Groups representing investor attorneys are throwing their support behind a proposal rule that would allow state securities regulators to expel or suspend financial professionals and their firms who don’t pay arbitration awards to the investors they defrauded.

The proposed rule from the North American Securities Regulators Association (NASAA) would give regulators the authority to punish and even take the license of any financial professional or firm that has unpaid arbitration awards or regulatory fines.

Both the Public Investors Advocate Bar Association (PIABA) and the St. John’s University School of Law Securities Arbitration Clinic wrote comment letters supporting the first-of-its-kind proposal, which NASAA President Melanie Senter Lubin said the organization will review comments and plans to prepare a proposed final rule to be voted on by NASAA membership in mid-2022.

Nearly one out of four dollars awarded to investors in 2020 went unpaid, even as many brokerage firms’ profits grew to record levels, according to a report by the PIABA.

“In 2019 alone, over $19 million of awards went unpaid. This represents nearly 20% of all monetary damages awarded that year,” said Christine Lazaro, St. John’s clinic director and professor of clinical legal education.

The clinic agrees that the proposal is “significant because they create clear repercussions for investment advisors who have not paid arbitration awards” and would prevent bad actors from simply moving to the advisor world to escape enforcement, Lazaro said.

Since the Financial Industry Regulatory Authority does not have authority over advisors "states must have clear authority to discipline investment advisors who do not comply with arbitration awards,” she added.

The rule allows state regulators to consider a broker or rep’s failure to pay in connection with their investment advisor licensing. This “may help eliminate regulatory arbitrage as Finra-regulated individuals shift to the advisory side of the industry,” Lazaro said.

“This is critical since investment advisors would no longer be incentivized to leave a brokerage firm because they have unpaid arbitration awards against them and transition to an RIA with a new title and clean slate,” said Lazaro, who said the rules should be tightened up to ensure they apply to registered investment advisor firms and that they have to disclose such awards to state regulators and investors.

Lazaro said that while the rule is a “noble effort” and would stop bad brokers and reps from committing further crimes, a fund to pay existing defrauded investors who won in arbitration and can’t collect should be established.

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