The Financial Industry Regulatory Authority (FINRA) is an independent, nonprofit organization that seeks to ensure that the securities industry operates fairly and honestly. Any firm or broker who sells securities publicly in the United States must be licensed and registered by FINRA and is subject to its oversight. FINRA has jurisdiction over securities-related disputes between investors and registered securities firms and brokers.
There are several reasons aggrieved investors should consider pursuing their claims through FINRA arbitration. Often, an investor who has been lied to or defrauded will be facing the prospect of filing a lawsuit against a large, sophisticated (and typically well-funded) broker-defendant. It is no secret that in civil litigation, if there is a large disparity in the parties’ available resources, the party with fewer resources might face a significant disadvantage. Many litigation tactics that more well-funded defendants can exploit in normal civil cases are eliminated, or at least significantly limited, in FINRA arbitrations.
For example, discovery is far narrower in FINRA than under the civil rules, so respondents cannot drive up unnecessary discovery expenses. Similarly, except in very limited circumstances, respondents cannot file dispositive motions, so the arbitration proceeds to a hearing much faster than in civil court. For smaller damages claims ($50,000 or less), there is almost no discovery and a hearing is not even required. In the overwhelming majority of FINRA cases, the complainant’s claim gets heard, the arbitration panel’s decision is final, and if damages are awarded, they must be paid promptly.
FINRA arbitration decisions are not appealable, so if a complainant is successful, the respondent cannot seek to delay paying an award by pursuing an appeal that could take months or even years.
FINRA was specifically designed to level the playing field and allow aggrieved investors to pursue remedies, regardless of how large or small their damages claims are and regardless of how large of a broker defendant they have to pursue.
History and Structure of FINRA
FINRA was formed in 2007 for the purpose of safeguarding the investing public against fraud and bad practices by investment brokers and investment firms. FINRA is not a part of the government, but it was formed with the approval of Congress and the Securities and Exchange Commission (SEC). Approximately 4,000 brokerage firms and more than 600,000 individual brokers in the United States are registered with FINRA.1
In pursuit of its mission to establish a fair securities market, FINRA writes and enforces rules and regulations governing the sale of investments, which it seeks to enforce in conjunction with federal and state securities laws. FINRA conducts regular compliance examinations of its broker-dealer members, examining between 1,500 and 2,000 brokerage firms each year.2 Every registered brokerage firm is examined at least once every four years.3
Investors’ Options with FINRA
There are two main paths an aggrieved investor can take via FINRA. First, if an investor simply wants to make FINRA aware of potentially fraudulent or suspicious activities by a brokerage firm or a broker, he or she can file an “investor complaint” with FINRA. Doing so triggers an investigatory process, which may lead to disciplinary action against the brokerage firm or an individual broker.
The upside of this option is that it is relatively easy for an investor to file an initial complaint and let FINRA conduct the investigation. The individual complainant will likely not have to invest significant time or resources.
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The downside is that the focus is regulatory in nature, meaning that the primary goal is not to recover monetary damages for the investor who initiated the investigation. There is no assurance that any action taken by FINRA in response to an investor complaint will result in a payment or return of funds or securities to the complaining investor, even if formal disciplinary action is taken, sanctions are imposed, or both. If an investor’s goal is to recover money he or she lost as a result of a broker or a brokerage firm’s misconduct, FINRA’s regulatory investigation process might not be sufficient.
The second path an aggrieved investor can take via FINRA is arbitration. Brokerage firms and investment brokers are required to arbitrate any dispute with an investor-customer if the customer requests arbitration through FINRA and the dispute arises in connection with the business activities of the brokerage firm or broker. Often the parties will have agreed contractually to arbitrate any disputes related to their business dealings, but even in the absence of a contractual arbitration clause, if the customer requests the dispute be heard through FINRA arbitration, the member brokerage firm or broker must arbitrate. That is not an option that brokerage firms can take away from their investor customers.
FINRA Arbitration Process and Advantages for Investors
In typical civil disputes between corporate parties and individuals, it is usually the corporate party that prefers arbitration, for reasons including cost, confidentiality, and limited appeals. But FINRA arbitration in particular can be very beneficial to individual investor-claimants. The FINRA rules specifically contemplate, and seek to protect investors from, the inevitable disparity in the balance of power and financial wherewithal between a large brokerage firm and an individual investor.
Small Claims versus Large Claims. The first major benefit of FINRA arbitration for investors is that the size of the claim dictates how the arbitration process works. Smaller claims (those seeking $50,000 in damages or less) can be decided through a “Simplified Arbitration Process,” which involves a single arbitrator deciding the case by reviewing materials submitted by the parties without an in-person hearing.4
This can save significant time and money (especially attorney fees) for the complaining investor and helps mitigate the “my claim is too small to pursue” problem that is prevalent in many areas of civil litigation. FINRA tries to accommodate all investors, because whether a person lost $25,000 or $2.5 million, if the broker lied about the investment, or engaged in fraud, the investor is entitled to have his or her claim heard.
Larger claims involve more intensive procedures and require an in-person hearing by a panel of three arbitrators. Although more expensive and time consuming than the simplified arbitration process used for smaller claims, there are still many advantages of FINRA arbitration to investors with larger damages claims.
FINRA tries to accommodate all investors, because
whether a person lost $25,000 or $2.5 million, if the
broker lied about the investment, or engaged in fraud, the
investor is entitled to have his or her claim heard.
Initial Pleadings. A claimant initiates FINRA arbitration by filing a statement of claim that specifies the relevant facts and remedies requested. Much like a civil complaint, the statement of claim should provide the details of the dispute, including relevant dates, names of entities and individuals involved, and the type of relief requested, which can include monetary damages, interest, or even specific performance. The claimant must pay a filing fee (ranging from $50 to more than $2,000 depending on the amount of damages requested) when initiating a case, but the filing fee may be waived in cases of financial hardship.
Once the statement of claim is filed, FINRA serves it on the respondent (for example, the brokerage firm or broker), who must file and serve an answer within 45 days. Another benefit of the FINRA arbitration process to investors is that the rules strictly limit dispositive motions. In the early years after FINRA was formed, brokerage-firm respondents would often file motions to dismiss or early summary-judgment motions seeking to delay the process and cause added expenses.
FINRA quickly adapted its rules to discourage that practice by substantially limiting the grounds on which a dispositive motion could be used to dispose of a case before a hearing is held.5 Currently available grounds include that the claim has already been settled or released; that the moving party was not associated with the account, security, or conduct at issue (that is, the claimant named the wrong defendant); or that the claim is not eligible for arbitration because the statute of limitation has run.6 If a party files a dispositive motion frivolously or in bad faith, the panel may assess fees against the moving party and issue other sanctions it deems appropriate.7
Selecting an Arbitration Panel. Another advantage of FINRA arbitration is that it allows the parties access to a great deal of information. In selecting an arbitration panel, FINRA uses a neutral list selection system (NLSS) to generate random lists of potential arbitrators selected from a roster of individuals preapproved by FINRA. The lists come with arbitrator disclosure reports, which disclose somewhat extensive background information about each of the potential candidates. FINRA also maintains a database, which the parties can access, detailing each candidate’s experience as a FINRA arbitrator and the results from all FINRA arbitrations each candidate has presided over.
After reviewing all the information, the parties can strike a certain number of potential arbitrators from the lists and then rank the remaining choices and submit their rankings to FINRA. The parties’ lists are then combined, and FINRA appoints the highest ranked available arbitrators to serve on the panel.8
Initial Prehearing Conference. Once a panel is appointed, an initial prehearing conference is scheduled. This is the first meeting between the parties and the arbitrators and it is typically conducted by telephone. Much like a scheduling conference in a civil case, the parties and arbitrators meet to discuss the case and set a case schedule, including establishing discovery and motion deadlines, setting briefing schedules, choosing dates for evidentiary hearings, determining whether mediation is desirable and worthwhile, and discussing any other preliminary matters that the parties think will need to be addressed before a final hearing can take place.9
Discovery. The FINRA Code of Arbitration Procedure (the code) requires parties to cooperate with each other to the fullest extent practicable in the voluntary exchange of documents and information to expedite the arbitration process. The code contains rules that govern the discovery process, including making discovery requests, responding and objecting to such requests, and arbitrator authority to issue sanctions against parties for discovery abuses.10
FINRA discovery focuses almost exclusively on the exchange of documents. Parties do not have the right (although it can be requested in extraordinary circumstances) to take depositions. This can benefit parties with fewer resources because it prevents the more well-funded party from driving up expenses by serving extensive written discovery and conducting numerous depositions.
FINRA’s Discovery Guide contains guidelines requiring parties to automatically exchange certain documents and information without requiring affirmative discovery requests.11 These categories of documents are considered relevant to every FINRA dispute. This is another benefit of the process to investors because there are certain categories of documents they are automatically entitled to from the respondent. Parties can request additional documents beyond those contemplated by the discovery guide, but the requests must be reasonable. A party who is served with additional discovery requests may object if the requests are overly burdensome or not relevant to the case or seek privileged information.12
Subpoenas to third parties can be issued in FINRA arbitration, but only by arbitrators, not directly by parties’ lawyers.13 A party who wants to subpoena a third party must make a motion to the arbitration panel to issue the subpoena. The arbitration panel determines whether, and to what extent, the subpoena should be issued and how the costs for compliance will be assessed. This is another example of how the FINRA rules are designed to expedite the process and deter larger parties from trying to exploit their stronger financial position by driving up the costs of the proceedings through extensive and unnecessary third-party discovery.
FINRA discovery focuses almost exclusively on the
exchange of documents. Parties do not have the
right (although it can be requested in extraordinary
circumstances) to take depositions.
Hearing and Decision. Once discovery is completed and any preliminary motions are ruled on, the arbitration hearing is held. The hearing typically takes place at the FINRA location closest to where the investor resided at the time of the events giving rise to the dispute.14 FINRA has locations throughout the United States, including at least one in every state (the Wisconsin FINRA office is in Milwaukee).
The hearing operates much like a civil bench trial and typically is conducted in the following order: opening statements; presentation of facts by the claimant (the investor) via live testimony and documents; presentation of facts by the respondent (the brokerage firm or broker) via live testimony and documents; presentation of any counter-claims, cross-claims, or third-party claims; rebuttal evidence; closing statements; and scheduling of post-hearing submissions.15 The hearing is recorded digitally but a stenographic record can be made as well.
After the hearing is concluded and any post-hearing briefing is completed, the arbitration panel deliberates and determines the relief the claimant is entitled to, if any. In the typical three-arbitrator panel, the award is based on the vote of a majority of the arbitrators; a unanimous decision is not required.16 The award must be made in writing, within 30 business days from the date the record is closed.17 The panel is not required to write a detailed opinion or even provide an explanation or reason for its decision, although the parties can jointly request an “explained decision.” As part of the award, the panel decides whether to assess any costs or fees from the arbitration against any party. All awards are posted online and made publicly available.
FINRA has no appeals process. Awards are final and are not subject to review, except under very limited circumstances. Under federal law, a FINRA arbitration award may be vacated only if it is proved that 1) the award was procured by corruption, fraud, or undue means; 2) the arbitrators engaged in misconduct that prejudiced the rights of one of the parties; 3) the arbitrators exceeded their powers or disregarded a clearly defined law; or 4) the award is based on complete irrationality (that is, there is absolutely no factual or reasonable basis for the award).18
If a claimant is awarded damages, the respondent must pay within 30 days after receiving the written award, unless he or she files a motion to vacate. If a brokerage firm fails to pay an arbitration award within 30 days, it risks being sanctioned heavily by FINRA, including having its license suspended or revoked.19
Often the knee-jerk reaction for individuals and their lawyers when they are opposing a large corporate party is that arbitration will benefit the corporate party more than the individual. Sometimes that is true. But the FINRA arbitration process, by design, seeks to mitigate many of the disadvantages individual investors who have been wronged may face in other venues, and provides them with a way to pursue their claims more efficiently. That is a major reason why individual investors and their attorneys should strongly consider pursuing their securities-related claims, no matter how large or small, through FINRA arbitration.
Meet Our Contributors
What is one of the biggest challenges you deal with in your practice?
In addition to representing clients on both sides of civil securities law cases, we also defend criminal securities fraud prosecutions and other similar white-collar crimes. One of the biggest challenges in those cases is that, because of the complexity of the issues, the defense often includes an important element of educating the judge and the jury regarding the facts and how they should be viewed in the context of the criminal securities laws.
While we embrace that challenge, it can be very stressful to know that innocent people could potentially be found guilty of a crime they did not commit because the trier of fact may misunderstand a complicated securities transaction, and might see what they believe to be evidence of fraud where there really wasn’t any. That is why it is vitally important in all securities cases to make sure we, as the lawyers, fully understand all of the details of the transactions at issue in the case, so that we are able to provide the best possible representation to our clients.
Aaron H. Aizenberg, Kravit, Hovel & Krawczyk S.C., Milwaukee.
What’s the best career advice you ever received?
One of the best pieces of advice I have received in my practice is to become a “master of the facts” at the start of each case. This means taking the time at the beginning of each new matter to understand all of the available information from the client’s perspective as well as identifying and considering the opposing party’s view of the facts. Mastering the facts requires reviewing and analyzing all of the available documents and information and asking the client the right questions to discover information they may have missed. This approach allows you to develop legal theories and strategies that will continue to benefit the client throughout the case.
Cases are won or lost on the facts, and the side with the better mastery of the facts is much more likely to successfully achieve its goals.
Benjamin R. Prinsen, Kravit, Hovel & Krawczyk S.C., Milwaukee.
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1 Financial Industry Regulatory Authority, About FINRA, (last visited April 1, 2017).
4 FINRA, (last visited April 1, 2017).
5 FINRA Code of Arbitration Procedure for Customer Disputes [hereinafter FINRA Code] Rule 12504.
7 FINRA Code Rule 12212.
8 FINRA Code Rules 12400-12403, 12800.
9 FINRA, Prehearing Conferences, (last visited April 1, 2017).
10 FINRA Code Rules 12505-12511.
11 FINRA, Discovery, (last visited April 1, 2017).
12 FINRA Code Rule 12508.
13 FINRA Code Rule 12512.
14 FINRA Code Rule 12213.
15 FINRA Code Rules 12600, 12607.
16 FINRA Code Rules 12608, 12904.
17 FINRA Code Rule 12904.
18 See Federal Arbitration Act, 9 U.S.C. § 10.
19 FINRA Code Rule 12904; FINRA Rule 9554.