Code of Procedure and Code of Arbitration

Code of Arbitration (COA)

When there are conflicts in the industry, how they get resolved is through the processes of either mediation or arbitration.

Arbitration is a formal, out-of-court process for resolving legal disputes. There is an impartial third party, or a panel of them, called Arbitrators, or Arbiters. In our industry, arbitration will be resolved with either 1 or 3 arbiters, and it is required in our industry.

Mediation

Primary thing to remember about mediation is it is option. It is when someone, often from FINRA, but an outside person comes in, and tries to resolve the dispute by talking to both parties, getting both parties to talk to each other, and trying to come to a mutually agreed upon resolution, without the costs of arbitration or courts.

Predispute arbitration agreement

Under FINRA rule 2263, as part of the U4 application form for association with a member firm, every person agrees to a predispute arbitration agreement. This means, as representatives, if we have a disagreement with our employer that in the outside world might be able to be handled in court, we are not able to, and we must go through arbitration.

The only exception to the forced arbitration rules, are when it comes to harassment or discrimination. In those cases, arbitration can still be used, but both parties must agree, it is not forced. If you believe your employer hasn’t honored the contract, or payed you correctly, or anything like that, you must go through arbitration, you cannot go to courts.

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 (unless it was harassment or discrimination).

Simplified arbitration uses 1 arbiter. Regular arbitration uses 3. For most cases, if the amount contested in $50,000 or less, than simplified arbitration and 1 arbiter will be used. For firms, they can agree up to $100,000 to use simplified arbitration. Having 1 arbiter will make the process cheaper, and quicker than with 3, but it is riskier as you only have 1 person to convince, instead of possibly 2 of 3.

Arbitrators only have to explain their reasoning for award if a joint request is made, by all parties involved, for an explanation. This request must be given to the panel at least 20 days prior to the first scheduled hearing.

Code of Procedure

The Code of Procedure (COP) is the process and procedures for disciplining a person for violating rules, either FINRAs or SECs. You can think of the idea is when someone does something bad, you would call the COPs. Although not likely to be tested in detail, it can be confused with the Conduct Rules. A simple way to think about it is that the Conduct Rules explain how we conduct ourselves with other financial professionals. How Firm A deals with Firm B is in the conduct rules. The COP deals with when a firm or associated person hurts a client, customer, or similar.

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 it to respond. If there is no response in those 25 days, a second notice is issues, and the respondent then has 14 days to respond. Failure to respond to the second notice within those 14 days, is considered an admission of guilt.

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 Office (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 have a prehearing conference to explain the process, and make the whole ordeal more orderly and efficient. Documentary evidence will be submitted by both sides, and generally will be submitted before. The exceptions are unlikely to be seen. Sometimes witnesses may be called. These witnesses could be industry people, having worked at some member firm, or they might be outsiders not affiliated with a member firm. Any witness who is under FINRA jurisdiction, being employed by a FINRA member firm, must testify is subpoenaed. Technically there is no force to make outsiders testify if they do not wish to. When FINRA requests a firm or associated person provide information within an investigation, the response can be made orally or in writing, and that writing could be pen and paper, typewriter, or electronic. If sent electronically, it must be secure, encrypted, or otherwise protected.

Within 60 days after the panel has stopped accepting documentary evidence, 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)

Generally combined with a MRV, 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, waver, and consent (AWC). The letter states the person willingly accepts the allegations, agrees to the sanctions that will be levied, and waives any right to appeal the decision. Again, like with MRV, these are usually for accidental violations of minor rules, important rules, but not like “don’t steal from clients”.

Sanctions

Sanctions are a punitive action. They are a punishment. That sounds like it should be obvious, but sometimes these exams can get a little tricky between actual punishments, and things like “someone died and their license is canceled”. That wouldn’t be a “punishment.”

• 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 - Sometimes referred to as suspension/revocation, they mean the same thing; they are taking away your license. Suspensions could be for days up to several to many months. They generally will not be over a year. Instead of time, they could be based on some other condition, such as passing the exam again, or anything else FINRA demands.
• Expulsion - Kicking the person out. FINRA (and all the other SROs), are member organizations; they are clubs, and they can kick anyone out, literally for any reason, except they will always have a reason. Expulsion is generally what would happen if a suspension would be for over 1 year. Expulsion is not barring, after the exclusionary period, which could last years, the person could potentially be reappointed. For firms, however, expulsion pretty much is a death sentence.
• Barring - Kicking the person out, closing the door, and putting their picture up on a board by the door that says “these people are never allowed to come back, ever”. For a great example, watch the movie The Wolf of Wall Street, and then do a BrokerCheck lookup for Jordan Belfort. You will understand why that man is forbidden from ever affiliating with a FINRA member firm.
• Anything else - As stated earlier, FINRA is a “member club”, and can basically make up whatever they want. They have to be fair and legal of course, and can be appealed, but often it is retesting, or potentially community service. They could make any punishment they wish, and you will accept it, or leave the industry.

Continuing commissions/payments to disciplined reps

If a member firm terminates a persons association, because they have been suspended, expelled, barred, or their license has been revoked, they are not allowed to continue to be paid during the time of their suspension. They cannot be appointed, so they clearly cannot be paid new commissions, as they can’t make new commissions, they can’t get any older commissions that would be earned by them, if they were not being disciplined.

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. With the filing of an appeal, the panels decision is immediately halted 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. First appeal of the DOE was to the NAC. To appeal the NAC it goes to the SEC. If the respondent doesn’t like that, they can then appeal to the courts, to the US Court of Appeals to be specific. Technically, if they also rule against the respondent, the respondent can appeal that. In this country, there is 1 and only 1 court that hears appeals from the US Court of Appeals; The Supreme Court. This gets very big, very quickly, if the respondent so chooses.