- SEC Approves New Rule Limiting Who Qualifies As a Public Arbitrator in FINRA Proceedings
- March 6, 2015
- Law Firm: Sutherland Asbill Brennan LLP - Washington Office
On February 26, 2015, the Securities Exchange Commission (“SEC”) approved proposed Financial Industry Regulatory Authority (“FINRA”) rules that will substantially reduce the number of public arbitrators on the roster for FINRA arbitrations.1 The SEC stated the new rules will help to “address any perceived bias of public arbitrators” and “enhance the perception of neutrality” within FINRA arbitrations.2 The rule is the conclusion of a rulemaking process that began on June 17, 2014, when FINRA filed a proposed rule change with the SEC to change the definition of the terms “non-public arbitrator” and “public arbitrator” in FINRA’s Code of Arbitration Procedures for both customer disputes and industry disputes.3 Sutherland has already noted its concerns with the proposal in a prior article. This legal alert provides an outline of the new rules, for which FINRA has not yet set an effective start date.
The new rule 12100(p)(1)4 deletes the former definitions of “non-public arbitrator” and “public arbitrator” in their entirety and replaces them with new definitions.5 The former definition of non-public arbitrator included those arbitrators who currently, or within the past five years, were affiliated with a financial industry entity.6 According to the former rule, these individuals could be reclassified as public arbitrators after a cooling off period of five years from severing ties with the financial industry entity - unless they retired from or spent a “substantial” amount of their career with a specific entity or they were affiliated for at least 20 years with a specific entity.7
While individuals who fell under the so-called “cooling off” exceptions must remain non-public arbitrators, the new definition removes the cooling off period for all individuals who are or ever were affiliated with any financial industry entity for any period.8 These individuals can never become public arbitrators. In addition, the new rule adds two categories of individuals who will be permanently classified as non-public arbitrators: those associated with mutual funds or hedge funds and individuals associated with investment advisers.9
Under the former Rule 12100(p)(3), attorneys, accountants and other professionals who served specific financial industry entities for at least 20 percent of their professional work were classified as non-public arbitrators but could be reclassified as public arbitrators two years after ceasing work with the specified entities unless that individual provided services for at least 20 years.10 The new Rule 12100(p)(2) increases the “cooling off” period from two to five years, applies to services not just to specific industry entities but to any person or entities affiliated with those entities and reduces the number of service years that would permanently disqualify a professional from 20 years to 15 years.11
In a move decried by PIABA, the new Rule 12100(p)(3) switches claimants’ attorneys from industry to public arbitrators. The new Rule 12100(p)(3) classifies as non-public any attorneys, accountants or other professionals who devoted 20 percent or more of their professional time to serving parties in investment or financial industry employment disputes until five years after they have stopped doing so. A person who provided such services for 15 years or more is now permanently disqualified from serving as a public arbitrator.
The new Rule 12100(p)(4) adds a five-year requirement before becoming a public arbitrator for those individuals who were employees of a bank or financial institution that effected securities transactions or who supervised the compliance with securities laws of those who did sell securities.12 If such an individual serviced the financial industry in this capacity for at least 15 years, however, the person is permanently disqualified from serving as a public arbitrator.13
The former Rules 12100(u)(6) and (7) allowed those individuals who are “directors or officers of an entity that directly or indirectly controls, is controlled by, or is under common control with, any partnership, corporation, or other organization that is engaged in the securities business” to become public arbitrators two years after ceasing their affiliations.14 The new rules replace the term “securities business” with “financial industry” and increase the cooling off period from two to five years.15
With respect to attorneys, accountants and other professionals, the new rules classify as a non-public arbitrator any individual whose firm derived $50,000 or more, or at least 10 percent of its annual revenue in any single year within the past two years from an entity listed in Rule 12100(u)(1)16 or its affiliates, or a bank or other financial institution involved in securities transactions.17 These individuals may become public arbitrators two years after ending the affiliation with the entity or two years after the individual’s employer no longer derives revenue from an entity involved in securities transactions.18
Finally, the new Rule 12100(u)(11) disqualifies from the public arbitrator roster those individuals whose immediate family member19 is an individual who is disqualified from being a public arbitrator.20 The individual may be reclassified as a public arbitrator two years after the immediate family member ends the disqualifying relationship or the individual ends the relationship with the immediate family member so that the persons are no longer immediate family members.21
In response to commentators’ concerns that the new rule could drastically reduce the number of public arbitrators in an already strained environment, the SEC stated that FINRA’s plan to mitigate the strain, by aggressively recruiting new public arbitrators and enhancing arbitrator retention, are appropriate in light of FINRA’s goals of implementing the new rules.22 No specific cost-benefit analysis was required from FINRA.
1 Exchange Act Release No. 34-74383, SR-FINRA-2014-028 (Feb. 26, 2015); see also Sarah Scott Peters, Bryan M. Ward and Andrew M. McCormick, Everybody Out Of The (Public Arbitrator) Pool, Law360 (July 03, 2014, 10:17 AM ET), http://www.law360.com/articles/552840/everybody-out-of-the-public-arbitrator-pool.
2 Exchange Act Release No. 34-74383 at 39.
3 Id. at 1.
4 This rule citation refers specifically to FINRA’s Customer Code, but all changes to the Customer Code have corresponding changes in the Industry Code. See id. at 4 n.11.
5 See id. at 4.
6 Id. at 4-5.
7 Id. at 5.
10 Id. at 6-7.
11 Id. at 7.
12 Id. at 8.
13 Id. at 9.
14 Id. at 13.
16 The following are definitions of covered entities under the new rules: (i) instead of referring to “[a person] registered under the Commodity Exchange Act; a member of a commodities exchange . . ., or associated with a person or firm registered under the Commodity Exchange Act,” new Rule 12100(u)(1)(B) refers to “a person who is, or was, associated with, including registered through, under, or with (as applicable), . . . the Commodity Exchange Act or the Commodities Futures Trading Commission;” (ii) instead of referring to “a member . . . of a registered futures association,” new Rule 12100(u)(1)(B) identifies the association as the National Futures Association; (iii) new Rule 12100(u)(1)(B) adds a reference to “[a person] who is, or was, associated with, including registered through, under, or with (as applicable), . . . the Municipal Securities Rulemaking Board;” and (iv) new Rule 12100(p)(1)(C) includes a provision to cover any entity “organized under or registered pursuant to the Securities Exchange Act of 1934, Investment Company Act of 1940, or the Investment Advisers Act of 1940.” Id. at 9-10.
17 Id. at 14.
18 Id. at 14-15.
19 New Rule 12100(u) adds to the definition of immediate family member. The definition now applies to a person’s parent, stepparent, child, stepchild, member of a person’s household, an individual to whom a person provides financial support of more than 50 percent of his or her annual income, a person who is claimed as a dependent for federal income tax purposes, spouse, partner in a civil union, or domestic partner. Id. at 16.
22 Id. at 40-41.