October 18, 2021
In 2019, investors won $96 million in arbitration awards against firms and advisors that they accused of misconduct. But some of those investors never saw a dime.
Almost a third of the arbitration awards, totaling $19 million, went unpaid, according to data from industry self-regulator Finra.
That dismal statistic underscores a pernicious problem in the wealth management industry: Arbitration is supposed to provide investors with a recourse when they feel they’ve been wronged by their financial advisor. However, too often the remedy turns out to be no such thing.
“When you’re talking about these unpaid awards, we’re typically talking about retail investors who are often seniors,” says Laura Posner, a partner at New York law firm Cohen Milstein and the former bureau chief for the New Jersey Bureau of Securities. “We’ve set up a system that too often fails, whereas the goal should be to protect them.”
Now, an association of securities regulators is seeking to mitigate the problem by harmonizing regulations and toughening consequences for firms and advisors who fail to pay arbitration awards owed to investors.
The proposed model rule would make it an unethical business practice for a broker-dealer, agent, investment advisor or registered representative to fail to pay an arbitration award or fine entered against them. That in turn could tee up enforcement actions, such as revoking a license, by members of the North American Securities Administrators Association (Nasaa), which represents regulators in the United States, Canada and Mexico.
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A new guideline. The proposal would create a template that state securities regulators could adopt and modify as a new regulation. It would also harmonize rules for broker-dealers and registered investment advisors, or RIAs. That’s an important issue since a broker can in theory rack up unpaid arbitration awards and then register as an RIA elsewhere.
Nasaa is soliciting public feedback on its proposal. After the public comment period concludes, the proposal can be presented to Nasaa members for approval and adopted as new regulations by regulators.
“In making this rule, we hope more awards will be paid because people want to be registered and if they aren’t paying awards, then they will only get one bite at the apple. They won’t be able to reincarnate elsewhere,” Standifer says.
The reforms are especially needed because going to state or federal court isn’t an option for many investors since firms often require customers opening accounts to agree to arbitrate any disputes. Customer complaints are typically heard in arbitration proceedings run by Finra, though they can be heard in privately run meditation forums.
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Recovery pool? Piaba, an association of attorneys who represent investors in arbitration, has called upon Finra and other regulators to create a national investor recovery pool that could make wronged investors whole in instances when arbitration awards go unpaid. The pool could potentially be funded by Finra or brokerage firms, which are members of Finra.
“If the goal is to protect people from suffering devastating injuries, would it be best to install seat belts before the car accident, or after?” Piaba asked in a report on unpaid arbitration awards, its third, issued last month.
A representative for Finra says it is working to reduce the number of unpaid awards, which typically result from firms and brokers declaring bankruptcy or going out of business.
“Finra appreciates that Piaba recognizes that customer recovery can be a challenge across the financial services industry and dispute resolution forums, and we remain committed to working with all stakeholders on this important issue,” the representative said.
Finra maintains a public database of brokers who have unpaid arbitration awards. Its statistics also show that firms with unpaid arbitration awards tend to be small, employing a median number of 61 registered representatives.
Finra has the power to suspend or bar from the industry individuals or firms that fail to pay arbitration awards. The regulator adds that many unpaid arbitration awards are against firms or individuals whose registration has been terminated, suspended, canceled, or revoked, or who have been expelled.
The regulator’s website notes that just as in federal and state court systems, its arbitration forum does not ensure payment of damages awarded. “Arbitration claimants have access to the same collection tools as in a court judgment: if a respondent fails to pay an arbitration award, the claimant may take the award to court and have it converted to a judgment. The claimant may then attempt to collect on the judgment using the court’s collection procedures,” the website states.
But that may be small comfort to investors who’ve lost money, particularly as it would entail having to hire an attorney for both the arbitration and court processes, all to collect an award for money they’ve already lost.
“I hope that Finra makes some real changes in this space so we don’t have this problem going forward,” Posner, the attorney, says. “This isn’t a new problem. It was an issue when I was a regulator in 2015. You’re talking about another $20 million or $25 million [in unpaid awards] every year.”
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