[Federal Register Volume 75, Number 184 (Thursday, September 23, 2010)]
[Notices]
[Pages 58007-58011]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-23776]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-62930; File No. SR-FINRA-2010-036]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of Proposed Rule Change to Amend the
Codes of Arbitration Procedure to Permit Arbitrators to Make Mid-case
Referrals
September 17, 2010.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on July 12, 2010, the Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been substantially prepared by FINRA.
The Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
FINRA is proposing to broaden an arbitrators' authority to make
referrals during an arbitration proceeding by amending Rule 12104 of
the Code of Arbitration Procedure for Customer Disputes (``Customer
Code'') and by creating new Rule 12902(e) to address the assessment of
hearing session fees, costs, and expenses if an arbitrator
[[Page 58008]]
makes a referral during a case that results in panel withdrawal.
Similarly, the proposal would amend Rule 13104 of the Code of
Arbitration Procedure for Industry Disputes (``Industry Code'') to
broaden an arbitrators' authority to make referrals during an
arbitration proceeding and create new Rule 13902(e) to address the
assessment of hearing session fees, costs and expenses if an arbitrator
makes a referral during a case that results in panel withdrawal.
The text of the proposed rule change is available on FINRA's Web
site at http://www.finra.org, at the principal office of FINRA and at
the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
Background
In light of recent well-publicized securities frauds that resulted
in harm to investors, FINRA has reviewed its rule on arbitrator
referrals and determined that it should be amended to permit
arbitrators to make referrals during an arbitration proceeding--rather
than solely at the conclusion of a matter as is currently the case--
when the arbitrator has reason to believe there is a serious, ongoing,
imminent threat to investors that requires immediate action.
Currently, Rule 12104(b) of the Customer Code and Rule 13104(b) of
the Industry Code (together, Codes), state, in relevant part, that any
arbitrator may refer to FINRA for disciplinary investigation any matter
that has come to the arbitrator's attention during and in connection
with the arbitration only at the conclusion of an arbitration (emphasis
added). FINRA believes that restricting arbitrators from making
referrals until the conclusion of an arbitration may hamper FINRA's
efforts to uncover fraud as early as possible.
FINRA is proposing, therefore, to broaden the arbitrators'
authority under the Codes to make referrals during the prehearing,
discovery, or hearing phase of an arbitration. Specifically, FINRA
would amend Rules 12104 and 13104 of the Codes to permit referrals to
the Director\3\ during the prehearing, discovery, or hearing phase of
an arbitration proceeding, when the arbitrators have reason to believe
that any matter or conduct poses a serious, ongoing, imminent threat to
investors that requires immediate action. Further, FINRA would add new
Rules 12902(e) and 13902(e) of the Codes to address the assessment of
hearing session fees, costs, and expenses when an arbitrator referral
during a case results in the withdrawal of the panel.
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\3\ The term Director means the Director of FINRA Dispute
Resolution, and includes FINRA staff to whom the Director has
delegated authority. See Rule 12100(k) of the Customer Code and Rule
13100(k) of the Industry Code.
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Explanation of the Proposed Rule Change
Changes to the Customer Code
Rule 12104--Effect of Arbitration on FINRA Regulatory Activities
First, FINRA proposes to add the phrase ``Arbitrator Referral
During or at Conclusion of Case'' to the title of Rule 12104 so that it
reflects accurately the proposed changes. The new title would read:
``Effect of Arbitration on FINRA Regulatory Activities; Arbitrator
Referral During or at Conclusion of Case.''
Second, the current rule would be rearranged to reflect the order
in which an arbitrator may make a referral in an arbitration case.
Subparagraph (a) would remain unchanged. The provision in current
subparagraph (b) of the rule, which addresses arbitrator referrals made
only at the conclusion of the case (hereinafter, ``the post-case
referral provision''), would be amended and moved to new subparagraph
(e). In its place, FINRA would insert new rule language in subparagraph
(b) to address arbitrator referrals made during the prehearing,
discovery, or hearing phase of an arbitration (hereinafter, ``the mid-
case referral provision''). New subparagraph (c) would require
arbitrator disclosure of a mid-case referral and withdrawal of the
panel upon a party's request. New subparagraph (d) would address the
administration of the case using a new panel. And finally, new
subparagraph (e) would contain the rule language in current
subparagraph (b) with some amendments to address post-case referrals.
Rule 12104(b)--Mid-case Referral Provision
Rule 12104(b) would be amended to state that any arbitrator may
refer to FINRA any matter or conduct that has come to the arbitrator's
attention during the prehearing, discovery, or hearing phase of a case,
which the arbitrator has reason to believe poses a serious, ongoing,
imminent threat to investors that requires immediate action. The
proposed rule would state further that arbitrators should not make mid-
case referrals based solely on allegations in the statement of claim,
counterclaim, cross claim, or third party claim.
The new language of Rule 12104(b) would provide arbitrators with
the express authority to alert the Director during a case when they
learn of what they believe to be fraudulent activity that requires
immediate action. This aspect of the rule would provide FINRA with a
vital tool for detecting and minimizing the effects of potentially
fraudulent activity as early as possible.\4\
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\4\ The proposed rule would not preclude an arbitrator from
notifying other departments of FINRA of its findings, as
appropriate.
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Specifically, under the new rule language, arbitrators would be
authorized to make mid-case referrals based on what they learn during
the prehearing, discovery, or hearing phase of a case. Moreover,
arbitrators could not make mid-case referrals based solely on
allegations in the statement of claim, counterclaim, cross claim, or
third party claim. This means that the mid-case referral would not be
based solely on the parties' pleadings.\5\ Because Dispute Resolution
routinely provides copies of the arbitration claims to FINRA's
Enforcement division, mid-case referrals based only on the pleadings
are not necessary to apprise Enforcement of possible wrongdoing.\6\ But
if arbitrators learn of information relating to a serious, ongoing,
imminent threat during the pre-hearing, discovery or hearing phase of a
case, the new rule would permit any arbitrator to make a mid-case
referral to FINRA. This rule would ensure that arbitrators have the
discretion to make a mid-case referral at the time they become aware of
evidence or other information that they believe poses a serious,
ongoing, imminent
[[Page 58009]]
threat to investors. Moreover, by providing that the arbitrators could
not make a mid-case referral based solely on the pleadings, the rule
would help avoid unnecessary mid-case referrals and the consequent
disruption to an ongoing case.
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\5\ A pleading is a statement describing a party's causes of
action or defenses. Documents that are considered pleadings are: A
statement of claim, an answer, a counterclaim, a cross claim, a
third party claim, and any replies. Rule 12100(s) of the Customer
Code and Rule 13100(s) of the Industry Code.
\6\ Dispute Resolution provides copies of all statement of
claims to Enforcement. Staff also provides to Enforcement copies of
answers in disputes involving promissory notes, or responses to
third party claims, counterclaims or cross claims.
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The new language of Rule 12104(b) would also require that the
matter or conduct that would be the subject of the mid-case referral
should pose a serious, ongoing, imminent threat to investors that
requires immediate action. Arbitrators should use their judgment in
determining whether the matter or conduct poses such a threat before
making a mid-case referral.
Rule 12104(c)--Arbitrator Disclosure and Withdrawal
If any arbitrator makes a mid-case referral under proposed Rule
12104(b), the Director will disclose to the parties the act of making
such referral. Further, if a party requests that a referring arbitrator
withdraw, the entire panel, at the time of the referral, must withdraw.
A party must make the withdrawal request within 10 days of receipt of
notice of the referral disclosure.
First, after an arbitrator makes a mid-case referral, the Director
would notify the parties of the referral. The Director will notify the
parties of the referral because a referral of a potentially serious,
ongoing, imminent threat to investors could cause a party to question
the neutrality of the arbitrators going forward. After receiving this
notification, any party may request that the panel,\7\ at the time of
the referral, withdraw from the case upon the Director's disclosure of
a mid-case referral.
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\7\ Under Rules 12101(g) and 13101(g) of the Codes, the term
``panel'' means the arbitration panel, whether it consists of one or
more arbitrators.
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Second, the proposed rule would require that a party make the
withdrawal request within 10 days\8\ of receipt of notice of the
disclosure. Once the parties learn of the mid-case referral, they
should decide promptly whether to keep the panel or request its
withdrawal.
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\8\ Under Rules 12100(j) and 13100(j) of the Codes, the term
``day'' means calendar day.
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Rule 12104(d)--Continuing the Arbitration Case With a New Panel
Proposed Rule 12104(d) would address how FINRA would administer the
arbitration case if a panel withdraws from the case and a new panel is
selected by the parties.
FINRA recognizes that the time required to select a new panel after
the initial panel makes a mid-case referral could delay the resolution
of the claimants' case. To minimize potential delays in continuing the
case, FINRA Dispute Resolution staff (staff) will endeavor to complete
the arbitrator selection process for the new panel, schedule the
subsequent Initial Prehearing Conference, and serve the award on an
expedited basis.\9\ In addition, while staff cannot shorten the time
requirements set forth in the Codes, parties may agree to modify a
provision of the Codes by written agreement of all named parties.\10\
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\9\ FINRA launched a voluntary national program in June 2004 to
expedite arbitration proceedings in matters involving senior or
seriously ill parties. Thus, staff has considerable experience in
expediting arbitration cases when necessary. See Notice to Parties--
Expedited Proceedings for Senior or Seriously Ill Parties, available
at http://www.finra.org/ArbitrationMediation/Parties/ArbitrationProcess/NoticesToParties/P009636.
\10\ See Rules 12105(a) and 13105(a) of the Codes.
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If the case moves forward, FINRA would administer the case as
follows. First, FINRA would not close the case, but instead, would keep
the original pleadings (i.e., the statement of claim, answer, and any
other pleadings) and proceed with the case after party selection of a
new panel under the Neutral List Selection System rules.
Second, the new panel would schedule an Initial Prehearing
Conference to set discovery, briefing, and motions deadlines, schedule
subsequent hearing sessions, and address other preliminary matters.\11\
At this time, the new panel would also determine whether any orders or
rulings from the original panel were still in effect, and these
decisions would be final and binding on the parties.\12\
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\11\ See Rules 12500(b) and 13500(b) of the Codes.
\12\ See Rules 12413 and 13413 of the Codes.
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Third, the new panel would determine whether to permit the
introduction of evidence and the record of proceedings from prior
hearing sessions in subsequent hearing sessions, pursuant to Rule
12604(a).\13\ This would provide arbitrators with the discretion to
permit access to and use of the record of proceedings from the hearing
record, based on the needs of the parties and the relevance of the
information in the hearing record. FINRA notes that parties would be
permitted to object to the admissibility of this information, but the
determination on admissibility would be within the panel's discretion.
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\13\ See also Rule 13604(a) of the Industry Code.
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The record of proceedings,\14\ hereinafter referred to as the
hearing record, from the first case would not contain references to
panel discussions about a mid-case referral. Such arbitrator
deliberations are not contained in the hearing record because
arbitrators discuss these types of issues in an executive session which
is not recorded or made a part of the hearing record. As a result, the
new arbitrators would not learn of the mid-case referral or its
rationale from the hearing record of the prior hearing sessions.
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\14\ See Rules 12606 and 13606 of the Codes.
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FINRA's Assessment of the Mid-case Referral Provision and its Potential
Effects on an Arbitration Case
The proposed rule would provide an additional tool to strengthen
FINRA's regulation of its members. Though mid-case referrals likely
would be rare, FINRA recognizes that such a referral would have an
impact on an investor's \15\ arbitration case. If an arbitrator makes a
mid-case referral and the panel withdraws, the customer's arbitration
case would be delayed until the parties settle, continue, or begin the
case anew, as discussed under Rule 12104(d). Further, a customer could
incur additional costs as a result of a mid-case referral, such as
attorney's fees. To minimize some of the additional expense that a
customer could incur, FINRA is proposing to waive certain fees for the
customer.\16\
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\15\ In intra-industry cases, the impact could be on an
associated person or on a member that is not the subject of the
referral.
\16\ See infra discussion under Rules 12902(e) and 13902(e).
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Moreover, FINRA understands that the impact would be greatest on
those customers whose hearings were almost completed. Thus, FINRA will
caution arbitrators, in those instances, to weigh carefully the
imminence of a possible threat to investors and the markets against the
harm to the customer whose case would be disrupted. In close cases,
FINRA suggests that arbitrators consider whether any time saved or harm
averted by a mid-case referral warrants disrupting a customer's
arbitration case. If the arbitrators conclude that disruption of the
investor's case is not warranted, a referral at the end of the case may
be more appropriate.
Rule 12104(e)--Post-case Referral Provision
The language in current subparagraph (b) of the Rule 12104, which
addresses arbitrator referrals made only at the conclusion of the case,
would be amended and moved to new subparagraph (e).
The current rule states that ``only at the conclusion of an
arbitration, any arbitrator may refer to FINRA for disciplinary
investigation any matter that has come to the arbitrator's attention
during and in connection with the arbitration, either from the record
of the proceeding or from material or
[[Page 58010]]
communications related to the arbitration, which the arbitrator has
reason to believe may constitute a violation of NASD or FINRA rules,
the federal securities laws, or other applicable rules or laws.''
The proposal would permit arbitrators to continue making post-case
referrals. However, FINRA would amend the rule to permit arbitrators to
make a post-case referral to the Director, rather than to FINRA,\17\ so
that the provisions of Rule 12104 are consistent. Further, FINRA would
delete the term ``disciplinary'' to ensure that the scope of potential
referrals is not limited to disciplinary findings, and would add the
phrase ``or conduct,'' so that the subject-matter of Rule 12104 is
consistent throughout the rule. The rule also would be amended to
replace the reference to violations of ``NASD or FINRA rules'' with
``the rules of FINRA'' because the current FINRA rulebook consists of
FINRA Rules, NASD Rules, and incorporated NYSE Rules.
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\17\ See notes 2 and 3.
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Rule 12902--Assessment of Hearing Session Fees, Costs, and Expenses if
an Arbitrator Referral During a Case Results in Panel Withdrawal
FINRA is proposing to adopt new Rule 12902(e) to address the
assessment of hearing session fees, costs, and expenses if an
arbitrator makes a referral during a case that results in panel
withdrawal.
First, FINRA recognizes the potential impact that the panel's
withdrawal during the course of a hearing would have on the customer.
Thus, FINRA is proposing new Rule 12902(e)(1) that would waive the
customer's hearing session fees for the sessions conducted prior to the
referral in an effort to reduce the potential financial impact.
Second, under proposed new Rule 12902(e)(2), FINRA may waive any
hearing session fees assessed against a member for hearing sessions
conducted prior to the mid-case referral, if the member is not the
subject of the referral. The proposed rule would provide FINRA with
discretion to waive any hearing session fees assessed against a member
that is named in the arbitration, but is not the subject of the mid-
case referral.
Last, under proposed new Rule 12902(e)(3), FINRA would postpone any
scheduled hearing sessions if a mid-case referral results in the
withdrawal of the panel, so that a new panel would have flexibility to
schedule new hearing sessions based on its availability. Thus, if any
scheduled hearing sessions are postponed, FINRA would waive the
postponement fees that would otherwise accrue.
Changes to the Industry Code
Rule 13104--Effect of Arbitration on FINRA Regulatory Activities
FINRA also is proposing to amend Rule 13104 of the Industry Code to
broaden the arbitrators' authority to make referrals during an
arbitration proceeding in intra-industry cases. The reasons for the
proposed changes to Rule 13104 are the same as those for Rule 12104 of
the Customer Code discussed above.
Rule 13902--Assessment of Hearing Session Fees, Costs, and Expenses if
an Arbitrator Referral During a Case Results in Panel Withdrawal
FINRA also is proposing to adopt new Rule 13902(e) to address the
assessment of hearing session fees, costs, and expenses on member firms
and associated persons if an arbitrator makes a referral during a case
that results in panel withdrawal.
Under proposed new Rule 13902(e)(1), FINRA would waive the hearing
session fees for sessions conducted prior to the referral for
associated persons \18\ who are not the subject of the referral in
order to reduce the potential financial impact on these parties.
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\18\ Under the Industry Code, a dispute must be arbitrated if it
arises out of the business activities of a member or an associated
person and is between or among members; members and associated
persons; or associated persons. Rule 13200(a) of the Industry Code.
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Further, under proposed new Rule 13902(e)(2), FINRA may waive any
hearing session fees assessed against a member for hearing sessions
conducted prior to the mid-case referral, if the member is not the
subject of the referral. The proposed rule would provide FINRA with
discretion to waive any hearing session fees assessed against a member
that is named in the arbitration, but is not the subject of the mid-
case referral.
Finally, under proposed new Rule 13902(e)(3), FINRA would postpone
any scheduled hearing sessions if a mid-case referral results in the
withdrawal of the panel, so that a new panel would have flexibility to
schedule new hearing sessions based on its availability. Thus, if any
scheduled hearing sessions are postponed, FINRA would waive the
postponement fees that would otherwise accrue.
Benefits of the Proposed Rule Change
FINRA believes that the benefits of the proposal outweigh the
potential burden that a mid-case referral could present to the
individual investor. For example, if the proposed rule is invoked and
arbitrators make a mid-case referral, the proposal would mitigate
somewhat the harm to these investors by waiving the hearing session
fees for sessions conducted prior to the referral. Moreover, FINRA
believes that if arbitrators make a mid-case referral and a serious,
ongoing fraud is exposed, it is likely that either the arbitration
would cease because of regulatory intervention or the party who is the
subject of the referral would attempt to settle, rather than risk
continuing with the case.
FINRA anticipates that given the rigorous criteria for making a
referral under the proposed rule change, mid-case referrals will be
extremely rare. FINRA notes that arbitrators make a relatively small
number of referrals under the current rule, which permits post-case
referrals only. However, regardless of the number of mid-case referrals
that the proposal may generate, FINRA believes that the consequences of
one widespread fraud, which could prove to be financially devastating
to many investors, outweigh the potential harm to an individual
investor whose arbitration is interrupted.
In addition to the benefits of the proposal, FINRA believes that
its mission of investor protection and market integrity requires that
it review continually its rules with the goal of improving their
effectiveness and relevance. As such, FINRA believes that the Codes
should not contain a rule that, on its face, requires an arbitrator who
has reason to believe that there is a serious, ongoing, imminent threat
to investors to wait until a case is concluded before making a
referral. In light of the recent well-publicized fraudulent schemes,
FINRA believes inaction is antithetical to its mission and is,
therefore, proposing this rule to prevent potential harm to investors
and the markets. Moreover, FINRA's effectiveness as a regulator would
be enhanced if it could be alerted earlier to a situation indicating
the existence of a market manipulation scheme or other ongoing fraud,
and it could take earlier action.
FINRA believes the proposal would strengthen its regulation of its
members and would provide an additional layer of protection to
investors and the markets from fraudulent securities market schemes.
2. Statutory Basis
FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\19\ which
[[Page 58011]]
requires, among other things, that FINRA rules must be designed to
prevent fraudulent and manipulative acts and practices, to promote just
and equitable principles of trade, and, in general, to protect
investors and the public interest. The proposed rule change is
consistent with FINRA's statutory obligations under the Act to protect
investors and the public interest because the proposal would help FINRA
detect potential market manipulation or fraud at an earlier stage,
which could minimize the financial losses of investors as well as the
effects fraudulent schemes could have on the securities markets. Thus,
the proposed rule change would strengthen FINRA's ability to carry out
its regulatory mission and provide another layer of protection to
investors and the markets against fraud.
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\19\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
FINRA does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Interested persons are also invited
to submit written data, views and arguments concerning an arbitration
panel's withdrawal. Comments may be submitted by any of the following
methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an e-mail to [email protected]. Please include
File Number SR-FINRA-2010-036 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2010-036. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Comments are also available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street, NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of such filing also will be available for
inspection and copying at the principal office of FINRA. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly. All
submissions should refer to File Number SR-FINRA-2010-036 and should be
submitted on or before October 14, 2010.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\20\
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\20\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-23776 Filed 9-22-10; 8:45 am]
BILLING CODE 8010-01-P