Update on Securities Arbitration Administered by FINRA

Tuesday, June 2, 2020

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

Tuesday, April 7, 2020

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

Sunday, February 2, 2020

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.

Unpaid Arbitration Awards: An Unabated Problem

Thursday, January 16, 2020

Earlier posts highlighted a long-recognized problem in the securities industry: investors who've proven that they were harmed by bad actors  all too often wind up recovering little or nothing even after winning a legal claim.

An analysis of arbitration awards a few years ago revealed that about 25%, nearly $1 out of every $4 awarded to customers in arbitration went unpaid.  There are solutions to the problem, like requiring insurance (as is required to register an automobile), requiring that broker-dealers maintain higher minimum capital reserves, or establishing a fund that could be used to pay arbitration awards against broker-dealers who can't or won't pay, as described here.  Have these or other solutions been implemented?  No, although they remain under consideration.

And the problem remains prevalent.  The industry faces a "fresh wave" of unpaid arbitration awards, according to reporting by Bruce Kelly in Investment News.  He reports, "From 2013 to 2017, brokers and firms failed to pay $167 million in arbitration awards to customers that FINRA hearing panels had approved."  A $1 million award made in Maine not long ago remains unpaid.  That's quite a bit of money, especially considering that it represents awards obtained after a legal proceeding and the vast majority, in some instances, of investors' retirement savings. 

This a a problem in need of a solution.  At stake is not just the well-being of customers who have been defrauded and face dire personal financial and lifestyle consequences, or the injustice of leaving customers without any real-world remedy in all too many instances.  The industry needs to weigh the risk of seriously undermining consumer confidence, which could have much broader implications for the health of financial markets.

Expungement: A Seriously Flawed Process?

Tuesday, November 12, 2019

In 2017, this blog featured a post examining the standard applied to requests by brokers to cleanse (erase) their public records of customer complaints, a process called "expungement," here.  A recently released (October 2019) study by the investor protection foundation run by the Public Investors Arbitration Bar Association (PIABA) reports that the process is “broken” as a result of being “systematically gamed, exploited and abused” by brokers and brokerage firms. 

Among the problems found, according to PIABA's study are sham cases seeking nominal damages ($1.00) resulting in lower costs and fewer arbitrators, and brokerage firms which almost never (only 2% of the time) oppose brokers' requests for expungement.  Investors only rarely appear to oppose expungement requests, and may not even get notice of expungement hearings.  The result is that the dice are loaded in favor of expungement, with the result that investor complaints, including those that may be settled for a significant payment, never see the light of day.  

Are meritless claims against brokers made by investors?  Without question.  Should brokers be able to unilaterally wipe the slate clean, leaving the appearance that no claim had ever been filed in the first place?  That is a much tougher to justify--especially if the system for vetting such requests lacks sufficient safeguards to ensure that they are granted only in extraordinary cases where the request is truly justified.

Lessons From "Arbitration Nation:" an Empirical Study of 40,000+ Consumer Arbitrations

Tuesday, October 1, 2019

A recent study identifies a problem -- "we know little about what actually happens in" arbitration -- and offers a solution: find out what happened in more than 40,000 consumer arbitrations administered by four major arbitration forums over the course of six years.

In the study, "Arbitration Nation: Data from Four Providers," Professors Andra Cann Chandrasekher and David Horton analyzed "40,775 consumer, employment, and medical malpractice arbitrations filed between 2010 and 2016 in four major arbitration administrators: the AAA, Judicial Arbitration and Mediation Services (JAMS), ADR Services, Inc., and the Kaiser Health Care Office of Independent Administration (Kaiser)."

Important conclusions:

  • consumer arbitration is relatively fast and affordable, with corporate defendants paying the lion's share of the costs;
  • although the U.S. Supreme Court has repeatedly and emphatically enforced mandatory arbitration clauses in recent years, the uptick in the volume of arbitration "has been modest;"
  • plaintiffs who represent themselves in arbitration rarely win (they only prevail in 10% of employment cases)--"pro se plaintiffs struggle mightily" (but do they fare any better in court?  -- the authors don't comment) and
  • arbitration favors repeat players (what I'll call frequent flyers) on both sides--arbitration favors frequent flyer corporate defendants but also frequent flyer plaintiffs' law firms.
To encourage more lawyers to take relatively small value cases to arbitration and thus (presumably) weed out cases without merit and improve outcomes for plaintiffs who have cases with merit, the authors propose "that state lawmakers create rewards for plaintiffs’ lawyers to arbitrate. Specifically, jurisdictions should create a statutory 'arbitration multiplier': an extra bounty for winning a case in arbitration." Intriguing.  And, not likely to be preempted.

What about securities arbitration?  Alas, the authors' study did not include data on FINRA arbitrations.  That is in part because the study relied on data on consumer arbitrations made public as required by Section 1281.96 of the California Code of Civil Procedure--a law that does not cover FINRA.  

New Maine Restrictions on Non-Compete Agreements; Bans Restrictive Employment Agreements

Wednesday, August 7, 2019

A new Maine law will make it more difficult for Maine employers to enforce non-compete agreements, an issue of particular interest in the securities industry where non-competition agreements often have been used to deter brokers from changing jobs. In enacting the new legislation, Maine joins other New England states, including Rhode Island, Massachusetts, and New Hampshire, which also have new laws on the books limiting the enforceability of non-compete agreements.

On June 28, 2019, Governor Mills signed LD 733 (“An Act to Promote Keeping Workers in Maine”) into law. Under the new law, a noncompete agreement is defined as a contract or contract provision that prohibits an employee or prospective employee from working in the same or a similar profession or in a specified geographic area for a certain period of time following termination of employment.

The new law applies to noncompete agreements entered into or renewed after September 18, 2019.

The new law makes clear that noncompete agreements are “contrary to public policy” and enforceable only to the extent that they are reasonable and are no broader than necessary to protect one or more of the following legitimate business interests of the employer: the employer’s trade secrets, the employer’s confidential information that does not qualify as a trade secret, or the employer’s goodwill. A noncompete agreement may be presumed necessary if the legitimate business interest cannot be adequately protected through an alternative restrictive covenant, including but not limited to a nonsolicitation agreement or a nondisclosure or confidentiality agreement. 

Further, the new law prohibits an employer from requiring or entering into a noncompete agreement with an employee earning wages at or below 400% of the federal poverty level. 

If an employer requires a noncompete agreement for a position of employment, the employer must disclose that requirement in any advertisement for that position, and an employer must provide an employee or prospective employee with a copy of a noncompete agreement at least three business days before requiring that employee or prospective employee to sign the agreement. 

The terms of a noncompete agreement (except for a noncompete agreement with a physician) are not in effect until after an employee has been employed with the employer for at least one year or a period of six months from the date the agreement was signed, whichever is later. 

The law is enforceable as civil violation subject to a fine of $5,000 or more. The Department of Labor is responsible for enforcement of the law. 

LD 733 also addresses “Restrictive employment agreements,” defined as an agreement: (a) between two or more employers, including through a franchise agreement or a contractor and subcontractor agreement; and (b) prohibits or restricts one employer from soliciting or hiring another employer's employees or former employees. With respect to such agreements, an employer may not enter into a restrictive employment agreement or enforce or threaten to enforce a restrictive employment agreement. An employer that does so commits a civil violation subject to a fine of $5,000 or more. The Department of Labor is also responsible for enforcement of this section.