State securities regulators are being pulled in different directions on their proposal to help harmed investors obtain award payments when they win arbitration cases. Generally, the financial industry wants to narrow the measure, while investor advocates want to expand it.
In early October, the North American Securities Administrators Association released a model rule that strengthens enforcement against brokerages, investment advisers and investment adviser representatives who shirk arbitration awards and regulatory fines.
Under the model rule, failing to pay or attempting to avoid paying an arbitration award or fine would be deemed an unethical business practice and serve as the basis for an enforcement action. States could deny registration to firms or individuals with outstanding arbitration awards.
Each of the organizations and firms that responded to NASAA’s request for comment voiced general support for state regulators’ effort to crack down on unpaid arbitration awards, a problem that for years has vexed the Financial Industry Regulatory Authority Inc., the broker self-regulator that runs the arbitration system. A recent report by the Public Investors Advocate Bar Association showed the total of unpaid arbitration awards increased in 2020.
But when it came to the details of NASAA’s model rules, the commenters diverged.
The Securities Industry and Financial Markets Association encouraged NASAA to narrow the rule by excising language about fines.
“It would put arbitration awards in competition with regulatory fines for payment,” Kevin Carroll, SIFMA managing director and associate general counsel, wrote in a Nov. 4 letter. “Perhaps in many cases regulatory awards would be prioritized over arbitration awards, thereby undermining the central purpose of the model rules. The better course would be to focus the model rules exclusively on unpaid arbitration awards.”
Carroll also argued that the model rule should cover all unpaid awards, including those owed to industry claimants by customers or other firms.
The Financial Services Institute, which represents independent broker-dealers and financial advisers, questioned whether state regulators can actually target a firm for trying to dodge an arbitration award.
“Generally, FSI believes it would be a very rare, subjective, and evidence-intensive regulatory action that would demonstrate a registrant is ‘attempting to avoid’ a payment,” Robin Traxler, FSI senior vice president and policy and deputy general counsel, wrote in a Nov. 4 letter. “In most, if not all circumstances, a clear-cut resolution of payment or non-payment would likely precede and be more unassailable, than any action based on [an attempt not to pay]. We do not believe there would be any benefit to investors or regulators in sanctioning an attempt to avoid payment if the payment is otherwise actually made as required or agreed upon.”
Investor advocates want NASAA to expand the rule. For instance, PIABA has long supported establishing a recovery fund paid for by the financial industry that would finance unpaid arbitration awards. NASAA said it is monitoring the debate over the idea, which is strongly opposed by the industry, but did not make it part of the model rule.
“The proposed model rules may create an incentive for brokerage firms, investment advisory firms, and representatives to obtain meaningful levels of insurance to cover themselves in case of potential liability,” PIABA President Michael Edmiston wrote in a Nov. 4 letter. “However, investors will continue to be harmed until the securities industry addresses the unpaid award issue head-on through an investor recovery pool.”
A group of students from the St. John’s University Securities Arbitration Clinic and their professor, Christine Lazaro, also called for an unpaid arbitration award fund.
“We support the proposed rules,” Lazaro and her students wrote in a Nov. 4 letter. “However, they are not a perfect tool to address unpaid arbitration awards because they do not ensure investors who have been harmed are compensated.”
But LPL Financial expressed concern about a potential fund.
“It is critical that the fund be supported by existing revenue sources rather than increasing revenues from firms, like LPL, that pay their arbitration awards in a timely manner,” John Cronin, LPL head of state government relations, wrote in a Nov. 4 letter. “Many states have excess revenues from registration fees. We recommend that the model rule explicitly state that excess registration revenues, where present, are used to support the unpaid arbitration fund.”
NASAA could change the model rule based on the comments before releasing a final rule that would then have to be adopted by each state.
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