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Choices for recouping unpaid FINRA awards seen as flawed


A range of solutions has emerged for dealing with a growing problem of brokerages that skip out on paying arbitration awards they owe to investors. Each, however, is far from perfect

The Financial Industry Regulatory Authority (FINRA), Wall Street’s self-funded regulator, is evaluating whether it needs to address an issue that some investor advocates say is getting out of hand: brokerages that lose securities arbitration cases against investors and then close up shop, leaving those investors unable to collect.

Unpaid awards totaled $51 million in 2011, or 11 percent of the total awards.

An initial idea floated by the regulator – requiring brokerages to carry insurance for payment of the awards – will be trickier to execute than it sounds, say lawyers and insurance professionals. A web of policy exclusions and reluctance by insurers to cover risky small firms, the source of most unpaid arbitration awards, are among obstacles that will have to be overcome, they say.

While FINRA would not comment on other options it may consider, lawyers for investors and consumer advocates have no shortage of suggestions, like making brokerages keep more cash on hand. As with insurance, the suggestions may sound reasonable enough at first glance. But they too have limitations and may increase brokerage industry expenses, setting off contentious battles in Washington, say lobbyists.

“You can come up with all kinds of schemes that could theoretically handle the problem, but then when you ask ‘who pays?'” said Marcus Stanley, policy director of Americans for Financial Reform, a Washington-based advocacy group. Clashes over “who pays” for industry reforms are often the most difficult to resolve, Marcus said.

The following are four more possible solutions to FINRA’s problem of unpaid securities arbitration awards and the hurdles experts say regulators would have to overcome:


A U.S. Securities and Exchange Commission regulation requires all brokerages to keep funds on hand to pay liabilities, including arbitration awards. This, known as net capital, can be as little as $5,000 at some small firms – not enough to cover even tiny awards.

“Why not just hike that amount?” was a recurring question among securities arbitration lawyers at a recent conference. First, doing so is not up to FINRA, but rather the SEC where changing requirements often takes years. Second, a substantial boost of net capital would be needed at smaller brokerages to make such a plan work, said Stephen Hall, a securities specialist at Better Markets, a financial reform group in Washington.

That idea would likely be met with “enormous push back” from the brokerage industry, Hall said. Its fierce lobbying power has been known to slow the SEC down. What’s more, requiring small firms to have even $500,000 on hand could still leave investors stranded when they win arbitration awards that exceed the amount, say lawyers. An SEC spokesman declined comment.


FINRA could require the 630,000 brokers it oversees to kick in annual dues for a recovery fund, said Scot Bernstein, a lawyer in Folsom, California, who has studied the topic of unpaid awards. The dues would not be steep: An annual $200 fee for each broker would create a $126 million fund to cover potential unpaid awards, less the fund’s expenses.

Possible downsides, however, include brokerages that would view the fund as a way to game the system, said William Jacobson, a professor at Cornell Law School’s securities law clinic in Ithaca, New York. That could include small firms that intentionally push risky, high commission securities to investors and then close up shop, knowing investors can recover from the fund. Capping the amount investors could recover may be one way to curb potential abuse, Jacobson said.


The Securities Investor Protection Corporation (SIPC) is a non-profit organization that provides insurance coverage in cases when brokerages close and customers’ assets go missing. SIPC, which is funded by the brokerage industry, does not help investors recover unpaid arbitration awards. Many lawyers for investors, however, say it should. Annual interest from SIPC’s $1.6 billion fund could be enough to pay all unpaid awards, said Ryan Bakhtiari, a Beverly Hills-based securities arbitration lawyer who represents investors.

SIPC’s head, Stephen Harbeck, was not available to comment.

Nonetheless, any SIPC reform measure would likely be a hot-button political issue that could get tied up in Washington for years, especially if it required more funding from the securities industry. “There’s some danger of making the good actors cover the bad actors, if you make everyone in the industry pay,” said Stanley of Americans for Financial Reform.

A lobbying group representing the largest U.S. brokerage firms already seems to be distancing its members from smaller firms causing the problem. “Our members pay their arbitration awards,” said Ira Hammerman, general counsel of the Securities Industry Financial Markets Association in a recent interview.


The ultimate solution may come from combining bits and pieces of the various options, said Hall of Better Markets. Beefing up net capital for small firms, while also requiring insurance, or creating a recovery fund, may collectively plug the gaps that any single choice poses, Hall said. “There is no silver bullet,” he said.

But for Hall, unpaid arbitration awards are one indication of a much larger problem. “What can we do to prevent this victimization in the first place?” he asked.