Document ID: SEC-2010-1074-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2010-07-15T04:00Z

[Federal Register: July 15, 2010 (Volume 75, Number 135)]
[Notices]               
[Page 41262-41264]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr15jy10-109]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-62480; File No. SR-FINRA-2010-022]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving Proposed Rule Change Relating To 
Amending the Codes of Arbitration Procedure To Increase the Number of 
Arbitrators on Lists Generated by the Neutral List Selection System

July 9, 2010.
    On April 29, 2010, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'') \1\ and 
Rule 19b-4 thereunder,\2\ a proposed rule change. The proposed rule 
change was published for comment in the Federal Register on May 26, 
2010.\3\ The Commission received six comments on the rule proposal.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Rel. No. 62134 (May 19, 2010), 
75 FR 29594 (May 26, 2010) (File No. SR-FINRA-2010-022).
    \4\ See Submission via SEC WebForm from A. M. Miller, dated May 
6, 2010 (``Miller comments''); Submission via SEC WebForm from 
Steven B. Caruso, Maddox Hargett Caruso, P.C., dated May 27, 2010 
(``Caruso comments''); Letter to Elizabeth M. Murphy, Secretary, 
Commission from Patricia Cowart, Chair, Arbitration Committee, 
Securities Industry and Financial Markets Association, dated May 27, 
2010 (``SIFMA letter''); Submission via SEC WebForm from Leonard 
Steiner, Steiner & Libo, P.C., dated May 27, 2010 (``Steiner 
comments''); Letter to Elizabeth M. Murphy, Secretary, Commission 
from Scott R. Shewan, President, Public Investors Arbitration Bar 
Association, dated June 14, 2010 (``PIABA letter''); and Letter to 
Elizabeth M. Murphy, Secretary, Commission from Jill I. Gross, 
Director, Ed Pekarek, Clinical Law Fellow, and Jeffrey Gorenstein, 
Student Intern, Pace Law School Investor Rights Clinic, dated June 
16, 2010 (``PIRC letter'').
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I. Description of the Proposed Rule Change

    FINRA proposed to amend Rules 12403 and 12404 of the Code of 
Arbitration Procedure for Customer Disputes (``Customer Code'') and 
Rules 13403 and 13404 of the Code of Arbitration Procedure for Industry 
Disputes (``Industry Code'') to increase

[[Page 41263]]

the number of arbitrators on each list generated by the Neutral List 
Selection System (``NLSS'').
    The NLSS is a computer system that generates, on a random basis, 
lists of arbitrators from FINRA's rosters of arbitrators (i.e., public, 
non-public, and chair rosters) for each arbitration case. The parties 
select their panel through a process of striking and ranking the 
arbitrators on the lists. Currently, FINRA sends the parties lists of 
available arbitrators, along with detailed biographical information on 
each arbitrator. In a three-arbitrator case, other than one involving a 
dispute among members, the parties receive three lists of eight 
arbitrators each--one public, one chair-qualified and one non-public. 
Each party is permitted to strike up to four of the eight names on each 
list and ranks the remaining names in order of preference. FINRA 
appoints the panel from among the names remaining on the lists that the 
parties return.\5\
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    \5\ In an arbitration between members, the panel consists of 
non-public arbitrators, and so the parties receive a list of 16 
arbitrators from the FINRA non-public roster, and a list of eight 
non-public arbitrators from the FINRA non-public chairperson roster. 
See FINRA Rules 13402 and 13403. Each separately represented party 
may strike up to eight of the arbitrators from the non-public list 
and up to four of the arbitrators from the non-public chairperson 
list. See FINRA Rule 13404.
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    When there are no names remaining on a list, or when a mutually 
acceptable arbitrator is unable to serve, a random selection is made to 
``extend the list'' by generating names of additional arbitrators to 
complete the panel. Parties may not strike the arbitrators on the 
extended lists, but they may challenge an arbitrator for cause (e.g., 
on the basis of conflict of interest).
    Prior to 2007, FINRA permitted parties unlimited strikes of 
proposed arbitrators on lists. This often resulted in parties 
collectively striking all of the arbitrators on each list generated 
through NLSS. When this occurred, staff would use NLSS to ``extend the 
list'' by generating names of additional arbitrators to complete the 
panel. Parties expressed concern about extended list arbitrator 
appointments because they could not strike arbitrators from an extended 
list. In response to this concern, in 2007, FINRA changed the 
arbitrator appointment process through a rule change that limited the 
number of strikes each party may exercise to four, in an effort to 
reduce the frequency of extended list appointments.\6\ Under the 
current rule, FINRA permits each party to strike up to four arbitrators 
from each list of eight arbitrators generated through NLSS and up to 
eight arbitrators from each list of 16 arbitrators generated through 
NLSS. The rules limiting strikes have significantly reduced extended 
lists and thus increased the percentage of cases in which FINRA 
initially appoints arbitrators from the parties' ranking lists. 
However, after each side exercises its strikes, typically only one or 
two persons remain eligible to serve on a case. Therefore, when FINRA 
grants a challenge for cause or an arbitrator withdraws, FINRA often 
must appoint the replacement arbitrator using an extended list. Forum 
users, including both investor and industry parties, continue to 
express concerns about extended list appointments.\7\
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    \6\ Exchange Act Release No. 55158 (January 24, 2007), 72 FR 
4574 (January 31, 2007) (File No. SR-NASD-2003-158).
    \7\ The rationale for the proposed rule change was confirmed in 
a telephone conversation between Margo Hassan, FINRA Dispute 
Resolution, and Joanne Rutkowski, Division of Trading and Markets, 
Commission, May 18, 2010.
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    As a result of these concerns, FINRA proposed to amend Rule 12403 
of the Customer Code to expand the number of arbitrators on each list 
(public, non-public, and public chairperson) generated through NLSS 
from eight arbitrators to 10 arbitrators. Thus, in every two party 
case, at least two arbitrators would remain on each list after 
strikes.\8\ FINRA stated that the additional number of arbitrators will 
increase the likelihood that the parties will get panelists they chose 
and ranked, even when FINRA must appoint a replacement arbitrator. 
FINRA also stated that, in cases with more than two parties, expanding 
the lists from eight to 10 arbitrators should significantly reduce the 
number of arbitrator appointments needed from extended lists.\9\
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    \8\ FINRA did not propose to expand the number of allowable 
strikes for each party.
    \9\ Under the rules, each ``separately represented'' party is 
entitled to strike four arbitrators from an eight arbitrator list. 
If, for example, a case involves a customer, a member and an 
associated person, and each party is separately represented, even 
with 10 arbitrators there is a chance that all of the arbitrators 
will be stricken from the list.
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    FINRA also proposed to amend Rule 13403 of the Industry Code to 
expand the number of arbitrators on lists generated through NLSS.\10\ 
For disputes between members, FINRA would expand the number of 
arbitrators on the non-public chairperson list generated through NLSS 
from eight arbitrators to 10 arbitrators and the number of arbitrators 
on the non-public list from 16 arbitrators to 20 arbitrators. For 
disputes between associated persons, or between or among members and 
associated persons, FINRA would expand the number of arbitrators on 
each list (public, non-public, and public chairperson) generated 
through NLSS from eight arbitrators to 10 arbitrators.
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    \10\ Again, FINRA did not propose to expand the number of 
allowable strikes for each party.
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    FINRA considered whether increasing each list of arbitrators would 
be unduly burdensome for parties since parties would be reviewing the 
backgrounds of additional arbitrators during the ranking and striking 
stage of the arbitrator appointment process. In instances where FINRA 
appoints arbitrators by extended lists, parties still need to review 
arbitrators' backgrounds to determine, for example, whether to 
challenge an extended list arbitrator for cause. FINRA staff discussed 
expanding the lists with both investor and industry representatives, 
and asked the representatives to address the potential burden of 
reviewing additional arbitrators. The representatives uniformly stated 
that they would prefer to review additional arbitrators at the ranking 
and striking stage of the arbitrator appointment process in order to 
reduce the incidences of extended list appointments.

II. Summary of Comments

    The Commission received six comments regarding the proposed rule 
change. On June 21, 2010, FINRA submitted a response to the 
comments.\11\
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    \11\ See Letter to Elizabeth M. Murphy, Secretary, Commission 
from Margo A. Hassan, Assistant Chief Counsel, FINRA Dispute 
Resolution, Financial Industry Regulatory Authority, dated June 21, 
2010 (``FINRA response'').
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    All of the commenters support the proposed rule change, either in 
whole or with certain modifications. The PIABA letter states that 
``this rule change is important because it will reduce the number of 
instances in which an arbitrator is appointed with no input from or 
approval by the parties.'' The SIFMA letter states that the proposal 
``will increase the likelihood that all arbitrators appointed to a case 
will have been selected by the parties, result in fewer administrative 
`extended list' appointments, and enhance party choice and satisfaction 
with the selection process.'' Likewise, PIRC supports the proposal 
``because it increases the parties' ability to present their dispute to 
an arbitrator of their own choosing,'' \12\ and the Caruso comments 
state that the proposed rule change ``would provide investors with 
greater control and choice over the individuals who will ultimately be 
appointed to serve on the arbitration panels'' and urges the Commission 
to approve the proposal on an expedited basis.
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    \12\ See PIRC letter.

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[[Page 41264]]

    The Steiner comments suggest limiting the current proposal to cases 
in which there is only one respondent or multiple respondents being 
represented by only one attorney.\13\ The Steiner comments also ask 
that: (1) FINRA be ordered to effectuate immediately additional 
modifications to eliminate the portions of Rule 12404 that give each 
separately represented respondent a separate set of strikes, and to 
replace those portions with provisions that the amount of strikes that 
may be exercised by respondents in total cannot exceed the amount of 
strikes that can be exercised in total by the claimant; (2) that FINRA 
be ordered immediately to rescind its interpretation of Rule 12404 that 
permits even non-appearing respondents from participating in the 
arbitrator selection process; and (3) that FINRA be ordered to 
immediately propose a rule change providing that instead of appointing 
a cram down arbitrator that a new selection list be sent to the 
parties. FINRA notes that it is not proposing to amend its rules 
relating to party strikes, participation in arbitrator selection, or 
extended list appointments and that, therefore, the comments are 
outside the scope of the proposed rule change.\14\
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    \13\ PIRC supports the proposed rule change, and advocates a 
further rule revision that would give four strikes per side, rather 
than to each ``separately represented party.'' See id.
    \14\ See FINRA response.
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III. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
association.\15\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 15A(b)(6) of the Act,\16\ in 
that it is designed, among other things, to prevent fraudulent and 
manipulative acts and practices; to promote just and equitable 
principles of trade; to remove impediments to and perfect the mechanism 
of a free and open market and a national market system; and, in 
general, to protect investors and the public interest.
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    \15\ In approving the proposed rule change, the Commission has 
considered the rule change's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
    \16\ 15 U.S.C. 78o-3(b)(6).
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    The Commission believes that the proposed rule change will protect 
investors and the public interest by providing investors greater 
control in the arbitrator selection process. Forum users have 
criticized extended list appointments and asked FINRA to reduce the 
number of arbitrators appointed in this way. Expanding the number of 
arbitrators on lists generated through NLSS should help to reduce 
extended list appointments and so increase the likelihood that 
arbitrators from each initial list would remain on the list after the 
parties complete the striking and ranking process. This, in turn, 
should enhance investor and industry participants' confidence in the 
arbitration process. Concerning the requests in the Steiner comments 
that FINRA be ordered to take certain actions, the Commission finds 
that requested actions are beyond the scope of the current rulemaking.

IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the Act and the rules and regulations 
thereunder applicable to a national securities association.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\17\ that the proposed rule change (SR-FINRA-2010-022) be and 
hereby is approved.
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    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-17275 Filed 7-14-10; 8:45 am]
BILLING CODE 8010-01-P