Securities regulators have created a special process for resolving claims related to auction-rate securities, a move that was welcomed by some who have been pressing for change in the arbitration process.
The Financial Industry Regulatory Authority, a non-governmental regulator for securities brokers and dealers, said Thursday that qualifying investors will have the option of having their claims heard by a three-person panel of arbitrators, none of whom are affiliated with a firm that recently sold auction-rate securities.
The new process stems from one Finra developed for the Securities and Exchange Commission’s settlement with Citigroup Inc. (C), in which the bank agreed to buy back about $7.3 billion in illiquid auction-rate securities, and pay $100 million in civil penalties, with $50 million going to the state of New York.
“The auction-rate securities matter is more widespread than other issues that have developed in the arbitration forum, and we wanted to make sure that any investor, whether in the Citigroup settlement who elects to have a three-person panel, or any other case related to ARS, all got the same treatment,” said Linda Fienberg, president of Finra Dispute Resolution. “This will apply to all auction-rate securities cases that are in our forum whether it’s part of a settlement or not.”
Finra will put the process in place as soon as possible, Fienberg said.
Thus far, Finra has confirmed that more than 170 cases involving auction-rate securities have been filed in its Dispute Resolution forum, but there may be as many as 200, Fienberg said.
The announcement was welcomed by Laurence Schultz, president of the Public Investors Arbitration Bar Association, a national association of attorneys which represent investors in securities disputes, and which has been pressing for change in the arbitration process.
“This is precisely what we’ve been asking for,” said Schultz, of Driggers, Schultz & Herbst in Troy, Mich. “We’re pleased that they have stepped up to this problem and recognized that arbitrators who are associated with firms that were issuing auction-rate securities cannot participate in these panels.”
Typically, for claims of more than $50,000, the three-member panel of judges must include two public members, who may have limited industry connections, and an industry representative. In the process announced Thursday, arbitration panels will continue to have that makeup, but individuals who since Jan. 1, 2005, have either worked for a firm that sold auction-rate shares or supervised someone who sold them will not appear on the lists of non-public arbitrators from which panel members are selected for current and future auction-rate arbitration cases, Finra said.
Arbitration Pilot Program Planned
Schultz said that the flood of auction-rate arbitration claims has helped to emphasize the flaws in the process.
In a May 7 letter to Fienberg, he wrote, “Every investment bank or brokerage firm which originated or sold these securities, either in the original offering or secondary market, is implicated in this wrongdoing. The conflicts of interest are obvious. No prospective ARS arbitrator associated with a firm involved in these activities can avoid the taint of bias or at the very least the appearance of bias.” As a result, any potential arbitrator associated with such firms must be disqualified from serving on any arbitration panel, he wrote.
PIABA believes that industry-connected arbitrators should be banned in all cases, Schultz said.
“We have always opposed the mandatory industry arbitrator on security arbitration panels, and we continue to oppose that,” he said. “This is a perfect example of why the industry arbitrator should not be required.”
“It’s a small step in the right direction,” he said. “I’m pleased, but I would be more pleased if there were no industry arbitrators on these or other cases. I think that customers deserve a completely fair shake, and that there shouldn’t be anybody on a panel with any contacts in the securities industry.”
The process Finra has put in place won’t ensure that investors receive an unbiased decision. “It simply suggests that those who sold or supervised those who sold them won’t be on a panel, but that doesn’t address the larger issue – they should all be public members.”
As an example, he said, imagine if you were presenting a bad faith insurance claim against an insurer as a result of a flood or a fire and you were told that one of the people on the panel would be an insurance adjustor.
“How would you feel?”
Arbitrators with securities-industry connections may be biased even though they didn’t sell auction-rate securities, he said. “That person, even though they didn’t sell the product, might be more friendly to a broker-dealer just because they’ve worked in the industry their whole lives.”
Fienberg said Finra works to eliminate conflicts of interest in all arbitration cases. It will exclude an arbitrator if it identifies a conflict, an arbitrator may recuse themselves or an attorney or investor may bring a challenge if they feel there is a conflict, she said.
Finra plans to undertake a two-year pilot project, which will begin Oct. 6, in which some cases will be heard before an all-public panel if an investor chooses. The pilot will involve at least 466 cases, but Finra hopes to include more, Fienberg said.
The regulator will gather data to determine possible future options for arbitration, she said.