FINRA initially postponed all in-person arbitrations and mediations scheduled through May 31, 2020. Subsequent announcements have extended these adjournments through January 31, 2021.
The inability to host in-person proceedings has not brought dispute resolution at FINRA to a halt, though evidentiary hearings have slowed significantly. Deadlines that do not involve in-person proceedings remain unchanged. In addition, parties may agree to conduct scheduled hearings via Zoom or by telephone. FINRA has also seemingly provided panels with the authority to order such hearings at the request of one party and over another’s objections. And at least one respondent has been unsuccessful in asking a court to enjoin a FINRA arbitration set for a hearing via Zoom. Parties who choose not to continue remotely may reschedule in-person proceedings with FINRA, a fact that has led to a backlog of cases set for hearing during the first half of 2021.
FINRA has described its virtual hearing services for conducting video and telephonic hearings and sharing documents remotely as high-quality, secure, and user-friendly. It has also made an Arbitrator Resource Guide for Virtual Hearings available to arbitrators and the public and indicated that FINRA staff is available to schedule virtual hearings and provide technical support. However, questions remain regarding the appropriateness of requiring objecting parties to conduct hearings virtually and the apparent atypical nature of the awards that such hearings have generated to date.
Efforts to Address Concerns with Collecting Awards
Investors are sometimes unable to collect arbitration awards entered against member firms or associated persons. In an effort to address this concern, FINRA has taken several steps. First, it has amended Rule 12202 of the Customer Code of Arbitration Procedure to expand the protections offered to customers asserting claims (1) against firms whose registrations become inactive in the course of an arbitration (it had previously applied only to firms that were inactive at the time of filing) and (2) against inactive associated persons (the rule had previously applied only to firms). For cases filed after June 29, 2020, claimants will now have 60 days after notice of the fact that the firm or associated person has become inactive to withdraw their claims in arbitration (so that they can be pursued in court), to add a new party or claim without the panel’s prior approval, or to postpone the evidentiary hearing. As before, customers may continue to request default proceedings against inactive members. The amendments are designed to allow customers to evaluate whether to move forward with arbitration when a respondent becomes inactive. Regulatory Notice 20-11 contains additional discussion of the rule changes, their effect on other rules, and the new definitions added to the code.
In addition, FINRA has adopted a rule that limits the safe harbor for business expansions found in IM-1011-1. Effective as of September 14, 2020, IM-1011-02 prohibits members from using IM-1011-1’s safe harbor provision to add an associated person in sales if that person or another of the member’s proposed additions has an unpaid arbitration award, unpaid settlement on an arbitration, or a covered pending arbitration claim.
Finally, FINRA has implemented changes to its Membership Application Program in an effort to offer further protections against unpaid arbitration awards. These changes were also effective as of September 14, 2020, and include the following:
- Rule 1014 (Department Decision) was amended to create a presumption that an applicant should be denied membership if it or any of its associated persons are currently subject to an arbitration claim. The applicant may rebut this presumption by demonstrating the ability to pay any unpaid awards or pending claims.
- Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations) was amended to require member applicants to demonstrate an ability to pay any unpaid awards before any of the applicant’s changes can become effective.
- Rule 1013 (New Member Application and Interview) and Rule 1017 were amended to require applicants to provide notice of any new pending claims or unpaid settlements or awards that become effective prior to a decision on their application.
Expungement continues to be a hot topic. FINRA has amended certain rules to apply minimum fees to expungement requests, effective for cases filed on or after September 14, 2020. The effect of the amendments is to increase the combined fees between parties from $500 in certain cases to $9,475. The cost increase would result from minimum filing fees, hearing fees, process fees, and member surcharges. FINRA has stated that the rule changes are designed to establish more consistent fees for all expungement requests and to shift the economic burden of such requests from FINRA to the parties.
More substantively, on September 22, 2020, FINRA announced proposed rule changes to the Customer and Industry Codes of Arbitration Procedure. They include the creation of a special roster of expungement-trained arbitrators who will be randomly assigned to decide most expungement requests, a requirement that expungement requests be made during a pending arbitration proceeding if the financial advisor is a named party, a prohibition on seeking expungement more than two years after the close of an arbitration case or more than six years after a customer complaint was filed (when no arbitration proceeding was commenced), and notification to state securities regulators of expungement requests. The proposed changes also include a number of additional procedural requirements and substantive hurdles that must be cleared by registered persons seeking to have their records cleared. Upon implementation of these changes, the expungement process will soon be more difficult and more expensive for financial advisors.
Senior and Vulnerable Investor Update
In August 2019, FINRA issued a regulatory notice regarding its decision to conduct a “review of the effectiveness and efficiency of its rules and administrative processes designed to help protect at risk investors from financial exploitation.” Given the relatively recent implementation of a number of rule changes (roughly 18 months prior to the regulatory notice), it was somewhat surprising to see FINRA already requesting feedback. This fact seems to be indicative of the importance that FINRA has placed on protecting senior and vulnerable adult investors as well as corresponding legislative developments across the country as numerous state legislatures moved to adopt laws aimed at protecting these investors from fraudulent activity. Specifically, FINRA sought input into the following issues:
- whether the safe harbor in FINRA Rule 2165 (Financial Exploitation of Specified Adults) should be extended beyond disbursements to include securities transactions;
- whether Rule 2165 should be extended to cover instances in which a firm has a reasonable belief that a customer is unable to protect his or her interests due to an impairment but there is no evidence of exploitation;
- whether Rule 2165’s temporary hold time period should be extended; and
- whether FINRA should create a means to obtain an extension on the hold period.
FINRA also sought feedback on a number of issues that would affect registered representatives, including (1) potential Forms U4 and U5 reporting obligations; (2) possible changes to Rule 3240 (Borrowing From or Lending to Customers); (3) prohibitions or limitations on the ability of registered persons to be named a beneficiary, executor, power of attorney, trustee, or similar position of trust on the account of a non-family-member customer; and (4) amendments to its Sanction Guidelines to add as a principal consideration whether a victimized customer is a senior or is otherwise considered an at-risk investor.
And, perhaps unsurprisingly, FINRA has acted quickly in moving to adopt several changes. For instance, FINRA has filed with the SEC a proposed rule change to adopt Rule 3241, which would require firms to preapprove registered persons who seek to be named as a client’s beneficiary or to act as a trustee or hold power of attorney for customers who are not immediate family members.
FINRA has also just announced that its board of governors has approved the filing of proposed amendments to FINRA Rule 2165. Rule 2165 allows a firm to put a temporary hold on disbursements from the accounts of senior and vulnerable investors when there is suspected financial exploitation. The first amendment would extend the hold period if the member firm had reported the matter to a state regulator or agency or a court of competent jurisdiction. Rule 2165(b)(2) currently provides for 15 business days. The second amendment extends the potential for holds to transactions in securities, not just disbursements. Both changes are consistent with the general trend in laws being adopted in a number of states across the country.
Third-Party Discovery Amendments
FINRA has also made a few minor adjustments to its third-party discovery processes. Recent amendments to the Customer and Industry Codes of Arbitration Procedures provided nonparties an additional five days to respond to subpoenas and orders of appearance of witnesses or production of documents. Thus, nonparties now have 15 days after receipt of service to respond. The rule changes also require service of such materials via overnight mail or delivery, hand delivery, email, or fax. Last, the amendments confirm the process by which the panel receives such motion papers; namely, that all materials are to be sent at the same time and after the reply deadline has passed.
The changes discussed above reflect FINRA’s efforts to adapt to constantly evolving litigation needs and to address concerns raised by members, investors and their counsel, and arbitrators.
This article originally appeared in American Bar Association’s Securities Litigation section on December 21, 2020.