A Few Things About AAA Arbitration of RIA (and Other) Claims

At a recent webinar, representatives of the American Arbitration Association ("AAA") provided several comments about the arbitration process as applied to claims involving registered investment advisors ("RIAs"):

Do the consumer or commercial AAA Rules apply?

Where the operative arbitration clause determines the applicable rules, that controls.  Otherwise, AAA's case team reviews the claim to determine whether the claim falls under the consumer or commercial rules.  On motion, the appointed arbitrator may also be asked to review which rules apply.

What's the number one difference between the Rules from the consumer perspective?

The AAA identified the fee structure as a primary difference between commercial and consumer AAA rules. The fees for consumer cases are much easier on the wallet; fees are capped at $2,500 per hearing day. The consumer's filing fee is $225 and no other fee is charged to the consumer. Under the commercial rules, AAA fees are charged at the arbitrators' standard hourly rates.

How are arbitrators assigned under the Commercial Rules?

• The strike-and-rank method.
• AAA will provide the parties with a link to arbitrators and they can then pick from the list. The parties may also limit the list based on the parties' requests regarding arbitrator fees or qualifications.
• AAA will discuss with the parties desired arbitrator qualifications, often industry experts are desired
• AAA will look at the contract and assess arbitrator qualifications best suited for the case. 

How are arbitrators assigned under the Consumer Rules?

• the arbitrator is directly appointed by AAA, the parties are provided the selected arbitrator's resume and allowed to object
• the parties may also agree to a panel of three; selection via strike-and-rank method (the AAA charge is $250 for five names)

What if the arbitration clause is unclear about the size/composition of an arbitration panel?

AAA will make a judgment regarding the size and composition of an arbitration panel upfront. Where there is an ambiguity in the arbitration clause, AAA will first seek agreement from the parties.  If there is no agreement, AAA will make judgment.  AAA generally will take into account that multi-arbitrator proceedings are much more expensive (in AAA's experience 5x more costly) and slower (on average requiring months of additional time).

How are conflicts vetted?  

AAA arbitrators are instructed to disclose, disclose, disclose; if in doubt, disclose.  

The parties can also request enhanced arbitrator selection, which makes particular sense on high-stakes cases. This typically involves getting on a ZOOM call and have a discussion with the arbitrators and pose questions related to any conflict-of-interest questions or concerns.

A party may make a bias or similar serious challenge to an arbitrator to AAA's Administrative Review Council.  The Council hears about 300 challenges per year.  The challenges result in a "yea" or nay" decision, not an explained decision about whether an arbitrator should stay or be removed.

What if a party wishes to object to hearing location, even where that is defined by agreement?

The AAA will make an initial determination, and a request can be made for review by AAA's Administrative Review Council.  The arbitrator can also be asked to make a ruling.

Registered Investment Advisor Claims and American Arbitration Association (AAA)

The American Arbitration Association (AAA) handles a great number of financial disputes. At a recent seminar, AAA shared some data:

• the AAA case load has risen rather sharply, a 19% rise in claimsin 2022 as compared to the prior year;
• The primary claim types driving that increase are: lender debtor, banking services, partnerships;
• 90% of cases are decided in favor of one side or the other--in general they do not see claims resolved on a "split the baby" basis;
• the usual time frame from filing to award is 6-9 months, of course there are outliers; 
• 65% of cases settle;
• case decisions are generally non-public, with exception of employment, labor, and some international case types (searchable in Westlaw);
• arbitration awards are not disclosed to securities regulators; and
• the AAA does not track win/loss ratio with particular arbitrators.

2022 Revisions to American Arbitration Association Rules

The American Arbitration Association (AAA) has updated its Commercial Arbitration Rules and Mediation Procedures, effective September 1, 2022.  Per AAA’s announcement the changes reflect the input of a wide range of AAA stakeholders, and “standardize important longstanding AAA practices—confidentiality, consideration of consolidation/joinder motions, and civility—as well as revise rules to further promote efficiency, reflect advances in technology, and include where appropriate discussions regarding cybersecurity.”

The AAA highlights five key changes:

1. Consolidation: AAA’s first-ever commercial rule for the consolidation of existing arbitrations or the joinder of additional parties.  New Rule R-8 now explicitly allows a party to file a request to consolidate and establishes a procedure for acting on such requests.
2. Confidentiality: Captures the long-standing requirements of the Code of Ethics for Arbitrators by including a commitment to the confidentiality of arbitration in the Rules, pursuant to new Rule 45(a).  Rule 45(b) specifically permits arbitrators to issue confidentiality orders.
3. Conduct of parties and their representatives: Specifically incorporates into the Rules the AAA’s expectations of civility and professionalism of all participants in arbitrations.
4. Providing arbitrators with the authority to interpret awards: Allows the arbitrator to explain the award (and correct clerical, typographical, or computational errors) on a party’s motion, per an update to Rule R-52.
5. The importance of cybersecurity, privacy, and data protection: Reflects the weight that the AAA places on cybersecurity and recommends that data protection be discussed in the preliminary hearing.

The revised rules include a number of other important changes.  The upper limit dollar threshold for the application of the Expedited Procedures rises from $75,000 to $100,000 and, similarly, the lower limit for application of Large, Complex Commercial Disputes Procedures doubles from $500,000 to $1 million.  Rule R-34 establishes procedures for dispositive motions and Expedited Procedure E-5 prohibits them absent good cause shown and arbitrator permission. Other rule amendments expressly authorize and promote use of videoconferencing. 

These are all welcome changes to promote AAA's goal of an "orderly, economical, and expeditious" procedure for the determination of disputes.  The amended rules can be found here. 

Attorneys' Fees under the Uniform Securities Act

Because of the expense of litigation (and arbitration), a common question is whether attorneys' fees are available to the prevailing party.  Yes, but only in connection with some claims and don't bank on it.

Under the Uniform Securities Act, which has been adopted in four New England States, the answer is yes, although recovery of attorneys' fees is permissive, not mandatory.  Maine and New Hampshire adopted the current version of the Act.  Massachusetts and Rhode Island adopted the original Act but have not adopted the current version.  Both the current and prior versions of the Act provide for recovery of attorneys' fees in connection with certain civil claims by the seller, purchaser, and in several other situations.

Update on Securities Arbitration Administered by FINRA

This is by no means verbatim, but presents the highlights of a town hall meeting with Rick Berry, Director of FINRA’s Arbitration Services and Manly Ray, Director of FINRA Arbitration’s Southeast Regional Office and the head of FINRA’s Mediation program, and Sam Edwards, President of the Public Investors Arbitration Association.

Has FINRA seen a spike in cases as a result of stock market volatility and the economic downturn?  Not yet.  FINRA expects a 3-6 month lag, or possibly longer as a result of delays caused by the COVID-19 situation.  So far in 2020, customer case filings are down 7%.

How fast are expedited cases moving?  They are moving as fast as allowed by the Code.  FINRA is considering changes to the Code to speed up cases for claimants over age 75 or with very serious medical conditions.

Has the mix of securities at issue in arbitration changed?  Yes.  In 2020, claims related to common stock, private equity, REITs are the top three claim types, followed by bonds and bond funds.  In recent prior years the top cases by volume were bond and bond fund cases.  The number of cases that go to hearing as a percentage of total cases continues to trend lower, perhaps driven by pre-hearing settlement of many bond cases.

Updated on commitment to diversity?  Of the new arbitrators added to the list in 2019, 39% were women, 19% were African-American, and 3% were Asian.  Many newer arbitrators are younger.  Mediator diversity is also improving.

What portal improvements are in the works?   FINRA is working toward offering a real-time fee display.  FINRA is working toward more clear and frequent invoicing.  FINRA will also move toward electronic expense, billing, and invoicing.  TAll arbitrator selection, including short lists, will be through the portal sometime next year.

Any progress toward reforming the expungement process?  Last week the SEC approved a new filing fee for expungement, $1575 fee.  The FINRA Board approved in Fall, 2019 a special roster of arbitrators to handle expungement cases.  They will have enhanced training and a certain amount of experience will be required.  Comments from SEC are pending.  FINRA is moving toward codifying Expanded Expungement Guidance, which currently describes the best practices arbitrators should follow when deciding expungement requests.

What's going on with unpaid arbitration awards?  FINRA has done three things to attack the issue of unpaid awards.  First, stopping bad conduct from taking place on the front end--targeting firms with significant history of misconduct.  Second, rule changes would give investor claimants more options in pursuing claims against firms/brokers that become inactive at any stage of the case; to withdraw a claim and go to court or to amend claims.  The proposal is meant to provide more flexibility in proceedings against defunct or inactive parties.  Third, the Membership Application Program (MAP) incentivizes the timely payment of arbitration awards and prevents an individual from switching firms, or a firm from using asset transfers or similar transactions to avoid payment of arbitration awards.  FINRA continues to weigh other options.

When will insurance information be discoverable?  The issue remains under study at FINRA, and there is no set deadline to update Code to require discovery of insurance information.  This will require further action by the FINRA Board. 

How successful has the simplified arbitration process been?  The rule became effective September 17, 2018.  It has not been a big success.  As of June 1, 2020, 66 cases have been administered under this rule.  11 of 66 cases were closed by award; 1 case awarded damages.  FINRA is considering moving to video as a default or at least making video optional.

FINRA Response to COVID-19.

Aside from in-person hearings and mediation, FINRA continues to move forward with remote hearings and electronic filings as normal.  The schedule and pace of cases has not slipped, with one exception ... FINRA postponed all hearings through July 31.  FINRA has also offered to waive hearing postponement fees through September 4, 2020.   By joint agreement, hearings can be conducted via Zoom.  The same is true for mediation (with added incentive of reduced fee mediation).

In customer cases, FINRA arbitrators have heard 18 contested motions by Zoom (in all cases 28 motions have been heard).  No customer cases have been heard in their entirety by Zoom; one case had a final hearing date by Zoom but the vast majority of the case was presented in-person.  One industry case was heard stem-to stern by Zoom.  The Zoom recording (audio only-not video) will be the official hearing record.

FINRA has been encouraging Zoom mediation.  FINRA's reduced fee mediation program has been working well since May 6.  Fee is $100/hr split by the parites.  FINRA waives all filing and administrative fees.  To date only 4 cases have opted in, but 20 or so are scheduled.  Some mediators use a mix of Zoom and telephone.

FINRA staff will host and facilitate Zoom hearings.  FINRA has substantial familiarity with Zoom and has been using it for several years. 

Arbitrators are presenting best practices for use of Zoom in "The Neutral Corner."  FINRA is finalizing a Zoom Guide for Arbitrators, and recording three instructional videos (3-5 minutes each): introduction to Zoom, technical instructions, and Zoom etiquette.  

For practitioners who prefer a remote hearing platform other than Zoom, the parties can file a motion with the panel and propose an alternative.  FINRA has thoroughly vetted Zoom and that is the default, but FINRA has not ruled out using other platforms if preferred by the parties or ordered by an arbitration panel.

The future of in-person hearings is revisited on an ongoing basis.  The lodestar is public health and safety.  FINRA is considering geographic differentiation; moving forward with in-person hearings in some locations, but not others.  FINRA is also considering venues that would accommodate social distancing.  It is considering whether to require masks at hearings and other changes when in-person hearings begin.

Maine Securities Administrator Warns of COVID-19-Related Fraudulent Investment Schemes

In an April 3, 2020 warning urging investors to be on guard against an anticipated surge of COVID-19 fraudulent investment schemes, the Maine Securities Administrator cautions that scammers will be targeting investors, capitalizing on the double whammey of the recent economic downturn and anxiety about the virus.   

Of special concern are get rich quick schemes specifically tied to the threat of COVID-19.  "Bad actors can be expected to develop schemes that falsely purport to raise capital for companies manufacturing surgical masks and gowns, producing ventilators and other medical equipment, distributing small-molecule drugs and other preventative pharmaceuticals, or manufacturing vaccines and miracle cures."  

Also flagged by the Securities Administrator as areas of likely abuse:

• Private placements and off-market securities. Scammers will take advantage of concerns with the regulated securities market to promote off-market private deals. These schemes will continue to pose a threat to retail investors because private securities transactions are not subject to review by federal or state regulators. 

• Gold, silver and other commodities. Scammers may also take advantage of the decline in the public securities markets by selling fraudulent investments in gold, silver and other commodities that are not tied to the stock market. These assets may also be attractive because they are often promoted as safe or guaranteed as hedging against inflation and mitigating systematic risks. However, scammers may conceal hidden fees and mark-ups, and the illiquidity of the assets may prevent retail investors from selling the assets for fair market value. 

• Recovery schemes. Retail investors should be wary of buy-low sell-high recovery schemes. For example, scammers will begin promoting investments tied to oil and gas, encouraging investors to purchase working or direct interests now so they can recognize significant gains after the price of oil recovers. Scammers will also begin selling equity at a discount, promising the value of the investments will significantly increase when the markets strengthen. 

• Replacement and swap schemes. Investors should be wary of any unlicensed person encouraging them to liquidate their investments and use the proceeds to invest in more stable, more profitable products. Investors may pay considerable fees when liquidating the investments, and the new products often fail to provide the promised stability or profitability. Advisors may need to be registered before promoting these transactions and legally required to disclose hidden fees, mark-ups and other costs.

• Real estate schemes. Real estate investments may prove appealing because the real estate market has been strong and low interest rates have been increasing the demand for housing. Scammers often promote these schemes as safe and secure, claiming real estate can be sold and the proceeds can be used to cover any losses. However, real estate investments present significant risks, and changes to the economy and the real estate market may negatively impact the performance of the products.

As reported in the Portland Press Herald, scammers are also using email "phishing" and other techniques to get access to investors' computers and steal stimulus relief checks.

Any investor targeted by suspicious activity is encouraged to contact the Maine Office of Securities at https://www.investors.maine.gov , by calling 1-877-624-8551 or writing to the Maine Office of Securities, 121 SHS, Augusta, Maine 04333-0121.

Maine Joins Other States by Requiring Mandatory Reporting of Suspected Financial Exploitation

To enhance prompt reporting of financial exploitation to state securities regulators and adult protective services, on April 2, 2019 Maine joined 25 other states by enacting the Act to Protect Vulnerable Adults from Financial Exploitation, Public Law 2019 Ch. 17.  The Act makes broker-dealers and others mandatory reporters of suspected financial exploitation of seniors and vulnerable adults. 

The Act is intended to combat financial exploitation of elderly and disabled persons, a not infrequent occurrence.  According to one reputable source as many as 20% of adults over the age of 65 have been victimized by financial fraud, and only one in 44 cases of financial abuse is ever reported.  The Maine law is largely identical to a model act developed by the North American Securities Administrators Association (NASAA), an organization of state securities administrators dedicated to protecting senior investors from financial exploitation. 

The Act contains five key elements:

• mandatory reporting to a state securities regulator and state adult protective services agency when a qualified individual has a reasonable belief that financial exploitation--generally, wrongful or unauthorized use of money--of an eligible adult has been attempted or has occurred;
• authorized disclosure only to third parties in instances where an eligible adult has previously designated the third party to whom disclosure may be made;
• authority for broker-dealers and investment advisers to delay disbursing funds from an eligible adult's account if there is a reasonable belief that a disbursement would result in financial exploitation;
• immunity from liability for reporting of suspected financial abuse and for delayed disbursements; and
• mandatory cooperation with requests for information by state investigators in cases of suspected financial abuse (any records provided under this clause are exempt from state public records law).

The Act applies to any "eligible adult," which is defined as persons age 65 or older or who are protected under adult protective services law.  The mandatory reporting requirement applies to any agent, investment adviser representative or individual who serves in a supervisory, compliance or legal capacity for a broker-dealer or investment adviser.  According to NASAA, the "reasonable belief" standard for making a report "is intended to be both a subjective and objective standard – i.e., a qualified individual must have a subjective belief in the existence of the financial exploitation, and this belief must be objectively reasonable."

The Act will force broker-dealers to make tough calls about whether to make a report.  Broker-dealers may perceive reporting as having the potential to alienate a customer or a customer's family, who may react negatively to a report and ensuing investigation.  Although a mandatory reporter is immune from liability, that does not mean that a customer (or customer's family) is obligated to continue to do business with a broker-dealer who (in the family's view) instigated an unjustified investigation.  Many customers will, however, recognize that reporting is ultimately for their own benefit.

How well is the Act working?  The Maine Office of Securities has not made public any statistics on the number of reports, the outcome of reports, or other activity related to the Act.   Nor has it pursued any enforcement action for failure to report.   The focus of Maine regulators is on educating the regulated community about this obligation, so far.