Code of Procedure and Code of Arbitration

Code of Arbitration (COA)

Disputes in the securities industry are resolved through mediation or arbitration.

Arbitration is a formal, out-of-court process for resolving legal disputes before an impartial third party, or a panel of them, called arbitrators (sometimes “arbiters”). A FINRA arbitration is heard by either 1 or 3 arbitrators, and it is required for most disputes in the industry.

Mediation

The main thing to remember about mediation is that it is optional. A neutral mediator, often from FINRA’s roster, talks with both parties and helps them talk to each other, to reach a mutually agreed resolution without the costs of arbitration or court.

Predispute arbitration agreement

As part of the U4 application form for association with a member firm, every person agrees to a predispute arbitration clause. FINRA rule 2263 requires the firm to give that person written disclosure about the clause before they sign - it’s the disclosure requirement, not the arbitration agreement itself. So a representative with a dispute against their employer that could otherwise go to court must go through arbitration instead.

The exceptions to the forced arbitration rules are statutory employment discrimination claims (including harassment), sexual assault and sexual harassment claims, and whistleblower claims under laws that ban predispute arbitration agreements. For these claims, the associated person is not forced into arbitration and may pursue the claim in court instead; arbitration applies only if the parties agree. Class actions and collective actions can’t be arbitrated under FINRA’s code at all. Every other dispute still goes to arbitration: a representative who believes their employer hasn’t honored their contract or paid them correctly must arbitrate the claim and can’t go to court.

In addition to the natural persons, firms are also bound by arbitration rules. If 2 firms have a disagreement, they must take it up through arbitration. If 2 associated persons have a disagreement, they must take it up through arbitration. If a member firm and an associated person, associated with them or not, have a disagreement, they must take it up through arbitration.

If a client has a problem, it would depend if they signed a predispute arbitration clause as part of the new account form. Many firms do have a predispute arbitration clause in their contracts, meaning all clients would have to agree to arbitration, and would not be able to go to court (class actions are the main exception).

Simplified arbitration uses 1 arbitrator: if the amount in dispute is $50,000 or less, simplified arbitration with 1 arbitrator is used. For claims over $50,000 up to $100,000, the case is a regular arbitration but still has 1 arbitrator, unless the parties agree in writing to 3. Over $100,000, regular arbitration uses 3, unless the parties agree in writing to 1. Having 1 arbitrator makes the process cheaper and quicker than with 3, but riskier, since there is only 1 person to convince instead of 2 of 3.

Arbitrators have to write an explained decision, a fact-based award stating the general reasons for their decision, only when all parties jointly request one. The request must be made no later than the prehearing exchange of documents and witness lists, which is at least 20 days before the first scheduled hearing. The requirement doesn’t apply to simplified cases decided without a hearing or to default cases, and any award may include the arbitrators’ reasoning without a request.

Code of procedure

The Code of Procedure (COP) is the process and procedures for disciplining a person for violating rules, either FINRA’s or the SEC’s. Don’t confuse it with the rules it enforces. The conduct rules set how firms and their associated persons deal with customers, and the Uniform Practice Code sets how firms deal with each other (how Firm A settles a trade with Firm B, for example). The COP is how FINRA disciplines a violation of any of them.

With disciplinary proceedings, when the Department of Enforcement (DOE) of FINRA believes that a member or an associated person of a member has violated a rule, regulation, or law that is within FINRA’s jurisdiction (which is very wide), they will go to the Office of Disciplinary Affairs to formally issue a complaint. The respondent then has 25 days from receiving the complaint to respond. If there is no response in those 25 days, a second notice is issued, and the respondent then has 14 days from that second notice to respond. Failure to respond to the second notice within those 14 days results in a default, and the allegations in the complaint are deemed admitted - note that each deadline attaches to its own triggering event, not to the start of the whole process.

Hearings may be requested by the respondent. Any such hearing would be before something called the hearing panel, which would consist of 3 persons; the hearing officer, who is an attorney employed by FINRA for this purpose, and 2 persons who either are or have been associated with member firms, with experience and knowledge in the areas of the dispute, and served on some type of large committee, either locally or nationally. The 2 additional panelists are appointed by the Chief Hearing Officer (CHO) of FINRA. Before the hearing has begun, the respondent may try and settle the case with the panel. If the respondent’s offer is accepted, there is no right to appeal, and it ends. If the respondent’s offer is rejected, the hearing proceeds.

The hearing officer may hold a prehearing conference to explain the process and make the whole proceeding more orderly and efficient. Documentary evidence will be submitted by both sides, generally beforehand. Sometimes witnesses may be called - these could be industry people who have worked at a member firm, or outsiders not affiliated with a member firm. A witness employed by a FINRA member firm must testify when FINRA requests it - FINRA can’t issue subpoenas, but Rule 8210 requires anyone under its jurisdiction to testify and provide information, and refusing is itself a violation; FINRA cannot force an outside witness to testify if they don’t wish to. When FINRA requests information from a firm or associated person during an investigation, FINRA chooses the form: it can require the answer orally, in writing, or electronically (when the information is kept in electronic form). Information handed over on a portable media device, such as a flash drive or disc, must be encrypted.

Within 60 days after the final date allowed for filing post-hearing briefs (and proposed findings of fact and conclusions of law), a written decision will be given, by majority vote of the 3 persons on the panel.

Minor rule violation (MRV)

When the DOE believes that some minor rule has been violated, important, but still minor, and the respondent doesn’t dispute it, FINRA will impose a fine of up to $2,500 and/or censure the respondent. If the respondent accepts the MRV, they can’t appeal. If the respondent wants to fight, then normal disciplinary proceedings will commence.

Minor rules would be things like;

• Late filing of documents or late reporting of required reports.
• Failing to properly mark trades and certain minor order handling violations.
• Failure to properly submit trading data
• Other similar minor things, likely accidental.

Acceptance, waiver, and consent (AWC)

Separate from the MRV process, an AWC is when the DOE believes violations have occurred, and the associated person or member firm don’t dispute it. The DOE can then have the respondent sign a letter of acceptance, waiver, and consent (AWC). In it, the respondent accepts a finding of violation, consents to the sanctions, and waives the right to a hearing and to any appeal. Unlike an MRV, an AWC isn’t limited to minor rules: violations of any seriousness are settled this way, including cases that end with the person being barred.

Sanctions

Sanctions follow a violation. FINRA’s Sanction Guidelines describe them as remedial: they are meant to keep the misconduct from happening again and to deter others, not to punish for its own sake. Exam questions may still call them punitive, and contrast them with actions that aren’t sanctions at all, such as a registration being canceled because the person died.

• Censure - This is the lowest punitive punishment that can be assigned. In real world phrasing, it is “an official slap on the wrist”, it goes in your permanent record held by FINRA and BrokerCheck. It often will include a small fine.
• Fines - A monetary payment as punishment. There is no limit.
• Suspension - A temporary removal of registration. It isn’t the same as a revocation, which cancels the person’s registration, or a bar, which permanently prohibits association with any member firm. Suspensions could be for days, months, or longer; FINRA’s Sanction Guidelines generally recommend no more than two years, and misconduct serious enough for a longer one usually calls for a bar instead. Instead of a fixed time period, a suspension could be based on some other condition, such as passing the exam again, or anything else FINRA demands.
• Expulsion - Removing a member firm from FINRA (other SROs can expel their members too). Expulsion applies to firms; an individual would instead be suspended, barred, or have their registration revoked. An expelled firm is subject to a statutory disqualification, so for firms, expulsion pretty much is a death sentence.
• Barring - A permanent removal from the industry; a barred person can never again associate with a FINRA member firm, and BrokerCheck will show the bar in their permanent record.
• Any other fitting sanction - FINRA can also impose “any other fitting sanction,” such as a requirement to requalify by examination (retesting). Like every sanction, it must be fair, and it can be appealed unless the respondent has waived that right.

No rule fixes a set penalty for each violation. FINRA’s Sanction Guidelines recommend ranges, and the hearing panel tailors the sanction to the misconduct, weighing factors such as the respondent’s disciplinary history, whether the conduct was intentional or negligent, and the harm it caused. The aim is to keep the misconduct from happening again, so a panel may order retesting in place of, or on top of, a fine.

Continuing commissions/payments to disciplined reps

If a person has been suspended, barred, or had their registration revoked, the member firm can’t let them work in any capacity the sanction doesn’t allow, and can’t pay or credit them any salary, commissions, or other pay that they would accrue during the sanction. Pay the firm can show they earned before the sanction took effect can still be paid, unless it relates to the misconduct that led to the sanction.

Appeals

As stated, much of this can be appealed, unless the respondent waives that right as part of an agreement. Once the panel has given its written decision, the respondent would have 25 days to appeal with the National Adjudicatory Council (NAC). The NAC has been given the authority to review decisions. If the respondent “won”, the same rights are held by the DOE, and they can appeal. Filing an appeal puts the panel’s decision on hold until the appeal process plays out. The NAC will review everything, and afterwards they have the power to affirm, reverse, modify, increase or decrease any sanction, or basically impose any other sanction they choose.

At this point, the respondent can still appeal: from the NAC, the next stop is the SEC, then the US Court of Appeals, and finally the US Supreme Court - the last court that can hear a further appeal.