The Financial Industry Regulatory Association (FINRA), a self-regulatory organization created and funded by the brokerage industry, wields powers ceded to it by its benevolent overseer, the Securities and Exchange Commission. One way the industry regulates itself is to have FINRA operate a mandatory dispute resolution system by which aggrieved investors are prohibited from suing brokers in a real court with judges, juries, and rules of evidence and procedure. Brokerage customers instead must arbitrate their claims in accordance with FINRA rules, must make due with limited pre-hearing discovery, and must present their cases to panels of mostly older or retired businesspersons and professionals who are decidedly not “juries of their peers.”
Whenever anyone is critical of this setup as being unfair to investors, the securities industry pushes back, arguing that their customers actually benefit from this mandatory arbitration system and should never be granted the right to opt out of it. But it turns out that when the tables are slightly turned, brokerage firms and their representatives don’t much like proceedings in which traditional judges and juries don’t exist and access to discovery is limited to documents.
Recent reporting in the financial press has revealed that the industry is in a dither over the SEC’s growing preference for using enforcement actions called “administrative proceedings,” rather than civil actions in federal courts. The percentage of enforcement matters going to administrative proceedings is growing, in part because the Dodd-Frank financial reform bill expanded the types of cases in which the Commission can pursue an administrative remedy, but also because the Commission has a big home field advantage in administrative proceedings.
There are no jury trials in SEC administrative proceedings. Each case is tried to one of five administrative law judges, all of whom are hired by the Commission and handle nothing but SEC matters. While the Commission almost always characterizes these administrative law judges as “specialized fact finders,” industry members and their lawyers complain that use of administrative law judges gives the Commission a huge advantage, evidenced by the fact that the Commission almost always wins in administrative proceedings.
Yet industry members have never seen a similar problem with FINRA arbitration proceedings being presided over by three-member panels of arbitrators recruited, trained, and paid by FINRA. Until very recently, one of those three arbitrators even had to be drawn from a pool of securities industry insiders. Without a hint of irony, FINRA and its member firms traditionally have justified the mandatory use of an industry arbitrator by referring to him or her as a specialized fact finder providing essential industry expertise. Thankfully, use of the industry arbitrator has finally become optional after many years of protests from claimants’ lawyers. But as far as the brokerage firms were concerned, it was perfectly appropriate and eminently reasonable to force customers to make their cases to arbitration panels rather than judges and juries.
Industry defendants also decry the fact that discovery in administrative proceedings is limited. The rules permit defendants to issue subpoenas for documents and to obtain the Enforcement Division’s non-privileged investigative documents, including documents containing any material exculpatory evidence. But with few exceptions, there are no depositions or other types of discovery permitted in an administrative proceeding.
Such limitations on discovery make administrative proceedings grossly unfair, according to defendants. Yet industry members have never complained about similar limitations in FINRA arbitration. As in administrative proceedings, discovery in arbitration generally is limited to documents. No interrogatories or requests for admission are available under FINRA rules, and depositions are forbidden absent extraordinary circumstances.
We could accuse the industry of hypocrisy, but actually, these seemingly contradictory positions about what is or is not fair are perfectly consistent. As far as brokerage firms are concerned, “fairness” is synonymous with “advantageous to brokerage firms.”
- FINRA Disciplinary Ruling Whittles Away Investor Protections
- Brokers Have Obligations Under FINRA Suitability Rule
- Group Arbitration
- Individual Arbitration
- FINRA Arbitration Lawyers
Hugh Berkson is a Securities Attorney with McCarthy, Lebit, Crystal & Liffman, Co. LPA. Hugh is rated AV® Preeminent™ by Martindale-Hubbell®.
He obtained a business degree in Finance from the University of Texas at Austin in 1989, and is a 1994 graduate of Case Western Reserve University School of Law, where he was a member of the Order of the Barristers and received both the American Jurisprudence Award, (National Mock Trial) in 1993 and the Jonathan M. Ault Mock Trial Prize for 1993-1994.