The FINRA Arbitration Process

What is FINRA Arbitration?

FINRA Arbitration is a method of having a dispute between two or more parties resolved by impartial persons who are knowledge in the areas related to brokerage controversy. Most importantly is the fact an arbitration award is final and binding. It is subject to review by a court only on a very limited basis. Parties should recognize, too, that in choosing arbitration as a means of resolving a dispute they generally give up their right to pursue the matter through the courts.

What Disputes are Eligible for FINRA Arbitration

In considering whether to initiate arbitration, it is important to keep in mind that, generally, a public customer has a right to require a broker-dealer to submit to arbitration only those disputes relating to or arising out of the business activities of the broker-dealer. An additional factor to be noted is that a controversy is not generally eligible for submission to arbitration if more than six years have elapsed from the date of the event that gives rise to the dispute. For example, a TIC foreclosure could be considered the occurrence or event that gives rise to the claim. The arbitrators also may dismiss a claim barred by shorter applicable state or federal statutes of limitation. However there are discovery and estoppel theories that allow old claims to be resolved.

What types of claims against financial advisors and brokerage firms are most common in FINRA Arbitration?

Suitability Claims: The most common complaint is “suitability.” In every investment recommendation made by a broker, it must be “suitable” based upon the investor’s risk tolerance, investment objectives, financial status and other relevant factors. It is up to the broker to be able to show that the broker had independent reasons for believing the investment was suitable. An investment recommendation may be unsuitable if it is not made in accordance with the investor’s investment objectives; the investor does not have the financial ability to incur the risk associated with the investment; or the investor did not know or understand the risk associated with the investment. If a broker ignores these things, he or she can be responsible and liable for the consequences to investors who had no business being in these investments.

Overconcentration Claims: Overconcentration claims are actionable when an investor, at the recommendation of a financial advisor or broker, maintains a portfolio that is over concentrated in a single type of investment or asset class. A financial advisor (broker) that fails to diversify a customer’s account may be liable should the investment decline in value.

Improper Use of Margin: Margin accounts can be very risky. The investor may leverage their assets via a margin account held at a financial institution (brokerage) and purchase securities with borrowed money. The loan from the institution is secured by securities in the account. Investors who trade securities on margin incur the potential for higher losses and for “margin calls.” The institution can force the sale of securities in your account and can sell your securities without contacting you. As a result, there are additional risks involved with trading on margin that financial advisors must disclose to their customers. When losses happen, there may be recourse through FINRA Arbitration.

Churning: Churning occurs when a financial advisor (broker) engages in excessive trading in an investor’s account in an attempt to generate increased commissions. To prove that the pattern of trading in the account was excessive, the activity in the account is analyzed to determine whether it meets certain threshold calculations. The investor must prove that the financial advisor (broker) exercised control over the decision making in the account, the trading was excessive, and that the financial advisor (broker) acted in reckless disregard of the investor’s interests.

Negligence: Generally, negligence is the failure to use such care as a reasonably prudent and careful person would use under similar circumstances. If a financial advisor (broker) is negligent in his dealings with an investor, then the investor may have recourse against that financial advisor or broker dealer in charge of supervision of the account in a FINRA Arbitration proceeding. Negligence is conduct which falls below the “legal standard” established to protect others against unreasonable risk of harm.

Misrepresentations and Omissions: Federal and state laws prohibit financial advisors (brokers) from making “material misrepresentations” about investments that they are selling to customers. The laws impose upon the financial advisors (broker) and brokerage institutions an obligation not to omit any information that a reasonable investor would want to know about in making a decision to invest. A financial advisor or financial institution may be liable to a customer if they misrepresent material facts or fail to disclose material facts to the investor in the sale or recommendation of an investment through FINRA Arbitration.

If I sue, how long does it take until the process is completed and how does FINRA Arbitration work?

Arbitration is less formal than court and cases are heard and resolved in shorter timeframes than in court actions. Investors can expect to have a final resolution of their claim within 9-18 months of filing their claim. The process mirrors the courts in that a claim is filed by the aggrieved party. The Registered Representative or the Representative’s firm typically files an answer to that claim, and parties present their case through the presentation of evidence by way of witnesses, documents and personal testimony.

All of the parties will have an opportunity to cross-examine the other side’s witnesses and may object to the introduction of evidence, with the decision on its admission to be decided by the arbitration panel. Your case will be arbitrated and heard before FINRA (Financial Industry Regulatory Authority). Arbitration is the method in which most disputes between investors and financial institutions are resolved. Typically, three arbitrators listen to the testimony and evidence and make the decision.

Who are the FINRA Arbitrators?

Arbitrators are impartial persons who are knowledgeable in the areas in controversy. Each sponsoring organization such as FINRA (formerly NASD) or NYSE, maintains a roster of individuals whose professional qualifications and experience qualify them for service as a FINRA arbitrators. The arbitrators are not employees of the sponsoring organization and they, not the sponsoring organization, will decide your dispute. The arbitrators do, however, receive an honorarium from the self-regulatory organizations. The Director of Arbitration will inform the parties of the names and business affiliations of the selected arbitrators, their employment histories as well as any conflict information disclosed pursuant to the Uniform Code of Arbitration. Some parties may be interested in previous awards issued by prospective arbitrators. Each sponsoring organization has developed procedures to make information available on public customer awards issued since May of 1989. Our expertise and experience with selecting arbitrators is a valuable resource for our customers.

Arbitration vs. Mediation

FINRA Arbitration Defined

A confidential legal process used to avoid settling a dispute in court. However, the neutral third party is appointed to review the case and make a final decision in favor of one of the parties. The arbitrator renders a decision that is generally binding and cannot be appealed. The process is more formal than mediation, although it is still usually less formal than litigation in the traditional court system.

FINRA Mediation Defined

A confidential legal process that uses a neutral third party to act as a facilitator to help the parties come to an agreement. The mediator is not a decision-maker, but a facilitator. The mediation process is informal and does not follow the rigid rules of evidence or procedure used in litigation. The parties to the dispute are in control. Ultimately, success depends upon the parties’ ability to reach an agreement. The mediator stimulates discussion between the disputing parties to help the negotiation process and move the dispute toward a resolution. Mediation is a non-binding process. It does not restrict the ability to pursue the dispute further unless the parties reach an agreement to settle and choose to be bound by the settlement agreement’s terms.

Differences Between Mediation and Arbitration

One of the most important differences between mediation and arbitration is that an arbitrator makes a final decision on a case, while a mediator does not. During the arbitration proceeding, FINRA arbitrators listen to and consider all relevant information, then decide which party should win. Essentially, the arbitrator acts as the judge and jury. In contrast, a mediator doesn’t impose a final resolution on the disputing parties. The mediator acts as a middleman who facilitates discussions for possible settlements or resolutions and encourages the disputing parties to arrive at their own decision. We handle both when it comes to FINRA Arbitration and FINRA Mediation.

When an arbitrator makes a final decision (an Award), it is legally binding. Appeals are not allowed (but certain technicalities might be grounds for appeal). In contrast, mediation settlements are final by their nature and can be judicially enforced. In most cases, if disputing parties sign a mediation clause, they are required to participate in mediation. The settlements are voluntary but binding and enforceable once the parties commit.

Another difference between mediation and arbitration is in the ability to withdraw from the process. While a mediation agreement can require persons to participate initially, neither party is required to complete the process or find resolution because mediation agreements are not legally binding. Conversely, parties involved in arbitration can withdraw only before a final decision is made and only if no arbitration clause has been signed. FINRA Arbitration clauses require that all parties use arbitration to resolve disputes arising out of a FINRA controversy.

FINRA Arbitration is generally less flexible, more time consuming and more costly than mediation. There is a tendency in arbitration to split the pot, which can leave the parties involved feeling dissatisfied.

FINRA Alternative Dispute Resolution options can achieve efficient and effective results. However, because of their inherent differences, they can affect the outcome of a dispute. Choosing the right form of ADR for your situation is key to getting the most favorable outcome. We are good at what we do and feel we can make a difference.