Raymond & Bennett attorney Joseph Blyskal contributed the following post to this Blog.
I recently read an article indicating that arbitration was the preferred forum for member companies of the Financial Industry Regulatory Authority, but with a caveat–that the only real reason it was preferred was as damage control for the industry. With only some exceptions, the Financial Industry Regulatory Authority (FINRA) requires arbitration of industry disputes, which simply means disputes amongst or between its members and associated persons. In addition, while nonmembers can compel members to arbitrate, nonmembers of FINRA cannot be compelled to arbitrate. Regardless of whether the motive is fiscal, public relations, or other, the mandatory arbitration requirement may be hard to get around. However, the presence of a good faith claim against nonmembers can create the option to litigate an industry dispute outside of arbitration.
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FINRA members are defined as any entity: “who is registered or has applied for registration under the Rules of FINRA” or “[a] sole proprietor, partner, officer, director, or branch manager of a member, or other natural person occupying a similar status or performing similar functions, or a natural person engaged in the investment banking or securities business who is directly or indirectly controlling or controlled by a member, whether or not any such person is registered or exempt from registration with FINRA.”FINRA Manual Rule 13100(r). Some examples include: Metlife Securities, Inc., Bernad L. Madoff (now obviously inactive), and ING Financial Markets, LLC.
There are only a few enumerated exceptions to the mandatory arbitration rule. Disputes arising out of the insurance business activities of a member that is also an insurance company, claims alleging employment discrimination in violation of a statute, class actions, shareholder derivative actions, and matters that are inappropriate for the forum in light of the “purposes of FINRA and the intent of the Code” are excluded. FINRA Manual Rule 13200-13205. Depending on the circumstances, these are easily applied.
Less easily applied are the two threshold requirements that trigger mandatory arbitration for a dispute–that the dispute arises from the (1) business activities of (2) members or associated persons. These must be addressed before considering the application of the exceptions.
Whether a dispute arises from business activities is a factual inquiry. It is liberally construed, however. It includes claims for commissions earned, discharge from employment, and non-statutory discrimination claims. Generally, this is a threshold element.
The more litigation-friendly element is the second—that the dispute is between members, a member and an associated persons, or associated persons. Whether an entity is a FINRA member is not usually debatable (there are formal registration requirements). However, whether an entity is an “associated person” is often subject to debate. Courts often deny motions to compel arbitration where a factual showing is not made to support a finding of “associated person” as defined in the Code.
Cases where there are parent companies and subsidiaries involved in the dispute, or where there are employees or registered representatives as parties that are not FINRA members, or not employed by FINRA members, are breeding grounds for litigation over this second threshold provision.
Of course, in any case—whether the threshold elements are present or an exception applies—the general rule that those not party to an agreement to arbitrate cannot be compelled to do so applies to the FINRA arbitration provision. Thus, litigation is clearly a viable option where there is at least one entity involved that is not a FINRA member.
While difficult to get around the arbitration provisions of FINRA, it may be possible to do so. Litigants, both those prosecuting and defending claims, should identify and categorize all the disputants before making a determination that arbitration is indeed “mandatory”.