PIABA decries new FINRA arbitrator criteria

Investor advocates are up in arms about a FINRA rule change they contend could prevent aggrieved brokerage clients from getting a fair hearing before their peers.

The Financial Industry Regulatory Authority, the broker-dealer industry’s self-regulator, last month changed the criteria it uses to determine who can be an arbitrator on the panels that resolve disputes between investors and brokerage firms. Previously, FINRA arbitrators needed to have only two years of college-level education credits; now they need to have a four-year degree.

Arbitrators previously also needed five years of “paid business and/or professional experience.” That criterion has been changed to specifically require five years of experience in a profession such as teaching, the law or medicine.

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A FINRA spokesperson defended the changes, saying, “We are constantly looking for ways to enhance the arbitration forum, and that includes the quality of the arbitrators.”

The case for and against arbitration

Mandatory arbitration has long been a subject of controversy in the securities industry. When investors open brokerage accounts, they’re almost always asked to sign a contract requiring them to bring any subsequent dispute they may have with their broker-dealer before a FINRA arbitration panel.

Advocates of the system say it expedites cases and leads to more consistent interpretations of often-complicated investor protections. But critics say it deprives investors of some of the most cherished legal protections found in the regular court system, including many of the grounds on which adverse decisions can be appealed. And the specially chosen arbitrators on FINRA panels are already one step removed from the constitutionally mandated juries of peers relied on by courts. 

Now lawyers who represent investors in disputes with brokerage firms say FINRA’s new criteria mean that arbitrators will most likely have even less in common with the investors appearing before them. Adam Gana, the president of the Public Investors Advocate Bar Association, said the changes greatly reduce the chances that aggrieved brokerage clients will be able to present their claims to arbitrators with whom they share similar backgrounds and educational attainments.

“Does a jury of your peers have to have these kinds of experiences when you go to court?” Gana said.

‘Bill Gates doesn’t have a college degree’

Douglas Schulz, the president of Invest Securities Consulting and a frequent arbitration panelist, estimated that most arbitrators now serving already meet FINRA’s new criteria. But there’s no doubt some candidates with relevant experience — for example, small-business owners who did not complete college — will be excluded, he said.

“Remember, Bill Gates doesn’t have a college degree,” Schulz said. “So Bill Gates couldn’t be on the panel.”

Schulz said the problem with limiting the arbitrator pool to professionals isn’t that people with college degrees look down on regular investors. Rather, it’s that many of them expect others to be as knowledgeable about investment markets as they are.

Schulz said firms have a routine defense they level against investors who claim they lost money after following a broker’s recommendations: that they were sophisticated and fully appreciated the risks they were running.

“And the arbitrator can’t believe the person doesn’t know what a bond is,” Schulz said. “It’s, ‘What do you mean he doesn’t know what a bond is? Everybody knows what a bond is.'”

Bill Singer, a securities lawyer and retired author of the Broke and Broker blog, said legal definitions of fraud in the brokerage industry often hinge on what a “reasonable person” could be expected to have thought when presented with a particular investment recommendation.

“But doctors and lawyers, their version of what is reasonable is often far different from that of many of the victims who come before them,” Singer said.

The argument for quality control

Others see merit to FINRA’s changes. Scott Matasar, a founder of the law firm MatasarJacobs in Cleveland, said he has long thought FINRA should tighten its arbitrator criteria.

Over the years, he said, he has argued claims before panelists who hailed from fields far removed from financial professions. One worked in the collections department at a trophy and plaque manufacturer and another managed firearms retail at a Walmart.

“Improving the quality of the arbitrator pool benefits all parties by reducing the litigation risk caused by uncertainty,” Matasar said.

Matasar noted that lawyers in FINRA arbitration are allowed to eliminate a certain number of arbitrators from the panels they’ll be appearing before. Some of those allotted “strikes” now are used to exclude candidates who shouldn’t have been there in the first place.

That said, Matasar shared Gana’s concerns that FINRA’s requirements for past professional experiences might now be too strict. He agreed that there are plenty of arbitrator candidates — real estate agents, bookkeepers and business owners — who could be an asset on FINRA panels but may be prevented from serving by the new rules.

“Excluding them deprives parties of arbitrators with real-life practical experience that could benefit both customer and industry litigants,” he said.

Depleted arbitrator pools

Matasar said the new rules also aren’t likely to help with another endemic problem in the arbitration system: the relatively small number of people who routinely serve on FINRA panels. 

FINRA says on its website that it has a roster of more than 8,100 arbitrators it can draw on to resolve disputes between investors and member firms. But the reality, according to Matasar, Gana and other critics, is that the same people tend to show up on panel after panel.

“And now they are limiting the diversity of arbitrators,” Gana said. “And the public pool already has a dearth of arbitrators.”

The FINRA spokesperson said the new criteria are meant to have the opposite effect.

“This change will help address the feedback that we have received that the prior standards discouraged attorneys and other professionals from applying to the roster,” the spokesperson said, without elaborating.

Rather than worry about what criteria a person must meet before joining a panel, Matasar said FINRA should invest more time and resources into training them after they’ve joined its arbitrator roster. Over the course of his career, he said, he’s seen serious degradation in how FINRA panelists “understand, apply and enforce the rules in the Code of Arbitration Procedure.”

“This results in improper rulings that directly violate the code, increased costs and increased litigation uncertainty for all parties,” Matasar said. “It also damages the public’s faith in FINRA’s arbitration forum as a whole when lawyers can’t explain to their clients how arbitrators decided motions filed during the course of their case.”

PIABA asks: Where was the invitation to comment?

Gana and others at PIABA meanwhile take exception to more than the new requirements for FINRA arbitrators. They also say the changes were adopted last week without allowing critics a chance to comment.

A press release PIABA issued on Monday accused FINRA of overhauling its “arbitrator qualifications in the dead of night — without transparency, notice or stakeholder input.”

“Had PIABA been consulted, we would have made clear that these changes shrink the public arbitrator pool and harm investors,” Gana said in the statement.

The FINRA spokesperson said the possibility of raising arbitrator criteria has come up in recent years in meetings of its National Arbitration and Mediation Committee. At least seven members of the committee are members of PIABA.

“FINRA’s Dispute Resolution Services has carefully considered input from all committee members on this issue,” the spokesperson said.

Gana said that no matter the procedures FINRA used, the new requirements shouldn’t have been instituted without warning.

“I am the president of PIABA, and I was floored by this change,” Gana said. “If they were seeking comments by PIABA members, I should have known about that.”