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FINRA steps up to arbitrate investment adviser disputes


Wall Street’s industry-funded watchdog does not have an official say over registered investment advisers, but it is not shy about stepping up with a solution to resolve their legal disputes.

The Financial Industry Regulatory Authority (FINRA) is opening its arbitration forum to disputes between registered investment advisers (RIAs) and investors. FINRA has long run an arbitration system where the securities brokerages it regulates and their customers must resolve legal disputes.

But whether there was access to that system for around 28,000 registered investment advisers, overseen by the U.S. Securities and Exchange Commission or by the states, has been unclear.

That changed late on Thursday when FINRA posted a guidance on its website on how investors and registered investment advisers can use its forum to arbitrate legal disputes. FINRA is now accepting those cases, subject to certain conditions, the regulator said.

Investors who have legal disputes with their investment advisers typically resolve them in court or other arbitration forums. But those options can be pricey and, in the case of court, time consuming, say lawyers.

The change comes as FINRA, Wall Street’s industry-funded watchdog, positions itself to oversee registered investment advisers – a move those advisers vehemently oppose.

The SEC does not have the staff or financial resources to regularly examine its registered advisers, according to a 2011 report by the agency’s staff. It examines them about once every 11 years, a problem that has prompted agency officials and lawmakers to consider alternatives, including as a self-regulatory organization.

A FINRA official, however, denies the shift in its arbitration forum is related to those efforts.

But lawyers for investors have asked FINRA to make the forum available for clients who want to bring claims against investment advisers, Linda Fienberg, the head of FINRA’s dispute resolution unit, told Reuters on Thursday.

While investment advisers may oppose being overseen by FINRA, using its arbitration system might be more cost effective than the options they have now. That has proven true in a few unusual cases involving registered investment advisers that were heard in FINRA’s forum, lawyers say.

Three such cases are now winding their way through FINRA’s arbitration system, Fienberg said.

FINRA held off formally revealing the plan until after the U.S. Congress wrapped up its 2012 legislative session to avoid creating “concern that we’re trying to get ahead of everything,” Fienberg said.

Fienberg mentioned the change last week at a conference in Austin, Texas, held by the Public Investors Arbitration Bar Association (PIABA) – a group of lawyers who represent investors in securities arbitration – but she did not reveal details.

The change puzzled one executive at a key industry group.

“Arbitration is not a prevalent practice among registered investment advisers,” said David Tittsworth, executive director of the Investment Adviser Association.

One reason: RIAs are bound to a fiduciary standard of care that obliges them to act in their clients’ best interest, while brokers need only recommend securities that are “suitable” for clients, based on factors such as risk tolerance and age.

Few registered investment adviser account agreements require clients to forgo court and arbitrate legal disputes against investment advisers, Tittsworth said. So-called “mandatory arbitration agreements” are typical in contracts that brokerage customers sign when they open their accounts.


Proponents of arbitration say the process is less time consuming and more cost-effective than going to court.

Those who do sign arbitration agreements with an RIA now typically agree that their cases will be heard by the American Arbitration Association (AAA) or JAMS Inc. But arbitrating in those forums can cost tens of thousands of dollars more than using FINRA, says Ryan Bakhtiari, past president of the Public Investors Arbitration Bar Association, a Norman, Oklahoma-based group of lawyers who represent investors in arbitration.

Arbitrators in those non-FINRA forums have leeway to set their own rates. Some AAA arbitrators might charge $100 to $200 per hour, while others are “much more than that,” according to Sandra Partridge, vice president of AAA’s commercial divisions for New York and the northeast. FINRA arbitrators can earn $400 each for an eight hour hearing.

The process of exchanging information between parties before the actual hearing, known as discovery, is also more predictable in FINRA’s forum, Bakhtiari said.

For example, FINRA arbitration rules do not allow questioning witnesses before a hearing, or “deposing” someone, he said. That saves time and money said Bakhtiari, who is also a securities arbitration lawyer in Beverly Hills, California.

“The FINRA process has some advantages,” said Peter Fruin, a lawyer in Birmingham, Alabama, who represents investment advisers.

Fruin has already arbitrated cases through FINRA involving investment advisers affiliated with broker-dealers.


FINRA’s guidance on Thursday provides some clarity about how the process for investment advisers would work. For example, both parties must sign an agreement to arbitrate after their dispute arises, and then a second agreement to have FINRA arbitrators hear that dispute, Fienberg said.

But since FINRA does not regulate investment advisers, there are certain measures it cannot impose, Fienberg said. For example, FINRA cannot suspend RIAs who do not pay awards as it can with the brokers and brokerages it oversees.

FINRA does not plan to recruit specialized arbitrators to hear cases, but will rely on its current roster of about 6,400 arbitrators, Fienberg said.

Investment advisers who arbitrate through FINRA should also expect the rulings to be publicly available in a database on its website. That is not always the case in other forums. AAA, for example, does not make its decisions public, a spokesman said.