Part 9: FINRA Dispute Resolution Task Force: Enhancing Securities Dispute Resolution One Recommendation At A Time. Large Claims, Time Limits, Class Action Waivers, and the Mandatory Nature of Arbitration.

alexhughesBy: Alexandra Hughes, Spring 2016 Graduate Research Assistant

Parts 2-8 of this series discussed those topics with task force recommendations. Parts 9 and 10 discuss topics without task force recommendations. Although the task force made no recommendations for these issues, they are no less important and can still be improved upon to make the FINRA arbitration and mediation forum more efficient, transparent, and impartial.

  1. Large Claims

Large claims raise two questions: (1) whether the FINRA forum is meeting the needs of the parties (which are often large sophisticated financial institutions) and (2) whether large cases place a disproportionate burden on the FINRA forum. To help with these concerns, FINRA launched a voluntary program for large cases with claims of at least $10 million. The program allows the parties to agree to different methods of: arbitrator appointment, discovery, hearing facilities, etc. and assigns a specially trained case administrator to help the parties plan their case. Since the program has launched, it has been underutilized.

Although recognizing that the program has been underutilized, the task force was unable to reach consensus on procedures for large claims. Namely, the task force disagreed on adoption of mandatory procedures for large claims which would include: an alternative method of selecting arbitrators, increased compensation for arbitrators, rights to take only one deposition, and ability to modify the discovery rules and hearing location.

  1. Time Limits

FINRA Rule 12206(a)—the 6-year eligibility rule—provides: “no claim shall be eligible for submission to arbitration under the Code where six years have elapsed from the occurrence or event giving rise to the claim. The panel will resolve any questions regarding the eligibility of a claim under this Rule.” The eligibility rule only prohibits a claimant from pursuing a claim in FINRA arbitration and does not bar a claimant’s ability to pursue remedies in court. The eligibility rule has long been a topic of debate. In the 1990s and early 2000s, the debate focused on whether the eligibility rule should be decided by an arbitrator or could be decided by a judge in court. In 2002, the United States Supreme Court in Howsam v. Dean Witter Reynolds, Inc. held an arbitrator should decide the procedural question of eligibility raised by the rule. Today, debate over the eligibility rule continues. For example, there are questions about when the 6-year time limit begins to run.

Task force deliberations surrounded whether the eligibility rule should be eliminated and stale claims issues be addressed by applicable statutes of limitations or whether the eligibility rule should be a rule of repose. If the 6-year eligibility rule is eliminated and replaced by applicable state statutes of limitations, the time for which a claimant can bring a claim may be decreased. If the 6-year eligibility rule became a rule of repose, the 6-year time limit would begin to run from the time the defendant’s act occurred, as opposed to the time the plaintiff’s injury occurred. Thus, transformation into a rule of repose could also decrease the time a claimant has to bring a claim. Although the task force substantially discussed these issues, no consensus was reached, and no recommendation made. For more information on the difference between a statute of limitations and rule of repose, and how it affects the securities industry, click here.

  1. Class Action Waivers

In 2011, Charles Schwab & Co. amended its customer agreement to include a class action waiver. This class action waiver provision prohibited customers from bringing judicial class actions to recover from any causes of action against Charles Schwab & Co. A class action waiver affects the rights of customers with small claims because it requires such customers to pursue individual arbitration in FINRA—which may be economically unfeasible—instead of being part of a larger class action suit. Charles Schwab’s class action waiver violated FINRA Rules 12204 and 2268. However, in February 2013, a FINRA hearing panel held FINRA’s rules prohibiting class action waivers were unenforceable because they were in conflict with the Federal Arbitration Act (FAA).

Subsequently, FINRA’s Board of Governors reversed the hearing panel’s decision, found the FAA did not prohibit such rules, held §15A of the Exchange Act allowed FINRA to regulate the dispute resolution process, of which prohibiting class action waivers was included. Eventually, Charles Schwab settled the case and paid a $500,000 fine to FINRA. Because the Schwab case was settled, there remains uncertainty whether FINRA’s Board of Governors will be reversed by a federal circuit or the Supreme Court. The task force, not able to make a recommendation on this issue, endorsed the decision of the Board of Governors that class action waivers are prohibited.

  1. Mandatory Nature of Arbitration

FINRA Rule 12200 provides mandatory arbitration if: (1) it is required in a written agreement—like a Predispute Arbitration Agreement (PDAA)—or requested by the customer; (2) the dispute is between a customer and a member or associated person; and (3) the dispute arises in connection with the business activities of the member or associated persons. The task force discussed the long-standing argument regarding the mandatory nature of FINRA arbitration—the argument between investor choice and the status quo.

Investor choice supporters don’t like the mandatory nature of FINRA arbitration because they believe: (1) investors should be able to chose the forum in which they seek remedies; (2) PDAAs are impermissible restrictions on investor’s rights; (3) arbitration makes it more difficult for investors to obtain necessary documents in discovery; and (4) customers don’t always achieve fair outcomes in arbitration. Conversely, status quo proponents like that firms can secure rights to arbitrate in PDAAs (just as customers can choose to arbitrate pursuant to Rule 12200). Status quo proponents also like FINRA arbitration because they find the forum a commercially reasonable dispute resolution forum. Despite fundamental disagreement between investor choice and status quo proponents on FINRA’s mandatory nature, the groups do agree that FINRA arbitration has advantages and disadvantages. Advantages include: regulatory oversight by the SEC, prompt payment of awards, and the ability to select an arbitrator. Disadvantages include: lack of developed legal authority and lack of system transparency.

The task force discussed the mandatory nature of FINRA arbitration and developed four proposals. However, the task force produced no recommendation because: the task force could not reach a consensus on any of the proposals, the task force believed the issue was a policy question, the task force didn’t have any empirical evidence available, and the task force felt improving the current FINRA forum was a better use of limited resources.

The full task force report is available online.