The brokerage industry continues to oppose the creation of any kind of firm-funded investor pool to offset unpaid investor arbitration awards—a bedeviling problem that impacts one out of three investors who take their grievances against brokers to arbitration.
The debate over how to pay investors who are stiffed by their brokers dominated a Securities and Exchange Commission Investor Advisory Committee meeting today. Any solution should be designed to make more investors who win in arbitration against bad brokers whole, proponents of reform say. The average unpaid arbitration award is currently $200,000, according to the Financial Industry Regulatory Authority.
How much have investors gotten stiffed by brokers, who can simply fold up shop or declare bankruptcy to avoid paying arbitration awards? Richard Berry, Finra’s executive vice president and director of dispute resolution, said about 2% of awards made by Finra arbitrators between 2012 and 2016 have gone unpaid, translating to about $14 million out of $119 million in unpaid arbitration awards in 2016.
“Finra is fully committed to reducing the incidence of unpaid awards and judgments in the financial services industry. We welcome the opportunity to explore the advantages and disadvantages of potential ways to do so with this committee,” Berry said.
While legislation from Sen. Elizabeth Warren (D., Mass.) and several Finra suggestions would require the industry to foot the bill for unpaid arbitration, Financial Services Institute Senior Vice President Robin Traxler said that such solutions would have “serious unintended consequences” for honest brokers. A better solution would be to ban derelict brokers and “make it impossible for them to continue working in any aspect of the financial industry,” Traxler said.
Currently, a bad broker who loses his or her Finra registration because of unpaid arbitration “can simply become an investment advisor representative or go into insurance and continue working with investors,” she told the room full of policy analysts, regulators and attorneys at the SEC’s Washington, D.C., headquarters.
Traxler also supported expanding the definition of “statutory disqualification” to include control persons of firms with unpaid arbitrations, a solution that Finra has put forth. This would mean that anyone at a firm with “control,” including founders, executives and supervisors, would be on the hook for unpaid arbitration or risk losing their Finra registrations.
“But disqualification from Finra is just a start to what needs to result in full disqualification from working in any capacity, in any aspect of the financial services industry,” said Traxler, who suggested that effective regulatory coordination would make it easier for the SEC and state insurance and securities regulators to efficiently reject registrations for individuals who have been statutorily disqualified by Finra for failing to pay an award.
“We feel that the potential consequences to the bad actor are a truly significant deterrent to engaging in reckless or fraudulent behavior to begin with,” Traxler said.
FSI opposes the Warren bill, which directs Finra to create a relief fund to provide investors with the full value of their unpaid arbitration awards. “First we believe the mere existence of the fund would encourage bad actors to act recklessly, knowing they can defraud investors, but not have to pay the consequences beyond losing their Finra registration,” Traxler said.