FINRA Arbitration and Emerging Trends

February 25, 2016

FINRA arbitration, the mandatory dispute resolution forum for brokerage firms, is experiencing an all-time low in new case filings. Positive market conditions have influenced the number of new customer claims filed against registered representatives and FINRA member firms. Generally, case filings decrease when the markets perform well and increase when the markets perform poorly. Obviously, investors who see stable or increased portfolio values do not complain or file claims against their registered representatives or brokerage firms. Nevertheless, should the economy take a downturn in the future, a significant increase in new case filings will likely follow.

FINRA arbitration offers certain advantages to its users: it is much quicker than a typical court proceeding and typically more cost-effective. The costs for conducting discovery are generally less than traditional litigation, given the lack of depositions in FINRA arbitration, and the total amount of money spent on arbitration is typically less than State or Federal court. When comparing FINRA arbitrations to State or Federal cases that go to a final hearing, FINRA arbitrations generally reach the merits hearing quicker than trials, thus saving the parties time and money.

There are also disadvantages to the FINRA arbitration process for brokerage firms. For example, arbitration does not have formal rules of procedure or evidence and participants run the risk of ending up with an unsophisticated arbitration panel.
Arbitrators are not required to be members of the securities industry and they are not required to issue written explanations for their awards unless requested by both parties (which is not typical and rarely occurs).

FINRA has precluded class actions from arbitration, but with regard to claims involving large monetary amounts or multiple respondents, we encourage brokerage firms to continue to press for the resolution of these claims in State and Federal court whenever possible.

Background of FINRA

FINRA is a quasi-governmental agency that was created in 2007 through the consolidation of the National Association of Securities Dealers (“NASD”) and New York Stock Exchange Regulation, Inc. (“NYSE Regulation”), the regulatory arm of the New York Stock Exchange, LLC.

FINRA arbitration is the primary venue for investors (“customers”) to resolve disputes against their registered representatives and brokerage firms.
Alternative dispute resolution is mandatory for all members of FINRA (brokers and brokerage firms). Virtually all brokerage firms include provisions in their standard-form customer agreements requiring the arbitration of customers’ disputes in the FINRA forum.

When a client signs a brokerage account agreement, they are submitting to the jurisdiction of FINRA.

By all accounts, FINRA arbitration is distinguishable from typical consumer, commercial and other commercial arbitration proceedings because it has the oversight of the Securities and Exchange Commission (“SEC”). The SEC reviews and approves the procedural rules governing the arbitral forum, adding a layer of protection above and apart from the Federal Arbitration Act (“FAA”).
However, FINRA arbitration is a less attractive option for brokerage firms than the traditional judicial process and U.S. Courts. Especially in complex cases, FINRA arbitration does not appear to have the necessary apparatus and structure to allow the parties to fully develop and litigate their claims.

For example, twenty days before the final arbitration hearing commences, the parties exchange documents they wish to use at the final hearing (which may or may not have been provided during discovery), along with a list of witnesses they intend to call. Arbitrators are not required to follow evidence rules, either State or Federal.

The tenor of a typical FINRA arbitration proceeding is much more relaxed and informal than a courtroom hearing and typically takes place in a private conference room. These differences may lead to the likeability of the parties and counsel coming into play, as opposed to in State or Federal Court, where rules govern the content and context of the proceeding.

The advantages of litigation to securities firms should entice these firms to seek to litigate matters in either State or Federal court when both parties will agree to opt out of arbitration. As discussed above, the advantages to formal litigation are numerous; the arbitration panel may not have anyone with securities experience or understand the subject matter of the dispute, the panel may not follow formal rules of evidence and the parties may not have an opportunity to fully develop their cases during discovery.

Current Trends in Arbitration

Case filings are at an all-time low, based on statistics maintained by FINRA. When compared to the overall U.S. economy (based on the Standard and Poor 500 economic index), the number of filings directly correlates to the market conditions. After rising 65% from the same period in 2008 and spiking at a high of 7,137 claims in 2009, case filings have now leveled off to an all-time low (3,714 in 2013 and 1,344 through April 2014). This spike in filings in 2009 and continuous drop off during the following years mirrors the Great Recession which took place in the latter part of 2008.

This rise and fall in claims filing is easy to understand when looking at the overall economic picture; when the economy is doing well, customers are less likely to sue their broker. In the short term, we can expect that this trend will continue. If and when the current economic expansion ends, we can expect an increase in the filing of FINRA arbitration claims. (See Charts “A,” “B” and “C,” showing the economic index, FINRA dispute statistics, and trends in the types of claims filed over time).

Monitoring of Markets and Proper Reserves

Given the drop-off in claims submitted to FINRA arbitration and the correlation to market performance, savvy brokerage firms should monitor and track economic forecasts to determine when to reserve for increased litigation and arbitration costs. Based on current trends, when the securities market dips, FINRA arbitration claim filings will again rise. Firms that have reserved appropriately will have the ability to weather the storm to deal with increased litigation.

Arbitration Cases Filed

S&P 500 Index

Cases Served by Controversy Involved


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