GUEST BLOG: FINRA Dictator of Dispute Resolution by Dochtor Kennedy, Esq

October 24, 2018

FINRA Dictator of Dispute Resolution

If you have ever interacted with FINRA, whether that be in a disciplinary action, an expungement matter, or up against them in court, then this article will not shock you. You have certainly experienced the frustrations that come along with the vague rules that are ever-changing and seem as though they must be designed simply to make everyone's lives that are affected by them just a tad more complicated.

The latest and greatest in arbitrary FINRA practices is the denial of Dispute Resolution Forum to brokers requesting expungement of customer dispute occurrences that arose from a prior arbitration that resulted in an award/judgment. In the letters of denial, the FINRA Director of Dispute Resolution cites Rule 13203 as the basis for the decision. Now, at this point you are probably thinking, 'Oh, that rule must state you cannot expunge customer disputes that resulted in an award/judgment.' Wrong; here is the text of FINRA Rule 13203. Denial of FINRA Forum:

(a) The Director may decline to permit the use of the FINRA arbitration forum if the Director determines that, given the purposes of FINRA and the intent of the Code, the subject matter of the dispute is inappropriate, or that accepting the matter would pose a risk to the health or safety of the arbitrators, staff, or parties or their representatives. Only the Director may exercise authority under this Rule.

(b) Disputes that arise out of transactions in a readily identifiable market may be referred to the arbitration forum for that market, if the claimant agrees.

Of course the letter does not actually explain how this rule is being applied, but my best guess is that the Director decided that "the subject matter of the dispute is inappropriate." Unfortunately for everyone other than FINRA, it is entirely on par for a rule to be this outrageously vague and allow for an outlandish amount of discretion. Now, based on the language of the rule, the fact that this happened might not seem like FINRA has stepped out of line, but let me take a step back. You may have heard of the Sean Michael Murphy case, a case where broker Murphy requested the expungement of four customer disputes from his record and the arbitrator recommended the expungement of all four occurrences. When Murphy's representation (our people here at AdvisorLaw) filed for state court confirmation as required by FINRA rules, FINRA partially opposed confirmation of one of the occurrences that arose from an arbitration that resulted in an award/judgment. You can read the whole story here at http://www.brokeandbroker.com/3981/finra-confirmation-expungement/

The main takeaway is FINRA attempted to argue issue preclusion and they lost. The state court ordered confirmation of the award for all four occurrences on May 15, 2018.

Coincidentally enough, after this huge loss for FINRA and major win for AdvisorLaw, the Director handed down two letters of forum denial to brokers being represented by AdvisorLaw on May 31, 2018 - two weeks later. In both cases, several months had elapsed since the Statement of Claim was filed and the respondents had already submitted Statements of Answer. Now, without getting into the weeds on issue preclusion, the first issue here is that there is no rule anywhere that says customer disputes that resulted in an award/judgment are ineligible for expungement. In fact, even in the arbitrators' expungement guide, FINRA discourages arbitrators from recommending expungement in those cases - but never goes so far as to say they cannot recommend expungement for those matters, that those matters are ineligible for expungement, or that those matters should not even be heard in their forum. You can see what I am talking about on Page 19 of the "FINRA Dispute Resolution Expungement " at http://www.finra.org/sites/default/files/FINRA-expungement-training-sept-2015.pdf. It is notable that after this blurb, they specifically rattle off the types of matters that cannot be expunged, but matters of prior award/judgments are not listed. Before the Murphy case, AdvisorLaw had personally seen cases involving award/judgments go through to arbitration and has continued to since then - in fact, AdvisorLaw just won an expungement for a broker on October 2, 2018 who was named in a prior arbitration that resulted in an award for the customer. In that case, the award only specifically held the broker-dealer as liable, so we could speculate that the cases being kicked from the forum now are ones where the broker himself or herself was specifically named and specifically found jointly ad severally liable with their broker-dealer, but of course FINRA will not actually tell us that.

Obviously AdvisorLaw and its affiliates were not going to accept this action from FINRA without a fight. Both of these actions are under review with the Securities Exchange Commission. The SEC has set forth a review process under 15 U.S.C. § 78s, which is widely used to review disciplinary actions or membership denials. However, the language of § 78s extends the reviewable action to prohibition or limitation of "any person in respect to access to services offered by such organization or member thereof." The question of course is whether the SEC considers the denial of the use of FINRA's arbitration forum as a prohibition or limitation to access to services offered by FINRA. The folks over here at AdvisorLaw argue that this type of action is absolutely reviewable under § 78s.

The SEC mandates that an application for review must be filed within 30 days of receiving notice of the reviewable action. Seems like a tight squeeze, but they also limit your application to a two-page summary of the action - smart of them. Of course it will come as no surprise that FINRA filed a Motion to Dismiss the two matters. (Let it be known, they filed this motion on a technicality - the SEC did not receive the copies of the application - due to an administrative error - within the 30-day time limit. Of course, it confused everyone at AdvisorLaw why FINRA filed a Motion to Dismiss essentially on the SEC's behalf. But of course, we were fully equipped with receipts of certified mail to squander their feeble attempt to take the easy way out of this.)

FINRA, of course, alluded to their stance that this action was not reviewable with language like, "Even assuming, for the sake of argument, that being told that an expungement request is improper was a FINRA action that can be appealed to the Commission . . .," but they never actually made the argument in their Motion to Dismiss. The brokers are still waiting to hear from the SEC.

So this brings me to all of the unanswered questions surrounding this new trend from FINRA: is the Director denying forum for these cases on the basis of issue preclusion? In other words, are they denying forum for these cases because they were told by a state court in the Murphy case that they cannot argue issue preclusion as a justification for vacating an award for expungement of a customer dispute that arose from a prior award/judgment after the arbitrator renders his decision? If so, is issue preclusion even a valid argument for FINRA to raise? And will they raise this only when the prior award finds the broker liable, not just the broker-dealer? These are the questions we hope will be answered in the SEC's review of these actions. Here's the thing: if the answer is yes for any of the above then there needs to be a bright-line rule that says as much! FINRA is notorious for leaving things just open-ended enough to allow them to spin it to their advantage whenever and however they want and they get away with it constantly; according to "Securities Regulation / Opportunities Exist to Improve SEC's Oversight of the Financial Industry Regulatory Authority" (Report to Congressional Committees / United States Government Accountability Office / May 2012) https://www.gao.gov/assets/600/591222.pdf, between 2009 and 2011 the SEC only disapproved one FINRA rule of 432 proposed. Clearly, the SEC has bigger fish to fry and monitoring FINRA is low on its list of to-dos.

Which brings me to the real question: how on Earth did a rule as vague as 13203 make it past SEC review? This rule allows for such an outrageous amount of discretion on the Director's part and is just one example of the flaws in the SEC's oversight of FINRA. Given the vast immunity that FINRA enjoys coupled with its broad authority and discretion - talk about having your cake and eating it, too - there is a clear need for major reform of both FINRA's current rules and the process for how they draft and promulgate rules in the future. AdvisorLaw understands the importance of protecting the investing public - but it cannot come at the cost of inconsistent, arbitrary, and unfair treatment of brokers and financial advisors.

ABOUT THE AUTHOR

Dochtor D. Kennedy
AdvisorLaw, LLC
President & Founder 

9737 Wadsworth Pkwy, Suite 205
Westminster, CO 80021
(720) 282-5154

Doc Kennedy is the President and Founder of AdvisorLaw, and sits on the board of Global Orphan Prevention Fund. AdvisorLaw provides a variety of services solely to FINRA registered representatives and and Investment Advisor Representatives. Mr. Kennedy specializes in representation of brokers and registered advisors before FINRA in arbitration proceedings and investigations/inquiries, as well as defense against FINRA formal complaints. AdvisorLaw has completed in excess of 275 FINRA arbitration proceedings, expunging over 475 disclosures. Mr. Kennedy has also negotiated countless settlements with broker-dealers on behalf of his clients.

He graduated from the University of Minnesota in 2003, before earning his MBA from KGSM in 2005, and obtaining his J.D. at University of Denver, Sturm College of Law in 2012. Mr. Kennedy is a frequent author and speaker on changes to the regulatory landscape, and is often quoted in the media on current regulatory matters.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of BrokeAndBroker.com Blog.