Document ID: SEC-2009-0192-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2009-02-11T05:00Z

[Federal Register: February 11, 2009 (Volume 74, Number 27)]
[Notices]
[Page 6928-6931]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11fe09-97]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59358; File No. SR-FINRA-2008-051]

Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving Proposed Rule Change Relating to
Amendments to the Codes of Arbitration Procedure To Require Arbitrators
To Provide an Explained Decision Upon the Joint Request of the Parties

 February 4, 2009.

I. Introduction

    The Financial Industry Regulatory Authority, Inc. (``FINRA'') (f/k/
a National Association of Securities Dealers, Inc. (``NASD'')) filed
with the Securities and Exchange Commission (``SEC'' or ``Commission'')
on October 14, 2008 pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to amend Rules 12214, 12514 and 12904 of the Code
of Arbitration Procedure for Customer Disputes (``Customer Code'') and
Rules 13214, 13514 and 13904 of the Code of Arbitration Procedure for
Industry Disputes (``Industry Code,'' and together with the Customer
Code, the ``Codes'') \3\ to require arbitrators to provide an explained
decision upon the joint request of the parties. The proposed rule
change was published for comment in the Federal Register on October 31,
2008.\4\ The Commission received five comments in response to the
proposed rule change.\5\ This order approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The former NASD Rule 12000 Series (Customer Code) and 13000
Series (Industry Code) have been adopted as the FINRA 12000 Series
(Customer Code) and 13000 Series (Industry Code) in the new
consolidated rulebook pursuant to SR-FINRA-2008-021, which was
approved by the Commission. See Securities Exchange Act Release No.
58643 (September 25, 2008), 73 FR 57174 (October 1, 2008) (SR-FINRA-
2008-021) (approval order). The FINRA Rule 12000 Series (Customer
Code) and 13000 Series (Industry Code), as set forth in SR-FINRA-
2008-021, became effective on December 15, 2008. See FINRA
Regulatory Notice 08-57 (SEC Approves New Consolidated FINRA Rules)
(October 2008).
    \4\ See Securities Exchange Act Release No. 58862 (October 27,
2008), 73 FR 64995 (October 31, 2008), (SR-FINRA-2008-051) (notice).
    \5\ See letter from Kevin Thomas Hoffman, dated November 10,
2008 (``Hoffman letter''); letter from Barbara Black, Director,
Corporate Law Center, University of Cincinnati College of Law, Jill
I. Gross, Director, Pace Investor Rights Clinic, Pace University
School of Law, and Deborah Sommers, Student Intern, submitted
November 20, 2008 (``Black and Gross letter''); letter from Barry D.
Estell, dated November 20, 2008 (``Estell letter''); letter from
Scott R. Shewan, Vice-President, Public Investors Arbitration Bar
Association, dated November 21, 2008 (``PIABA letter''); and letter
from Theodore M. Davis, submitted November 21, 2008 (``Davis
letter'').
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II. Description of the Proposed Rule Change

    FINRA proposed to amend its Customer Code and Industry Code to
require arbitrators to provide an explained decision upon the joint
request of the parties. The explained decision would be a fact-based
award stating the general reason(s) for the arbitrators' decision; it
would not be required to include legal authorities and/or damage
calculations. Under the proposed rule change, parties would be required
to submit any joint request for an explained decision at least 20 days
before the first scheduled hearing date.\6\ The chairperson would: (1)
Be required to write the explained decision; and (2) receive an
additional honorarium of $400 for writing the decision. The panel would
allocate the cost of the additional honorarium to the parties as part
of the final award.
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    \6\ The term ``hearing'' means the hearing of an arbitration
under Rules 12600 and 13600 (see Rules 12100(m) and 13100(m)).
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    The arbitrators would not be required to provide an explained
decision in cases resolved without a hearing under simplified
arbitration Rules 12800 and 13800 or in default cases conducted under
Rules 12801 and 13801.
    FINRA did not propose to amend Rules 12904(f) and 13904(f), which
provide that an award may contain an underlying rationale. This means
that arbitrators would continue to be permitted to decide, on their
own, to write an explained decision. Thus, as is currently the case, if
the panel decides on its own to write an explained decision, FINRA
would not pay an additional honorarium to any panel member.

Background

    The absence of explanations in awards is a common complaint of non-
prevailing parties in the FINRA forum, especially customers and
associated persons. In order to address these complaints and increase
investor confidence in the fairness of the arbitration process, in
March 2005, FINRA filed a proposed rule change with the SEC that would
have required arbitrators to provide explained decisions upon the
request of customers, or of associated persons in industry
controversies. The SEC published the original proposed rule

[[Page 6929]]

change for comment in July 2005.\7\ The SEC received almost two hundred
comment letters in response to the original proposed rule change, many
of which were critical.
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    \7\ See Securities Exchange Act Release No. 52009 (July 11,
2005); 70 FR 41065 (July 15, 2005) (SR-NASD-2005-032) (notice).
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    While FINRA was considering its next steps, there were several new
developments related to explained decisions in other contexts. FINRA
filed with the Commission dispositive motions \8\ and expungement
procedures \9\ proposals, both of which require arbitrators to write an
explanation for granting relief. In addition, the Securities Industry
Conference on Arbitration (SICA) conducted a ``Perceptions of
Fairness'' survey of participants in securities arbitration
proceedings.\10\ The survey results, released in February 2008,
indicate that 55.5% of customers who responded to the survey would be
``more satisfied if they had an explanation in the award.'' In light of
the comments, and these later developments, FINRA withdrew the original
proposed rule change as filed in SR-NASD-2005-032 and filed a new
proposed rule change. Key provisions of the proposed rule change are
discussed in more detail below, together with related comments from the
original proposed rule change.
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    \8\ FINRA filed the proposed dispositive motion rule on November
2, 2007 (SR-FINRA-2007-021). The proposal was published for comment
on March 20, 2008 (see Securities Exchange Act Release No. 57497
(March 14, 2008); 73 FR 15019). The Commission approved the proposal
on December 31, 2008 (see Securities Exchange Act Release No. 59189
(December 31, 2008); 74 FR 731 (January 7, 2009)).
    \9\ FINRA filed an expungement procedures proposal on March 13,
2008 (SR-FINRA-2008-010). The proposal was published for comment on
April 3, 2008 (see Securities Exchange Act Release No. 57572 (March
27, 2008); 73 FR 18308). The Commission approved the proposal on
October 30, 2008 (see Securities Exchange Act Release No. 58886
(October 30, 2008); 73 FR 66086 (November 6, 2008)).
    \10\ Jill I. Gross and Barbara Black, Perceptions of Fairness of
Securities Arbitration: An Empirical Study, (February 6, 2008). The
report can be downloaded at http://digitalcommons.pace.edu/cgi/
viewcontent.cgi?article=1477&context=lawfaculty.
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Parties Must Jointly Request an Explained Decision

    The original proposed rule change would have permitted a customer,
or an associated person in an intra-industry controversy, to require an
explained decision. Many commenters objected to the one-sided nature of
that provision. Under the new proposed rule change, all parties to a
case would have to agree to an explained decision. Moreover, while the
arbitrators will be resolving the entire matter and the explained
decision would normally address all the claims asserted by the parties,
the parties may request that an explained decision address only certain
claims. According to FINRA, requiring the parties' joint agreement to
an explained decision is consistent with FINRA's general policy to
accommodate a joint request of the parties.

Parties Must Submit Any Request for an Explained Decision 20 Days
Before the First Scheduled Hearing Date

    The new proposed rule change would provide that parties must submit
any joint request for an explained decision no later than 20 days prior
to the first scheduled hearing date. This deadline coincides with the
time that parties must exchange documents and identify witnesses they
intend to present at the hearing. In FINRA's view, this approach would
establish a clear deadline, give the parties sufficient time to request
an explained decision, and provide notice to the arbitrators that an
explained decision will be required before the hearing begins.

The Chairperson Must Write the Explained Decision

    The new proposed rule change would require that the chairperson
write the explained decision. The original proposed rule change
contemplated that any of the arbitrators, or all of them, might draft
the decision. Many commenters on the original proposed rule change were
concerned that poorly written decisions might harm the public's
perception of arbitration, or increase the likelihood of a party
successfully vacating an award. To address these concerns, the rule
would require that the chairperson write the decision.
    Under the Codes, arbitrators must meet specific experience and
training criteria to serve as chairpersons in arbitrations.\11\
Therefore, chairpersons may be more experienced than non-chairpersons
and should be better able to produce higher quality explained
decisions. Further, assigning this responsibility to the chairperson
would eliminate any confusion over who would be responsible for
drafting the decision and would streamline the decision writing
process. Having one arbitrator draft the decision after all the
arbitrators have been consulted would reduce the time required to
complete the decision. Once the decision was drafted, the arbitrators
still would be required to sign the decision as provided in Rules
12904(a) and 13904(a).\12\
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    \11\ Pursuant to Rules 12400 and 13400, arbitrators are eligible
for the chairperson roster if they have completed FINRA chairperson
training and:
     Have a law degree and are a member of a bar of at least
one jurisdiction and have served as an arbitrator through award on
at least two arbitrations administered by a self-regulatory
organization in which hearings were held; or
     Have served as an arbitrator through award on at least
three arbitrations administered by a self-regulatory organization in
which hearings were held.
    On June 23, 2008, the SEC approved a proposal to eliminate the
Code provision allowing arbitrators to serve as Chairpersons
provided they have ``substantially equivalent training or
experience'' in lieu of completing FINRA Dispute Resolution's
Chairperson training course (see Securities Exchange Act Release No.
58004 (June 23, 2008); 73 FR 36579 (June 27, 2008) (SR-FINRA-2008-
009) (approval order). This rule became effective on September 22,
2008.
    \12\ Rules 12904(a) and 13904(a) require all awards to be in
writing and signed by a majority of the arbitrators or as required
by applicable law.
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The Explained Decision Must Be Fact-Based

    Under the new proposed rule change, the explained decision would be
a fact-based award stating the general reason(s) for the arbitrators'
decision.\13\ The award would not be required to include legal
authorities and damage calculations. FINRA believes that requiring only
fact-based reasons in explained decisions will reduce the potential for
misstatements in an award, thereby decreasing the possibility of a
subsequent vacatur, modification or remand of an award and ensuring the
continued finality of a FINRA award. FINRA believes the proposed rule
change would provide the parties with the information they want while
simultaneously maintaining the expediency, flexibility, and finality of
arbitration.
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    \13\ While Rules 12604 and 13604 provide that the panel decides
what evidence to admit and is not required to follow state or
federal rules of evidence, FINRA intends that, as with current
arbitration awards, explained decisions will have no precedential
value in other cases. Thus, arbitrators will not be required to
follow any findings or determinations that are set forth in prior
explained decisions. In order to ensure that users of the forum are
aware of the non-precedential nature of explained awards, FINRA
plans to revise the template for all awards to include the following
sentence: ``If the arbitrators have provided an explanation of their
decision in this award, the explanation is for the information of
the parties only and is not precedential in nature.''
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Only the Chairperson Will Be Compensated for an Explained Decision

    The original proposed rule change did not address who would have
been responsible for preparing the explained decision and provided that
each arbitrator would be paid an additional $200 honorarium for cases
in which an explained decision was required. Under the new proposed
rule change, only the chairperson would write the decision,

[[Page 6930]]

and only the chairperson would be paid an additional honorarium. The
additional honorarium paid to the chairperson would reflect the
increased effort involved in drafting an explained decision. Under the
new proposed rule change, the panel may allocate the cost of the
honorarium to one party, or may allocate it between or among all
parties.\14\
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    \14\ Under the Customer and Industry Codes, the panel has the
authority to assess fees in connection with discovery-related
motions, contested subpoena requests, and hearing session fees to
one party, or may split the fees between or among all parties.
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Parties May Not Require Explained Decisions in Some Cases

    Under the new proposed rule change, parties would not be able to
require explained decisions in two types of arbitration proceedings.
The first is simplified arbitrations that are decided solely upon the
pleadings and evidence filed by the parties, as described in Rules
12800 and 13800. The second is arbitrations that are conducted under
the default procedures provided for in Rules 12801 and 13801. According
to FINRA, explained decisions would not be appropriate in either of
these situations because of the abbreviated nature of these arbitration
proceedings.

Arbitrators May Choose To Write Explained Decisions in Other
Circumstances

    Under the new proposed rule change, arbitrators would continue to
be permitted to decide, on their own or upon the motion of one party,
to write an explained decision. Arbitrators would not receive an
additional honorarium if the panel issues an explained decision that is
not required under the proposed rules. The new proposed rule change
would not affect the current rule that permits arbitrators to include a
rationale in an award, even if the parties have not requested it, and
would not encourage arbitrators to write an explained decision when
they are not asked to do so by all the parties.

III. Comment Letters

    The SEC received five comment letters.\15\ Three commenters
essentially supported the proposal \16\ and two opposed it.\17\ The
Commission also received FINRA's response to comments, which is
discussed below.\18\
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    \15\ See note 5, supra.
    \16\ See Hoffman, Black and Gross, and Davis letters. The
Hoffman letter supported the proposal with reservations. The Davis
letter supported the proposed rule change with the caveat that the
SEC re-visit FINRA's chair eligibility rules. FINRA did not propose
to amend the chair eligibility rules in this proposal (see Rules
12400(c) and 13400(c)). Therefore, FINRA determined that the chair
eligibility issue is outside the scope of the rule proposal and
FINRA did not address it in its response to comments.
    \17\ See Estell and PIABA letters. FINRA did not address the
concerns raised by the Estell letter, as it viewed those concerns as
outside the scope of the rule proposal.
    \18\ Letter from Margo A. Hassan, FINRA, dated December 15, 2008
(``FINRA Letter'').
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    One commenter supported the proposal, but asserted that every panel
should provide a brief explanation for each award.\19\ Another
commenter supported the proposal but expressed concerns that investors'
perceptions concerning the unfairness of the arbitration process would
increase in circumstances in which an industry party blocks an
investor's request for an explained decision.\20\ One commenter argued
that only the investor should be able to request an explained
decision.\21\
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    \19\ See Hoffman letter.
    \20\ See Black and Gross letter.
    \21\ See PIABA letter.
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    FINRA responded to these comments by stating that under FINRA's
original proposal (which has since been withdrawn), arbitrators would
have been required to provide explained decisions upon the request of
customers, or of associated persons in industry disputes.\22\ FINRA
stated that many commenters on that proposal objected to the one-sided
nature of the proposal.\23\ In addition, FINRA noted that a number of
commenters were concerned that the proposal would lead to an increase
in motions to vacate based on the arbitrators' explanations.\24\
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    \22\ See FINRA letter. See also note 7, supra.
    \23\ See FINRA letter.
    \24\ Id.
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    FINRA further asserted that one of the benefits of arbitration is
that it is final and binding, and courts rarely vacate awards.\25\ In
light of this, FINRA stated that any risks that may be associated with
explained decisions should be borne by the parties only after they have
agreed jointly to request an explained decision.\26\ For these reasons,
FINRA declined to amend the provision that requires joint agreement of
the parties.\27\
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    \25\ Id.
    \26\ Id.
    \27\ Id.
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    One commenter stated that the proposal does not provide sufficient
guidance to arbitrators.\28\ The commenter asserted that the rule is
ambiguous concerning the extent of the fact-based detail sufficient to
constitute an explanation, and that the proposal is silent on whether
the explanation would have to address every legal theory presented.\29\
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    \28\ See Black and Gross letter.
    \29\ Id.
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    FINRA responded by stating that the proposed rule specifies that a
fact-based decision includes the general reasons for the arbitrators'
decision, and that arbitrators do not have to include legal authorities
or damage calculations.\30\ FINRA stated that the proposal, as filed,
gives the arbitrators the flexibility they need to tailor each award to
the specific case being decided.\31\ FINRA further responded by stating
that the proposal requires the chairperson of the panel to write the
explained decision.\32\ Because chairpersons have completed chairperson
training and have served as arbitrators through award on at least two
arbitrations,\33\ FINRA stated that requiring the chairperson to write
the explained decision will ensure that parties are provided with the
information called for in the proposed rule change.\34\ Therefore,
FINRA declined to amend the proposal to add further explanation
regarding the content of the fact-based decision.\35\
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    \30\ See FINRA letter.
    \31\ Id.
    \32\ Id.
    \33\ Rules 12400 and 13400 state that an arbitrator is eligible
to serve as chairperson if the arbitrator has completed chairperson
training and: 1) has a law degree and is a member of a bar of at
least one jurisdiction and has served as an arbitrator through award
on at least two arbitrations in which hearings were held; or 2) has
served as an arbitrator through award on at least three arbitrations
in which hearings were held.
    \34\ See FINRA letter.
    \35\ Id.
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    One commenter argued that requiring a joint request for an
explained decision eliminates the need for the proposal.\36\ The
commenter noted that FINRA already fosters a policy of accommodating
parties' joint requests. Another commenter asked whether, under the
current Codes, a panel would be required to write a reasoned decision
if the parties made a joint request.\37\ FINRA responded by stating
that the panel currently is not required to accede to a joint request
for an explained decision.\38\ FINRA explained that under current
practice, FINRA would forward the parties' joint request for an
explained decision to the arbitrators, but that the arbitrators could
decline the parties' request.\39\ FINRA further stated that the
proposed rule change would make it clear that arbitrators must provide
an explained decision upon the joint request of the parties, set a
timetable for such requests and provide for compensation for the
chairperson's efforts in writing the explained

[[Page 6931]]

decision.\40\ Finally, FINRA noted that the proposed rule change also
specifies that arbitrators would not be required to provide an
explained decision in cases resolved under the simplified or default
arbitration rules.\41\
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    \36\ See PIABA letter.
    \37\ See Davis letter.
    \38\ See FINRA letter.
    \39\ Id.
    \40\ Id.
    \41\ Id.
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    FINRA concluded by stating that the proposal will increase investor
confidence in the fairness of the arbitration process, and should be
approved.\42\
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    \42\ Id.
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IV. Discussion and Findings

    After careful review of the proposed rule change, the comments, and
FINRA's response to the comments, the Commission finds that the
proposed rule change is consistent with the requirements of the Act,
and the rules and regulations thereunder that are applicable to a
national securities association.\43\ In particular, the Commission
believes the proposed rule change is consistent with the provisions of
Section 15A(b)(6) of the Act,\44\ which requires among other things,
that FINRA rules must 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. The proposed rule change should address complaints
that FINRA has received from non-prevailing parties regarding the
absence of explanations in arbitration awards, by providing a framework
through which parties could jointly require arbitrators to write an
explained decision.
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    \43\ In approving this proposal, the Commission has considered
the proposed rule's impact on efficiency, competition, and capital
formation. See 15 U.S.C. 17c(f).
    \44\ 15 U.S.C. 78o-3(b)(6).
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    In general, the Commission believes that FINRA has responded to the
comments adequately and appropriately, and has explained how the
proposed rule change is consistent with the requirements of the Act,
and the rules and regulations thereunder that are applicable to a
national securities association.
    The Commission's oversight of the securities arbitration process is
directed at ensuring that it is fair and efficient. The Commission
shares the concerns expressed by a commenter that the proposal may not
increase investors' perceptions of fairness in circumstances in which
an industry party does not agree to an investor's request for an
explained decision. Nevertheless, the Commission believes that the
even-handed approach of providing parties a means of jointly requesting
a decision represents a reasonable compromise between the status quo,
whereby the Codes offer parties no formal means of requesting an
explained decision, and the original proposal, whereby claimants alone
would have the right to request an explained decision. Further, the
Commission believes that the procedures set forth in FINRA's proposed
rule (including, procedures related to: Deadlines for submitting a
request; designating the chairperson as the writer of explained
decisions; compensation for writing explained decisions; substance of
the explained decision; and eligibility of cases for explained
decisions) will contribute to the efficiency of the securities
arbitration process by setting forth clear guidelines for parties and
arbitrators in instances where parties have jointly requested an
explained decision.
    At the same time, the Commission is concerned that it may be
difficult for parties to mutually agree to request an explained
decision, because the decision of whether to request an explained
decision (or whether to refuse to request an explained decision) may
ultimately be a strategic decision. In order to gauge the effectiveness
of the proposal, the Commission has requested that FINRA gather
statistics for a period of one year from the effective date of this
proposal, on the number of joint requests for explained decisions made
in arbitration. Further, the Commission has asked FINRA to report on
any anecdotal evidence it receives during this one-year period that may
shed light on how often parties are unable to agree to request an
explained decision.

V. Conclusions

    It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\45\ that the proposed rule change (SR-FINRA-2008-051) be, and
hereby is, approved.
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    \45\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\46\
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    \46\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E9-2775 Filed 2-10-09; 8:45 am]

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