The Neutral Corner, Volume 4—2008
Writing a Disciplinary Referral
By Jeffrey Bloom*
The Enforcement Department (Enforcement) is the division of FINRA that enforces FINRA's rules and the federal securities laws governing broker-dealer firms and associated persons. In addition to monitoring the industry, Enforcement investigates and brings actions based on information received from other FINRA departments and outside sources, including referrals from arbitrators.
Because of limited resources, FINRA staff cannot investigate every case. Also, not every complaint alleging a violation of FINRA rules or securities laws establishes a violation. By having heard the evidence and reviewed the case materials, arbitrators provide a very important screening function—and can help Enforcement identify those cases that justify further action.
Arbitrators should make referrals if they believe that the evidence or other information they receive in a case indicates misconduct by individuals or firms in the industry. Keep in mind, however, that not all cases decided in favor of claimants are appropriate for disciplinary referral. This article will address the referral process, the types of cases that are appropriate for referral and suggestions for writing the referrals.
The Referral Process
Arbitrators can make referrals once an arbitration is concluded.1 At that time, if arbitrators determine a referral is appropriate, they should complete the Disciplinary Referral Form and return it to Dispute Resolution staff; referrals should not be sent directly to Enforcement.2
Dispute Resolution then forwards the form to Enforcement or Member Regulation. All referrals undergo a preliminary review, which may involve obtaining documents and information directly from the firm or associated person.3 If Enforcement deems it appropriate, it will refer the matter to an investigator or to a team for a full investigation, including on-the-record testimony. FINRA does not reveal the source of the referral at any point in the process.
Following the investigation, Enforcement will determine whether to pursue formal or informal action. Some cases are closed without action; others result in informal action, such as a Letter of Caution, which is not reported publicly but remains part of the firm or individual's disciplinary record should other misconduct occur in the future. The more significant cases result in formal action, leading to a settlement or filing of a disciplinary complaint. Sanctions in formal actions can include fines or suspensions, bars or expulsions from the industry. Arbitrators will not be called as witnesses in disciplinary hearings resulting from their referrals.
Because disciplinary investigations are confidential, FINRA cannot advise arbitrators what actions resulted from their referrals. FINRA publishes formal sanctions in its Regulatory Notices.
Cases Appropriate for Referral
In general, violations that can lead to arbitrator referrals fall into four major categories: 1) substantive, 2) ethical, 3) a combination of substantive and ethical and 4) procedural. Arbitrators will deal most often with substantive trading violations, such as churning, suitability and unauthorized trading. Ethical violations include falsifying documents, lying to customers and lying to supervisors. Less common but usually more severe are violations that are a combination of both ethical and substantive, including market manipulation and fraud on the market. Finally, certain procedural violations only come to light in arbitration, such as discovery abuses and restrictive customer agreements (e.g., attempting to limit punitive damages).
Enforcement is committed to ensuring that the arbitration process is fair and takes referrals of discovery abuses very seriously; however, not all situations warrant a disciplinary referral. An example of a strong case for referral would be one in which the firm failed repeatedly to produce materials without realistic explanations, despite the arbitrators' numerous warnings.
Arbitrators should also exercise discretion when citing substantive violations in a disciplinary referral. In many situations, the evidence will not establish a clear violation of rules or laws, but the panel may find in favor of the claimant based on credibility determinations or belief in the validity of the claim. If the panel sees evidence of a systemic problem, a referral may be appropriate. For example, a case may involve one customer and one broker, but the evidence suggests that the problem extends to numerous brokers and customers, or that firm-wide supervisory problems allowed the improper activity to occur. These types of referrals may enable Enforcement to prevent future harm to customers and to remedy past activity.
Occasionally, important referrals result from gut instinct or a general sense that something is wrong. Cases like this can be difficult to describe in the referral form; the best approach is to describe, in detail, the facts that caused the panel to make the referral, without drawing a specific conclusion.
Similarly, arbitrators should make referrals when they perceive a problem that extends beyond the broker and firm at issue. This can arise in cases in which the defense suggests that the broker's actions were not unusual in the industry, possibly even presenting evidence in support of this theory. Relying on industry experience, the non-public panel member may believe the practice is in violation of FINRA rules, even if it is followed at a number of firms. If there is no violation present, a referral still gives FINRA the opportunity to review questionable activity to determine if additional rule-making or clarification of existing rules is necessary.
With referrals in general, the more recent the activity, the stronger the case. Although there is no statute of limitations applicable to disciplinary actions, delay in bringing an action can be a basis for a defense. Additionally, if too much time has passed, FINRA may not bring a formal action because disciplinary sanctions at that point would have little or no deterrent value.
Helpful Hints When Writing a Referral
Arbitrators should provide as much detail as possible. Simply repeating the allegations of the Statement of Claim provides no guidance as to why the panel made the referral. Whenever possible, arbitrators should reference particular testimony or documents that support their referral. Arbitrators are not limited to referring the parties to the case; they can also refer the activities of non-parties (broker-dealers or associated persons) for disciplinary review.
Arbitrators should discuss, objectively, why the activity or behavior appears to violate FINRA rules. Arbitrators should also avoid using vague language like, "this is why the panel ruled the way it did." Instead, they should consider using specific examples or references, "although this case involved just one customer, documents presented and the respondent's own testimony (specifying documents or aspects of the testimony) suggested this type of activity was common at that firm." This is particularly useful for cases in which the panel perceives a systemic problem (e.g., the firm sold the same unsuitable investment to many or all of its elderly clients, or supervisors routinely ignored evidence of excessive trading).
The referral should explain what factors stood out from normal practice. For example, in a suitability case, arbitrators should describe their concerns about the product and how it was sold to its customers. In the situation where the referral is based on a feeling rather than evidence of a particular rule violation, arbitrators should discuss in detail what they believe is wrong about the activity.
If the activity occurred in the distant past, the panel should discuss why it believes it may be ongoing or could occur again in the future. An Enforcement case that has the potential to prevent future customer harm gets more attention than one in which a customer has already received compensation through arbitration.
Arbitrator referrals are very important to FINRA's ability to regulate the securities industry. Detailed referrals enable Enforcement to promptly and thoroughly investigate individuals and firms when arbitrators believe a disciplinary referral is warranted.
* Jeffrey Bloom joined FINRA in January 2000, and is Senior Special Counsel in the Washington, D.C. office of the Enforcement Department. In this position, he represents FINRA in disciplinary investigations and hearings.
Prior to joining FINRA, Mr. Bloom was in private practice for 19 years, most recently as a partner in the Washington office of Duane Morris LLP, specializing in securities litigation and arbitration. He represented broker-dealers, associated persons and public customers. He served as an arbitrator for FINRA and other organizations, and taught Continuing Legal Education programs on securities law and Alternative Dispute Resolution. He graduated from the State University of New York at Binghamton and obtained his law degree from the Georgetown University Law Center.
1 Code of Arbitration Procedure Rules 12104(b) and 13104(b).
2 A copy of the Disciplinary Referral Form may be found in the Arbitrator's Reference Guide.
3 Enforcement staff will not contact arbitrators directly. If additional information is needed, Enforcement will ask Dispute Resolution to initiate the contact.
Dispute Resolution News
Arbitration case filings from January through May 2008 reflect a 22 percent increase compared to cases filed during the same five-month period in 2007 (from 1,398 cases in 2007 to 1,708 cases in 2008). In recent months, we have received numerous cases claiming that losses were incurred from investments holding subprime mortgages (typically claims that funds were overconcentrated in this investment vehicle without adequate disclosure) and "failed auctions" for auction rate securities.
From January 1 through June 30, 2008, the average processing time from service of claim to issuance of award for arbitration cases (hearing and simplified) declined to 13.5 months (from 13.6 months in 2007).
Neutral Roster Call-In Workshop
June 19, 2008: Experienced Neutrals Present: Best Practices for Handling Difficult Situations
FINRA hosted a call-in workshop on June 19, 2008, entitled "Experienced Neutrals Present: Best Practices for Handling Difficult Situations." George Friedman, Executive Vice President and Director of FINRA Dispute Resolution, updated listeners on current developments in Dispute Resolution. He then moderated a discussion with two experienced arbitrators—Constantine (Gus) Katsoris, Wilkinson Professor of Law at Fordham Law School, and David Robbins, a partner in the law firm Kaufmann, Feiner, Yamin, Gildin & Robbins LLP. Using real-life scenarios, the faculty discussed best practices for arbitrators in handling difficult situations during an arbitration proceeding. They also addressed questions that other arbitrators submitted in advance of the workshop.
If you missed the workshop, you may listen to a recording of it on our Web site.
2008 FINRA Spring Securities Conference
In May, FINRA held its 2008 Spring Securities Conference in Hollywood, Florida. This conference provided comprehensive updates on securities industry rules, regulations and compliance issues.
During the conference, Dispute Resolution conducted a workshop on the basics of arbitration using a hypothetical arbitration claim. Presenting this interactive program were: Linda Fienberg, President of FINRA Dispute Resolution; George Friedman; Garry O'Donnell, FINRA Arbitrator; Melanie S. Cherdack, of the law firm Genovese Joblove & Battista, P.A.; and Richard L. Martens, of the law firm Casey Ciklin Lubitz Martens & O'Connell. More than 70 participants attended the Dispute Resolution workshop.
SEC Filing and Approval
Proposed Rule Change to Amend the Discovery Guide to Update the Document Production Lists
On June 11, 2008, FINRA filed with the Securities and Exchange Commission (SEC) a proposed rule change to amend the Discovery Guide to update and make changes to the Document Production Lists. Please visit our Web site for more information about this rule proposal.
Amendment to the Definition of Public Arbitrator
On March 13, 2008, the SEC approved SR-NASD-2007-021, which amends the definition of public arbitrator to add an annual revenue limitation. This is the latest in a series of rule amendments designed to "tighten up" the definition of public arbitrator. Under the new rule, a person will not be classified as a public arbitrator if he/she is an attorney, accountant or other professional whose firm derived $50,000 or more in annual revenue in the past two years from professional services rendered "to any persons or entities involved in securities business relating to any customer disputes concerning an investment account or transaction…" The rule specifically includes law firm fees, accounting firm fees and consulting fees. It complements a 2004 rule change excluding from the public arbitrator pool an attorney, accountant or other professional whose firm derived 10 percent or more of its annual revenue from securities industry clients.1
The SEC published the Approval Order in the Federal Register on March 13, 2008. FINRA published a Regulatory Notice on May 9, 2008 that describes the proposal and how it will be applied. The rule became effective on June 9, 2008.
FINRA sent a survey to the available public arbitrators on its roster to ensure that they were correctly classified when the rule went into effect. Public arbitrators who did not return the survey by June 9 were made inactive on the roster, and will not receive any new assignments until they submit a completed survey. If you have not yet responded to the survey, please email the office of Neutral Management for information about completing the survey and possibly being reinstated to the active roster.
To review the Approval Order or for more information about the new rule, please visit our Web site.
Web Site Updates
The Neutral Corner Index
FINRA Dispute Resolution has indexed its back issues of The Neutral Corner. In addition to listing our back issues and making them available on our Web site, we have now indexed the topics of each issue for easy reference.
You can review the newly indexed issues of The Neutral Corner on our Web site.
New Webcast Available
FINRA has introduced a new Webcast that explains FINRA's regulatory processes: What to Expect: The FINRA Rulemaking Process. The Webcast—featuring an introduction from FINRA CEO Mary Schapiro and a presentation by FINRA staff—explains FINRA's rulemaking process and the process by which the public can comment on a proposed rule.
You can find out more about the Webcast on FINRA's Education and Programs page.
Hearing Scripts Changes
FINRA Dispute Resolution has made changes to its hearing scripts, effective April 28, 2007. Before closing the hearing, arbitrators will ask parties: 1) for a summary of their final requests for damages; and 2) whether they want to raise any other issues or objections. Specifically:
- In response to parties' recommendations that the award include information reflecting the amount of damages requested in the pleadings and at the conclusion of the evidentiary hearing, FINRA modified the Hearing Script to have arbitrators ask the parties to restate their respective claims and summarize their final damage requests following their closing arguments at the hearing. FINRA will add the final damage requests to the award if they differ from the earlier damage requests. The new procedure provides more information to the public about the final damage requests made and makes it easier to understand why there may be a difference between the monetary damages initially sought and the amount awarded.
- FINRA's Hearing Script formerly required arbitrators, before closing the hearing, to ask parties to state affirmatively whether they had a "full and fair" opportunity to be heard. At the recommendation of the NASD and NYSE task group charged with integrating the two SROs' (self-regulatory organization) dispute resolution programs, FINRA modified the Hearing Script by removing the "full and fair" language and replacing it with the following question the arbitrators will pose to the parties: "Do the parties have any other issues or objections that they would like to raise that they have not previously raised?" The new procedure gives the parties an opportunity to raise issues they might have previously failed to raise.
You can find more information about these changes at the Arbitration and Mediation page.
Know Your Arbitrator Identification Number
With over 6,000 arbitrators on our roster, it is important that arbitrators know their arbitrator identification number. You will need the number whenever you register for an online training program, update your arbitrator disclosure profile or contact our offices with an inquiry. You will find the five-digit arbitrator identification number on your disclosure report and on all FINRA correspondence mailed directly to you (it begins with the letter "A"). We have several arbitrators with the same name, therefore, presenting your arbitrator identification number will reduce confusion and enable staff to provide you with information quickly and efficiently.
1 Code of Arbitration Procedure Rules 12100(u)(4) and 13100(u)(4).
Arbitration Awards: The Offset Option
By Avi Badash, Arbitration Administrator, FINRA Case Administration
In most cases, arbitration cases conclude with an award, in which arbitrators will order one party to pay another. However, in some awards, arbitrators may order opposing parties to pay each other monetary damages. For example, arbitrators may order that Claimant pay Respondent $5,000 and Respondent pay Claimant $100,000.
Under the Code of Arbitration Procedure (Code), monetary awards must be paid within 30 days of receipt of the award.1 The Code does not contemplate automatic payments of the net difference of awards (commonly referred to as offsets). In other words, the parties in the example above each have separate obligations to comply with the award. The parties cannot assume that Respondent must pay the net difference of $95,000 under the award.2
Without further clarification from the panel, the parties may wonder whether the panel intended for each party to pay the full amount or for the party who owes the higher amount to pay the net difference. This ambiguity may lead to an issue of fairness. In the example above, the parties' obligations to pay are independent. If Claimant refuses to pay, Respondent must still pay Claimant the full $100,000, and not the net difference of $95,000. Moreover, if Respondent refuses to pay, Claimant must still pay Respondent $5,000, even though Claimant has not received any payment.
Clarify the Award
The panel should clarify its intentions in the award in order to avoid ambiguity regarding payment. If the panel intended the party which owes the higher amount to pay the net difference, the panel might state the parties' liabilities in the award and also include an offset provision that clarifies payment. The following is an example of an award with an offset provision:
- Respondent is liable for and shall pay to Claimant compensatory damages in the amount of $100,000.
- Claimant is liable for and shall pay to Respondent compensatory damages in the amount of $5,000.
- The above amounts are offset. Respondent is liable for and shall pay to Claimant the sum of $95,000.
Conversely, if the panel's intent is to have each party's obligation to pay as an independent obligation, the panel might include a provision to that effect in the award. The following is an example of an award with such a provision:
- Respondent is liable for and shall pay to Claimant compensatory damages in the amount of $100,000.
- Claimant is liable for and shall pay to Respondent compensatory damages in the amount of $5,000.
- Each party shall pay the full amount awarded against that party, irrespective of the other party's liability.
In cases where arbitrators order opposing parties to pay each other monetary damages in an award, the panel should clarify its intent by indicating whether each party should pay the other or offset the awarded amounts. Arbitrators should contact their case administrator if they have any questions.
1 Code of Arbitration Procedure Rules 12904(i) and 13904(i).
2 The parties may stipulate to an offset and have the party who owes the higher amount pay the net difference.
Question and Answer: Non-Party Subpoenas
Question: I recently received a request to issue a non-party subpoena. What are the guidelines arbitrators should consider when determining whether to grant such a request?
Answer: Pursuant to Rules 12512 and 13512 of the Codes of Arbitration Procedure, only arbitrators have the authority to issue subpoenas for documents and for the appearance of witnesses at a hearing before the arbitrators. This rule became effective on April 2, 2007, and applies to subpoenas issued on or after that date, regardless of when the case was filed. FINRA staff will send the arbitrator the requesting party's motion for issuance of the subpoena, the subpoena itself, and any related papers filed by the other parties.
Whenever a party requests that the arbitration panel sign a subpoena, the panel should consider the propriety, relevance and reasonableness of the materials requested. If there is a question regarding applicable law governing a subpoena request, the panel should require parties to provide briefs and/or schedule a prehearing conference call to address the unresolved legal issues.
Once an arbitrator signs a subpoena, FINRA will send it to the requesting party, who will then be responsible for its service and enforcement. If a non-registered entity or an individual not associated with a brokerage firm fails to comply with the subpoena, the party who requested the subpoena must seek its enforcement in a court of proper jurisdiction.
Mediation and Business Strategies Update
Mediation Outreach Efforts
On April 1, 2008, Julie Crotty, Assistant Director of Mediation, participated in a panel about "Careers in Dispute Resolution," sponsored by the Benjamin N. Cardozo Office of Career Services, the New York State Dispute Resolution Association, Cardozo Dispute Resolution Society and the ABA Section of Dispute Resolution. Approximately 150 participants, including students, mediators and professionals interested in changing careers, attended the panel discussion.
On April 18, 2008, Kenneth Andrichik, Director of Mediation, guest-lectured at Georgetown University Law School.
On June 19, 2008, Ms. Crotty participated in a panel entitled "Diversity and ADR Panels" at the Center for Alternative Dispute Resolution's Annual Conference in Greenbelt, Maryland.
FINRA Dispute Resolution's Mediation Department is also participating as a sponsoring organization in the New York State Bar's Diversity Internship Program.
Business Strategy Developments
Associate Director William Kimme has been working with FINRA's U.S. Exchange Solutions Department (Exchange Solutions) to promote FINRA's regulatory and dispute resolution services to several U.S. exchanges. Dispute Resolution manages the dispute resolution forum for seven exchanges. Mr. Kimme continues to work with the Counselors of Real Estate's (CRE) dispute resolution board in preparation for the formal opening of its arbitration forum.
In an effort to expand FINRA Dispute Resolution's international presence, Mr. Kimme expanded the London roster with additional FINRA arbitrators and mediators who travel to London frequently.
NOTE: Participants must successfully complete the online portion of the Basic Arbitrator Training Program before attending an onsite training program. Please visit the Arbitrator Training page at www.finra.org for more information. FINRA generally requires a minimum of nine attendees to conduct an onsite session.
Northeast Regional Update
On June 4, 2008, Elizabeth Clancy, Vice President and Director of the Northeast Regional Office, participated in a panel discussion entitled "Securities Arbitration and Mediation Hot Topics 2008: The Program for Attorneys, Experts, Arbitrators & Mediators" at the New York City Bar Association.
During the next three months, the Northeast Regional Office will conduct the following in-person Basic Arbitrator Training programs:
|Philadelphia, PA||July 16, 2008|
|Albany, NY||August 20, 2008|
|Rochester, NY||September 10, 2008|
|New York, NY||September 18, 2008|
If you are interested in attending a Basic Arbitrator Training program, please contact Cicely Moise at (212) 858-3963.
Midwest Regional Update
During the next three months, the Midwest Regional Office will conduct the following in-person Basic Arbitrator Training programs:
|Minneapolis, MN||July 16, 2008|
|Columbus, OH||August 13, 2008|
|Wichita, KS||September 17, 2008|
If you are interested in attending a Basic Arbitrator Training program, please contact Deborah Woods at (312) 899-4431.
West Regional Update
In April, the West Region held two recruiting events to attract new arbitrators to FINRA's roster. On April 10, Judith Hale Norris, Vice President and Regional Director, met with prospective arbitrators at the Straus Institute of Dispute Resolution's program entitled "Negotiating, Mediating, and Managing Conflict: Evolution in a Global Society" at Pepperdine University School of Law. From April 28 – 30, Case Administrator Audrey Philips and Ms. Norris attended the Inter-Pacific Bar Association's 18th Annual Meeting and Conference in Los Angeles and met with interested participants about FINRA's dispute resolution program.
In April, Paula Union, formerly a Senior Arbitration Counsel with the New York Stock Exchange, relocated from FINRA's Northeast Regional Office. Please join us in welcoming Paula in her new role as a Case Administrator in the West Regional Office.
During the next three months, the West Regional Office will conduct the following in-person Basic Arbitrator Training programs:
|Denver, CO||July 15, 2008|
|Seattle, WA||August 19, 2008|
|Dallas, TX||September 16, 2008|
If you are interested in attending a Basic Arbitrator Training program, please contact David Newson at (213) 613-2693.
Southeast Regional Update
During the next three months, the Southeast Regional Office will conduct the following in-person Basic Arbitrator Training program:
|Raleigh, NC||September 23, 2008|
If you are interested in attending this Basic Arbitrator Training program, please contact Lanette Cajigas at (561) 447-4911.
Arbitrator Tip: Witnesses Testifying Out of Order
During a hearing, a claimant will generally present a case, followed by a respondent's defense.1 The panel has discretion to vary the order in which it conducts the hearing but must give each party a fair opportunity to present its case.2 Parties generally can set the order of their witnesses when presenting their cases. Occasionally, counsel will ask to present a witness out of order because of scheduling conflicts.
Frequently, the parties will agree that a witness for one side may testify during the other side's presentation of its case. These witnesses are typically not parties or the main fact witness in the case; examples include records custodians or persons with limited knowledge of the facts. A witness who will testify as to the authenticity of exhibits might be a candidate to testify out of order. If the parties agree, the arbitrators should allow the witness to testify out of order.
If the parties do not agree to allow a witness to testify out of order, the arbitrators should weigh the parties' arguments and ask for an estimate of the length of time of the witness' testimony. Party witnesses or essential fact witnesses should generally testify during their side's presentation of its case. If testifying out of order cannot be avoided, arbitrators should consider whether this would unreasonably disrupt the party's ability to present its case effectively.
Arbitrators should also be mindful to conduct the arbitration in a fair and efficient manner.3 In deciding whether to permit the witness to testify out of order, the arbitrators should consider the possible travel cost or inconvenience to the witness, who may need to appear at the hearing for a second time.
1 Code of Arbitration Procedure Rules 12607 and 13607.
2 Code of Arbitration Procedure Rules 12607 and 13607.
3 AAA/ABA Code of Ethics for Arbitrators in Commercial Disputes, Canon I, Paragraph F. A copy of the Code of Ethics may be found at http://www.finra.org/ArbitrationMediation/ResourcesforArbitratorsandMedi....
Message from the Editor
In addition to comments, feedback and questions regarding the material in this publication, we invite you to submit suggestions for articles and topics you would like addressed. We reserve the right to determine which articles to publish.
Please send your comments to:
Jisook Lee, Editor
The Neutral Corner
FINRA Dispute Resolution
One Liberty Plaza
165 Broadway, 27th Floor
New York, New York 10006
You may also email Jisook.
Linda D. Fienberg
George H. Friedman
Kenneth L. Andrichik
Jean I. Feeney
Richard W. Berry
Barbara L. Brady
Elizabeth R. Clancy
Judith Hale Norris
David Carey - Case Administration
Julie Crotty - Mediation
Nicole Haynes - Northeast Region
Mignon McLemore - Office of Chief Counsel
Nene Ndem - Southeast Region
Rina Spiewak - West Region
Patrick Walsh - Midwest Region
FINRA Dispute Resolution Offices