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Finra Arbitration for Investment Advisers Explained

Wall Street Journal

The Financial Industry Regulatory Authority explained Thursday how it will open its arbitration forum to registered investment advisers, a group it doesn’t have any enforcement power over–at least not yet.

Wall Street’s self-regulator now oversees only brokers and not investment advisers, who are supervised directly by the Securities and Exchange Commission. Traditionally, its arbitration system has been used to resolve disputes between brokerages and their clients or employees.

On its website Thursday, Finra said it was starting to offer arbitration services to investment advisers and laid out a series of guidelines, such as requiring the parties in dispute to agree to accept arbitrators’ rulings and to pay costs. It said the expansion was the result of inquiries from lawyers representing both investors and advisers.

The move comes as Finra is angling to assume oversight of investment advisers from the SEC, but has said the two activities aren’t connected.

Many investment advisers fiercely oppose Finra becoming their regulator, but they may be inclined to test out Finra’s dispute-resolution system. Their disputes now are often heard through the American Arbitration Association or JAMS, another dispute resolution provider, which lawyers say are more costly than Finra’s system.

Investment advisers and their customers “may take advantage of this opportunity for no other reason than it’s less expensive,” said Scott Ilgenfritz, a partner at Johnson Pope in Tampa and president of the Public Investors Arbitration Bar Association.

He pointed out that Finra arbitrators are paid a flat fee per hearing session whereas AAA arbitrators are paid on an hourly basis. Finra arbitrators can make a maximum of only $475 per day–$200 per hearing session of four hours or less plus an additional $75 if acting as the chairman. Finra arbitration panels have discretion to assign hearing session fees and when they issue decisions they also typically determine which party will bear the costs or whether they will be split equally.

“It’s also an established forum and has a code, so you know what the rules of the road are,” Mr. Ilgenfritz added.

Linda Fienberg, president of Finra dispute resolution, announced the move in a speech at Piaba’s annual meeting in Austin last week, but gave no details then.

In its guidance Thursday, Finra said it will accept adviser-investor disputes on a voluntary, case-by-case basis as long as both parties submit a post-dispute agreement to arbitrate; the adviser or other parties agree to pay all arbitration surcharge fees and the investor files a special written submission agreement. That agreement must be signed by all parties to the arbitration and after the events occurred that forged the underlying dispute.

The agreement requires the parties to acknowledge that Finra can’t “enforce awards entered against non-member IAs and/or their employees (because Finra is not a self-regulatory organization for IAs),” according to its guidance.

But one lawyer says opening its system might help Finra’s case in that respect.

“If they can get RIAs to adopt their system, it might go a long way toward capturing the rest of the business later on,” said Ryan Bakhtiari, a partner at a Los Angeles, Calif.-based law firm. It also benefits registered investment advisers, he said, by allowing them to “test-drive” the system while Finra isn’t their overseer.

For now, the prevailing parties will have to go to court to enforce their awards. However, Finra said it may bar an investment adviser from the forum in future cases if the adviser fails to pay any award, settlement agreement or Finra fees.

As with disputes involving brokers, final awards will be made publicly available. And Finra said it will accept industry disputes between investment advisers and their employees as well.

Finra is also opening mediation services to advisers, which it noted can be faster and less expensive than arbitration or litigation. Finra touted its mediation program as having achieved an 80% success rate, with parties resolving four out of every five cases.