SEC Says FINRA Doesn't Have To Sell Cheese At Its Arbitration Shop (or something like that)

October 25, 2019

Today's featured FINRA Arbitration reminds me of the famous Monty Python's Flying Circus "Cheese Shop" sketch. As the SEC finds on appeal, FINRA doesn't actually offer any arbitration services, well, at least to the extent that FINRA doesn't actually review an arbitrator's award to ensure that the document complied with the self-regulatory organization's rules. As the SEC writes this sketch, FINRA doesn't actually run an arbitration forum by its rules. As the SEC sees it, FINRA is merely a minister at its own arbitration forum -- it merely prepares and serves the awards of its arbitrators, and, moreover, does this service without ensuring that its done by the FINRA rulebook. The SEC insists that this FINRA cheese shop can't be sued for not providing a service that it doesn't offer. Do you have arbitrations? Yes? Can I have one that is adjudicated according to your rules? Ummm . . . no. 

2017 FINRA Arbitration Decision

In a FINRA Arbitration Statement of Claim filed in January 2018, associated person Claimant Kincaid sought the expungement of two customer complaints from his Central Registration Depository record ("CRD"). In the Matter of the Arbitration Between John Boone Kincaid, Claimant, v. Cetera Advisors LLC and Legacy Financial Services, Inc., Respondent (FINRA Arbitration Decision 18-00248 / October 2, 2018).  Respondent Cetera took no position on the requested relief; and Respondent Legacy did not submit an Answer. The sole FINRA Arbitrator denied the requested expungement without providing any rationale.

2018 SEC Appeal

On November 2, 2018, Kincaid filed an appeal to the SEC of the FINRA Arbitrator's denial of his expungement request. In the Matter of the Application of John Boone Kincaid III for Review of Action Taken by FINRA (SEC Application for Review of FINRA Action) In pertinent part, Kincaid's Application asserts that:

[O]n July 5, 2018, an Initial PreHearing Conference ("IPHC") was held in the matter. The hearing was scheduled for October 15, 2018. On October 2, 2018, before the scheduled hearing, Mr. Kincaid received an Executed Award in which the arbitrator denied Mr. Kincaid's request for expungement. Exhibit 6. On October 3, 2018, FINRA case representative, Michelle Vickerman, told Mr. Kincaid that the arbitrator "could rule on the papers." 

FINRA Rule 13200(a) requires arbitration of disputes between Members and Associated Persons. FINRA Rule 13600(a) states that hearings will be held unless the arbitration is administered under Rule 13800(c), Rule 13801, or Rule 13806(e)1; the parties agree otherwise in writing; or the arbitration has been settled, withdrawn, or dismissed. Rule 13600(b) also states that the panel will decide the time and date of the hearing at the IPHC. FINRA Rule 13800(c)(l) states that hearings will not be held for Simplified Arbitration unless the claimant requests a hearing. Rule 13800(c)(2) also states that if no hearing is requested, no IPHC will be held and the arbitrator will render an award based on the pleadings. FINRA Rule 13805 states that to grant expungement, the panel must hold a recorded hearing session. The FINRA Arbitration Manual states that "before ruling on requests to recommend expungement," the panel must hold a recorded hearing session regarding the appropriateness of expungement. Exhibit 7 at Page 74. 

The parties did not agree to forego a hearing in writing, nor was the proceeding dismissed. Mr. Kincaid requested a telephonic hearing for this Simplified Arbitration both in his Statement of Claim, and at the IPHC. An IPHC was held and the telephonic hearing was granted and scheduled. FINRA Rule 13805, coupled with the FINRA Arbitrator's Guide, require that the panel hold a recorded hearing session before ruling on requests for expungement. The FINRA Award Information Sheet specifically requires the panel to indicate whether they conducted an in-person or telephonic hearing. There is no option for no hearing. Exhibit 8 at Page 8. 

By reason of the foregoing, Mr. Kincaid submits this Application for Review to the Commission requesting that he be permitted to resubmit his request for expungement in a new proceeding with FINRA Dispute Resolution and be permitted to present his case in a recorded telephonic hearing before a neutral arbitrator. . .

Opinion of the SEC 2019

Following consideration of Kincaid's appeal, the SEC dismissed his Application on the basis that the federal regulator lacked jurisdiction over the claim. In the Matter of the Application of John Boone Kincaid III for Review of Action Taken by FINRA (SEC Application for Review of FINRA Action; '34 Act Rel. No. 87384; Admin Proc. File No. 3-18882 / October 22, 2019) SEC Opinion offers in part this explanation of the procedural issues in contention [Ed: footnotes omitted]:

On July 5, 2018, a FINRA arbitrator held a prehearing conference at which the parties "accepted" that the arbitrator would serve in that role. The arbitrator then issued an order scheduling a telephonic hearing on October 15, 2018, but noted that "[m]ore than six years has elapsed since" the two complaints Kincaid sought to expunge. He gave Kincaid the opportunity by August 27, 2018-seven weeks before the hearing-to "file a brief attempting to show why the Arbitrator should not dismiss this case under FINRA Rule 13206(a)." That rule provides a six-year time limit on the submission of claims in arbitration. FINRA states that "[t]here is no evidence that Kincaid filed any such brief," and Kincaid does not suggest that he did. 

On October 2, 2018, which was more than five weeks after the deadline for filing a brief about whether Kincaid's arbitration claims should be dismissed, the arbitrator issued a written award denying Kincaid's request for expungement based on the "pleadings and other materials filed by the parties." FINRA's Arbitrator's Guide explained that the process for issuing awards is that "FINRA staff provides the panel with an Award Information Sheet" to be completed by the panel, on which basis the staff "will prepare an award" for the panel's review and approval. It provided further that "[a]rbitrators should review carefully the award to ensure that it is accurate, and that all issues have been clearly decided before signing it." And it explained that "[a]ll awards rendered are final and not subject to review or appeal within FINRA." Consistent with the Arbitrator's Guide, Kincaid asserts that after the arbitrator issued the award his counsel spoke with a FINRA case administrator who told him that Kincaid "had no options for relief from FINRA moving forward," "ratified" the award, and "closed Mr. Kincaid's case." 

at Page 3 of the SEC Opinion

Knockin' on the Wrong Door?

In characterizing Kincaid's appeal, the SEC Opinion asserts that:

[K]incaid has not identified any way in which FINRA limited his access to its arbitration service, nor does he provide any other basis for our jurisdiction to review FINRA's actions.13 Rather, as courts have long explained, Kincaid's recourse for challenging an allegedly erroneous arbitration award would be by seeking to vacate, modify, or correct the award in court through the Federal Arbitration Act. 
= = = = =
Footnote 13: We have explained that "[a] denial of access involves a denial or limitation of 'the applicant's ability to utilize one of the fundamentally important services offered by the SRO.'" Eric David Wanger, Exchange Act Release No. 79008, 2016 WL 5571629, at *4 (Sept. 30, 2016). We express no opinion here on whether FINRA's arbitration forum is "fundamentally important," because, even if it is, Kincaid has not shown that FINRA prohibited or limited his access to that service. Id. Nor do we suggest any view here about the outcome in any pending proceedings in which the question of whether FINRA arbitration is a "fundamentally important service" arises. See, e.g., Kaplow, 2019 WL 1489709.

at Pages 4 - 5 of the SEC Opinion

FINRA's "Ministerial Role" a/k/a the Service Not Offered

In considering Kincaid's argument that by limiting his access to its arbitration service and by not enforcing its procedural rules, FINRA's cited misconduct imbued the SEC with jurisdiction. In response, the SEC found that [Ed: footnotes omitted]:

[K]incaid has not established that FINRA offers a service whereby it reviews an arbitrator's award to ensure that the process complied with its rules. As discussed above, FINRA has only a ministerial role in preparing and serving the awards that arbitrators render. Indeed, FINRA's rules vest arbitrators with the sole authority to interpret and apply FINRA's arbitration rules-specifying that "[s]uch interpretations are final and binding," and that an arbitrator's award is "not subject to review or appeal" by FINRA. Kincaid thus faults FINRA for failing to provide access to a service it does not "offer[]." 

at Page 5 of the SEC Opinion

The Sidestep

The SEC doubles-down on its position that Kincaid's recourse was to pursue his FAA remedies of vacatur or modification of the FINRA Award [Ed: footnotes omitted]::

Instead, Kincaid now attempts to sidestep the FAA-and the high standard for prevailing on a motion to vacate-by seeking our review of the arbitration decision. He does so by claiming that the FAA's requirements do not apply here because "his appeal to the Commission is not based on the arbitrator's findings, but rather on FINRA's refusal to follow and enforce its own rules" by giving effect to an award that he says violates those rules. And because courts lack the authority to order FINRA to enforce its rules, he argues, a challenge to the award "would have failed entirely in a court proceeding." Kincaid does not explain why that necessarily would be the result in court if he filed a motion to vacate or why the FAA would not apply. In any case, the alleged importance or necessity of our review does not confer jurisdiction where we have determined Congress has not authorized it: we will not review a FINRA action simply because an applicant claims "extraordinary circumstances" or "compelling reasons." 

Kincaid argues in his reply brief that a motion to vacate would be unnecessary had the arbitrator correctly applied FINRA's arbitration rules governing expungement relief because the arbitrator would have simply dismissed his claim without prejudice-and thereby "not preclude [him] from seeking expungement in other jurisdictions." We take no position on whether the arbitrator correctly applied those rules or Kincaid's interpretation of them. But there is no merit to Kincaid's suggestion that because he "would not have to" move to vacate an award correctly applying those rules, he should not be required to challenge an award erroneously applying those rules through a motion to vacate. We similarly reject Kincaid's argument that we should accept his petition because a court would not "take [his] case prior to him exhausting all administrative remedies." As explained above, the FAA governs any relief to which he would be entitled and there are no administrative remedies to exhaust. 

at Page 7 of the SEC Opinion


Finally, the SEC addresses Kincaid's invitation that it exercise jurisdiction over FINRA based upon the federal regulator's oversight role and its statutory authority to ensure that FINRA fairly enforces its own rules. Consistent with its framing of Kincaid's matter as one requiring resort to FAA remedies, the SEC declined to accept his invitation to exert jurisdiction over FINRA. In part, the SEC Opinion explains that [Ed: footnotes omitted]

Next, Kincaid invokes two additional sections of the Exchange Act governing our SRO oversight authority: (1) the general regulatory framework under Section 15A for national securities associations such as FINRA; and (2) our discretionary authority under Section 21 to investigate and bring civil enforcement actions for certain violations of the securities laws, including actions to "command compliance" with SRO rules. But Kincaid does not explain how these provisions apply here let alone establish jurisdiction under Section 19(d). We have not taken action against FINRA under them with respect to his claims, nor must we. And even if we did, the result would not be to confer jurisdiction over his claims but rather the institution of a new court or administrative proceeding to which Kincaid would not be a party. 

Nor can Kincaid establish jurisdiction by re-framing his arguments in terms of FINRA's failure to "enforce its rules." As courts have long held, parties cannot re-frame their argument to make an otherwise impermissible collateral attack on an arbitration award. Kincaid's application for review challenges FINRA's refusal to reopen his case so that he can "resubmit his request for expungement in a new proceeding with FINRA Dispute Resolution . . . ." We would have to set aside the award in order to provide Kincaid with the relief he seeks. This collateral challenge to the award "is entirely incompatible with the expedited process envisioned in the FAA." And while the FAA "may be overridden by a contrary congressional command," Kincaid identifies no basis for concluding that Congress provided such a command here.

at Pages 8 - 9 of the SEC Opinion

Bill Singer's Comment

To say that I am struck with ambivalence about this case would be a gross understatement. I understand Kincaid's anger and frustration, but I also find much of the SEC's rationale compelling. Notwithstanding this portion of the SEC Opinion really troubles me:

[K]incaid has not established that FINRA offers a service whereby it reviews an arbitrator's award to ensure that the process complied with its rules. As discussed above, FINRA has only a ministerial role in preparing and serving the awards that arbitrators render. Indeed, FINRA's rules vest arbitrators with the sole authority to interpret and apply FINRA's arbitration rules-specifying that "[s]uch interpretations are final and binding," and that an arbitrator's award is "not subject to review or appeal" by FINRA. Kincaid thus faults FINRA for failing to provide access to a service it does not "offer[]." 

First off, let's no lose sight of the fact that FINRA Interpretive Material-13000: Failure to Act Under Provisions of Code of Arbitration Procedure for Industry Disputes states in pertinent part that:

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. . .

Moreover, FINRA Rule 13200: Required Arbitration states in pertinent part that:

(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. . . .

As such, FINRA is hardly a bystander or merely acting in a "ministerial role" when it comes to intra-industry disputes such as Kincaid's. FINRA, which I deem little more than a Wall Street trade group on steroids, threatens to bring regulatory charges against associated persons who would prefer to pursue their employment disputes against FINRA's member firms in court. IM-13000 is the club that FINRA uses at the behest of its voting member firms to bludgeon those employers' non-voting associated persons into the private alternative-dispute-resolution of mandatory FINRA intra-industry arbitration. So, you know, let's not pretend that FINRA is just punching tickets on a commuter train. Moreover, under FINRA Rule 13203: Denial of FINRA Forum, we are informed in part that:

(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 arbitrators, staff, or parties or their representatives. Only the Director may exercise the authority under this Rule. . . .

Rule 13203(a) doesn't sound like the Director of FINRA Arbitration is impotent and a mere hands-off minister. Notwithstanding that FINRA threatens to file charges against a stockbroker who dares to seek the resolution of an intra-industry dispute in a state or federal court, FINRA arrogates to its Director the right to decline to make its arbitration forum available in the discretion of that same Director -- and the basis for shutting the doors in the faces of wannabe litigants is premised upon such amorphous considerations as determining that "the subject matter of the dispute is inappropriate." 

Further, it's hard to reconcile the SEC Opinion's blanket assertion that "FINRA has only a ministerial role in preparing and serving the awards that arbitrators render. Indeed, FINRA's rules vest arbitrators with the sole authority to interpret and apply FINRA's arbitration rules . . ." with FINRA Rule 13904: Awards, which states in pertinent part that:

(e) The award shall contain the following:
(1) The names of the parties;
(2) The name of the parties' representatives, if any;
(3) An acknowledgement by the arbitrators that they have each read the pleadings and other materials filed by the parties;
(4) A summary of the issues, including the type(s) of any security or product, in controversy;
(5) The damages and other relief requested;
(6) The damages and other relief awarded;
(7) A statement of any other issues resolved;
(8) The allocation of forum fees and any other fees allocable by the panel;
(9) The names of the arbitrators;
(10) The dates the claim was filed and the award rendered;
(11) The number and dates of hearing sessions;
(12) The location of the hearings; and
(13) The signatures of the arbitrators.
(f) The award may contain a rationale underlying the award.

Contrary to what the SEC presents as a mere "ministerial role," in fact, FINRA has codified by Rule what "shall" be contained in a typical Award -- with no less that 13 enumerated requirements and one optional aspect of a rationale. Oddly, the SEC implies that the regimen presented in the 14 characteristics of an Award are so ministerial that no one at FINRA even assures that the Rule is being followed. Which may well explain the often lousy quality control that is suggested by typos, errors, and inconsistencies that are published by FINRA as Arbitration Decisions. 

Ultimately, I'm still on the fence with Kincaid. I'm not convinced that the SEC got it wrong. Not convinced that it got it right. I'm not quite sure why Kincaid didn't just pursue his FAA remedies and file his appeal in a court. On the other hand, perhaps this matter will wind up before a federal court on appeal and blaze new law. I am no fan of FINRA's mandatory customer or industry arbitration. I have no reservations about arbitration provided it is freely negotiated and all parties consent to the procedural rules. That's not what's in play at FINRA. Associated Persons are dealt a stacked deck -- take it or else! And despite being forced into the jaws of FINRA's arbitration beast, associated persons are still not entitled to any rationale in any rendered Award. That is something I find despicable. 

Customer: Have you in fact got any cheese here at all?

Owner: Yes,sir.

Customer: Really?

Owner: No. Not really, sir.

Customer: You haven't.

Owner: No sir. Not a scrap. I was deliberately wasting your time,sir.