FINRA

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Contents

Overview

In the United States, the Financial Industry Regulatory Authority (FINRA) is a private corporation that acts as a self-regulatory organization (SRO).

FINRA is the successor to the National Association of Securities Dealers, Inc (NASD).

Though sometimes confused for a government agency, FINRA is not part of the U.S. government and is not a government agency—it is a private corporation that performs market regulation under contract with brokerage firms and trading markets. The complete name of the entity is Financial Industry Regulatory Authority, Inc.

FINRA regulates its members through the adoption and enforcement of rules and regulations governing the business conduct of its members.

It often provides advice to the Securities and Exchange Commission (a U.S. government agency).

However, because FINRA receives its funding from the Wall Street organizations it actually seeks to regulate, FINRA is sometimes viewed as the 'fox guarding the hen house'. Some view FINRA as having a conflict of interest.

FINRA also provides the binding arbitration service which investors (customers of Wall Street firms) are forced to agree to (through contracts of adhesion), rather than being able to bring their disputes against Wall Street firms and stock brokers, for example, into the federal court system for a judge or jury to rule upon.

FINRA focuses on regulatory oversight of all securities firms that do business with the public; professional training, testing and licensing of registered persons; arbitration and mediation; market regulation by contract for the New York Stock Exchange, the NASDAQ Stock Market, Inc., the American Stock Exchange LLC, and the International Securities Exchange, LLC; and industry utilities, such as Trade Reporting Facilities and other over-the-counter operations.

FINRA was formed by a consolidation of the enforcement arm of the New York Stock Exchange, NYSE Regulation, Inc., and the NASD. The merger was approved by the United States Securities and Exchange Commission on July 26, 2007.[1]

The opinion of NASD was that the regulatory consolidation will "increase efficient, effective, and consistent regulation of securities firms, provide cost savings to securities firms of all sizes, and strengthen investor protection and market integrity." According to NASD, additional benefits are to "streamline the broker-dealer regulatory system, combine technologies, and permit the establishment of a single set of rules and a single set of examiners with complementary areas of expertise within a single SRO."[2]

With respect to the regulatory agency merger, SEC Chairman Chris Cox said, "The consolidation of NASD's and NYSE's member firm regulatory functions is an important step toward making our self-regulatory system not only more efficient, but more effective in protecting investors. The Commission will work closely with FINRA to eliminate unnecessarily duplicative regulation, including consolidating and strengthening what until have now been two different member rulebooks and two different enforcement systems."[3]

History

The NASD was founded in 1939, in response to the 1938 Maloney Act amendments to the Securities Exchange Act of 1934. In 1971, NASD launched a new computerized stock trading system called the National Association of Securities Dealers Automated Quotations (NASDAQ) stock market. The NASDAQ and AMEX stock exchanges merged in 1998. Two years later, the NASDAQ underwent a major recapitalization and became an independent entity from NASD. In July 2007, the SEC approved the formation of a new SRO to be a successor to NASD. The NASD and the member regulation, enforcement and arbitration functions of the New York Stock Exchange were then consolidated into the Financial Industry Regulatory Authority (FINRA). [4]

Structure

The NASD Board of Governors consists of two staff members (the CEO and the President of one of NASD's divisions), seven individuals representing the industry, seven more individuals representing the industry, and two individuals categorized as "non-public" but also representing the industry. [5]

Size

The Financial Industry Regulatory Authority (FINRA), is the largest independent regulator for all securities firms doing business in the United States. All told, FINRA oversees nearly 4,850 brokerage firms, about 173,000 branch offices and approximately 647,000 registered securities representatives.

FINRA has a staff of nearly 2,800 and an annual budget of more than $500 million. [6] FINRA is funded primarily by assessments of member firms' registered representatives and applicants, annual fees paid by members, and by fines that it levies. The annual fee that each member pays includes a basic membership fee, an assessment based on gross income, a fee for each principal and registered representative, and charge for each branch office.


Functions: Regulation and licensure

NASD regulates trading in equities, corporate bonds, securities futures, and options, with authority over the activities of more than 5,100 brokerage firms, approximately 173,000 branch offices, and more than 676,000 registered securities representatives. All firms dealing in securities that are not regulated by another SRO, such as by the Municipal Securities Rulemaking Board ("MSRB"), are required to be member firms of the NASD.

NASD licenses individuals and admits firms to the industry, writes rules to govern their behavior, examines them for regulatory compliance, and is sanctioned by the U.S. Securities and Exchange Commission ("SEC") to discipline registered representatives and member firms that fail to comply with federal securities laws and NASD's rules and regulations. It provides education and qualification examinations to industry professionals. It also sells outsourced regulatory products and services to a number of stock markets and exchanges (e.g. American Stock Exchange ("AMEX") and the International Securities Exchange ("ISE").

NASD founded the NASDAQ ("National Association of Securities Dealers Automated Quotations") stock market in 1971. In 2006, NASD demutualized from NASDAQ by selling its ownership interest.

FINRA and FSA sign MOU

The Financial Services Authority (FSA) and the US Financial Industry Regulatory Authority (FINRA) have entered into a Memorandum of Understanding (MOU) to support more robust cooperation between the two regulators.

The MOU establishes a strong framework for enhancing the ability of the FSA and FINRA to oversee the world’s largest securities firms and markets. The agreement will facilitate the exchange of information on firms and individuals under common supervision, support collaboration on investigations and enforcement matters, and allow further sharing of regulatory techniques, including approaches to risk-based supervision of firms.

The agreement was signed by Jon Pain, FSA’s managing director of supervision and FINRA’s Chairman and CEO Richard Ketchum.

Jon Pain said:

“Given the linkages between our markets, it is vital that both regulators cooperate closely with each other, this MOU will enhance the supervision of firms and financial markets in both the UK and the U.S.”

Richard Ketchum added:

“To ensure consumer protection and market integrity in today’s global market, regulators must work together with key regulatory partners. Under this agreement, the FSA and FINRA will be able to share information more freely and expeditiously in support of the oversight of common firms and investigations into wrongdoing.”

FINRA discloses licensing plans for ops executives

The Financial Industry Regulatory Authority has publicly launched its proposal to license operations executives in the securities industry.

The regulatory agency for broker-dealers said the requirements for licensing would apply to currently employed operations executives within six to nine months of a final regulation. New employees would need to register as operations professionals and pass an examination before doing their jobs.

Currently, say brokerage officials, only the senior ranking operations executives at brokerage firms are licensed – and that means a handful at best instead of several dozen or even several hundred.

That licensing often comes under the category of financial and operations principals under a FINRA Series 27 exam often called FINOP 27.

“Given the growing complexity of the financial services industry and the importance of services provided by a firm’s so-called back-office personnel, Finra has concerns about the potential for regulatory gaps in the licensing and education requirements for individuals engaged in or supervising the securities or investment banking business of a member firm be qualified and registered persons,” said FINRA in a bulletin issued on Wednesday.

Comments are due by July 12.

The Securities and Exchange Commission cited the importance of licensing operations executives in the wake of Madoff’s Ponzi scam when it was revealed that operations executives helped cook the books and issue fraudulent statements to unsuspecting investors. But few details were disclosed at that time.

As reported by Securities Industry News, operations executives did mention the potential licensing requirements at the Securities and Financial Industry Association’s operations conference in Palm Desert, Calif on May 6.

However, executives at FINRA and the Securities Industry and Financial Markets Association (SIFMA), which has been working with FINRA to design the licensing examination, did not respond to further inquiries from Securities Industry News for further comment last week and earlier this week.

FINRA said that among the operations executives affected by the licensing will be those involved in trade confirmation, account statements, settlement and margin, securities lending, prime brokerage, customer account data and document maintenance; financial controller, bank custody, and financial regulatory reporting. The licensing would apply to senior management; supervisors, managers or other persons responsible for approving or authorizing operations work; and those with the authority to commit the firm’s capital. The requirement would not apply to persons engaged “solely in clerical or ministerial activities.”

The licensing exam, said FINRA, would cover three key areas: professional conduct and ethical considerations; essential product and market knowledge for an operations professional; and knowledge associated with operations activities.

FINRA will exempt individuals who hold the following certifications within two years prior to registering as an operations executive: registered options principal, compliance officer, supervisory analyst, general securities principal, investment company products-variable products principal; financial and operations principal, introducing broker-dealer financial and operations principal; municipal fund securities principal and municipal securities principal.

Criticism of decline in enforcement levels

FINRA levied fines against financial firms totaling $40 million in 2008, according to a Wall Street Journal analysis. That was the third straight annual decline in fines levied by FINRA or one of its predecessor agencies. The total was 73% below the $148.5 million in fines collected in 2005.[7]

A new study has found that FINRA’s fines and enforcement actions against broker/dealers and registered representatives dropped sharply in 2008, the first full year that FINRA represented the combined regulatory arms of NASD and NYSE.

According to the study, penned by lawyers at Sutherland Asbill & Brennan LLP, FINRA fined firms and individuals approximately $35 million in 2008, compared to $77.6 million imposed during 2007, a decline of 55%. The 2008 fines represent an even sharper decline from the peak in 2005, when NASD and the NYSE fined firms and individuals approximately $184 million, and 2006 when the fines totaled approximately $111 million. Moreover, there was a significant drop in “supersized” fines (i.e., fines over $1 million), from 19 in 2007 to three in 2008, the lawyers found.

Sutherland says that the number of disciplinary actions also declined in 2008, with FINRA resolving 1,007 formal disciplinary actions, a decline of about 9% from 2007, when FINRA resolved 1,107 disciplinary actions.

The magnitude of this drop is more significant than the numbers indicate, the lawyers write, “because the 2007 statistics are for (1) NASD alone for one-half of the year and (2) the combined NASD and the NYSE for the second half of the year, while the 2008 statistics are for the combined entity. The 2007 and 2008 statistics represent a significant decline from prior years: NASD and the NYSE resolved 1,454 disciplinary actions in 2005 and 1,428 in 2006.”

Sutherland found that “Blockbuster” issues (where industry practices allegedly resulted in significant customer harm), such as market timing, late trading, directed brokerage, revenue sharing, and mutual fund share class issues, characterized enforcement actions in 2005. “These matters each resulted in several enforcement actions involving large fines. As a result, in 2005 there were a record number—35--of “supersized” (or $1 million-plus) fines, including seven fines in excess of $5 million,” the lawyers write. “The number of “supersized” fines decreased to 19 in both 2006 and 2007. In 2006 only three fines were greater than $5 million, while in 2007 one was greater than $5 million. As discussed above, in 2008, FINRA assessed only three “supersized” fines and no single fine exceeded $5 million.”

The top five fine-generating issues for FINRA in 2008 were: mutual funds, suitability, licensing, excessive brokerage compensation (commissions/markups/markdowns), and electronic communications, the study found. Sutherland says that while this list includes some of the “usual suspects” like mutual funds, suitability, and electronic communications, there are some surprises (such as excessive brokerage compensation and licensing).

Suthlerand said that an analysis of the disciplinary actions in the top five categories reveals the following trends:

  • The “blockbuster” mutual fund cases of the past few years (e.g., market timing, late trading, unsuitable sales of Class B mutual fund shares, and directed brokerage) are on the wane;
  • The issues that FINRA has been trying to turn into “blockbusters,” such as variable product and hedge fund sales, sales to seniors, and anti-money laundering generally have not yet generated “supersized” fines; and

FINRA seems to have been more attentive to more traditional, individual sales practice and gatekeeping violations (e.g., suitability and licensing violations), than to more novel rulemaking-by-enforcement industry violations, such as market timing."


According to a study by Deborah G. Heilizer and Brian L. Rubin, both partners in Washington with Sutherland Asbill & Brennan LLP, regulators with NASD and NYSE (now collectively known as FINRA) Regulation obtained fines of over $1 million in 35 actions taken in 2005.

In 2006, that number dropped to 19. And the number of enforcement actions over $5 million also fell. In 2005, there were seven such actions as opposed to three in 2006. According to the written report, the “data suggest that securities regulators may have retrenched their efforts to regulate through the use of novel theories.”('Supersized’ fines on the wane, study says", Investment News, October 3, 2007)

Former Finra director to defend broker dealers after leaving Finra

Susan Merrill, Finra's head of enforcement, is leaving this week to join the law firm Bingham McCutchen LLP.

She will be a New York-based partner in the firm's 75-lawyer broker-dealer practice group and will lead Bingham's enforcement practice for financial-industry clients, the law firm said today.

Ms. Merrill starts her new post Thursday.

Her departure was > expected.

Ms. Merrill's leaving marks a return to private practice after six years at the Financial Industry Regulatory Authority Inc. and the New York Stock Exchange. Prior to joining the NYSE, she was a partner at Davis Polk & Wardwell LLP for 10 years.

NASD and the NYSE's regulatory unit merged to form Finra in 2007.

Ms. Merrill oversaw consolidating the two enforcement units.

“In a way, I felt my work was completed,” she said in an interview. “I think I set the tone for the department by getting people focused on investor protection and making sure we could get money back to investors.”

James Shorris, executive director of enforcement, is running the Finra enforcement department on an interim basis, Ms. Merrill said.

During her tenure at Finra, she witnessed the financial crisis and the collapse of major securities firms, as well as the emergence of numerous Ponzi schemes such as the Madoff and Stanford Financial Group frauds.

Those events “didn't have anything to do with my decision” to leave Finra, Ms. Merrill said. “Those things … happened along the course of financial history … I made the decision that I didn't want to spend [the rest of] my entire career at a regulator.”

Critics have faulted Finra for focusing on smaller firms and minor sales practice issues, while missing larger systemic problems.

Ms. Merrill said that the responsibility for the big issues doesn't always lie with Finra.

“One thing you have to understand about Finra is that we're not the [Securities and Exchange Commission],” she said. “We're charged with bringing some of the small cases that sometimes the SEC doesn't have the resources to bring.”

Finra and the SEC often coordinate cases, “so if the SEC is looking at the top five [brokerage] firms for something, [Finra is] not going to look at the same” firms, Ms. Merrill said.

Finra director of enforcement has resigned

Susan Merrill, the enforcement director at Finra, informed her staff on Wednesday that she plans on stepping down, according to several published reports.

The Financial Industry Regulatory Authority Inc. reportedly stated that that the timing of Merrill's resignation and her next job are not known. No successor has been named.

Ms. Merrill's exit marks the second high-profile departure at the self-regulatory organization in a little more than a month. In February, Robert Errico, Finra's executive vice president for member regulation, indicated he planned to leave the regulator at the end of March.

Ms. Merrill was chief of enforcement at the New York Stock Exchange for three years when she joined Finra in 2007. That was the year Finra was created through the merger of NYSE Member Regulation and the National Association of Securities Dealers.

The exit of Finra's top cop comes in the wake of heavy criticism aimed at the regulator for failing to detect massive investment frauds, including the Ponzi scheme orchestrated by Bernard Madoff.

In a letter sent in late February to several congressional committees, a good-government group known as the Project on Government Oversight took direct aim Finra. The group lambasted the watchdog's "abysmal track record" in regulating the financial industry, adding that Finra and other self-regulatory organizations failed to prevent “virtually all of the major securities scandals dating back to the 1980s.”

In a statement addressing those accusations, Finra spokesman Herb Perone said the group's letter had “numerous inaccuracies and misperceptions.”

House scraps amendment to place B-D advisers under Finra

"The House today killed a proposal that would have given the Financial Industry Regulatory Authority Inc. the authority to regulate investment advisers at broker-dealers.

An amendment scrapping the proposal was introduced by Rep. Barney Frank, D-Mass., and Rep. Frank Cohen, D-Tenn.. The amendment was passed by a voice vote. (Read the full story on Rep. Frank's plans here.)

The proposal to put advisers associated with broker-dealers was introduced by Rep. Spencer Bachus, R-Ala. He agreed to strike the Finra provision and indicated he would explore other options to regulating advisers.

Public oversight group encourages Congress to reduce reliance on Finra

"...In various pieces of legislation aimed at reforming the financial regulatory system, Congress has called for an independent review of SROs such as FINRA. For instance, Section 7304 of the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173), which recently passed in the House, would require an independent analysis to determine "whether adjusting the SEC's reliance on self-regulatory organizations is necessary to promote more efficient and effective governance for the securities market."20

We would go one step further. In light of FINRA's abysmal track record, and the flawed premise of self-regulation in general, POGO calls on Congress to consider vastly curtailing the power of SROs. Effective, independent, and efficient government regulation is the only proper way to safely oversee our markets. Our economy is too important to be left in the hands of the very financial industry that brought us to the brink of collapse."

Finra's report by the 2009 Special Review Committee

Last week, FINRA released a report by the 2009 Special Review Committee that examines in detail the failure of FINRA’s examination program to detect the Stanford and Madoff frauds (the FINRA Report). The Special Committee recommends a series of reforms to FINRA examinations for adoption by FINRA management and its board, including items that would require SEC approval and – with respect to jurisdiction over registered investment advisers - Congressional action. These reforms would significantly expand FINRA’s enforcement and regulatory reach beyond its current mandate.

The FINRA Report follows on the heels of the final recommendations of the SEC Inspector General for reforming the agency’s Division of Enforcement operations (the SEC Report), which grew out of his earlier scathing critique of the SEC’s failures to identify the Madoff fraud. The Director of Enforcement has agreed to adopt and implement all of the SEC Report’s recommendations. While many of the proposed FINRA reforms outlined in the FINRA Report would take time to implement (if they are implemented at all), the immediate changes to the respective examination and enforcement programs of FINRA and the SEC triggered by these reviews are being felt by financial services firms immediately and they will need to react to these changes.

FINRA Reforms.

A. The FINRA Report concludes that FINRA should seek authority from Congress to regulate activities under the Investment Advisers Act. It suggests that if FINRA had this authority, it may have discovered Madoff’s Ponzi scheme through its regular examination process after he registered as an investment adviser in 2006. The SEC has not taken a public position on this proposal. The current Obama Financial Regulatory Reform does not contemplate an SRO regulatory structure for investment advisers, nor do any of the current proposals being considered by House Financial Services Chairman Barney Frank or Senate Banking Chairman Chris Dodd. Please see recent Blog posting called "House and Senate Take Expedited But Divergent Approaches to Financial Regulatory Reform Plan." It would be surprising if this jurisdictional reach by FINRA gets traction in the present Congress.

B. The FINRA Report also recommends that FINRA seek SEC authority to broaden its authority to examine not only outside business activities of associated persons of members, but also affiliates of member firms. This expansion of FINRA’s regulatory reach would give it broader investigative powers than the SEC itself. It remains to be seen how the SEC will react to this proposal.

C. The FINRA Report notes that FINRA staff declined to pursue inquiries into complaints about Stanford’s high-pressure sales of CDs issued by its off-shore Antigua bank affiliate because of a concern that the CDs were not securities. This decision apparently was made by non-attorneys and contrary to the specific position of the SEC Fort Worth Regional Office on the issue, and was taken without fully informed consultation with FINRA General Counsel. The FINRA staff’s surprisingly and well-documented timid view of its jurisdictional limits, which appear to have had a material impact on its failure to pursue complaints related to Stanford, provides an interesting contrast to the Special Committee’s recommendation of a much more expanded and robust jurisdictional scope for FINRA going forward.

D. One recommendation from the FINRA Report that FINRA itself can implement is the proposal to increase FINRA’s fraud detection capacity and to focus more heavily on so-called “cause” examinations. The shift to an examination program focused primarily on items triggered for cause, however, would transform the examination staff to an adjunct of the FINRA enforcement division. Assuming this recommendation is adopted by the FINRA board, it could require members and associated persons to prepare for and approach future examinations with a much more guarded approach. Management will need to promptly assess the allegations that trigger the cause examination and independently determine whether the cause determination is warranted and, if so, whether remedial action is appropriate.

E. The FINRA Report notes that it is standard practice of FINRA not to defer to another regulatory agency’s parallel enforcement efforts, unless there is an express request to defer made by the SEC or other agency. This statement will come as a surprise to many practitioners who have successfully persuaded FINRA to defer its own review of an enforcement matter on burdensomeness grounds where there is a parallel SEC or DOJ investigation into the same conduct. It remains to be seen how this newly announced FINRA policy will be applied in practice.

SEC Enforcement Reforms.

While the SEC IG proposed myriad reforms regarding training and oversight at the SEC, financial services firms are most likely to be affected by reforms relating to the staffing and handling of complaints as well as a proposed more targeted focus of examinations.

A. A new Office of Market Intelligence will be created within the Enforcement Division to coordinate the process of reviewing and evaluating tips and complaints. In addition, SEC Chairman Mary Schapiro is seeking Congressional authority to reward whistleblowers with financial incentives.

B. The SEC will work to deploy adequately qualified staff with experience tailored to the matters at issue in a specific investigation. The Office of Compliance Inspections and Examinations (OCIE) hopes to fill new “Senior Specialized Examiner” positions with professionals with experience in areas such as valuation, sales and forensic accounting. Dealing with such specialized professionals could result in a streamlining and acceleration of the enforcement investigation and examination process for financial services firms. Whether this results in a fairer process for these firms remains to be seen.

C. Finally, the Enforcement Division will institute a more rigorous and systematized process for the planning, oversight and management of the investigation process, including the processes for both opening and closing investigations. Although more targeted investigations may lighten the burden on financial services firms in some respects, OCIE, like FINRA, intends to increase its focus on “cause” investigations. This focus raises the same concerns as it does with FINRA’s shift in emphasis and puts greater burdens on financial services firms to more carefully prepare for and respond to issues raised in examinations and investigations. It will also increase the need for management to conduct its own independent review of the matter under scrutiny.


A special review has found that the brokerage industry's self-policing body must make reforms to protect investors after its inspections failed to uncover the massive Ponzi scheme run by Bernard Madoff and the alleged fraud by R. Allen Stanford.

The special committee's review recommends the Financial Industry Regulatory Authority's brokerage examination program be revamped to ensure that detecting and preventing fraud are central elements.

The review found that FINRA lacks a central database for its examiners with investors' complaints about firms, so staff members missed numerous "red flags" on Stanford's firm.

FINRA challenged on compensation of officers

The Financial Industry Regulatory Authority will review claims its management is overcompensated after the brokerage-industry regulator paid former Chief Executive Officer Mary Schapiro $3.26 million in 2008.

Finra’s board of governors will meet Feb. 10 to discuss a letter sent to the regulator from lawyers representing a member brokerage firm, Finra spokesman Herb Perone said yesterday.

The Dec. 4 letter, signed by Richard D. Greenfield and Jonathan W. Cuneo, called 2008 compensation “excessive” given Finra’s regulatory performance and a $568 million decline in the authority’s investment portfolio. The lawyers urged Washington- based Finra to recoup bonuses paid to managers including Schapiro, who left a year ago to become U.S. Securities and Exchange Commission chairman. The letter was released yesterday.

“Consistent with established procedures, the Finra board will review the allegations at its next regular meeting and determine the appropriate course of action,” Perone said.

Executive compensation has triggered fury in Congress as banks pay billions of dollars in bonuses a year after receiving government bailouts. Finra, which oversees Wall Street, paid its 20 most highly compensated employees $1.49 million on average in 2008, according to its most recent tax filing.

“It strikes me, as a lowly academic, as a lot of money and I think it would strike a lot of politicians that way too,” said James Cox, a law professor at Duke University in Durham, North Carolina. “They’ve got to be worried that the spotlight will be turned to them at some point.”

Finra’s Funding

Finra, funded by securities firms and overseen by the SEC, inspects and writes rules for more than 5,000 U.S. brokerages. Its board includes 10 representatives of the financial industry along with former regulators and academics.

Greenfield and Cuneo represent Lieutenant Colonel Elton Johnson Jr., president of Moreno Valley, California-based Amerivet Securities Inc. Johnson filed an August lawsuit against Finra, saying it failed in regulating Bear Stearns Cos., Lehman Brothers Holdings Inc. and Bernard Madoff’s securities firm.

The complaint seeks access to Finra documents so Johnson can try to determine what triggered the regulator’s investment losses. His suit seeks no money. Greenfield and Cuneo said in a statement that the Finra board will discuss Johnson’s charges.

The effort is “part of an ongoing publicity campaign by a party and counsel who are already in litigation with Finra,” Perone said. It “repeats earlier allegations without providing any new facts.”

Schapiro

Schapiro, 54, received a $937,961 salary from Finra in 2008, a bonus and incentive compensation worth $1.75 million and other pay totaling $565,995, according to the regulator’s tax filing. She also received a Finra “defined-benefit plans” payment of $7.2 million. She makes $162,900 a year at the SEC.

SEC spokesman John Nester declined to comment on Finra’s board meeting.

It’s unlikely that Finra will try to recoup Schapiro’s pay, Cox said. The board may request an internal review of pay practices, he said.

“They will have a reasonable basis for not pursuing a clawback,” Cox said. “That’s water that has already gone under the bridge.”

$35,000 given to member firms

"NASD could have paid two to three times more than the $35,000 given to member firms in exchange for approving its 2007 merger with the New York Stock Exchange's regulatory unit, according to an attorney who represents two brokerage firms that are suing NASD.

In a court hearing last week, Jonathan Cuneo, founding member of Cuneo Gilbert & LaDuca LLP, who represents the two firms, told a federal judge that NASD member firms could have received an additional $35,000 to $76,000 each under an Internal Revenue Service opinion letter.

The suits allege that NASD, now known as the Financial Industry Regulatory Authority Inc., claimed falsely that the $35,000 it paid to each member firm — in exchange for their giving up significant voting rights — was the maximum allowed by the IRS.

Although portions of the March 2007 IRS opinion letter have been previously disclosed, the range of payments that the IRS approved have been the subject of a court seal and never revealed.

“We dispute the figures” cited by Mr. Cuneo, Finra spokesman Brendan Intindola said in a statement. “We cannot comment further, as the materials remain under seal.”

Mr. Cuneo declined to comment about the figures he cited in court.

The original case was filed by Standard Investment Chartered Inc. in May 2007.

In December 2008, Benchmark Financial Services Inc. filed a similar case.

Judge Jed Rakoff of the U.S. District Court for the Southern District of New York will decide by year-end on an NASD motion to dismiss the claims.

The suits also name a number of NASD executives, including its former chief executive, Mary Schapiro, who is now chairman of the Securities and Exchange Commission."

Arbitration

FINRA arbitration statistics here.

FINRA operates the nation's largest arbitration forum for the resolution of disputes between customers and member firms, as well as between brokerage firm employees and their firms. Virtually all agreements between investors and their stockbrokers include mandatory arbitration agreements, whereby investors (and the brokerage firms) waive their right to trial in a court of law. Although the fairness of such mandatory arbitration clauses has been called into question, U.S. courts have consistently found them to be lawful.

As of June 2005, the pool of arbitrators consisted of 2,700 individuals classified by FINRA as industry panelists and 3,700 individuals classified as non-industry panelists.

In 1987, in Shearson/American Express v. McMahon, the United States Supreme Court ruled that account forms signed by customers requiring arbitration for disputes were enforceable contracts. Brokerage firms now require all customers to sign such documents, requiring binding arbitration.

For disputes between customers and member firms, the panel that decides the case consists of three arbitrators, one industry panelist and two non-industry panelists. For disputes between an employee and member firms, all three arbitrators are industry panelists.

For a given case, the two sides are provided separate lists by FINRA of local, available arbitrators, from which they chose. If one side rejects all listed arbitrators, FINRA names the arbitrators who will serve; these can be rejected only for biases, misclassification, conflicts, or undisclosed material information, and biases or conflicts must be identified prior to the beginning of hearings.

For an overview of the Securities Arbitration process, see Introduction to Securities Arbitration.

New case filings through July:

  • 2007 -- 1,878
  • 2008 -- 2,614
  • 2009 -- 4,481
  • 2009 Vs 2008 -- 71%

FINRA rules do not require parties to be represented by attorneys. A party may appear "pro se", or be represented by a non-attorney in arbitration. However, representation by a non-attorney is not advised since this may be the unauthorized practice of law. [8]

Brokerage firms routinely hire attorneys, so a customer who does not can be at a serious disadvantage. One organization whose members specialize in representing customers against brokerage firms in FINRA and NYSE arbitration is the Public Investors Arbitration Bar Association (PIABA).

In June 2006, Lewis D. Lowenfels, one of two partners at the New York law firm of Tolins & Lowenfels, and co-author of the looseleaf treatise Bromberg and Lowenfels on Securities Fraud and Commodities Fraud, 2d said of the NASD arbitration process: "What started out as a relatively swift and economical process for a public customer claimant to seek justice has evolved into a costly extended adversarial proceeding dominated by trial lawyers and the usual litigation tactics."

References


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