Unpaid Finra Arbitration Awards are a Big Problem
Winning an arbitration award in Finra's arbitration and mediation forum can turn out to be a short-lived victory if the award remains unpaid. These unpaid awards worry Finra, broker-dealer firms, industry-registered individuals and lawyers alike.
“It’s a major problem,” Steven B. Caruso, chairman of the National Arbitration and Mediation Committee said at a Practicing Law Institute conference last month. NAMC recommends rules, regulations and procedures governing the conduct of arbitration, mediation and other dispute resolution matters before Finra.
“Unpaid awards do not do anything for Finra. They do not do anything for giving people confidence” in the arbitration process, he said.
But Caruso notes that while one would think the victors in arbitration cases would want to get their hands on the money as soon as possible, unpaid awards are a sensitive issue as the company paying out might be struggling financially.
When broker-dealer firms or registered individuals lose an arbitration case and are unable to pay the awards, they can request a hearing from the Office of Hearing Officers to argue an “inability to pay.” The OHO is described by Finra as an office of impartial adjudicators of disciplinary cases against Finra members.
“I believe everyone should pay their awards,” Michael Alford, deputy general counsel at Raymond James, said at the PLI conference.
He said Raymond James is affected by unpaid awards primarily when seeking the recovery of promissory note funds from departing advisors. “We do occasionally see advisors who receive adverse awards with an inability to pay, and they go to Finra with what is essentially a hardship request that is typically, in our experience, granted if the person is in otherwise good standing.”
Alford’s problem with that outcome is Raymond James’ inability “to seek recovery once that process is initiated and the lack of transparency in the process once Finra has made that decision.”
In response to Finra’s ongoing comprehensive self-evaluation and organizational review – announced in March and known as Finra 360 – Sifma submitted comments in June touching on its concerns about unpaid awards and recommending actions for the regulator to address the issues.
In the comment letter, Sifma associate general counsel Kevin Carroll says unpaid awards are a “perennial issue.” He says there were 190 cases with awards in favor of claimants totaling $203 million in 2015, but 42 awards totaling $26 million went unpaid. He adds that it is unclear what percentage or number of those unpaid awards were eventually paid, whether in whole or in part, and whether through a court action or settlement.
Also troubling, he says, is the lack of data about the scope or scale of unpaid awards cases in which both parties are industry members.
Sifma offered the following recommendations to Finra: publish and track annual data on unpaid arbitration awards; eliminate the inability-to-pay defense in intra-industry disputes; and require CRD disclosure regarding the inability-to-pay defense if that defense remains permissible.
Sifma wants Finra to publish the following information in both customer-claimant and intra-industry cases: the total number of cases in which claimants won awards; the total dollar value of the awards in those cases; the total number of awards paid; and the total dollar value of awards paid. For each unpaid award, Sifma recommends Finra publish the identity of the respondent and state whether that respondent remains registered; the type of claim; whether a motion to vacate is pending; and whether the award was subsequently settled or otherwise satisfied.
“We believe that such data would provide a useful tool for both regulators and industry participants to help spot trends, track changes, and shed some much-needed light on this poorly understood issue,” Carroll says.
Sifma believes Finra should eliminate the inability-to-pay defense -- which can help the non-paying party avoid an industry suspension -- in intra-industry cases. Suspending broker-dealer firms or registered individuals from the industry due to unpaid awards is considered to be a deterrent to future unpaid awards by both Finra and Sifma. The inability-to-pay defense was already removed – in 2010 – as an exemption to suspension in cases in which the claimants are customers.
Finra has an expedited suspension procedure for broker-dealer firms or registered individuals who do not pay arbitration awards. If claimants – whether customers or Finra members – haven’t been paid within 30 days of being granted an arbitration award, they can request the expedited suspension process from Finra. After that request is filed, Finra then sends the derelict parties a letter informing them they have 21 days to do one of the following: pay the award; formulate a payment plan and get the claimants to agree to the plan; file for bankruptcy; or – for Finra members – request a hearing from the OHO to argue an inability to pay.
Continuing to allow the inability-to-pay defense in intra-industry cases “limits Finra’s leverage to suspend an industry respondent, and thereby induce his or her payment of the arbitration award,” Carroll says.
He adds that “even if the industry respondent has a bona fide inability to pay, it would hardly be equitable or just to allow such person – who has a demonstrated issue with managing his or her own financial affairs – to avoid suspension and continue to advise retail clients.”
Carroll says that while the inability-to-pay defense in intra-industry cases remains, this should be recorded in the respondent’s CRD record because that “would certainly be highly relevant and beneficial information” to a retail customer who contemplates doing business with such a respondent or a member firm that may seek to hire the respondent.
Richard Berry, Finra’s director of dispute resolution, said at the PLI conference that the regulator has “heard loud and clear” the industry’s concerns over unpaid awards and is considering the best course of action.
In its own comment letter submitted in June by Mike Rothman, president of the North American Securities Administrators Association, the NASAA says that “despite best intentions,” Finra's proposals “would not resolve the problem investors face when they win an arbitration award which will never be paid.”
Rothman was specifically referring to two actions taken by the Finra board following its May 2017 meeting.
One board action concerns the proposed amendments to Finra’s Code of Arbitration Procedure for Customer Disputes to expand a customer’s option to withdraw an arbitration claim and file in court, even if a mandatory arbitration agreement applies to the claim. Finra, which is currently seeking comments on this proposal, says this would let customers evaluate the likelihood of collecting on an award and make an informed decision about whether to proceed in arbitration, to file the claim in court or to amend the claim to add other respondents.
Another board action is the proposed amendments to the Uniform Application for Securities Industry Registration or Transfer (Form U4) to require information from registered representatives that do not pay arbitration awards, settlements and judgments. Representatives of broker-dealer firms, investment advisors, or issuers of securities use the Form U4 to register with Finra.
More recently, after its July meeting, Finra's board proposed amendments to the regulator’s membership application program rules in order to provide the regulator with rule-based authority to presumptively deny a new membership application if the applicant or its associated persons are subject to pending arbitration claims.