Mandatory FINRA Arbitration: The Beginning of The End or Another False Start?


The Financial Industry Regulatory Authority (FINRA) is a private, non-governmental corporation that acts with the authorization of the Securities and Exchange Commission (SEC) to regulate the U.S. securities industry.  Born in 2007 from the merger of the former National Association of Securities Dealers (NASD) and New York Stock Exchange (NYSE) regulatory division, FINRA is now the largest self-regulatory organization in the country.  Its stated mission is to protect investors and market integrity through effective and efficient regulation and complementary compliance and technology-based services. 

Today, with the exception of class actions, the far majority of claims between investors, brokerage firms and stock brokers continue to be arbitrated before FINRA’s Dispute Resolution forum.  Virtually every agreement between a public investor and brokerage firm includes a broad, mandatory arbitration clause.  Employees and affiliates of brokerage firms are similarly obligated to arbitrate any claims against a FINRA-member firm or another registered individual (to the extent such claims arise out of their FINRA-related activities), pursuant to their employment or registered representative agreements, as well as the Form U4 and related FINRA Rules.  As such, FINRA Dispute Resolution administers thousands of binding arbitrations each year from its regional offices and hearing sites located across the country. 

FINRA’s arbitration forum has been criticized by investor rights and consumer protection groups, who claim the forum is unfair to investors.  Among other differences from court, FINRA cases are decided by arbitrators, rather than a judge or jury; the proceedings are not a matter of public record (the only aspect of a FINRA arbitration that is public is the final award, if there is one); and the discovery tools available to litigants are more limited.  Depositions and interrogatories are generally prohibited.  

Critics of FINRA arbitration also challenge the statistical “win rate” for public investors.  Each year, FINRA analyzes its arbitration docket and publishes statistics on the types of cases brought and the relief, if any, awarded.  Over the past 5 years, those statistics show that investors recovered money in just 38-43% of arbitrations that proceed to a final hearing.  And those investors who do recover money rarely recover all or anywhere near the total damages claimed.  These “win rate” statistics do not, however, reflect the more than 80% of filed cases that are settled, withdrawn or otherwise resolved prior to hearings.  Nor is there empirical data to demonstrate investors would fare substantially better in court than in arbitration, as court often is a more costly forum in which to litigate.  But the point is, according to critics, that investors should be able to choose the forum for their claims.   

In 2010, in the wake of the financial crisis and in response to the public’s demand for stronger regulation of the financial industry, congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Best known for its sweeping overhaul of the rules and regulations governing the securities and financial industries, Dodd-Frank also authorizes the SEC to determine whether the “public interest” and its mission of furthering the “protection of investors” would require a ban on mandatory arbitration clauses in consumer financial agreements.  The act authorizes the SEC to implement such a ban should it choose to do so.  See 15 U.S.C. §78o(o).  To date, however, the SEC has not shown interest in conducting such a study or reevaluating the existing arbitration rules.   

As part of a renewed challenge to mandatory arbitration, Senate Democrats recently introduced the Arbitration Fairness for Consumers Act (AFCA), which calls on the SEC to reevaluate mandatory arbitration and, if passed, would prohibit the mandatory, pre-dispute arbitration agreements that appear in virtually every brokerage firm account agreement.  House and Senate Democrats recently introduced another bill, the Forced Arbitration Injustice Repeal Act, which is even broader than the AFCA and seeks to amend the Federal Arbitration Act and vastly restrict the circumstances under which consumers could be required to sign mandatory, pre-dispute arbitration agreements.  Both proposals would effectively unwind the landmark Supreme Court rulings in Shearson/American Express, Inc. v. McMahon and Rodriguez de Quijas v. Shearson/American Express, Inc. decisions, in which the court confirmed that brokerage firms could require investors to arbitrate claims arising under the Securities and Exchange Acts of 1934 and 1933. 

While neither bill is likely to pass the Republican-controlled Senate, it remains to be seen whether renewed interest in the issue of mandatory arbitration, or renewed political pressure, could prompt the SEC to exercise its authority under Dodd-Frank and comprehensively review its stance on mandatory arbitration.  Unless or until that happens, it is unlikely the latest noise around mandatory arbitration will result in any meaningful change to the status quo. 

George C. Miller is a Partner in the firm’s San Diego, California offices.  His practice focuses on securities litigation and financial services law. 

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