Outside FINRA offices in New York Outside FINRA offices in New York. (Photo: ThinkAdvisor/Ronald Pechtimaldjian)

While the dollar amounts of arbitration awards that are going unpaid has been decreasing, improving this process is “of vital importance to investors and broker-dealers who are playing by the rules,” according to outgoing Securities and Exchange Commission member Kara Stein.

In comments before the SEC Investor Advisory Committee meeting Thursday, Stein, a Democrat, stated that even after investors win their claim against a broker-dealer in the Financial Industry Regulatory Authority arbitration process, “they may not get their damages award.”

In 2016, 27% of cases where damages were awarded remain unpaid, Stein said. “That’s getting close to a third. In dollar terms, investors were unable to recover $14 million that had been awarded to them in the arbitration process.”

Fortunately, she continued, the dollar amounts of awards that are going unpaid has been decreasing. “In 2013, there was $75 million in unpaid awards. In 2014, there was $23 million and in 2015 there was $24 million in unpaid awards,” Stein reported. “This is good news, but we still have a way to go.”

Richard Berry, FINRA’s executive vice president and director of dispute resolution, told the committee in his comments that unpaid awards represent “about 2% of the nearly 13,000 customer cases closed between 2012 and 2016.”

The “vast majority” of customer cases close by settlement, not award, Berry added.

“This means that most arbitration cases will be resolved without the need for an award. However, when we focus more closely on the smaller subset of cases in which the arbitrators award damages to the customer, we note that about a third of these awards go unpaid,” he explained.

He argued that the challenge of unpaid awards and judgments “is not unique” to the broker-dealer industry, and also occur “in the investment advisor space” as well as the broader financial services sector.

“FINRA has provided greater transparency for investors about a broker’s arbitration history,” he said. ”And, unlike any other arbitration forums of which we are aware, FINRA provides data on unpaid customer awards for the past five years on its website, including a list of those responsible for the unpaid awards.”

FINRA has taken numerous steps to address unpaid awards.

For example, FINRA has implemented regulatory measures “to identify and remove bad actors from the broker-dealer industry through enforcement actions, examinations and rulemaking,” he said.

“We are continuing to identify additional steps that we can take in this area,” Berry stated.

FINRA also takes “strong action against those that do not pay awards” by suspending individuals and firms from the broker-dealer industry for nonpayment.

He stated that he’s unaware of “any federal provision that prevents those suspended for nonpayment from operating in other financial services industries.”

Robin Traxler, senior vice president of policy and deputy general counsel for the Financial Services Institute, noted during her comments before the SEC committee that financial advisors and firms that fail to pay their arbitration fines should be banned from working in the financial services industry in any capacity.

“Any solution to the issue of unpaid arbitration awards should not unfairly impact honest actors in the industry,” Traxler said. “Instead, the consequences of not paying an award should preclude the bad actor from continuing to work with investors in any capacity, creating an important deterrent to bad behavior.”

FINRA’s Berry added that the broker-dealer self-regulator has proposed a series of rules to further address unpaid awards, including rules to prevent parties from avoiding payment of awards through asset transfers.

He also pointed to a FINRA discussion paper that noted approaches that raise broader policy issues, or that require SEC rulemaking or federal legislation, that FINRA believes “are worth exploring further — along with any additional options that might be identified by others — as we continue our dialogue and consider potential courses of action.”

The approaches outlined in FINRA’s discussion paper include:

  • Rulemaking by the SEC to require firms to raise or maintain additional capital;
  • Amendments to the SEC’s Form BD to require disclosure regarding unpaid awards by firms;
  • Legislation to amend the Exchange Act statutory disqualification definition to enable FINRA to deny registration or membership to a broader group of brokers with unpaid awards;
  • Legislation to amend the Bankruptcy Code so that arbitration awards cannot be discharged in bankruptcy as is currently possible;
  • Legislation to expand SIPC coverage to include unpaid customer arbitration awards;
  • Legislation or rulemaking to create a second brokerage industry fund, separate from SIPC; and
  • Legislation or rulemaking to require brokerage firms to carry insurance to cover unpaid awards.

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