The Financial Industry Regulatory Authority (“FINRA”) operates the largest securities arbitration forum in the United States. The forum provides a neutral, efficient, and fair setting for investors to resolve disputes with securities firms and individual brokers.
But, as with other dispute resolution forums, FINRA arbitration has its inherent limitations. One central and recently explored limitation is FINRA’s difficulty in collecting arbitration awards from firms that are found liable for misconduct. As an illustration of this problem, FINRA stated in a 2018 report on unpaid arbitration claims that roughly 22 to 30 percent of damages awards went unpaid between 2012 and 2016. In terms of dollars, investors couldn’t recover $14 million in 2016 alone.
So, can this be fixed? Or, better yet, what can you do to prevent this from happening to you?
Fixing the System
The simple answer is that FINRA already started to explore solutions. On February 8, 2018, for example, FINRA reached out to the securities industry and the public for commentary on FINRA’s proposed rules that help ensure broker-dealer firms will pay owed awards. Even Congress and investor advocacy organizations, such as the Public Investors Arbitration Bar Association, have stepped in to help. Notable solutions may be an industry-funded unpaid arbitration pool; a requirement for broker-dealers to carry more insurance coverage; and/or a requirement that broker-dealer firms certify an ability to pay an arbitration award before any firm reorganization.
These proposed solutions have merit. But until Congress, FINRA, the SEC, or another regulatory organization picks a winning solution to the issue, investors are left to manage the problem on their own. Nonetheless, investors can protect themselves now, by taking the below-mentioned cautionary actions before any arbitration claim comes up.
What Can Investors Do Now?
The following options provide several precautionary steps for investors that are searching for their next financial advisor. These steps cannot guarantee that a firm or an advisor will pay an arbitration award if one were to come up in the future, but these steps can lower the risk.
First, as an investor, look closely at the firm that manages your funds. Think to yourself, have you asked all the questions about what the firm will do if things go wrong? For example, the Securities and Exchange Commission currently uses guidelines on how much cash or liquid assets a firm must have at its disposal for any potential claims from its customers (known as “Net Capital Requirements for Brokers” under SEA Rule 15c3-1). Ask how your firm meets those guidelines. Even if the firm gives you a weird look as to why you would ask such a focused question, the firm should give you a clear answer on their obligations and how they exceed them. Your overall conclusion should be that your firm-of-choice can financially handle any issue with its customers.
Second, you should think about how a larger firm may offer lower risks. Though small advisory firms can offer more personalized and friendly help to investors, there is an inherent risk in trusting such firms with your assets. In other words, large firms generally have a strong foundation to survive the worst-case scenarios; small firms often do not. But if you happen to go with a smaller firm, doing research on the firm before-hand is essential.
Third, thoroughly investigate the particular advisor that the firm wants to provide for you. This investigation is easy. In fact, FINRA operates a BrokerCheck system, where you can look up a broker-dealer and view past complaints or issues with that advisor’s previous customers. Take the time to review your potential advisor closely. If they have several complaints or marks on their record, consider another firm. The best way to prevent any unpaid award is to reduce the likelihood of any claim in the first place. Be careful about working with financial advisers with long records of customer complaints.
And last, always be aware of the financial risks in the financial industry. No investor wants to think of losing their money. But be aware of the risk that a broker-dealer may not pay an arbitration award. This awareness at least keeps you focused on your advisor’s actions and account monitoring.
In sum, FINRA deserves industry respect for tackling the issue of unpaid arbitration claims—especially because of FINRA’s transparency in addressing the problem. As investors, the general public, or advocates, it is now our duty to assist FINRA when we can, and to recognize the risks in the financial industry when we can’t.