Firms and registered reps with pending arbitration awards will find it much tougher to jump to another firm in order to duck payment under rules changes being proposed by Finra.
For the first time, firms seeking either new or continuing Finra membership would need to be able to demonstrate that they have the assets to pay pending arbitration claims of any firm or individual they bring on board, according to Finra's proposal. Interested parties have until April 9 to comment on the proposal.
“Finra is concerned about new members onboarding principals and registered representatives with pending arbitration claims without the firm having to demonstrate how those claims would be paid if they go to award. In addition, Finra is concerned about the new firm’s supervision of such individuals who may have a history of noncompliance,” the self regulator said.
Finra arbitration panels awarded $119 million to investors in 2016, with $14 million going unpaid. Unpaid awards have decreased significantly from 2012 and 2013, when brokers and firms that lost in arbitration failed to pay investor awards of $51 million and $75 million, respectively. About 69 percent of customer cases result in settlements, with only 18 percent of claims ever making it to arbitration, Finra said.
The proposed amendments would “create further incentives for the timely payment of arbitration awards by preventing an individual from switching firms, or a firm from using asset transfers or similar transactions, to avoid payment of arbitration awards while staying in business,” Finra said.
The Financial Services Institute (FSI) is supporting the proposed changes, with some caveats. "FSI supports efforts to ensure that investors receive the recovery to which they are entitled whether they receive an award through Finra arbitration, a court decision or through some other forum,” said David Bellaire, FSI executive vice president and general counsel.
But “the solution to this problem should not require those who honor their obligations to bear the burden of the bad acts of those that left the industry or are otherwise avoiding their responsibilities. We look forward to participating in this important dialogue with regulators, policy makers and other stakeholders and appreciate Finra’s efforts to initiate it,” Bellaire said.
Under the proposal, a firm seeking new Finra membership can only overcome the presumption of denial for pending arbitrations if they have the assets to satisfy the pending claims. Finra said assets can include “an escrow agreement, insurance coverage, a clearing deposit, a guarantee, a reserve fund or the retention of proceeds from an asset transfer that Finra must deem acceptable.”
Patrick O’Neill, an attorney with the Wisconsin-based law firm of Halling & Cayo, said he “applauds Finra for encouraging this important discussion. If a customer who has fallen prey to investment fraud or abuse is able to obtain a judgment against their former broker or advisor, they should not have to then worry about whether they can actually collect that judgment." O’Neill said Finra should create a second tier of investor protection by creating an industry fund or enhanced insurance or SIPC coverage requirements—something the industry has opposed.
Finra said it is also making it much tougher for existing firms to consort with industry players with unpaid or pending arbitration. The regulator said it will not permit firms to engage in business expansion that involves adding one or more reps with a covered pending arbitration claim if the claim exceeds the firm’s excess net capital, even if a firm is not subject to a continued membership application CMA. Instead the firm will need to consult with Finra’s Membership Application Program (MAP) about the expansion.