[Federal Register Volume 79, Number 199 (Wednesday, October 15, 2014)]
[Notices]
[Pages 61915-61920]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-24420]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-73319; File No. SR-FINRA-2014-005]


Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving a Proposed Rule Change, as Modified by 
Partial Amendment No. 1, To Broaden Arbitrators' Authority To Make 
Referrals During an Arbitration Proceeding

 October 8, 2014.

I. Introduction

    On July 12, 2010, the Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed a proposal pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ with the Securities and Exchange Commission 
(``Commission'') to amend Rule 12104 (Effect of Arbitration on FINRA 
Regulatory Activities) of the Code of Arbitration Procedure for 
Customer Disputes (``Customer Code'') and Rule 13104 (Effect of 
Arbitration on FINRA Regulatory Activities) of the Code of Arbitration 
Procedure for Industry Disputes (``Industry Code'') (collectively, the 
``Codes''). This initial proposal would have permitted arbitrators to 
make referrals to FINRA during an arbitration case, would have required 
the FINRA Director of Arbitration (``Director'') to disclose the 
referral to the parties, and would have required the entire panel to 
withdraw upon a party's request that a referring arbitrator withdraw 
(``original proposal''). The Commission published the original proposal 
for comment on September 17, 2010.\3\ On July 7, 2011, FINRA responded 
to comments received by the Commission by filing an amendment to the 
original proposal,\4\ which replaced the original proposal in its 
entirety.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Rel. No. 62930 (Sept. 17, 2010), 
75 FR 58007 (Sept. 23, 2010) (SR-FINRA-2010-036).
    \4\ See Securities Exchange Act Rel. No. 64954 (Jul. 25, 2011), 
76 FR 45631 (Jul. 29, 2011) (SR-FINRA-2010-036) (Notice of Filing 
Proposed Rule Change and Amendment No. 1 to Amend the Codes of 
Arbitration Procedure To Permit Arbitrators To Make Mid-Case 
Referrals) (hereinafter, the ``Amended Original Proposal,'' to 
distinguish Amendment No.1 to the original proposal from the current 
proposal as amended by Partial Amendment No. 1.).
---------------------------------------------------------------------------

    Under the Amended Original Proposal, an arbitrator would have been 
permitted to make a mid-case referral if he or she became aware of any 
matter or conduct that the arbitrator had reason to believe posed a 
serious threat, whether ongoing or imminent, that was likely to harm 
investors unless immediate action was taken. A mid-case referral could 
not have been based solely on allegations in the pleadings. The Amended 
Original Proposal also would have instructed the arbitrator to wait 
until the arbitration concluded to make a referral if, in the 
arbitrator's judgment, investor protection would not have been 
materially compromised by the delay. Further, if an arbitrator made a 
mid-case referral, the Director would have disclosed the act of making 
the referral to the parties, and a party would have been permitted to 
request recusal of the referring arbitrator. The Amended Original 
Proposal would have required either the President of FINRA Dispute 
Resolution (``President'') or the Director to evaluate the referral and 
determine whether to forward it to other divisions of FINRA for further 
review. Finally, the Amended Original Proposal would have retained the 
provisions in Rule 12104(b) of the Customer Code and Rule 13104(b) of 
the Industry Code that permits an arbitrator to make a post-case 
referral. The Commission received five comment letters in response to 
the Amended Original Proposal.
    On January 29, 2014, FINRA withdrew the Amended Original Proposal 
\5\ without responding to the comments and filed the current proposal 
(``Proposed Rule''). The Proposed Rule was identical to the Amended 
Original Proposal. As part of the Proposed Rule, FINRA responded to 
comments received on the Amended Original Proposal. The Proposed Rule 
was published for comment in the Federal Register on February 12, 
2014.\6\ The Commission received 10 comment letters in response. On 
March 28, 2014, FINRA extended to May 20, 2014, the time period in 
which the Commission must approve the Proposed Rule, disapprove the 
Proposed Rule, or institute proceedings to determine whether to approve 
or disapprove the Proposed Rule. On May 19, 2014, FINRA responded to 
comments to the Proposed Rule and filed Partial Amendment No. 1.\7\
---------------------------------------------------------------------------

    \5\ See SR-FINRA-2010-036, Withdrawal of Proposed Rule Change, 
available at http://www.finra.org/Industry/Regulation/RuleFilings/2010/P121722.
    \6\ See Securities Exchange Act Rel. No. 71534 (Feb. 12, 2014), 
79 FR 9523 (Feb. 19, 2014) (SR-FINRA-2014-005) (``Notice of 
Filing'').
    \7\ See Letter from Mignon McLemore, Assistant General Counsel, 
FINRA Dispute Resolution, to Lourdes Gonzalez, Commission, dated May 
19, 2014 (``May Response''). The May Response and the text of 
Partial Amendment No. 1 are 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. The May Response is also 
available on the Commission's Web site at http://www.sec.gov.

---------------------------------------------------------------------------

[[Page 61916]]

    On May 20, 2014, the Commission published for comment both Partial 
Amendment No. 1, and an order instituting proceedings pursuant to 
Section 19(b)(2)(B) of the Act \8\ to determine whether to approve or 
disapprove the Proposed Rule, as modified by Partial Amendment No. 
1.\9\ The Commission received nine comments on the Proposed Rule as 
modified by Partial Amendment No. 1 (together, the ``Amended Current 
Proposal'').\10\ On August 14, 2014, FINRA responded to these 
comments.\11\
---------------------------------------------------------------------------

    \8\ 15 U.S.C. 78s(b)(2)(B).
    \9\ See Securities Exchange Act Rel. No. 72196 (May 20, 2014), 
76 FR 30206 (May 27, 2014) (``Order Instituting Proceedings'').
    \10\ Jenice L. Malecki, Esquire, Malecki Law (May 20, 2014, 
commenting only on the Proposed Rule) (``Malecki''); George H. 
Friedman, Esquire, George H. Friedman Consulting, LLC (Jun. 9, 2014) 
(``Friedman''); Nicole G. Iannarone, Assistant Clinical Professor, 
and Patricia Uceda, Student Intern, Investor Advocacy Clinic, 
Georgia State University College of Law (Jun. 20, 2014) (``Georgia 
State''); Guillermo Gleizer, Esq. (Jun. 25, 2014) (``Gleizer''); 
Jason Doss, President, Public Investors Arbitration Bar Association 
(Jun. 26, 2014) (``PIABA''); Ellen Liang, Student Intern, Elissa 
Germaine, Supervising Attorney, and Jill Gross, Director, Pace 
Investor Rights Clinic (Jun. 26, 2014) (``Pace''); Richard P. Ryder, 
Esquire, President, Securities Arbitration Commentator, Inc. (Jun. 
26, 2014) (``Ryder''); Andrea Seidt, President, North American 
Securities Administrators Association and Ohio Securities 
Commissioner, (Jun. 27, 2014) (``NASAA''); and Steven B. Caruso, 
Esq., Maddox Hargett & Caruso, P.C. (July 2, 2014) (``Caruso'').
    \11\ Letter from Mignon McLemore, Assistant Chief Counsel, FINRA 
Dispute Resolution, Inc., to Kevin O'Neill, Deputy Secretary, 
Commission, dated August 14, 2014 (``FINRA Letter'').
---------------------------------------------------------------------------

    This order approves the Amended Current Proposal.

II. Description of the Amended Current Proposal

    As further described in the Notice of Filing, FINRA is proposing to 
amend Rule 12104 of the Customer Code and Rule 13104 of the Industry 
Code to broaden arbitrators' authority to make referrals during an 
arbitration proceeding. Under the Amended Current Proposal, an 
arbitrator would be permitted to make a mid-case referral if the 
arbitrator becomes aware of any matter or conduct that the arbitrator 
has reason to believe poses a serious threat, whether ongoing or 
imminent, that is likely to harm investors unless immediate action is 
taken. A mid-case referral could not be based solely on allegations in 
the pleadings. The Amended Current Proposal would further provide that 
when a case is nearing completion, the arbitrator should wait until the 
case concludes to make a referral if, in the arbitrator's judgment, 
investor protection would not be materially compromised by the delay. 
If an arbitrator makes a mid-case referral, the Director would disclose 
the act of making the referral to the parties, and a party would be 
permitted to request recusal of the referring arbitrator. The Amended 
Current Proposal would require either the President or the Director to 
evaluate the referral and determine whether to forward it to other 
divisions of FINRA for further review. The Amended Current Proposal 
would retain the provisions in Rule 12104(b) of the Customer Code and 
Rule 13104(b) of the Industry Code that permit an arbitrator to make a 
post-case referral. Partial Amendment No. 1 would require that a party 
requesting recusal of an arbitrator following a mid-case referral, and 
based on such a referral, do so within three days of being notified of 
the mid-case referral. FINRA stated that the amendment is intended to 
prevent a party from receiving notice of the mid-case referral and 
reserving the right to strategically request recusal when it would best 
benefit that party.

III. Comments on the Amended Current Proposal

    The Commission received nine comments on the Amended Current 
Proposal.\12\ Five commenters opposed the Amended Current Proposal,\13\ 
three commenters partially supported the Amended Current Proposal,\14\ 
and one commenter supported the Amended Current Proposal.\15\
---------------------------------------------------------------------------

    \12\ See note 10, supra.
    \13\ PIABA, Georgia State, Gleizer, Ryder, and Caruso.
    \14\ Pace, NASAA, and Malecki.
    \15\ Friedman.
---------------------------------------------------------------------------

A. Support for the Goals of the Amended Current Proposal

    One commenter states that the Amended Current Proposal, along with 
certain suggested changes, would enhance the investor protection 
mission of FINRA and the SEC.\16\ Two other commenters support FINRA's 
efforts to identify and stop ongoing securities market schemes that 
could harm investors by authorizing arbitrators to make mid-case 
referrals.\17\ They express concerns, however, about the potential 
impacts of the Amended Current Proposal on individual claimants and 
suggest further changes that, in their view, would minimize the 
negative impact of the Amended Current Proposal.\18\
---------------------------------------------------------------------------

    \16\ Friedman.
    \17\ Pace and NASAA. See also Malecki (supporting the goal of 
the Proposed Rule).
    \18\ Pace and NASAA. These suggestions are discussed further 
below.
---------------------------------------------------------------------------

    FINRA replies that it has carefully considered the impact that its 
proposal could have on an individual investor claimant. However, it 
states further that its regulatory obligations also require it to weigh 
the potential effect that failing to allow mid-case referrals could 
have on a large group of investors. In considering these potential 
effects, FINRA determined that the proposal would help FINRA detect 
serious threats to investors at an earlier stage than would otherwise 
occur; this early warning, FINRA states, could help curb financial 
losses of a potentially large group of investors. Therefore, FINRA 
states that providing additional protection to public investors 
generally by strengthening its regulatory structure outweighs the 
potential increased costs to an investor party.\19\
---------------------------------------------------------------------------

    \19\ FINRA Letter at 4.
---------------------------------------------------------------------------

B. Effect on Retail Investors

    The Commission solicited comment on the Amended Current Proposal's 
effects on retail investors.\20\ In response, some commenters express 
concern about increased costs and delays incurred by the investor in 
the arbitration if an arbitrator made a mid-case referral.\21\ Two 
commenters also contend that a retail investor should not be expected 
to incur the costs that could arise if an arbitrator made a mid-case 
referral.\22\ These commenters suggest that the costs that result from 
a mid-case referral should be borne by the party seeking recusal or by 
FINRA.\23\
---------------------------------------------------------------------------

    \20\ See Order Instituting Proceedings, note 9, supra.
    \21\ See, e.g., PIABA, Ryder, and Pace.
    \22\ PIABA and Malecki.
    \23\ Id.
---------------------------------------------------------------------------

    Regarding the suggestion that FINRA pay an investor's costs and 
expenses that could arise as a result of a mid-case referral, FINRA 
states it does not believe that it would be appropriate for the forum 
that administers the arbitration process to bear the costs for any 
party. FINRA states also that it provides an arbitration forum that is 
neutral and fair for all parties to a dispute, and that if the forum 
were to agree to pay for one party's costs and expenses it would raise 
questions about the forum's neutrality and its role in administering 
the arbitration process; FINRA therefore declines to make such a 
change.\24\
---------------------------------------------------------------------------

    \24\ FINRA Letter at 5, incorporating by reference May Response 
at 12.
---------------------------------------------------------------------------

    While FINRA acknowledges that it cannot eliminate all of the 
potential costs or delays to an individual claimant

[[Page 61917]]

associated with a mid-case referral, it also describes a number of ways 
in which the Codes permit a hearing panel to allocate costs in a manner 
that takes into account the circumstances leading to the costs' 
incursion, ways in which the Codes permit FINRA to absorb some costs 
that may be incurred as a result of a mid-case referral, as well as 
ways in which the parties themselves can minimize costs and delays.\25\
---------------------------------------------------------------------------

    \25\ FINRA Letter at 4, incorporating by reference May Response 
at 12-13.
---------------------------------------------------------------------------

    For example, FINRA notes that the Codes permit a panel to allocate 
the amount of certain costs and expenses incurred by the parties, and 
which party or parties will pay those costs and expenses.\26\ Citing an 
example, FINRA states that if an investor party incurs costs and 
expenses as a result of a mid-case referral, the investor can request 
that the arbitrator or panel assign liability for the investor's costs 
and expenses to the respondent.\27\ Similarly, FINRA notes that the 
Codes give arbitrators the ability to allocate postponement fees 
against the party that contributed to the need for the 
postponement.\28\ FINRA notes further that, under Rule 12601(b)(1) of 
the Customer Code and Rule 13601(b)(1) of the Industry Code, if a party 
requests a postponement as a result of an arbitrator's recusal based on 
a mid-case referral request, the panel could also assess part or all of 
any postponement fees against a party that did not request the 
postponement, if the panel determines that the non-requesting party 
caused or contributed to the need for the postponement.\29\
---------------------------------------------------------------------------

    \26\ FINRA Letter at 5, citing Rule 12902(c) and Rule 13902(c).
    \27\ FINRA Letter at 5, incorporating by reference May Response 
at 11-12.
    \28\ FINRA Letter at 5, incorporating by reference May Response 
at 12.
    \29\ Id.
---------------------------------------------------------------------------

    As to existing Code provisions that allow FINRA to help absorb some 
costs associated with any need for the replacement of an arbitrator, 
FINRA notes that it pays the replacement arbitrator to review the 
hearing record (e.g., listen to the digital recording or review a 
transcript, when available, of the prior hearing sessions) and learn 
about the arbitration case up to the point at which it was stopped.\30\ 
Pursuant to forum policy, FINRA notes the parties would not be assessed 
any fees for this review time.\31\
---------------------------------------------------------------------------

    \30\ FINRA Letter at 5, incorporating by reference May Response 
at 13.
    \31\ FINRA Letter at 5, incorporating by reference May Response 
at 14.
---------------------------------------------------------------------------

    FINRA also highlights the options parties have to control the costs 
they could incur if an arbitrator makes a mid-case referral.\32\ For 
example, FINRA states that the parties may agree to rehearing only key 
witnesses, or stipulate to summaries of prior testimony.\33\ In light 
of these factors, FINRA believes its current policies and procedures 
address the commenters' concerns and declines to make any changes to 
the Amended Current Proposal.\34\
---------------------------------------------------------------------------

    \32\ FINRA Letter at 5, incorporating by reference May Response 
at 12-13.
    \33\ FINRA Letter at 5, incorporating by reference May Response 
at 14.
    \34\ FINRA Letter at 5.
---------------------------------------------------------------------------

    Other commenters raise concerns about the adverse effects a recusal 
request would have on an investor's arbitration case, as well as the 
resulting motion to vacate that the commenters believe a respondent 
would file, if the referring arbitrator denies a recusal request.\35\ 
In response, FINRA notes that, while a denial of a recusal request 
could result in a motion to vacate, courts have found that such actions 
do not provide parties with valid bias grounds on which to challenge an 
award.\36\ Further, FINRA notes that it expects to issue a Regulatory 
Notice if the Amended Current Proposal is approved that would, among 
other things, emphasize that arbitrators are not required to grant a 
recusal request based on making a mid-case referral, and also provide 
guidance on the courts' findings on what constitutes grounds for 
evident partiality.\37\ This guidance, FINRA believes, could further 
mitigate the effect of these motions on a retail investor claimant. 
Consequently, FINRA believes that its current policies and procedures, 
as well as case law, address these concerns.\38\
---------------------------------------------------------------------------

    \35\ Caruso, Ryder, and Pace.
    \36\ FINRA Letter at 4.
    \37\ Id.
    \38\ FINRA Letter at 4-5.
---------------------------------------------------------------------------

C. Standard of Referral

    The Commission solicited comment on the proposed standard of 
referral, and whether FINRA should propose a different standard. In 
response, one commenter states that a different standard of referral 
under proposed Rule 12104(b) would not insulate a claimant from the 
adverse impacts of the proposal.\39\ Another commenter states that the 
proposed standard may be inadequate for those arbitrators who are not 
attorneys and not trained in the nuances of the legal system.\40\ A 
third commenter states that the standard is designed to assure that the 
rule is rarely invoked, but does not believe it would prevent 
arbitrators from making an unnecessary and wrongly-based referral.\41\ 
In response, FINRA states that the reasonable belief standard is 
appropriate for arbitrators because it would allow arbitrators to use 
their judgment, based on their assessment of the facts, evidence, and 
testimony, when making decisions during an arbitration.\42\ Further, 
FINRA agrees to provide training for arbitrators on the mid-case 
referral rule and how it should be applied.\43\
---------------------------------------------------------------------------

    \39\ PIABA.
    \40\ Caruso.
    \41\ Ryder.
    \42\ FINRA Letter at 8, incorporating by reference May Response 
at 8-9.
    \43\ FINRA Letter at 6.
---------------------------------------------------------------------------

    One commenter, who supports the standard for referral as well as 
FINRA's proposed training, states that the standard, along with the 
training, should help prevent arbitrators from making unnecessary mid-
case referrals, and facilitate a smoother transition for them to learn 
how to apply the rule.\44\ FINRA agrees, and, believes the proposed 
standard is appropriate and should remain unchanged.\45\
---------------------------------------------------------------------------

    \44\ Pace.
    \45\ FINRA Letter at 6.
---------------------------------------------------------------------------

    One commenter suggests that FINRA eliminate the proposed provision 
of the rule that directs an arbitrator to delay a referral if a case is 
nearing completion until the case concludes if, in the arbitrator's 
judgment, investor protection will not be materially compromised by 
this delay. \46\ This commenter believes the phrase ``nearing 
completion'' in the proposed rule text is vague and would invite 
inconsistent interpretation.\47\ In response, FINRA states that this 
option to delay a referral permits arbitrators to protect a party from 
the effects that a mid-case referral could have on a person's case, if 
the facts and circumstances support waiting until the case concludes, 
and that such a result could provide protections to investors in the 
arbitration process.\48\ FINRA also states that this provision provides 
additional guidance to arbitrators as to when it is appropriate to make 
a mid-case referral.\49\ Thus, FINRA declines to make the commenters' 
suggested changes.
---------------------------------------------------------------------------

    \46\ Friedman.
    \47\ Id.
    \48\ FINRA Letter at 6, incorporating by reference May Response 
at 5.
    \49\ FINRA Letter at 6.
---------------------------------------------------------------------------

D. Whether Partial Amendment No. 1 Ameliorates Potential Adverse 
Effects on Claimants

    Partial Amendment No. 1 requires that a party file a recusal 
request for the referring arbitrator no later than three days after the 
Director notifies the parties of the referral, or forfeit the right

[[Page 61918]]

to request recusal based on the mid-case referral. The Commission 
solicited comment on this amendment, and in particular whether the 
amendment ameliorates commenters' concerns that notifying parties of a 
mid-case referral could lead to adverse consequences to the claimant, 
including requests for recusal and challenges to an award. In response, 
three commenters state they do not believe Partial Amendment No. 1 will 
ameliorate the rule's potential adverse effects on claimants.\50\
---------------------------------------------------------------------------

    \50\ PIABA, Pace, and Georgia State.
---------------------------------------------------------------------------

    One commenter contends that Partial Amendment No. 1 would not 
minimize the negative consequences of the Amended Current Proposal.\51\ 
The commenter states that if the respondent inadvertently or 
purposefully fails to file a recusal request within three days of being 
notified about the referral, this failure would serve as basis for a 
subsequent motion to vacate an award.\52\ One commenter indicates that 
Partial Amendment No. 1 does not ameliorate its concerns because the 
proposal contains an explicit reference to recusal.\53\ This commenter 
argues that a mid-case referral should not provide any grounds for 
recusal or for a motion to vacate an award.\54\ Another commenter 
believes that Partial Amendment No. 1 does not ameliorate its concerns 
about the effect that notifying the parties would have on the 
claimant's case, namely that a mid-case referral would result in a 
recusal request and a motion to vacate if the subject of the mid-case 
referral loses the request or case.\55\ Finally, one commenter suggests 
that FINRA expressly state in the rule that mid-case referral is not 
grounds for recusal.\56\
---------------------------------------------------------------------------

    \51\ PIABA.
    \52\ Id.
    \53\ Pace.
    \54\ Id.
    \55\ Georgia State.
    \56\ NASAA.
---------------------------------------------------------------------------

    In response, FINRA states that a party's inadvertent or deliberate 
failure to comply with a forum's rules, such as by not filing a recusal 
request within three days, is not grounds, under the Federal 
Arbitration Act, for vacating an arbitration award.\57\
---------------------------------------------------------------------------

    \57\ FINRA Letter at 7 (citing 9 U.S.C. 10(a)).
---------------------------------------------------------------------------

    As to commenters' suggestion that the Amended Current Proposal 
either creates a right to request recusal, encourages recusal motions, 
or that the rule should mandate the outcome of such motions, FINRA 
notes that a party currently may make such a request under the Codes in 
any arbitration case; the Amended Current Proposal does not create such 
a right.\58\ FINRA also explains that its rules do not dictate the 
grounds for granting recusal requests and do not require specific 
decisions by arbitrators in response to such requests.\59\ In response 
to the commenter's concern about the subject of a mid-case referral 
filing a motion to vacate if the request is denied or case is lost, 
FINRA acknowledges that such motions may occur, but notes that courts 
have found that an arbitrator's denying a recusal request does not 
provide parties with valid bias grounds on which to challenge an 
award.\60\ FINRA believes that its current policies, procedures, and 
case law address the commenters' concerns and declines to amend the 
Amended Current Proposal.\61\
---------------------------------------------------------------------------

    \58\ FINRA Letter at 7.
    \59\ Id.
    \60\ FINRA Letter at 4.
    \61\ FINRA Letter at 8.
---------------------------------------------------------------------------

E. Eliminating the Notice Requirement

    The Commission solicited comment regarding whether the requirement 
to notify parties of a mid-case referral should be eliminated. 
Commenters were divided, with three commenters opposing 
elimination,\62\ and three other commenters supporting it.\63\ One 
commenter believes that notification is consistent with the current 
obligations of arbitrators to provide full disclosure to help ensure 
fairness in the arbitration process.\64\ FINRA, in response, points to 
the forum's policies encouraging a wide variety of arbitrator 
disclosures and its rules that require arbitrators to make disclosures 
when appointed to a FINRA arbitration, at any stage of the arbitration, 
or as circumstances dictate.\65\ Further, FINRA also notes that, in 
addition to its rules and practices, case law has established a broad 
requirement that arbitrators make full disclosures,\66\ and, that a 
failure to do so could provide a party with grounds to challenge an 
award by claiming evident partiality against the arbitrator.\67\ For 
the reasons, FINRA declines to eliminate the notice requirement.\68\
---------------------------------------------------------------------------

    \62\ Pace, Ryder, and Friedman.
    \63\ Georgia State, NASAA, and Caruso.
    \64\ Pace.
    \65\ FINRA Letter at 8, incorporating by reference May Letter at 
9-10.
    \66\ Id.
    \67\ FINRA Letter at 8.
    \68\ Id.
---------------------------------------------------------------------------

    One commenter suggests that providing the subject of a mid-case 
referral advance notice of a potential investigation could negatively 
impact subsequent criminal or regulatory investigations.\69\ In 
particular, the commenter believes that such notice could lead to 
destruction of evidence and obstruction of the investigation.\70\ FINRA 
states in response that knowledge of behavior that would warrant a mid-
case referral, if revealed during a hearing, would likely not be a 
revelation to the alleged wrongdoer. However, the airing of such 
information during a hearing would serve as notice to the wrongdoer 
that the matter or conduct is on the verge of public exposure.\71\ 
FINRA states that, after that, the wrongdoer could begin to engage in 
the behavior described by the commenter, regardless of whether a mid-
case referral is made.\72\ FINRA believes that, in these instances, 
disclosure of a mid-case referral would give regulators advance notice 
of a serious threat that is likely to harm investors, and, thus, permit 
them to take immediate action instead of waiting until the end of the 
case.\73\ FINRA states further that if FINRA did not learn of the 
referral until after the case closes, there is a risk that the 
wrongdoer would have extra time to destroy evidence.\74\
---------------------------------------------------------------------------

    \69\ Caruso.
    \70\ Id.
    \71\ FINRA Letter at 8-9.
    \72\ Id.
    \73\ Id.
    \74\ Id.
---------------------------------------------------------------------------

F. Forwarding the Mid-Case Referral to the President or Director

    Two commenters suggest removing the provision that would require 
forwarding the mid-case referral to the President or Director for 
review.\75\ One commenter believes the referral could be forwarded 
directly to the regulatory or enforcement department of FINRA.\76\ The 
other commenter suggests expanding the direct referral concept to 
include the SEC, state securities regulators, or local or federal law 
enforcement.\77\ FINRA states that it modeled this provision after the 
current practice used when an arbitrator makes a post-case 
referral.\78\ FINRA also states that the purpose of the review is to 
determine which FINRA division should receive the referral, and whether 
other divisions or regulators should be notified.\79\ FINRA believes 
that this provision would result in an efficient use of its resources, 
and, thus, declines to make the suggested change.\80\
---------------------------------------------------------------------------

    \75\ Friedman and NASAA.
    \76\ Friedman.
    \77\ NASAA.
    \78\ FINRA Letter at 9.
    \79\ Id.
    \80\ Id.

---------------------------------------------------------------------------

[[Page 61919]]

G. Other Issues Related to the Amended Current Proposal Than Those 
Specifically Raised by the Commission

1. Explicit References to Recusal
    Two commenters contend that the explicit reference to recusal in 
the Amended Current Proposal suggests implicitly that an arbitrator 
could be biased after the person has heard enough evidence of 
wrongdoing.\81\ One commenter states that finding liability based on 
evidence presented does not mean that the arbitrator is sufficiently 
biased against the wrongdoer to justify good cause for recusal.\82\ 
Another commenter compares the proposal to the Federal laws, such as 
the Bankruptcy Code, which, according to the commenter, are less 
stringent and do not expressly provide for recusal.\83\ This commenter 
contends that by explaining the availability of a recusal request in 
the Amended Current Proposal, even though it is available in other 
parts of the Codes, FINRA is seeking to make its rules more stringent 
than the Federal laws.
---------------------------------------------------------------------------

    \81\ Pace and Malecki.
    \82\ Pace.
    \83\ Malecki.
---------------------------------------------------------------------------

    In response, FINRA first notes that the Amended Current Proposal 
does not create a right to make a recusal request, which already exists 
in any arbitration case.\84\ Second, FINRA disagrees that the explicit 
reference to recusal implies potential bias on the part of an 
arbitrator.\85\ Last, FINRA notes that the Federal laws, to which one 
commenter refers, relate to grounds for recusal. The reference in this 
rule is not about the grounds for recusal.\86\ FINRA states that 
arbitrators are expected to make decisions based on evidence presented 
during a hearing, and such decisions alone have been insufficient to 
support a showing of evident partiality.\87\
---------------------------------------------------------------------------

    \84\ FINRA Letter at 10.
    \85\ Id.
    \86\ Id.
    \87\ Id.
---------------------------------------------------------------------------

    FINRA states also that the act of making a mid-case referral is not 
evidence of bias, whether implied or overt.\88\ The forum's rules, 
according to FINRA, are designed to guide parties and staff in the 
administration of arbitration cases. FINRA believes its rules are more 
effective when procedures are expressly incorporated in the arbitration 
rules, and that this transparency results in the efficient 
administration of cases and consistent application of the rules.\89\
---------------------------------------------------------------------------

    \88\ Id.
    \89\ FINRA Letter at 10.
---------------------------------------------------------------------------

2. Rely on Current Referral Process
    Three commenters suggest that FINRA rely on the current process for 
referring actions or matters for further investigation.\90\ These 
commenters believe FINRA should use this process to detect wrongdoing 
rather than rely on the arbitrators to enforce the rules and, thus, 
create issues of bias and impartiality.\91\ FINRA, in response, notes 
that when an arbitration claim is filed, FINRA's Central Review Group 
(``CRG'') receives a copy of statements of claims and pleadings and 
reviews them to determine if referral to FINRA Enforcement is 
warranted.\92\ FINRA states also that the enforcement procedures 
conducted by CRG prior to an arbitration hearing would not be an 
effective substitute for arbitrator action taken during a hearing based 
on evidence presented.\93\ FINRA notes further that analysis by FINRA 
Enforcement employees conducted on the claims and pleadings permit 
FINRA to monitor and analyze volumes of data through various market 
data systems to detect evidence of wrongdoing.\94\ FINRA states, 
however, that expanding these Enforcement procedures would not 
necessarily provide the same benefits as having earlier notification by 
arbitrators, who may learn of a serious threat during the course of a 
hearing.\95\ For these reasons FINRA declines to expand its enforcement 
procedures as an alternative to the Amended Current Proposal.\96\
---------------------------------------------------------------------------

    \90\ Georgia State, PIABA, and Malecki.
    \91\ Georgia State, PIABA, and Malecki.
    \92\ FINRA Letter at 10.
    \93\ FINRA Letter at 10-11.
    \94\ FINRA Letter at 11.
    \95\ FINRA Letter at 11, citing May Response at 7-8.
    \96\ FINRA Letter at 11.
---------------------------------------------------------------------------

3. No Evidence To Support the Need for the Amended Current Proposal
    Three commenters contend that FINRA did not provide evidence to 
support the need for the Amended Current Proposal or FINRA's assertion 
that it would prevent ongoing fraud or losses for investors.\97\ FINRA 
responds that its assessment of its regulatory structure, as well as 
its determination that its rules would be strengthened by closing a gap 
that currently permits arbitrators to make post-case referrals only, 
justify the need for the Amended Current Proposal.\98\ FINRA believes 
that its assessment of the issue addresses this concern.\99\
---------------------------------------------------------------------------

    \97\ Georgia State, Malecki, and Caruso.
    \98\ FINRA Letter at 11.
    \99\ Id.
---------------------------------------------------------------------------

4. Amended Current Proposal May Compromise an Arbitrator's Role
    Three commenters express concern that the Amended Current Proposal 
would deputize arbitrators as examiners, who would be required to 
evaluate and report rule violations.\100\ They believe this role would 
conflict with an arbitrator's duty, which is to serve as an arbiter of 
a dispute to achieve the best resolution in a manner that serves the 
interests of the parties.\101\ FINRA responds that its rules require 
arbitrators to be impartial and free from conflicts that could hinder 
their ability to decide a case fairly.\102\ FINRA cites case law in 
support of its position that arbitrators would not compromise their 
neutrality by making a mid-case referral, because, in doing so, 
arbitrators would be performing one of the duties that is expected of 
arbitrators.\103\ FINRA believes that its current rules, case law, and 
the Code of Ethics for Arbitrators in Commercial Disputes address these 
concerns.\104\
---------------------------------------------------------------------------

    \100\ Ryder, Gleizer, and Malecki.
    \101\ Id.
    \102\ FINRA Letter at 11-12.
    \103\ FINRA Letter at 12.
    \104\ Id.
---------------------------------------------------------------------------

5. Monitor Effectiveness and Provide Statistics to the Commission
    Two commenters recommend that FINRA monitor the effects of the 
Amended Current Proposal on individual investors and disclose 
statistics periodically to the Commission on the number of mid-case 
referrals that arbitrators make.\105\ FINRA notes that it has 
implemented procedures to track post-case referrals and says that it 
will update its procedures to track the number of mid-case referrals 
made under the Amended Current Proposal and would provide this data to 
the Commission a year after the effective date of the proposed rules, 
and thereafter at the Commission's request.\106\ FINRA would also 
monitor the effects of the Amended Current Proposal to determine 
whether further action would be necessary.\107\
---------------------------------------------------------------------------

    \105\ NASAA and Pace.
    \106\ FINRA Letter at 12.
    \107\ Id.
---------------------------------------------------------------------------

IV. Discussion

    After carefully considering the Amended Current Proposal, the 
comments submitted, and FINRA's response to the comments, the 
Commission finds that the Amended Current Proposal is consistent with 
the requirements of the Act and the rules and regulations thereunder 
applicable to

[[Page 61920]]

a national securities association.\108\ In particular, the Commission 
finds that the Amended Current Proposal is consistent with Section 
15A(b)(6) of the Act,\109\ which requires, among other things, that 
FINRA rules 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.
---------------------------------------------------------------------------

    \108\ In approving this proposed rule change, the Commission has 
considered the proposed rule change's impact on efficiency, 
competition, and capital formation. See 15 U.S.C. 78c(f).
    \109\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    The rule will permit arbitrators to refer to FINRA any matter or 
conduct that an arbitrator has reason to believe poses a serious 
threat, whether ongoing or imminent, that is likely to harm investors 
unless immediate action is taken. The Commission believes that allowing 
arbitrators to voice a serious concern under extremely limited 
circumstances provides a necessary means of alerting FINRA senior staff 
should an arbitrator have reason to believe during the pendency of an 
arbitration that there is a threat of serious ongoing or imminent harm. 
This notification would provide FINRA with earlier warning of 
potentially harmful conduct than might otherwise occur, and allow FINRA 
to better protect investors by intervening more quickly under the 
appropriate circumstances.
    As FINRA acknowledges, the rule may cause delays and increase costs 
for a claimant in some instances. However, the rule is designed in a 
way that should make its invocation rare, limiting such negative 
effects. First, the standard for reporting is high. Because the rule 
limits mid-case referrals to situations where the arbitrator has reason 
to believe that a matter or conduct poses a serious threat likely to 
harm investors unless immediate action is taken, it should be rarely 
invoked. Second, permitting mid-case referrals only for matters or 
conduct unearthed during the proceedings--and not on the basis of 
allegations in the pleadings--means that an arbitrator will need to 
make a mid-case referral decision only in cases when FINRA might not 
otherwise know about the potentially harmful conduct. Third, the 
proposal allows an arbitrator to delay making a mid-case referral when, 
in the arbitrator's judgment, investor protection would not be 
materially compromised, further reducing the number of times the rule 
is invoked. Fourth, as amended, the rule limits recusal requests based 
on the referral itself to three days after the parties are notified of 
the recusal, limiting the opportunity for recusal requests and the 
potential strategic delay of a recusal request.
    Even in those rare instances where the rule is invoked and there is 
potential harm to an investor whose case involves a referral, such as a 
delay or additional costs, FINRA has identified ways that such harm can 
be limited. First, allocation of costs by an arbitrator or panel can 
take into account relative fault of the parties. Second, FINRA will 
bear certain costs itself, such as paying a replacement arbitrator to 
review the hearing record and to learn about the arbitration up to the 
point where the case was interrupted. Third, FINRA has identified ways 
in which the parties themselves can help minimize costs and delays, 
such as by agreeing to rehear only key witnesses, or stipulating to 
summaries of prior testimony.
    While this would not eliminate every potential cost or dilatory 
burden on an investor whose case may be adversely affected by a 
referral, we believe FINRA has identified ways those harms to parties 
in arbitration can be mitigated or minimized while better protecting 
investors and the public interest.
    Moreover, notifying parties of the fact of a referral can help to 
safeguard the fairness of the arbitration forum by keeping the parties 
equally informed, consistent with current arbitration practices. Also, 
having the Director or President serve as an intake point for any 
referrals would result in an efficient review and assignment process, 
and could help direct appropriate resources toward potentially harmful 
conduct as quickly as possible. In addition, by requiring requests for 
recusal to be made within three days of being notified, the rule will 
limit the uncertainty associated with whether a mid-case referral will 
result in an eventual recusal request. The Commission notes also that a 
recusal request can still be made for any reason at any time for 
reasons other than the referral request itself.
    In light of the potential gravity of the misconduct that may be 
reported, and because we believe the potential negative effects will be 
relatively limited and partially mitigated by the operation of other 
FINRA rules, we believe the Amended Current Proposal is consistent with 
the Act in that it is 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.
    We appreciate the concerns of some commenters that mid-case 
referrals may disrupt or delay some arbitration proceedings. Therefore, 
as some commenters have suggested, and FINRA has agreed, FINRA will 
gather statistics and report to the Commission, for the period of one 
year from the effective date of this rule change and for later periods 
upon request, on the number of cases in which an arbitrator made a mid-
case referral. FINRA will also monitor the effects of the Amended 
Current Proposal to determine whether further action is necessary.

V. Conclusion

    It is therefore ordered pursuant to Section 19(b)(2) of the Act 
\110\ that the proposed rule change (SR-FINRA-2014-0005), as modified 
by Partial Amendment No. 1, be and hereby is approved.
---------------------------------------------------------------------------

    \110\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\111\
---------------------------------------------------------------------------

    \111\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-24420 Filed 10-14-14; 8:45 am]
BILLING CODE 8011-01-P