All Registered Investment Advisors are supervised by the Securities and Exchange Commission. However, many RIAs have little connection to the Financial Industry Regulatory Authority. Unless an advisory firm is dual-registered (as an investment advisor with the SEC and as a broker-dealer with FINRA), it is not be subject to FINRA rules and supervision.
This also means that many RIAs cannot be compelled to submit to FINRA arbitration in the context of customer or employment disputes. Now, however, FINRA has issued a “guidance” notifying the public that its dispute resolution arm (FINRA Dispute Resolution, Inc.) will agree to hear disputes involving RIAs under certain specified circumstances. The guidance is available on FINRA’s website. FINRA’s mediation services will also be available.
Is it worth considering? The answer will depend upon the RIA’s comfort level with a FINRA arbitration forum that has a long track record and a predictable process, if not always predictable outcomes.
Customers have a nearly absolute right to use FINRA arbitration to resolve disputes with FINRA members. Employment disputes between FINRA members and licensed employees are required to be resolved through FINRA. Non-member RIAs, on the other hand, can insist on resolving disputes with their clients and employees through the courts if they so choose.
Private arbitration is another option. An RIA can require its clients to arbitrate disputes by including a provision in an investment management agreement. So what may be attractive to an RIA about FINRA arbitration?
First, the arbitration will be decided by three arbitrators if the amount in dispute exceeds $100,000. To some, a panel of three arbitrators (as opposed to a single arbitrator) is seen as favoring the defense.
Second, the pool from which arbitrators will be chosen generally consist of individuals who have some experience with securities issues and some training in arbitration, and will likely include at least one arbitrator with work experience in the financial services industry.
However, RIAs may be quick to point out that the advisory segment of the industry is quite different from the broker-dealer disputes most often heard by FINRA panels. Thus, the perceived benefit of the arbitrators’ experience may be illusory.
Third, the FINRA arbitration rules provide for limited, but reciprocal, discovery — primarily through written requests for documents and information. These rules save the expense of full-blown litigation discovery while providing a method to obtain necessary documents from your opponent. Finally, the hearing itself will be handled in a predictable manner similar to a trial, with arbitrators likely to take their roles quite seriously.
The downside? FINRA arbitration panels hear cases in a limited number of cities and Rochester is not one of them. Also, RIAs can only use FINRA arbitration if the customer or employee agrees in writing. In the case of an investor, the agreement must be signed after the dispute arose. Pre-dispute arbitration clauses will not be sufficient. Additionally, unlike private arbitrations, an award against an RIA will be publicly available on the FINRA website.
Is a FINRA award binding? Unlike their broker-dealer cousins, RIAs cannot be forced by FINRA to pay any award. Like private arbitrations, the investor may have to bring an action in court to confirm the award. An award would be binding but not self-executing.
FINRA mediation may be attractive to an RIA, but primarily because of the stable of experienced mediators that regularly engage in mediations of securities disputes. These mediators are not exclusive to FINRA, and may be hired directly. However, FINRA’s mediation arm is a good resource. Several mediators available through FINRA are skilled in the art of making investors feel good about a negotiated settlement while at the same time maintaining credibility with large institutional broker-dealers and their counsel.
A word about FINRA’s fees — FINRA arbitration costs money and FINRA mediators don’t come cheaply. FINRA’s arbitration fees are mostly refundable to the investor, if the case settles more than 10 days before hearing. The RIA has to pay a “surcharge” in an amount determined by reference to the amount of the investor’s claim, ranging from $150 to $3,750. The surcharge is only refundable if the RIA prevails at the hearing or the arbitration panel makes a separate award requiring the investor to reimburse the RIA.
If the case proceeds to a hearing, the parties share “hearing session fees” of $600 to $1,200 per hearing session (for three-arbitrator panels), unless the panel decides to reallocate those fees in its award. A hearing “session” is a morning or an afternoon session, and there can be two hearing sessions per day.
RIAs should consider the possibility of pursuing FINRA arbitration and mediation in customer and employment disputes. In appropriate cases, FINRA’s resources and procedures may be helpful in resolving disputes in a timely and cost-effective manner.
Steven E. Cole is a partner in the law firm of Leclair Korona Giordano Cole LLP, and concentrates his practice in the area of commercial and securities litigation.