Debating the Riddle Wrapped In An Enigma of FINRA Intra-Industry Arbitration

February 1, 2019

Today's blog arises from a FINRA Arbitration Decision that tells us next to nothing about the substance of a multi-million dollar complaint filed against 10 respondents. The Decision dutifully ticks off the many causes of action but they are left suspended in mid-air without being tied to any specific facts. Moreover, we got two arbitrators ruling one way and a third arbitrator dissenting but we don't have any idea as to what the three adjudicators didn't agree about and why. As such, we don't know what prompted the litigation and there's no rationale presented for the ensuing Award. How did Winston Churchill put it? A riddle wrapped up in an enigma. Our publisher Bill Singer criticized the hide-and-seek nature of the arbitration. A reader took Bill to task. Presented for your consideration is the debate.

Case In Point

On January 31, 2019, I published the following piece on the Securities Industry Commentator

David Lerner Associates, Inc. Wins $1 Million FINRA Arbitration Against Wells Fargo Advisors and 9 Individuals -- What Happened? Why? How Come There's A Dissent? FINRA mum.
In the Matter of the Arbitration Between David Lerner Associates, Inc., Claimant, v.  Wells Fargo Advisors, LLC Daniel Robert Burns Edward Thomas Finocchiaro Mitchell Lewis Fischer Joseph Michael Lafferty Charles Joseph Margiasso Michael Robert Rosen Loreto Thomas Testani Martin David Weiss and Timothy J. Cheriaparampil (FINRA Arbitration Decision 15-02443 / January 29, 2019)
In a FINRA Arbitration Statement of Claim filed in September 2015 and as amended, FINRA member firm David Lerner Associates asserted  breaches of contract, the duty of loyalty and good faith, and fiduciary duty; aiding and abetting breach of fiduciary duty; tortious interference with contract, tortious interference with economic relations; unfair competition; and, misappropriation of trade secrets, confidential and proprietary information. Claimant , sought a permanent injunction restraining Respondents from soliciting any Claimant accounts for a period of one year from the date of the award and requiring Respondents to immediately return to Claimant all records and information regarding any Claimant's clients. Further, Claimant sought at least $10 million in compensatory damages, punitive damages, attorneys' fees, and  costs. Respondents generally denied the allegations and asserted various affirmative defenses.The FINRA Panel of Arbitrators found by a 2:1 majority that Respondents jointly and severally liable and ordered them to pay to Claimant David Lerner Associates $1.08 million in compensatory damages. No explanation was provided as to why one arbitrator dissented.
Bill Singer's Comment: After some 3 1/3 years from the date of the filing of the arbitration Complaint, we have a dispute in which Claimant David Lerner Associates asserted some very, very serious claims and sought the jaw-dropping sum of at least $10 million -- and on the Respondents' side of the caption are 10 parties with no less a heavyweight FINRA member firm than Wells Fargo Advisors, LLC. Sadly, all that FINRA tells us is that two of three arbitrators awarded Lerner $1.08 million in compensatory damages. We have no inkling as to what prompted the dispute. We have no explanation as to why the Panel rejected Claimant's damage calculation yet awarded a still impressive $1.08 million. We are told the Award is for compensatory damages but not told compensation for what. Worse, we have a split decision but not so much as a word as to why. In an industry using mandatory arbitration, there should be some minimum explanation as to what happened, why arbitrators ruled as they did, and, certainly, some brief reference to the basis for any dissent by any arbitrator(s).

SIDE BAR: The Codification of Mandatory FINRA Intra-Industry Arbitration:

FINRA Rule 13200. Required Arbitration

(a) Generally
Except as otherwise provided in the Code, a dispute must be arbitrated under the Code if the dispute arises out of the business activities of a member or an associated person and is between or among:
  • Members;
  • Members and Associated Persons; or
  • Associated Persons.
(b) Insurance Activities
Disputes arising out of the insurance business activities of a member that is also an insurance company are not required to be arbitrated under the Code.

FINRA IM-13000. Failure to Act Under Provisions of Code of Arbitration Procedure for Industry Disputes

It may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2010 for a member or a person associated with a member to:

(a) fail to submit a dispute for arbitration under the Code as required by the Code;

(b) fail to comply with any injunctive order issued pursuant to the Code;

(c) fail to appear or to produce any document in his possession or control as directed pursuant to provisions of the Code;

(d) fail to honor an award, or comply with a written and executed settlement agreement, obtained in connection with an arbitration submitted for disposition pursuant to the rules applicable to the arbitration of disputes before FINRA or other dispute resolution forum selected by the parties where timely motion has not been made to vacate or modify such award pursuant to applicable law; or

(e) fail to comply with a written and executed settlement agreement, obtained in connection with a mediation submitted for disposition pursuant to the procedures specified by FINRA.

All awards shall be honored by a cash payment to the prevailing party of the exact dollar amount stated in the award. Awards may not be honored by crediting the prevailing party's account with the dollar amount of the award, unless authorized by the express terms of the award or consented to in writing by the parties. Awards shall be honored upon receipt thereof, or within such other time period as may be prescribed by the award.

It may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2010 for a member to require associated persons to waive the arbitration of disputes contrary to the provisions of the Code of Arbitration Procedure.

A Reader Disagrees

A reader of the Securities Industry Commentator and the Blog sent me an email, which I reprint below in full absent reference to the author's identity. The author is a prominent industry lawyer and compliance authority, and someone I respect:

Hi Bill - Hope all is well and a belated happy new year. I saw the story on David Lerner winning a million dollars against Wells Fargo and it kind of peaked (piqued?) my interest. I normally agree with you on the failings of the arbitration system and FINRA in general but I think I have to disagree with your comments on this particular case. 

It seems to me that this is the exact type of case that arbitration was designed for. You have two, mostly corporate, parties who wanted to privately resolve their dispute. That's always been the key to arbitration in my mind . . . that it's a private alternative dispute resolution mechanism. Why can't two parties agree that they would like to keep their dispute private and enter into an agreement to have a third party resolve it for them? Is it just the mandatory nature of arbitration?

Sure it would be nice if we knew all the details of this particular case. . . really . . . at the end of the day . . . from these parties' perspective . . . t's none of our business, right? (I mean that's the theory anyway). These two parties had a business dispute and didn't want to air their dirty laundry in public so they agreed to resolve it privately. 

I don't know . . . maybe I'm wrong . . .Convince me otherwise?  

My Reply

I love a robust debate and find that such challenges often better inform my own opinions. When we debate only to change someone else's opinion, it's never as rewarding as when we debate to test the integrity of our own opinions. In that spirit, I welcome the above correspondence from my long-time industry colleague. Below see my reply:

I am a libertarian and support the right to private contract and the right to arbitration. That aside, FINRA intra-industry arbitration is NOT voluntary, as you seem to suggest, but mandated upon all associated persons. Further, there is no free negotiation for public customers or associated persons because the industry will not offer a New Account Agreement without the customer arbitration clause and FINRA's rules require intra-industry arbitration. To call such a forced route an "alternative" has always struck me as nonsense. At best, FINRA imposes this process upon customers and associated person in order to accomplish exactly what you noted -- the ability of member firms (typically Large members) to avoid public scrutiny via files available to all in the court clerk's office. If intra-industry arbitration is the byproduct of freely negotiated contracts, then I support the privacy and the resort to ADR. As presently concocted, the FINRA system is a sham and does not offer many of the due process protections found in our court system. 

You may feel differently. I respect your opinion. I respect my right to disagree with you.

The Reader's Rebuttal

In response to my reply, the reader noted: 

I agree with your argument on the contract-of-adhesion issue when it comes to public customers and when reps are dealing with employment disputes against their employers. Absolutely . . .you get no argument from me on that score. 

But when it comes to two BD's fighting each other, I have no sympathy for the adhesion aspect of the arbitration clause. My feeling is that if the BD's don't like arbitration in intra-industry disputes . . . they're the ones holding the keys to the courthouse as it were and can eliminate the mandatory nature of arbitration. I think that was my only point. 

Hegel Weighs In

Proving that the Hegelian Dialectic of thesis, antithesis, and synthesis survives into the 21st Century, I ended our exchange as follows:

In the end, we seem  to agree to agree! 

FINRA member firms should have the unfettered right to arbitrate their disputes in privacy and within the confines of whatever arbitration forum and subject to whatever rules they desire. Notably, FINRA affords the right to vote on its rule proposals and on all elective offices ONLY to its member firms. Accordingly, only FINRA member firms approve the regulator's and the ADR forum's rules; and, to that extent, since they make that bed, you and I agree that they should be free to lie down on it. On the other hand, since public customers and associated persons are disenfranchised at FINRA, those individuals should NOT be forced into an industry-controlled arbitration forum subject to industry-approved rules.

As the caption discloses In the Matter of the Arbitration Between David Lerner Associates, Inc., Claimant, v.  Wells Fargo Advisors, LLC, Daniel Robert Burns, Edward Thomas Finocchiaro, Mitchell Lewis Fischer, Joseph Michael Lafferty, Charles Joseph Margiasso, Michael Robert Rosen, Loreto Thomas Testani, Martin David Weiss, and Timothy J. Cheriaparampil (FINRA Arbitration Decision 15-02443 / January 29, 2019), in addition to two FINRA member firms on either side of the dispute, we also had nine individual, associated person respondents. Those associated persons were not involved in any voluntary negotiations about the choice of mandatory forum or its rules. Until such times as associated persons are freed from the prerogatives of FINRA and its member firms, I will continue to object to the veil of secrecy that allows member firms to wash their dirty laundry in private. Put the due process back into the system and I will stand aside.

Comment from Bill Singer

To be very clear, I support the ability of parties to freely negotiate a contract that provides for alternative dispute resolution in a forum of their choosing subject to rules that they find appropriate. I can't put it any plainer than that. What I can put plainly is that mandatory intra-industry arbitration as presently promulgated by FINRA is not the byproduct of free negotiation but the forced outcome of fiat. That is offensive.

As presently constructed, FINRA's version of intra-industry ADR is a self-serving pile of warm crap that was drafted and approved ONLY by the regulator's member firms. It doesn't take a genius to infer from that predicate how the process favors the employer/member-firm over the employee/associated-person. The bias is not always obvious, as is too often the case in such lop-sided undertakings. The unfairness is often apparent only to veteran industry practitioners, or only emerges when it's too late to do anything about it. Worse, the hundreds of thousands of industry men and women entrapped in this affront to fair-play often feel caught between a hammer and an anvil when they are forced to arbitrate in what they view as an unfair forum and the mechanism by which their unwilling compliance is enforced is none other than an employer-controlled,so-called self-regulatory-organization FINRA. Our rules. Our forum. Our regulator.

Few issues on Wall Street set me off with more passion than my decades-long fight for fairness and fair-play for public customers and associated persons. For those unfamiliar with some of my historic gripes, consider this excerpt from my May 30, 2017, Comment submitted to FINRA

On March 21, 2017, the Financial Industry Regulatory Authority ("FINRA") published "Special Notice: Engagement Initiative / FINRA Requests Comment on Potential Enhancement to Certain Engagement Programs / Comment Period Expires May 5, 2017." As set forth, in part, in the "Executive Summary" of the Special Notice:

FINRA's status as a self-regulatory organization (SRO) requires that, in pursuing its mission of investor protection and market integrity, FINRA engage effectively with its member firms, as well as investors and other stakeholders. FINRA currently expends significant resources on its engagement programs, and many individuals from its member firms and the public also devote time to these programs. This Notice provides an overview of these engagement programs, with particular focus on FINRA's committees, rulemaking process and member relations and related programs. FINRA requests comment regarding how it can enhance these programs to promote its mission and its effectiveness as an SRO.
. . .


Unquestionably, FINRA's 180 Large firms employ the bulk of the 633,822 registered
representatives. As I have long noted in the press and my published works, it is unconscionable that there is no seat on FINRA's Board specifically set aside for a Registered Representative  Governor and that there is no voting afforded to registered men and women. It all smacks of the constitutionally discredited practice of deeming certain human beings as 3/5ths of a person for purposes of allocating a state's voting power but a non-person for all else. In response to legitimate calls to democratize its Board, FINRA thinks it is cleverly deflecting the criticism by cynically offering to adjust its committee structures and so-called engagement programs:

Because they are established by statute, regulation and FINRA's By-Laws, the checks and balances described above -- FINRA's Board composition, the comprehensive SEC oversight of FINRA and the limitations on FINRA's powers-operate as effective constraints on FINRA's Board and management and cannot be changed by them. However, FINRA's Board and management can adjust many aspects of FINRA's committee structure and other elements of its engagement programs described below. In reviewing comments on these engagement programs, FINRA intends to evaluate any potential changes in light of this framework of checks and balances governing FINRA, the policy objectives it reflects and the extent to which such changes would enable FINRA to more effectively protect investors and promote market integrity while helping to support vibrant capital markets.

Page 4 of the Special Notice

The above concluding paragraph from the "Background and Importance of Engagement" section of the Special Notice is nothing more than calculated disinformation designed to maintain the failed status quo at FINRA. FINRA altered the composition of its Board so as to dilute the voting role of its smaller member firms and diminish their influence. That reallocation of power was accomplished via SEC-approved rulemaking, and it can be reformed via that same route. In 2017, FINRA pretends that its Board composition "cannot be changed." We are indeed in the age of alternative facts. As if proposing a By-Law amendment to restructure the Board so as to make it fairer and more representative is illegal?

. . .

Past as Prologue

On August 1, 2002, On Wall Street magazine published "Attorney Seeks Broker Voice on NASD Board," which discussed several proposals I had made, among which were that:

1. NASD consider allowing some 700,000 registered persons the right to vote on rule proposals involving their careers because I believed that their ongoing disenfranchisement favored employer over employee and management over labor. I believed that registered persons would feel more involved in the regulatory process if they had a voice. It was the idea of giving someone a stake in self-regulation and transforming them into stakeholders. 

2. Forms U-4 should be filed directly by registered reps with CRD (with full copies to the employing BD). I called for an end to filing only through the employer member firm. I did not propose any change in any supervisory rules and regulations. I believed that RRs should have the ability to directly access their registration and that this is an important step to ensure that such individuals are viewed as professionals rather than mere salespersons. It is the same process required of lawyers and doctors, who do not maintain their licenses or registrations solely through the grace of an employer. Put another way, imagine if you could only submit an application for a driver's license through your employer; and then imagine that your license automatically expired when you quit or were fired from a job - and the only way to renew your license was through another employer. As silly as that make-believe licensing process seems, that's about how it works for the industry's registered representatives.

On Wall Street noted this reaction to my thoughts from NASD:

In response to a request for comment, Tom Holloman, a spokesman for NASD
Regulation Inc., said: "Mr. Singer's agenda is clearly out of step with the times,
pandering to those who would seek less, not more oversight and accountability. For example, Mr. Singer's proposal that registered representatives vote on all regulatory changes governing their behavior would almost certainly block or delay any effort to enact meaningful reforms. We will resist proposals that would water down industry oversight."

Some 15 years ago, I commented in a constructive manner and NASD's petulant response was conveyed to me in the press. NASD spokesman Hollomon (who I had never spoken to or communicated with) pejoratively dismissed my opinions as out of step with the times, pandering, and watering down industry oversight. Is that what is meant by engagement?

Private Sector Regulatory Organization ("PSRO")

All of those in the FINRA community must accept the symbiotic need to police the industry, to root out the bad actors, to empower regulatory staff with the prerogatives and tools to fairly investigate and prosecute misconduct, and, in the end, to persuade the public for whom the industry exists that, yes, the private sector is a more nimble and effective regulator than big government. If you re-read the Special Notice, you will not find a single reference to the appropriate influence of associated persons, public customers, issuers, and other market participants. Who stands for those stakeholders? Who speaks out on their behalf? When do those market participants get to raise concerns about the inappropriate influence of FINRA's larger firms and of FINRA itself?

I urge FINRA to reinvent itself as a "private sector regulatory organization" ("PSRO") and to expand and enhance its mission from one for the broker-dealer industry towards one for the larger private sector served by the financial services community. In furtherance of that change, the PSRO would serve in a holding-company role that oversees each of three regulatory divisions dedicated to Small member firms (smallest 25% of broker-dealers), Mid-sized member firms (50% of broker-dealers measured from midpoint), and Large member firms (largest 25% of broker-dealers). Pursuant to that restructuring, each division would draft a rulebook responsive to the unique needs of its constituency. The PSRO would fully enfranchise associated persons, and provide for the proportionate representation for such stakeholders as public customers, issuers, and regulators. Without question, a PSRO Board seat should be set aside for an investors' advocacy group such as PIABA.

As part of reimagining the SRO into a more expansive PSRO, all industry registration and continuing education should be undertaken directly by an applicant through the PSRO holding company and not through the member firms. FINRA should establish an Anti-Fraud Fund whereby all defrauded public customers would obtain restitution in the event that member firms or associated persons fail to timely honor any awards for compensatory damages, costs, and fees. Finally, I would abolish mandatory arbitration for customers and associated persons. . . .