How Does the FINRA Arbitration Process Work for Investor Claimants?

FINRA is the acronym for the Financial Industry Regulatory Authority, formerly known as the National Association of Securities Dealers, or NASD. FINRA regulates securities firms, as well as securities professionals, in the United States. FINRA has authority over 4,580 brokerage firms, 162,850 branch offices and 630,695 registered securities representatives.

The overwhelming majority of claims investors have against their securities firm and/or securities professionals are adjudicated through the FINRA arbitration process, rather than in civil court. This is because the agreements investors sign to open a securities account with a firm and/or a securities professional (often times called registered representatives) provide that FINRA arbitration is the exclusive means by which disputes arising under the agreements are decided. FINRA Rule 12200. In the absence of a written agreement, parties can still agree to arbitrate with FINRA. FINRA Rule 12201. FINRA cannot arbitrate class action claims, however. FINRA Rule 12204.

The FINRA Code of Arbitration Procedure for Customer Disputes (the “Code”) governs arbitrations, much like rules of civil procedure govern civil cases. Failure to comply with the Code can result in sanctions, some as serious as claim dismissal. FINRA Rule 12212.

An investor claimant has six years “from the occurrence or event giving rise to the claim” to bring a claim with FINRA. FINRA Rule 12206. If an arbitration panel dismisses an investor claimant’s claims as being untimely, the investor claimant can pursue claims in civil court. FINRA Rule 12206. However, investor claimants should be cautious as many civil statutes of limitations (which vary from state to state) are shorter than six years.

In a civil case, a judge or jury decides who wins. FINRA arbitrations are decided by a panel arbitrators who are appointed after the investor files a Statement of Claim and the securities firm or professional answers. For claims over $100,000, the panel will consist of three arbitrators – two public arbitrators who have not worked in the securities industry and one non-public arbitrator who has strong ties to the securities industry, and a working knowledge of its norms and practices (If the investor claimant’s claim is for less than $100,000, the panel will typically consist of only one arbitrator. FINRA Rule 12401. That one arbitrator will be a public arbitrator. FINRA Rule 12402. Additionally, for claims $25,000 or under, no hearing will take place unless the investor claimant requests one. FINRA Rule 12800.

A claim is initiated with FINRA by the investor claimant filing a Statement of Claim. A Statement of Claim is filed by maling copies to the closest FINRA office. FINRA Rule 12300. The FINRA Director will serve the investor claimant’s Statement of Claim on the other parties. FINRA Rule 12300. The Statement of Claim must specify the relevant facts surrounding the complaint and the remedies requested. FINRA Rule 12302. The investor claimant also must submit a signed Submission Agreement, agreeing to be bound by FINRA rules. FINRA Rule 12302. Finally, the investor claimant must submit his or her filing fee with the Statement of Claim. FINRA Rule 12900. Currently, filing fees range from $50.00 to $1,800.00 (FINRA Rule 12900. Part of this fee is refundable if the claim settles more than ten (10) days prior to a hearing. Id. Additionally, as part of an award to an investor claimant, an arbitrator panel can award filing fees. Id.

The respondent(s), the securities firm(s) and/or professional(s) against whom the investor claimant brings its claims, must then answer the investor claimant’s Statement of Claim within forty-five (45) days of service, also specifying the relevant facts that surround the dispute and explaining its defenses. FINRA Rule 12303. The respondent can also bring counterclaims (claims against the investor claimant), cross-claims (claims against other respondents, if any), or third-party claims (claims against individuals not currently involved in the FINRA action yet) in its Answer. FINRA Rule 12303. The respondent(s) also must sign a Submission Agreement. FINRA Rule 12303. If a party does not answer, or answers deficiently, the panel can bar that party from presenting the omitted defenses or facts at the hearing. FINRA Rule 12308.

After a respondent answers an investor claimant’s Statement of Claim, the three arbitrators are selected. FINRA Rule 12401. The counsel for the claimant and the counsel for respondent each receive a sheet with 30 arbitrators randomly listed. FINRA Rule 12400. Counsel for each side can strike listed arbitrators, and then ranks the remaining names. FINRA Rules 12400,12404. Counsel then each submit their rankings to FINRA confidentially. Based upon the strikes and the rankings, FINRA compiles the arbitration panel, choosing the three highest ranked arbitrators. FINRA Rule 12406. No counsel, claimant or respondent can communicate with an arbitrator without all parties being present. FINRA Rule 12210. Arbitrators are required to make certain disclosures about their personal and professional ties to the securities industry to the parties to ensure impartiality. FINRA Rule 12408.

Once the arbitration panel is selected, FINRA sets an Initial Prehearing Conference. FINRA Rule 12500. In this conference, the counsel for all parties participate, as well as the panel of arbitrators, and a date for the arbitration is decided upon. The hearing date is typically scheduled for nine months from the date of the initial prehearing conference.

When the Statement of Claim is served, the Director will provide the parties with the FINRA Discovery Guide and Document Production Lists. FINRA Rule 12506(a). The documents described in Document Production Lists 1 and 2 are presumed discoverable in all arbitrations between an investor claimant and a securities firm or registered representative. FINRA Rule 12506(a). The documents described in Document Production Lists 3-14 may also be discoverable, depending on the specific causes of action alleged in the statement of claim. FINRA Rule 12506(a).

The Document Production Lists are as follows:

List 1: Documents to be produced in all customer cases by firm/associated person

List 2: Documents to be produced in all customer cases by customer

List 3: Churning documents to be produced by firm/associated person

List 4: Churning documents to be produced by customer

List 5: Failure to supervise documents to be produced by firm/associated person

List 6: Failure to supervise documents to be produced by customer

List 7: Misrepresentation/omissions documents to be produced by firm/associated person

List 8: Misrepresentation/omissions documents to be produced by customer

List 9: Negligence/breach of fiduciary duty documents to be produced by firm/associated person

List 10: Negligence/breach of fiduciary duty documents to be produced by customer

List 11: Unauthorized trading documents to be produced by firm/associated person

List 12: Unauthorized trading documents to be produced by customer

List 13: Unsuitability documents to be produced by firm/associated person

List 14: Unsuitability documents to be produced by customer

As discussed above, the documents in List 2, documents to be produced in all customer cases by customer, are presumed discoverable and include many of the documents investor claimants may feel uncomfortable producing: federal income tax returns, financial statements, other investment account records, etc. Investor claimants can object to these document requests, and in making any rulings on the objections, the arbitrators may consider the relevance of documents or discovery requests, and the relevant costs and burdens to parties to produce such information.

Parties may also request additional documents or information from any party by serving a written request directly on the party. FINRA Rule 12507(a)(1). Any request or documents or information not described in applicable Document Production Lists must be specific and relate to the matter in controversy. FINRA Rule 12507(a)(2).

Depositions are strongly discouraged in arbitration. FINRA Rule 12510. Upon the motion of a party, the arbitration panel may permit depositions, but only under very limited circumstances, including the following: (1) to preserve the testimony of ill or dying witnesses; (2) to accommodate essential witnesses who are unable or unwilling to travel long distances for a hearing and may not otherwise be required to participate in the hearing; (3) to expedite large or complex cases; and (4) if the arbitration panel determines that extraordinary circumstances exist. FINRA Rule 12510.

Unless the parties agree otherwise, within 60 days of the date that the answer to the statement of claim is due, or, for parties added by amendment or third party claim, within 60 days of the date that their answer is due, the parties must either: (1) produce to all other parties all documents in their possession or control that are described in Document Production Lists 1 and 2, and any other Document Production List that is applicable based on the causes of action alleged; (2) identify and explain the reason that specific documents described in Document Production Lists 1 and 2, and any other Document Production List that is applicable based on the causes of action alleged, cannot be produced within the required time, and state when the documents will be produced; or (3) object as provided in Rule 12508. FINRA Rule 12506.

Other discovery requests may be served on the claimant or any respondent named in the initial statement of claim 45 days or more after the Director serves the statement of claim (FINRA Rule 12507(a)(2)). Other discovery requests may be served on any party subsequently added to the arbitration 45 days or more after the statement of claim is served on that party (FINRA Rule 12507(a)(2)). Parties must serve copies of the other discovery requests on all other parties (FINRA Rule 12507(a)(2)).

Unless the parties agree otherwise, within 60 days from the date a discovery request other than the Document Production Lists is received, the party receiving the request must either: (1) produce the requested documents or information to all other parties; (2) identify and explain the reason that specific requested documents or information cannot be produced within the required time, and state when the documents will be produced; or (3) object as provided in Rule 12508. FINRA Rule 12507(b)(1).

“The parties must cooperate to the fullest extent practicable in the exchange of documents and information to expedite the arbitration.” FINRA Rule 12505. Further, the parties must act in good faith when complying with the Document Production Lists and other discovery requests. FINRA Rules 12506(b)(2), 12507(b)(2). “Good faith” means that a party must use its best efforts to produce all documents or information required or agreed to be produced. FINRA Rules 12506(b)(2) and 12507(b)(2). If a document or information cannot be produced in the required time, a party must establish a reasonable time frame to produce the document or information. FINRA Rules 12506(b)(2) and 12507(b)(2).

The failure to cooperate in the exchange of documents and information may result in discovery sanctions. FINRA Rule 12511(a). The arbitration panel may issue discovery sanctions against any party in accordance with Rule 12212(a) for: (1) failing to comply with the discovery provisions unless the arbitration panel determines that there is a substantial justification for failing to comply; or (2) frivolously objecting to the production of requested documents or information. FINRA Rule 12511(a). Further, the arbitration panel may dismiss a claim, defense, or proceeding with prejudice in accordance with Rule 12212(c) for intentional and material failure to comply with a discovery order of the arbitration panel if prior warnings or sanctions are ineffective. FINRA Rule 12511(b).

Unlike civil cases, after the parties exchange discovery, not much frequently happens between the parties until 20 days before the arbitration hearing. In civil cases, the time from when discovery starts until a trial begins is typically full of motion practice and the taking of depositions. In a FINRA arbitration, depositions are strongly discouraged except in exceptional circumstances. FINRA Rule 12510. Motion practice is typically much lighter than in a civil case, and motions to dismiss a case prior to the investor claimant presenting his or her evidence at the arbitration hearing are expressly discouraged. FINRA Rules 12503, 12504. It is for these two reasons that engaging in a FINRA arbitration can be less costly for an investor claimant than a civil case.

Twenty (20) days prior to the arbitration hearing, the claimant and respondent tell one another what witnesses they will be calling at the hearing, including expert witnesses if any, and give one another copies of the exhibits they will be using at the hearing. FINRA Rule 12514.

FINRA will typically select a hearing location which is closest to the investor claimant’s residence. FINRA Rule 12213. Arbitration hearings are conducted at neutral places, such as hotels, conference centers, or, if one is available, at a local office of FINRA.

Arbitration hearings generally follow the same flow as a civil trial. At the arbitration hearing, each side will make an opening statements. A claimant will then present its witnesses and evidence. FINRA Rule 12607. The respondent then does the same. FINRA Rule 12607. The panel decides what evidence to admit, and is not required to follow state or federal rules of evidence (FINRA Rule 12604). The arbitration hearing is concluded by closing arguments.

After the hearing, the arbitration panel will meet to decide on the arguments and evidence they have heard. The arbitration panel will then issue a written decision outlining the award. FINRA Rule 12904. The FINRA rules state a panel should try to issue an award within thirty (30) days after the end of the hearing. FINRA Rule 12904. A majority of arbitrators must agree with the ruling unless the parties have agreed otherwise. FINRA Rule 12414. Unfortunately, many times the arbitration panels will not include an explanation for why they decided the way they did. If the panel awards a claimant any money, a respondent has thirty (30) days to pay.

If an investor claimant wins his or her arbitration and the respondent fails to pay what the arbitration panel awards the inestor, FINRA can suspend the Respondent until the investor is paid.

Unfortunately for the unsuccessful investor claimant, FINRA arbitration decisions are final and not subject to appeal unless applicable law provides otherwise. FINRA Rule 12904. The basis on which an arbitration decision can be appealed is very narrow and the chance of an appeal being successful is slim.

The FINRA arbitration process can be somewhat expensive and time-consuming. However, with experienced counsel guiding you, the difficulty case be minimized as much as possible and the result can mean recovery of some or all of what you have lost as a result of someone else’s wrongdoing.