From Investment News
It is clear to anyone paying attention that there is something wrong with the Financial Industry Regulatory Authority Inc.’s arbitration system. While the process of deciding guilt or innocence seems to be working, there doesn’t seem to be any accountability as far as ensuring that investors who win arbitration awards actually get paid.
Imagine the frustration of an investor who believes he was defrauded by a broker or brokerage firm. The investor hires a lawyer and because of mandatory arbitration, cannot go to court but is forced to litigate the case in an arbitration proceeding. After what can take up to 16 months, the investor wins the case and is awarded damages, but can’t collect because the firm or broker is now out of business.
This issue was first championed by the Public Investors Arbitration Bar Association, an organization of plaintiff’s attorneys, that recently estimated that about 27% of arbitration awards from 2012 to 2016 went unpaid, an amount totaling $200 million.
While a skeptic might say the group’s study is self-serving, Finra recently released its own study showing that between those same years, anywhere from 22% to 30% of arbitration awards were not paid. It reported that the dollar amounts ranged from $14 million in 2016 to $75 million in 2013.
In that same study, Finra outlined a number of possible remedies. They included raising capital requirements for brokerage firms, expanding the Securities Investor Protection Corp. coverage, requiring brokerages to carry unpaid-arbitration insurance, creating a brokerage industry fund separate from SIPC to pay claims, and amending the bankruptcy code to prevent firms from discharging their arbitration awards. Finra further suggested that the solution would require the involvement of the Securities and Exchange Commission, Congress and other regulators.
While it is encouraging to see that Finra has the issue on its radar, its suggested solutions are not really viable. Some of them require members that pay their arbitration claims to help foot the bill for those that don’t. That’s just not fair. And Finra’s suggestion to involve the other institutions it names to help solve the problem will only ensure that it will be years before this issue is adequately addressed.
A much more feasible remedy has been put forth by PIABA and was recently included in a bill introduced by Sen. Elizabeth Warren (D-Mass.) Under this proposal, Finra would use some of the money it collects each year in fines to create a pool that would be available to investors who have not been able to collect arbitration awards.
There are several reasons why this is the best possible solution to the problem. First, Finra can afford it. Hugh Berkson, one of the co-authors of the PIABA report, pointed out that there was $14 million in unpaid arbitration awards in 2016, the same year Finra collected $178.8 million in fines. Surely, Finra can divert less than 10% of its fine money toward a pool to satisfy these unpaid awards. If it feels that it can’t, then it should consider imposing an added surcharge on every firm and broker it fines.
Another reason to endorse this recommendation is that it does not force the majority of Finra members who abide by Finra’s rules to pay for those that don’t. Perhaps that is why the Financial Services Institute, the lobbying group that represents the interests of independent broker-dealers, is supporting the proposal.
An added benefit is that this recommendation ostensibly is within Finra’s power to implement relatively quickly. As well-meaning as Ms. Warren’s bill is, Finra does not need an act of Congress to force it to do something it can do on its own. The time for studies, reports and discussion is over. Finra should move on this and move quickly to spare even one more investor the indignity of not receiving an arbitration award to which he is rightfully entitled.