Investment Fraud Lawyers Cite “Serious Flaws” in FINRA Arbitration Panels

A group of attorneys who represent investors in claims against stock brokers and the financial industry is criticizing the independent regulatory organization through which all cases must be pursued, saying that arbitrators used lack diversity and transparency, and that investors should be able to take their grievances to court instead of being forced into binding arbitration. 

The Public Investors Arbitration Bar Association (PIABA) released a report this week titled “The Importance of Arbitrator Disclosure” (PDF), which criticizes the hiring and vetting process used by Financial Industry Regulatory Authority (FINRA) for arbitration panels used to decide investment fraud lawsuits.

FINRA is a non-governmental agency that acts as a self-regulator for investment firms. It was created in July 2007, as a successor to the National Association of Securities Dealers, contractually handling all disputes between investors and stockbrokers or other financial firms.

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Investors are required to pursue any stock brocker fraud or misconduct claims through FINRA arbitration, including cases for breach of contract, breach of fiduciary duty, negligence, misrepresentation, unauthorized trading and other claims that investments were improperly handled.

According to the PIABA report, 80% of FINRA arbitrators used to resolve conflicts between investors and stock brockerage firms are male, with an average age of 69. The report also finds that FINRA has done little to expose or investigate potential conflicts of interest among the arbitrators.

The report calls FINRA’s arbitrator disclosure process “illusory” and determined that it fails to provide meaningful and reliable information about arbitrators’ bias and possible conflicts of interest. FINRA has failed to disclose to either the public or those involved in arbitration how and why arbitrators are recruited, which PIABA says is important in rooting out potential conflicts of interest.

PIABA maintains that FINRA collects and has that information, but it just refuses to share it.

The diversity issue is another major concern, PIABA notes. Female investors are underrepresented among the arbitrators, the group found, and there are serious concerns about the ability of arbitrators to effectively participate in deciding cases when about 40% are 70 or older and 17% are 80 or older. The average age is 69.

PIABA notes that in 1992, about 60% of investors who brought arbitration claims received an award. Those awards were about 60% of the amount claimed. In 2013, under FINRA, only 47% of investors were granted an award for their grievances, and the amounts awarded have dropped.

“FINRA states that the cornerstone of the integrity of its entire arbitration forum depends on FINRA having an effective and reliable process to detect and disclose arbitrators’ biases and conflicts of interest to the parties. PIABA has showed that FINRA’s arbitrator disclosure process fails at every step,” PIABA President Jason R. Doss said in a press release. “Therefore, investors have no other choice but to conclude that arbitration is unfair. The sad state of FINRA arbitration today is the most powerful argument that can be made for Congress to give investors the option to go to court.”

SEC Involvement, Court Options Recommended

The report makes a number of suggestions to rectify the situation, including a viable alternative to FINRA for investors with grievances.

“If investors had a choice to seek justice in a forum other than FINRA, then many of the problems in this report would be alleviated,” the report notes. “Right now, investors are forced into FINRA’s flawed system to seek justice. PIABA believes that a viable alternative would do much to clean up FINRA’s arbitration system and, thus, urges congress to pass the Investor Choice Act of 2013 making securities arbitration optional for investors.”

PIABA also calls for the U.S. Securities and Exchange Commission (SEC) to place an independent board in an oversight position to ensure transparency of FINRA’s arbitration process. It also recommends that the SEC make some FINRA documents subject to the Freedom of Information Act and to perform an independent study on how FIRA’s arbitrator recruiting practices affect the demographics of its arbitrator roster and the outcomes of arbitration cases.


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