SEC Approves Revision to the Definition of “Public Arbitrator” in FINRA’s Customer Code of Arbitration

FINRA has issued Regulatory Notice 13-21 announcing that the Securities and Exchange Commission (“SEC”) has approved amendments to FINRA’s Code of Arbitration concerning the definition of “public arbitrators.”  FINRA classifies arbitrators as either “non-public” or “public.”  Non-public arbitrators are affiliated with the securities industry either through their current or former employment in the securities industry or by providing professional services to those in the securities industry.  Public arbitrators do not have any significant affiliation with the securities industry.

Under the revised definition, persons associated with, including registered through, a mutual fund or hedge fund cannot serve as “public” arbitrators.  Also, there is now a two-year “cooling off” period before certain non-public arbitrators may be reclassified as public.  Revised Rule 12100 of the Customer Code of Arbitration provides:

(u) Public Arbitrator

The term “public arbitrator” means a person who is otherwise qualified to serve as an arbitrator and:

(1) is not engaged in the conduct or activities described in paragraphs (p)(1)–(4);

(2) was not engaged in the conduct or activities described in paragraphs (p)(1)–(4) for a total of 20 years or more;

(3) is not an investment adviser, or associated with, including registered through, a mutual fund or hedge fund;

(4) is not an attorney, accountant, or other professional whose firm derived 10 percent or more of its annual revenue in the past two years from any persons or entities listed in paragraphs (p)(1)–(4);

(5) is not an attorney, accountant, or other professional whose firm derived $50,000 or more in annual revenue in the past two years from professional services rendered to any persons or entities listed in paragraph (p)(1) relating to any customer disputes concerning an investment account or transaction, including but not limited to, law firm fees, accounting firm fees, and consulting fees;

(6) is not employed by, and is not the spouse or an immediate family member of a person who is employed by, an entity that directly or indirectly controls, is controlled by, or is under common control with, any partnership, corporation, or other organization that is engaged in the securities business;

(7) is not a director or officer of, and is not the spouse or an immediate family member of a person who is a director or officer of, an entity that directly or indirectly controls, is controlled by, or is under common control with, any partnership, corporation, or other organization that is engaged in the securities business; and

(8) is not the spouse or an immediate family member of a person who is engaged in the conduct or activities described in paragraphs (p)(1)–(4). For purposes of this rule, the term immediate family member means:

(A) a person’s parent, stepparent, child, or stepchild;

(B) a member of a person’s household;

(C) an individual to whom a person provides financial support of more than 50 percent of his or her annual income; or

(D) a person who is claimed as a dependent for federal income tax purposes.

A person whom FINRA would not designate as a public arbitrator because of an affiliation under subparagraphs (3)-(7) shall not be designated as a public arbitrator for two calendar years after ending the affiliation.

For purposes of this rule, the term “revenue” shall not include mediation fees received by mediators who are also arbitrators, provided that the mediator acts in the capacity of a mediator and does not represent a party in the mediation.

(Revisions emphasized).  These revisions take effect July 1, 2013.

Florida Investors Recover Investment Losses on Lehman Preferred Stock Against Royal Bank of Canada (RBC)

Bloomberg News is reporting that the Royal Bank of Canada was ordered to pay more than $800,000 to Florida investors by a FINRA arbitration panel over investment losses including losses in Lehman Brothers Holdings preferred stock.  According to the article,  the arbitration panel found that an RBC broker falsified the risk tolerance of the Florida investors and misrepresented that the government would not let Lehman fail.  The panel awarded punitive damages of $250,000 after finding that the broker had engaged in intentional misconduct and gross negligence.

LPL Financial LLC Hammered With $7.5 Million FINRA Fine for EMail Deficiencies & Misstatments to FINRA

Yesterday, FINRA issued a press release announcing that LPL Financial LLC (“LPL”) was hit with a $7.5 million fine “for 35 separate, significant email system failures, which prevented LPL from accessing hundreds of millions of emails and reviewing tens of millions of other emails” and for making material misstatements to FINRA during its investigation of the firm’s email failures.

According to the release, examples of LPL’s failures include the following:

  • Over a four-year period, LPL failed to supervise 28 million “doing business as” (DBA) emails sent and received by thousands of representatives who were operating as independent contractors.
  • LPL failed to maintain access to hundreds of millions of emails during a transition to a less expensive email archive, and 80 million of those emails became corrupted.
  • For seven years, LPL failed to keep and review 3.5 million Bloomberg messages.
  • LPL failed to archive emails sent to customers through third-party email-based advertising platforms.

As a result of LPL’s numerous deficiencies in retaining and surveilling emails, the firm “failed to produce all requested email to certain federal and state regulators, and FINRA, and also likely failed to produce all emails to certain private litigants and customers in arbitration proceedings, as required.”  (Emphasis added).  FINRA further stated:

In addition, LPL likely failed to provide emails to certain arbitration claimants and private litigants. LPL will notify eligible claimants by letter within 60 days from the date of the settlement and the firm will deposit $1.5 million into a fund to pay customer claimants for its potential discovery failures. Customer claimants who brought arbitrations or litigations against LPL as of Jan. 1, 2007, and which were closed by Dec. 17, 2012, will receive, upon request, emails that the firm failed to provide them. Claimants will also have a choice of whether to accept a standard payment of $3,000 from LPL or have a fund administrator determine the amount, if any, that the claimant should receive depending on the particular facts and circumstances of that individual case. Maximum payment in cases decided by the fund administrator cannot exceed $20,000. If the total payments to claimants exceed $1.5 million, LPL will pay the additional amount.

See LPL’s Letter of Acceptance, Waiver and Consent (AWC) here (No. 2012032218001).

Not This Year: SEC Commissioner Says No Time to Address Mandatory Pre-Dispute Arbitration in Broker Client Agreements

The Investment News is reporting that Securities and Exchange Commissioner Elise Walter told an audience at a FINRA conference that the SEC will not be addressing the issue of mandatory pre-dispute arbitration agreements in the near future stating:

It’s not going to happen in the next few months or this year because there is so much we have left to do under Dodd-Frank and the JOBS Act – and we have to deal with money market funds and a few other things that by virtue of market interest really are ahead of all of this.

(Emphasis added).  Section 921 of the Dodd-Frank Act provided the SEC the discretionary rulemaking authority to restrict mandatory pre-dispute arbitration.  However, there has been no action to date despite recent pressure from lawmakers.

SEC and FINRA Issue Investor Alert Concerning Purchase of Risky Pension or Settlement Income Streams from Brokers

The Securities and Exchange Commission (SEC) and FINRA have issued an investor alerts concerning the sale and purchase of pension or settlement income streams. According to the SEC’s Press Release, investors should beware of special risks and issues concerning these products:

  1. Products can be expensive with commissions of seven percent or higher.
  2. Pension and structured settlement income-stream products may or may not be securities and may not be registered with the SEC.  Accordingly, there will be more limited information concerning the product.
  3. These products are illiquid.
  4. Your “rights” to the income stream you purchased could face legal challenges.  For example, it may not be legal to purchase someone’s pension or structured settlement.

See the SEC’s Bulletin here.

Charles Schwab Backs Down on Class Action Waivers in Client Account Agreements

Reuters is reporting that the brokerage firm of Charles Schwab Corp. is backing down on its requirement that account holders waiver class action lawsuits.  Reuters reports

Charles Schwab Corp has temporarily reversed its requirement that clients waive their right to bring class-action lawsuits, adding a new twist in a battle closely watched by the securities industry and plaintiffs’ attorneys.

“Effective immediately, Schwab is modifying its account agreements to eliminate the existing class-action lawsuit waiver for disputes related to events occurring on or after May 15, 2013 and for the foreseeable future,” the San Francisco-based brokerage company said in a statement that was posted on its website on Wednesday.

Schwab still believes that arbitration is the best forum for clients to resolve disputes with the firm, but said it was backing off the litigation ban in deference to clients who are uncertain about their rights as it fights to defend its original ban.

Schwab’s attempt to curtail consumer rights has drawn broad attention in recent months and has been cited as a principal reason by lawmakers to entirely abolish the mandatory pre-dispute arbitration provisions in customer account agreements.   Section 921 of Dodd-Frank Act provided the SEC with the discretionary rulemaking authority to restrict mandatory pre-dispute arbitration.  However, the SEC has taken no action on this issue to date.



Florida Supreme Court Says Statute of Limitations Applies In Arbitration – Raymond James v. Phillips

Yesterday, the Florida Supreme Court issued the much awaited decision in Raymond James Financial Services, Inc. v. Phillips, Case No. SC 11-2513 (May 16, 2013).  In this case, the Florida Supreme Court considered whether Florida’s statute of limitations (SOL) that is applicable to a “civil action or proceeding” applies to arbitration proceedings.  The Supreme Court agreed with the brokerage firm holding that

[T]he Legislature intended to subject arbitration proceedings to the statute of limitations. An arbitration proceeding is an “action” broadly defined in section 95.011 to encompass any “civil action or proceeding,” including arbitration proceedings.

Although this ruling provides additional ammunition for defense attorneys at the final hearing, this ruling does not provide a basis for dismissal of a Statement of Claim based on a statute of limitations.  FINRA Rule 12504 (which became effective in 2009) provides that “motions to dismiss a claim prior to the conclusion of a party’s case in chief are discouraged in arbitration.”  FINRA’s Notice to Members on this issue further states:

Under the rules, the panel cannot act upon a motion to dismiss a party or claim, unless the panel determines that: (1) the non-moving party previously released the claim(s) in dispute by a signed settlement agreement and/or written release; (2) the moving party was not associated with the account(s), security(ies) or conduct at issue; or (3) the claim does not meet the criteria of the eligibility rule.

See NTM 09-07 (Motion to Dismiss and Eligibility Rules).  Since there is no separate grounds for dismissal based on a state statute of limitations defense, brokers and their firms are not entitled to summary adjudication on the SOL affirmative defense and will still have to proceed to the final hearing.


Lawmakers’ Letter to SEC Urging the Abolishment of Forced Arbitration Agreements Used By Brokers

As previously discussed, here is the letter signed by Senator Franken and other lawmakers to the Securities and Exchange Commission urging the prohibition of mandatory pre-dispute arbitration agreements:

Dear Chairman White,
We write to express our strong belief that the Securities and Exchange Commission (the “Commission”) should promptly exercise its authority under Section 921 of the Dodd-Frank Wall Street Reform and Consumer Protection Act to prohibit the use of mandatory arbitration provisions in customer service agreements.

The Dodd-Frank Act was enacted, among other reasons, to protect American consumers from abusive financial services practices. Section 921 reflects Congress’s concern over the increasingly widespread use of mandatory arbitration agreements in customer and client contracts, and grants the Commission authority to restrict or prohibit the use of these provisions. Ensuring a choice of forum, particularly for small investors, heightens fairness and ultimately enhances participation in our capital markets. To our disappointment, in the almost three years since the Dodd-Frank Act’s enactment, the Commission has largely disregarded this important mandate.

The time is ripe for the Commission to act under Section 921 to protect the investing public and prevent further abuse of forced arbitration contracts.

Recently, we were alarmed to see further attempts to erode investor rights when Charles Schwab, one of the country’s largest brokers, expanded the mandatory arbitration clauses in its customer agreements to include a mandatory class action waiver clause. In this instance, Schwab argued that, in response to the Supreme Court’s interpretation of the Federal Arbitration Act (FAA) in AT&T Mobility v. Concepcion, it could include a waiver of class action and class arbitration rights in its customer agreements. FINRA initiated a disciplinary action against Schwab for violation of FINRA rules barring class action waivers. In February, however, a FINRA hearing panel ruled that although Schwab’s actions did in fact violate FINRA rules, those rules could not be enforced under Concepcion.[1]

While the Supreme Court in Concepcion did find that the FAA preempts state actions that would restrict the use of arbitration, the facts in the Schwab case are notably distinguishable-not least because FINRA is a membership organization seeking to enforce its own rules. However, the ambiguity created by the panel’s ruling underscores the urgency with which the Commission should adopt rules under Section 921.

Section 921 was included in the Dodd-Frank Act to address the threat to consumers posed by mandatory arbitration clauses in investment contracts. During Congress’s deliberation of this section, legislators heard concerns that investors forced into arbitration must face “high upfront costs; limited access to documents and other key information; limited knowledge upon which to base the choice of arbitrator; the absence of a requirement that arbitrators follow the law or issue written decisions; and extremely limited grounds for appeal.”[2]

If arbitration offers investors an efficient forum to resolve disputes, as some argue, investors may choose that option-but they should be given the choice. It is equally important that investors not be precluded from bringing class actions because of contractual fine print imposed by a mandatory waiver class action clause.

Although evidence suggests that the use of mandatory arbitration agreements is widespread, we are concerned about the lack of transparency and reliable data regarding the prevalence of such agreements. We encourage the Commission to track how many brokerage firms are inserting mandatory arbitration agreements and class action waivers into consumer contracts, so that this questionable practice may be better monitored and addressed.

We are deeply concerned that the Commission’s failure to respond to the dangers posed by widespread forced arbitration will weaken existing investor protections. Given the uncertainty created by the recent FINRA decision, we urge the Commission to act quickly to exercise its authority under Section 921 to prevent this practice and protect investor rights.

We recognize that the Commission is balancing competing demands, and that it must prioritize its recent mandates by Congress. The exigent circumstances at hand, however, require that the Commission exercise its authority under Section 921 of the Dodd-Frank Act and prohibit the use of mandatory arbitration provisions.

[1] FINRA Department of Enforcement v. Charles Schwab & Company Inc. (CRD No. 5393) Disciplinary Proceeding No. 201102976021. February 21, 2013.
[2] Senate Committee on Banking, Housing, and Urban Affairs on S. 3217, S. Rep. No.111-176, at 110.