Just prior to the New Year, the Financial Industry Regulatory Authority, Inc. (FINRA) filed with the Securities and Exchange Commission (SEC) a 96-page proposed rule modification to make certain clarifying and technical changes to the Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes (collectively “the Codes”) relating to the arbitrator list selection process as well as other procedural amendments. These proposed rule changes come in response to an independent review by Lowenstein Sandler, LLP that investigated potential abuses of the arbitrator selection process and issued a report in June 2022 making recommendations to provide greater transparency and consistency.
In response to the independent review, FINRA is proposing to amend the Codes to implement the report’s recommendations. First, FINRA seeks to clarify its current procedure that the FINRA Director will remove arbitrators from the arbitrator lists based upon a review of current conflicts of interest not recognized within the list selection algorithm. Under the proposed rule change, in cases where an arbitrator is excluded from the arbitrator list due to conflict of interest concerns, the list selection algorithm would randomly select another arbitrator to serve. Next, the FINRA proposal seeks to codify DRS’s practice of conducting a manual review for conflicts of interest prior to sending an arbitrator list to the parties and would require the FINRA Director to “provide a written explanation to the parties of the Director’s decision to grant or deny a party’s request to remove an arbitrator.” Additionally, under the proposal, FINRA will also “clarify for forum users that parties may challenge an arbitrator for cause at any point after receipt of the arbitrator lists until the first hearing session begins.”
With this proposal, FINRA hopes to identify potential conflicts, including when: the arbitrator is employed by a party to the case; the arbitrator is an immediate family member or relative of a party to the case or a party’s counsel; the arbitrator is employed at the same firm as a party to the case; the arbitrator is employed at the same law firm as counsel to a party to the case; the arbitrator is representing a party to the case as counsel; the arbitrator is an account holder with a party to the case; the arbitrator is employed by a member firm that clears through a clearing agent that is a party to the case; or the arbitrator is in litigation with or against a party to the case.
Additionally, the proposed rule changes also include procedural amendments, along with clarifying and practical changes to requirements in the Codes, for initiating and responding to claims, motion practice, witness lists, arbitrator compensation practices, claim and case dismissals and providing a hearing record. These proposals include:
- Virtual Prehearing Conferences – Prehearing conferences will generally be held by video conference unless the parties agree to, or the panel grants a motion for, another type of hearing session.
- Virtual Option for Special Proceeding – Special proceeding will be held by video conference, unless the customer requests at least 60 days before the first scheduled hearing that it be held by telephone, or the parties agree to another type of hearing.
- Redacting Confidential Information – Extending the requirement to redact personal confidential information to parties in simplified arbitrations.
- Number of Hearing Sessions Per Day – Amending the definition of “hearing session” to clarify that in one day, the next hearing session begins after four hours of hearing time has elapsed.
- Update Submission Agreement When Filing a Third-Party Claim – Providing that if an answer contains a third-party claim, the respondent must execute a Submission Agreement that lists the name of the third-party. In addition, the proposed rule change would amend the Codes to clarify that the respondent must file the Submission Agreement with the Director.
- Amending Pleadings or Filing Third-Party Claims – Expressly adding the procedures for the filing of third-party claims to the provisions in the Codes, such that the procedures that would apply to the filing and serving of third-party claims would be the same procedures that would apply to amended pleadings. In addition, the proposed rule change would restructure the provisions related to amending pleadings and filing third-party claims and add titles to clarify what processes are available based on various milestones in a case, including before and after panel appointment and before and after ranked arbitrator lists are due to the Director.
- Combining Claims – Providing that if a panel has been appointed to the lowest numbered case (i.e., the case with the earliest filing date), the panel in that case may: (a) combine separate but related claims into one arbitration; and (b) reconsider the Director’s decision upon motion of a party. In addition, the proposed rule change would codify current practice that if a panel has been appointed to the highest numbered case (i.e., the case with the latest filing date), but not to the lowest numbered case, the panel appointed to the highest numbered case may: (a) combine separate but related claims into one arbitration; and (b) reconsider the Director’s decision upon motion of a party.
- Motion Practice – Codifying the current practice by providing that the Director will send all motions, responses, and replies to the panel after the last reply date has elapsed, unless otherwise directed by the panel. After the last reply date has elapsed, if the Director receives additional submissions on the motion, the Director will forward the submissions to the panel upon receipt and the panel will then determine whether to accept them.
- Witness Lists Shall Not Be Combined with Document Lists – Specifying that if the parties create lists of documents and other materials in their possession or control that they intend to use at the hearing and have not already been produced, the parties may serve the lists on all other parties but shall not combine the lists with the witness lists filed with the Director.
- Hearing Records – Providing that if the panel orders a transcription, or the stenographic record is the official record of the proceeding, a copy of the transcription or stenographic record must be provided to each arbitrator, served on each party, and filed with the Director by the party or parties ordered to make the transcription or electing to make the stenographic record, as applicable. Also, the proposed rule change would amend the Codes to provide that executive sessions held by the panel will not be recorded.
- Dismissal of Proceedings for Insufficient Service – Providing that the panel may dismiss without prejudice a claim or an arbitration for lack of sufficient service upon a respondent.
- Dismissal of Claimant’s Claims Requires Issuance of an Award – Requiring that if a panel dismisses all of claimant’s claims at the conclusion of the case in chief, the decision must contain the elements of a written award and must be made publicly available as an award.
In sum, FINRA has proposed a number of changes to its arbitrator selection process and has introduced several procedural amendments that if enacted, will provide greater clarity, transparency and consistency to parties moving forward.
A link to the proposed FINRA rule changes can be found here
Any questions may be referred to David Hantman or Alexander Middlemiss.