Wednesday, April 18, 2018

NASAA backs FINRA proposal to incentivize payment of arb awards, offers improvements

By John M. Jascob, J.D., LL.M.

NASAA has offered support for a FINRA proposal that would use FINRA’s Membership Application Program to incentivize the timely payment of arbitration awards. NASAA believes that the proposed rule amendments represent a positive step in addressing the problem of broker-dealers and associated persons who fail to comply with their regulatory and ethical obligations to satisfy arbitral awards against them. NASAA cautioned, however, that the amendments will not, by themselves, resolve this important investor protection concern. Accordingly, NASAA’s comment letter offered suggestions to strengthen the proposal while offering help in finding a solution that will ensure that no investor awards or settlements go unpaid.

Amendments to Membership Application Program. As described in FINRA Regulatory Notice 18-06, the amendments would amend FINRA’s new and continuing member application processes to address situations in which a FINRA member firm hires individuals with pending arbitration claims, where there are concerns about the possible payment of those claims. The proposal also seeks to address situations where a member firm with substantial arbitration claims seeks to avoid the payment of pending claims by shifting assets to another firm and closing down.

In responding to FINRA’s specific requests for comments, NASAA stated that it is appropriate for the proposal to distinguish new membership applications from continuing membership applications with respect to whether a presumption of denial should apply to pending arbitration claims. Applying a presumption of denial to new membership applications with pending awards is appropriate given that these firms will lack operating histories with FINRA, NASAA wrote. In contrast, existing FINRA members have operating histories that FINRA can review and consider in any continuing membership application request. Presumptively denying continuing membership applications with pending claims would be unnecessarily disruptive and would disincentivize FINRA members from taking-on potential liabilities through business acquisitions, possibly resulting in more arbitration awards ultimately going unpaid.

Scope and definitions. NASAA also supports the broad scope of the proposal, which NASAA interprets to cover any person who seeks to become associated with a FINRA member. NASAA believes that making the proposal applicable only to principals, control persons, officers or similar persons would open the process up to gamesmanship by member firms, who could avoid the proposal’s reach by staffing such individuals temporarily in administrative positions.

NASAA urged FINRA, however, to expand the proposal's definition of "Covered Pending Arbitration Claim" to include all investment-related arbitration claims, such as JAMS or AAA proceedings. NASAA also suggested that FINRA expand the definition to include any investment-related claims pending in a state or federal court. Without these clarifications, an investment adviser representative seeking to become associated with a FINRA member might conclude that a private proceeding or pending court case need not be disclosed under the proposal. In addition, NASAA recommends the term “claim amount” be defined more broadly so that pending claims with joint liability are assessed to each respondent maximally, as if no other person could be potentially liable.

Verification of disclosures. Among its other comments, NASAA also recommended that FINRA expressly state in the proposal that FINRA may in its discretion contact claimants to confirm the accuracy of an applicant’s disclosures concerning unpaid arbitration awards or settlements. In addition, the NASAA urged FINRA to revise the proposal to explicitly state that FINRA may require an expert’s opinion to support an applicant’s assertion that it can satisfy any unpaid award or settlement obligation it intends to assume. In NASAA's view, however, this expert opinion does not necessarily need to be from an “independent” source. Instead, the proposal should give FINRA staff the authority to assess the veracity and reasonableness of an offered expert opinion on a case-by-case basis, NASAA wrote.