Publication
American Bar Association
03.17.2022

As it was for the rest of the world, 2021 was an interesting year for the Financial Industry Regulatory Authority (FINRA). For those unfamiliar with ongoing developments at FINRA—including its dispute resolution process, expungement concerns, efforts to protect vulnerable investors, and response to the pandemic—a review of the Section’s Securities Litigation Journal article summarizing FINRA’s efforts in 2020 might be of interest as a starting point. As the pandemic roared into 2021, FINRA obviously made efforts to evolve the dispute resolution process to address the ever-changing COVID-19 landscape. In addition, FINRA withdrew proposed rule changes and sought to significantly amend a rule implemented roughly three years earlier. These changes and more are discussed in detail below.

Continuing Response to COVID-19 Issues

In March 2020, FINRA barred in-person arbitration hearings due to COVID-19 concerns. In response to improving conditions across the country, this total bar was lifted for most hearing locations in early July of 2021. This move had been sought by investor advocates since at least the spring of 2021. As of August 2, 2021, all hearing locations have been opened for in-person proceedings.
In October 2021, FINRA began to require all in-person hearing or mediation participants to be fully vaccinated in order to attend. FINRA made an exception for in-person participants with circumstances that prevent them from being vaccinated. Those individuals can instead provide proof of a negative COVID-19 test within 72 hours of the start of the hearing or mediation and every 72 hours during the course of the hearing or mediation. FINRA also created other protective protocols for in-person hearings and mediations, including selecting venues large enough to allow for social distancing and mask requirements. In addition, upon request of the parties or by order of the panel, FINRA continues to allow virtual hearings and provides videoconferencing for hearings through the Zoom platform. In late 2020, FINRA sought comments from stakeholders in an effort to evaluate lessons learned during the COVID-19 outbreak. The questions that were posed largely related to supervisory and registration concerns. Comment letters by the North American Securities Administrators Association and the Securities Industry and Financial Markets Association (SIFMA) are likely of particular interest to practitioners. With respect to possible changes to the arbitration process, FINRA has not publicly engaged in any regulatory process initiating potential rule changes or officially sought input indicating that it is planning to do so. However, Richard Berry, executive vice president of FINRA’s Dispute Resolution Services, recently spoke on the FINRA Unscripted podcast about tips for practicing in a remote environment and plans for the future of arbitration and mediation. In addition to touting FINRA’s successful implementation of virtual hearings, Mr. Berry stated that FINRA is planning to convene a Zoom task force of practitioners to consider improvements to FINRA’s processes and the manner in which it is conducting virtual hearings. Practitioners interested in his comments should listen to (or read) the full episode. It seems certain that additional changes will be forthcoming as FINRA continues to adapt to issues caused by the pandemic.

Proposed Amendments to Senior and Vulnerable Client Exploitation Rule

On June 9, 2021, FINRA announced a proposed rule change to amend Rule 2165 (Financial Exploitation of Specified Adults). The amendments would make two changes to the rule, which was implemented just over three years ago. First, the rule change would extend by 30 business days a temporary hold if the member firm has reported the matter to a state regulator or agency or a court of competent jurisdiction. This change would more than double the potential hold period from 25 business days (15 for the initial hold per section (b)(2) plus an allowable extension of an additional 10 business days under section (b)(3)) to 55 business days. Second, it would also allow firms to place such a hold on securities transactions. Under the current version of the rule, holds may be placed only on disbursements of funds or securities. FINRA Rule 4512 also provides protections for senior and vulnerable clients. Subject to certain limitations, Rule 4512 generally requires firms to ask customers to identify a “trusted contact” who may be contacted about the customer’s account. A number of states, such as Oklahoma, have more flexible provisions that allow firms to reach out to individuals reasonably associated with the accounts, though some states, such as South Carolina, require that such contacts be made only with people previously designated by the customer. Nothing in FINRA’s announcement regarding the proposed amendments to Rule 2165 evidences whether FINRA is considering expanding the scope of Rule 4512, or other rules, to provide for the type of notice being explicitly allowed by a number of states.

Withdrawal of Proposed Changes to the Expungement Process

In September 2020, FINRA sent proposed rule changes designed to overhaul the expungement process to the Securities and Exchange Commission (SEC) for approval. The proposal was slated to be adopted or rejected by the SEC in May 2021. However, on the day of the deadline for a decision, FINRA confirmed that it had temporarily withdrawn the proposed changes from SEC consideration. Among other changes, the new rules would have created time limits on when expungement can be requested, created a special roster of arbitrators to decide most expungement requests, and required an associated person named as a party in a non-simplified customer arbitration to request expungement during that arbitration or forfeit the right to do so. The withdrawal came on the heels of criticism from both investor advocates and the industry. On the one hand, the Public Investors Advocate Bar Association has argued that expungement should be made more difficult for advisors and has advocated for the creation of an independent investor advocate who could oppose expungement requests on behalf of interested parties, including investors and state regulators. On the other hand, SIFMA has raised a number of concerns regarding the proposed changes, including the grounds available for expungement, the ability to proceed in court, fees charged, and the timing and type of regulator involvement in the revised expungement process that FINRA has contemplated. It should be noted that, subject to these criticisms, SIFMA explained that it “generally support[ed]” the proposed changes. Advisors may hold out hope that FINRA adopts some of SIFMA’s suggestions and can currently take advantage of the reprieve from the potential changes thanks to FINRA’s withdrawal of the proposed rule changes. However, we strongly suspect that FINRA’s withdrawal is a signal that it intends to make the expungement process more difficult and perhaps more expensive than even what was contemplated by the withdrawn proposals.

Limitations on Beneficiary Designations and Appointments to Positions of Trust

On February 15, 2021, FINRA’s new Rule 3241 (Registered Person Being Named a Customer’s Beneficiary or Holding a Position of Trust for a Customer) became effective. Under Rule 3241(a)(1), a registered person must decline being named a beneficiary of, or receiving a bequest from, any customer’s estate. Under subsection (a)(2), a registered person must also decline being named as an executor, trustee, power of attorney, or similar position for or on behalf of a customer unless (A) the customer is immediate family or (B) the representative provides written notice to his or her firm and receives written approval prior to the designation or appointment. With respect to the approval request under Rule 3241(b), firms must (1) perform a reasonable assessment of the risks created by the representative assuming such role, including an evaluation as to whether the role will interfere with or compromise any responsibilities to the customer; (2) make a reasonable determination as to whether to approve, conditionally approve, or deny the request; and (3) inform the advisor in writing of the decision. In addition, firms must adopt supervisory procedures governing this process and retain certain records relating to the request.

FINRA Fee Increases, Technical Changes, and Reminders

As of April 2021, FINRA amended its Codes of Arbitration Procedure for Customer and Industry Disputes to increase chairperson honoraria. Specifically, FINRA increased the additional hearing-day honorarium that arbitrator chairpersons receive from $125 to $250 for hearings on the merits and created a $125 chairperson honorarium for prehearing conferences. It funded these changes by increasing arbitration fees. In particular, FINRA increased process fees for claims of more than $250,000, claims for unspecified damages, and nonmonetary claims, and increased filing fees and hearing session fees for claims of more than $500,000, claims for unspecified damages, and nonmonetary claims. FINRA also made a few technical and other non-substantive rule changes, including one technical change reflecting 2020 amendments to Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations) and other rules to help address the issue of customer recovery of unpaid arbitration awards. In addition, FINRA issued guidance to remind member firms that mandatory arbitration agreements in customer agreements must comply with FINRA rules, including Rules 12204 (Class Action Claims), 12206 (Time Limit), 12213 (Hearing Locations), and 2268 (Requirements When Using Predispute Arbitration Agreements for Customer Accounts).

Conclusion

The changes discussed above reflect FINRA’s efforts to adapt to constantly evolving litigation needs in the face of the pandemic, as well as its attempts at addressing several long-standing concerns.

This article originally appeared in American Bar Association’s Securities Litigation section on March 17, 2022. 

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