The Financial Industry Regulatory Authority is actively assessing regulations to rein in brokerage firms that fail to pay investors monetary awards they’ve won in arbitration, the self-regulator’s chairman and CEO, Richard Ketchum, said Thursday.
Sen. Elizabeth Warren, D-Mass., challenged Ketchum during his Thursday testimony before the Senate Banking Subcommittee on Insurance, Securities and Investment to explain recently released findings of a report finding that $62.1 million of customer arbitration awards issued in 2013 were still unpaid.
The crux of the problem is that brokerage firms lack the funds to actually pay the awards, Warren said, citing the report from the Public Investors Arbitration Bar Association, a group for lawyers who represent investors in disputes with the securities industry.
According to the PIABA analysis of 2013 arbitration awards, “more than one out of three cases investors take through to an arbitration hearing and win an award assessing liability and damages goes unpaid.” Viewed differently, the PIABA study states, “nearly $1 of every $4 awarded to investors in arbitration hearings goes unpaid.”
Warren pointedly asked Ketchum, shouldn’t there “be more regulations so that people get paid?”
Ketchum responded: “Something should be done about it; I do believe that we want to work with the [Securities and Exchange Commission] on this.”
Firms that continue to do business and maintain their FINRA membership “are barred” if they don’t pay their awards, Ketchum continued. However, he said, if firms “become insolvent” or “leave FINRA, we lose our jurisdiction” over them.
While the capital requirement issue is mainly within the SEC’s purview, Ketchum said that FINRA was “looking at” whether there should be regulatory mechanisms put in place “to ensure they [firms] have enough capital” before leaving FINRA’s jurisdiction.
Sen. Mark Warner, D-Va., agreed that action was needed, and could include “a reserve fund” to ensure arbitration awards got paid. However, he said, FINRA and the SEC should not study such an action for “years.”
Ketchum told ThinkAdvisor after his testimony that FINRA is “actively” looking at regulatory measures in this area, which could come out in proposal form before he leaves this year as head of the self-regulator.
The arbitration award “is meaningless if the broker or brokerage firm does not have the resources to pay the award,” Hugh Berkson wrote in the PIABA report. “Unfortunately, this is an all too common problem, and has been for quite some time.” Berkson claimed in the report that regulators have failed to act even after a 15-year-old GAO (then General Accounting Office) report revealed that unpaid securities arbitration awards were a problem and “set forth a number of suggested cures.”
Unfortunately, as the years have passed, Berkson said, “few of the suggested cures have actually been implemented and the problem appears to be on the rise again – a surprising turn given the fact that the markets have (until very recently) been on an upward trending glide path.”
The GAO reported the most frequent reasons for the unpaid awards: (1) the broker-dealer was out of business; (2) the broker-dealer claimed to be financially unable to pay the award; (3) the individual broker owing all or part of the award could not be found; and, (4) the broker-dealer filed for bankruptcy.
Says Berkson in the report: “Reasons one, two and four are substantially similar: the broker-dealer simply did not have the financial resources to pay the award. Obviously, those firms failed to maintain the sort of financial health the industry recommends that individual investors maintain.”
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