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The Basics of Security Arbitration

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Professor George Friedman, adjunct law professor at Fordham Law and member of our Board of Directors at Arbitration Resolution Services, made this presentation to the Seton Hall Investor Advocacy Project.

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The Basics of Security Arbitration

  1. 1. Securities Arbitration Class Seton Hall Law School, October 11, 2013 “Hot Topics in Securities Arbitration” © 2013 by George Friedman, Board Member – Arbitration Resolution Services, Inc. (no claim to protected works)
  2. 2. Arbitration Resolution Services  Copyright © 2013 Short Bio  Retired earlier this year as FINRA’s Executive Vice President and Director of Arbitration, a position held from 1998.  Previously held a variety of positions of responsibility at the American Arbitration Association, most recently as Senior Vice President from 1994 to 1998.  Adjunct Professor of Law at Fordham Law School; teaches course on alternative dispute resolution since 1996.  Since early 2013, member of the Board of Directors of Arbitration Resolution Services, Inc.  Board of Editors of the Securities Arbitration Commentator.  Member of Securities Experts’ Roundtable.  BA, Queens College; JD, Rutgers Law School (Law Review).  CRCP (Certified Regulatory & Compliance Professional), Wharton-FINRA Institute.  Admitted in NY and NJ and US Supreme Court.  Follow me on Twitter @GFriedmanADR and at http://blog.arbresolutions.com 2
  3. 3. Arbitration Resolution Services  Copyright © 2013 A Prediction “A day of reckoning is coming on predispute arbitration agreements in consumer arbitration. “A dichotomy is developing between arms-length pre- dispute arbitration agreements and those imposed in an adhesion contract with consumers (and perhaps employees). “This will be addressed in the next several years by the Supreme Court, Congress, the SEC or all.” - George Friedman –Law Class Lecture at Fordham Law School …from 2005 3
  4. 4. Arbitration Resolution Services  Copyright © 2013 The Future (2013 - 18) My bold and fearless predictions for the future. You can disagree, but you can’t definitively say I’m wrong. Unless you claim to be from the future. In which case, let’s talk later… 4
  5. 5. Arbitration Resolution Services  Copyright © 2013 The Future (2013 - 18) And now, let’s go………. 5
  6. 6. Arbitration Resolution Services  Copyright © 2013 The Future (late 2013-18) 6 © 1985; 1990 Universal Pictures, Inc.
  7. 7. Arbitration Resolution Services  Copyright © 2013 The Future: headlines from 2013-2018… 2013-5: Consumer Financial Protection Bureau bans PDAAs in many types of consumer financial contracts; SRO arbitration carved out for SEC 2014: FINRA better defines “customer” for arbitration purposes 2015: SEC acts on predispute arbitration agreements under Dodd-Frank 2017: Arbitration Fairness Act finally enacted (sort of) 2018: Cloud-based ADR overtakes “Brick-and-Mortar” 2013-18: Supreme Court continues strong support for arbitration, but this began to shift in 2017 7
  8. 8. Arbitration Resolution Services  Copyright © 2013 2013-15: Consumer Financial Protection Bureau banned PDAAs in many types of consumer contracts  Background: Dodd-Frank established a new Consumer Financial Protection Bureau, required it to study PDAAs in consumer contracts (section 1028(a)), and authorized it to limit or ban their use (section 1028(b)).  By February 2013, CFPB had already banned PDAAs for mortgages and home equity loans, as Dodd-Frank mandated.  Later, CFPB banned PDAAs in many types of consumer financial contracts:  Car loans, consumer loans, credit card agreements, payday loans, rent-to- own contracts  SRO securities arbitration programs were carved out for the SEC 8
  9. 9. Arbitration Resolution Services  Copyright © 2013 2014: FINRA better defined “customer” for arbitration purposes  Anticipating that PDAAs might be banned, FINRA in 2014 clarified its definition of “customer” for purposes of its Rule 12200.  This rule allows a customer to require a broker to arbitrate disputes arising out of the business activities of the broker  After predispute arbitration agreements were banned -- first by the SEC in 2015 and later by Congress in 2017 -- FINRA Rule 12200 would become the investor’s only practical way into arbitration.  There was a huge battle, with the securities industry saying it was unfair to let investors “cherry pick” which cases to take to arbitration. It called for the abolition of Rule 12200.  In the end, FINRA and SEC stuck to their guns and Rule 12200 stayed.  The securities industry sued FINRA and the SEC (more on that later) . 9
  10. 10. Arbitration Resolution Services  Copyright © 2013 2015: The SEC acted on predispute arbitration agreements under Dodd-Frank  Background: Section 921 amended the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 to authorize but not require the SEC to:  limit or prohibit use of pre-dispute arbitration agreements (PDAAs) arising under the Federal securities laws, the rules and regulations thereunder, or the rules of a self-regulatory organization  “if it finds that such prohibition, imposition of conditions, or limitations are in the public interest and for the protection of investors.” 10
  11. 11. Arbitration Resolution Services  Copyright © 2013 SEC acted on predispute arbitration agreements under Dodd-Frank (cont’d)  The Timeline (a/k/a “The Letter of the Month Club”):  February 2013: Massachusetts's Secretary of the Commonwealth William F. Galvin urged the SEC to ban PDAAs in brokerage and IA agreements.  March 2013: The North American Securities Administrators Association, the association of state securities regulators, urged the SEC to act under Dodd-Frank to ban mandatory PDAAs. Repeats the demand in a May letter to SEC Chair White.  April 2013: SEC Commissioner Luis Aguilar came out against mandatory PDAAs in brokerage and investment adviser agreements.  April 2013: Thirty-seven Democratic Senators and House members urged the SEC to prohibit brokerage firms from requiring customers to submit to arbitration. 11
  12. 12. Arbitration Resolution Services  Copyright © 2013 SEC acted on predispute arbitration agreements under Dodd-Frank (cont’d)  May 2013: The Public Investors Arbitration Bar Association, attorneys who represent investors in arbitration, urged the SEC to ban mandatory PDAAs.  May 2013: Then-SEC Commissioner Elisse Walter said that the SEC was unlikely to get to the PDAA issue in 2013 due to other pressing Dodd-Frank requirements (mandatory rulemaking and studies).  May 2013. SEC Chair Mary Jo White responded to the April letter from the 37 Congressional Democrats. She agreed that mandatory securities arbitration was “an important issue for investors,” but echoed Commissioner Walter on timing. She added that the JOBS Act has similar rulemaking requirements for the SEC.  February 2014: A consortium of anti-arbitration types produced a Super Bowl ad featuring…. 12
  13. 13. Arbitration Resolution Services  Copyright © 2013 SEC acted on predispute arbitration agreements under Dodd-Frank (cont’d) …. Clint Eastwood and an empty chair singing “All we are saying, is give choice a chance.” 13 © 2013 New Yorker Magazine
  14. 14. Arbitration Resolution Services  Copyright © 2013 SEC acted on predispute arbitration agreements under Dodd-Frank (cont’d) …. And this became the group’s logo. 14 Photo © 1971 Warner Brothers, Inc.
  15. 15. Arbitration Resolution Services  Copyright © 2013 SEC acted on predispute arbitration agreements under Dodd-Frank (cont’d) So, here’s what happened:  SEC studied mandatory PDAAs. It started in 2011 and finished in 2014. The rule went into effect in 2015.  SEC found that securities arbitration was fair for investors.  After allowing PDAAs in customer-broker contracts since 1987 (McMahon and Rodriguez), SEC would have been hard pressed to say securities arbitration was unfair.  SEC’s Report to Congress cited everything George Friedman had been saying for years about fairness of the FINRA forum.  But the SEC’s 2015 rule provided that “perceptions of fairness dictate that investors have a choice of forum” – that is, going to court or arbitration.  Turns out Commissioner Aguilar knew he had the votes. 15
  16. 16. Arbitration Resolution Services  Copyright © 2013 SEC acted on predispute arbitration agreements under Dodd-Frank (cont’d)  So, the rule prohibiting brokerage firms and IAs from using or enforcing PDAAs in customer account agreements was a one-way street. It preserved FINRA Rule 12200, which gives customers of brokerage firms the right to take a dispute to arbitration.  This immediately spurred litigation initiated by the securities industry against SEC and FINRA over whether FINRA Rule 12200 violates the “Takings Clause” of the US Constitution.  Two years later, the industry challenged whether the Franken-Stein Arbitration Fair Play Act of 2017 (more on that later) trumped Rule 12200 because it was essentially a PDAA, meaning the investor had no right to require arbitration with their brokers under this FINRA Rule.  Both matters are still unresolved. 16
  17. 17. Arbitration Resolution Services  Copyright © 2013 2017: The Arbitration Fairness Act was finally enacted (sort of)  There were prior failed efforts -- going back at least to 2005 -- to amend the Federal Arbitration Act (“FAA”) to ban mandatory PDAAs in consumer, employment, and sometimes franchise contracts and civil rights claims.  The FAA – 9 U.S.C. §1 et seq. – is a 1925 federal law enforcing predispute arbitration agreements and arbitration decisions involving interstate commerce. It enjoys strong support from the US Supreme Court.  Even in 2009, when the Democrats controlled the White House and both houses of Congress (and Barney Frank, an avowed opponent of PDAAs in consumer contracts, chaired the House Financial Services Committee), the bills died. 17
  18. 18. Arbitration Resolution Services  Copyright © 2013 The Arbitration Fairness Act was finally enacted (sort of)  So, here’s what happened:  AFA was reintroduced in 2013: It was introduced in both houses of Congress on 5-7-2013 (Franken-S; Johnson –H).  August 2013: The Investor Choice Act of 2013 (HR 2998) was introduced in the House by Rep. Ellison (D – Minn.). The bill would prohibit stockbroker and investment advisory firms from using mandatory PDAAs.  Hearings were held on both bills in the wake of the Supreme Court’s decisions in Oxford and Amex. – Both failed to get out of committee.  AFA reintroduced in 2015: Failed to get out of committee. 18
  19. 19. Arbitration Resolution Services  Copyright © 2013 The Arbitration Fairness Act was finally enacted (sort of)  Finally in 2017: Spurred on by George Friedman’s ground-breaking compromise proposed in an article published in the Securities Arbitration Commentator in the summer of 2013, the Franken-Stein Arbitration Fair Play Act of 2017 was enacted. – after the Democrats regained control of Congress in the 2016 elections – over the veto of President Christie  It amended the Federal Arbitration Act to require that: 19
  20. 20. Arbitration Resolution Services  Copyright © 2013 The Arbitration Fairness Act was finally enacted (sort of)  in a consumer contract, any predispute arbitration agreement must be separately signed or clicked by the consumer;  a consumer cannot be denied goods or services if the consumer declines the arbitration option;  in an employment contract that is not individually negotiated, any predispute arbitration agreement must be separately signed by the employee;  a prospective or current employee cannot be denied employment if the employee declines the arbitration option; AND  clear procedural fairness guidelines be followed in any consumer or employment arbitration.  To avoid Constitutional challenges, the law was prospective. It applied to contracts entered into or revised after the effective date, but required that contracts be revised within two years of the effective date. 20
  21. 21. Arbitration Resolution Services  Copyright © 2013 2018: Cloud-based ADR overtakes “Brick-and-Mortar” Background: Starting in the 1990s, technology improved the way arbitrations and mediations were processed.  Early 1990s: The first fax machines and simple email systems were introduced.  Mid-1990s:The advent of the web spurs the major ADR providers to establish web sites.  Circa 2000: Improvements in technology lead to awards becoming available online at AAA and FINRA at the dawn of the millennium.  Mid-2000s: Further improvements in technology lead to online case filing systems at providers such as AAA and FINRA.  2008: Digital recording supplants analog taping at FINRA.  2011: Major ADR providers begin rolling out robust web-based “self- help” case administration systems. 21
  22. 22. Arbitration Resolution Services  Copyright © 2013 Cloud-based ADR Overtakes “Brick-and-Mortar”  2012: First mobile ADR apps appear.  2012: Arbitration Resolution Services, Inc. (ARS) is formed.  The world’s first cloud-based ADR provider where the entire process can be completed online.  2012: JOBS Act passed.  Allows crowdfunding portals such as Kickstart and Indiegogo to issue stock.  Requires SEC to write rules first.  2013: George Friedman retires from FINRA. Joins the ARS Board.  2013: SEC seeks public comments on its JOBs Act rulemaking. 22
  23. 23. Arbitration Resolution Services  Copyright © 2013 Cloud-based ADR Overtakes “Brick-and-Mortar”  April 2013: North American Association of Securities Administrators (“NASAA”) President Heath Abshure says, at the “NASAA, SEC 19(d) Conference” in Washington: “Arbitration doesn’t make sense for a $10,000 investment, much less a $2,000 investment—which is the size contemplated by the crowdfunding provisions in the JOBS Act.”  July 2013: ARS EVP and GC Mark Norych files a comment letter with the SEC pointing out that most disputes arising out of crowdfunding will be relatively small, and that traditional “brick-and-mortar,” paper-based arbitration is not a solution. He concludes: “We urge the SEC to consider rulemaking that establishes an efficient, fair, inexpensive cloud-based means for resolving crowdfunding disputes.”  July 24, 2013: Rules go into effect; say nothing about dispute resolution (17 CFR Parts 230, 239 and 242). 23
  24. 24. Arbitration Resolution Services  Copyright © 2013 Cloud-based ADR Overtakes “Brick-and-Mortar” So, here’s what happened:  2013: AAA, FINRA and JAMS launch voluntary web portals that shift some of the ADR process to an online environment.  Late 2013: For the first time in recent history, both the stock and bond markets crash at the same time.  2014: FINRA is inundated with crash-related claims. Case filings break the old record of 8,945 set in 2003 in the wake of the “tech wreck.”  Early 2014: SEC promulgates revised crowdfunding rules. The rules permit use of arbitration, including PDAAs, but leaves the choice to investors (foreshadowing what was to come regarding securities arbitration in general), but require that arbitrations be conducted online.  Mid-2014: ARS launches the first online ADR platform for crowdfunding disputes that meets the SEC standards. Case filings soar. 24
  25. 25. Arbitration Resolution Services  Copyright © 2013 Cloud-based ADR Overtakes “Brick-and-Mortar”  Late 2014: To address the growing post-crash caseload at FINRA, SEC promulgates a rule giving investors the option of a completely web- based ADR system for “simplified” cases involving under $50,000.  Early 2015: ARS launches the first online ADR platform for simplified disputes that meets the SEC standards. Case filings soar.  March 2015: A little-noticed provision in the Patient Protection and Affordable Care Act (a/k/a “Obamacare”), requiring that health insurers establish external review of claims decisions, leads to massive claims with nowhere to be filed.  June 2015: Congress amends Obamacare to give patients the right to require “expedited online arbitration” of disputed healthcare claims with their insurers.  August 2015: ARS launches the first online ADR platform for Obamacare disputes that meets the Act’s standards. Case filings soar. 25
  26. 26. Arbitration Resolution Services  Copyright © 2013 Cloud-based ADR Overtakes “Brick-and-Mortar”  Fall 2015: Hurricane Ella devastates the mid-Atlantic.  Late 2015: Congress, which had to be relocated after the storm, passes the “Hurricane Ella Relief Act” giving insureds the right to require “expedited online arbitration” of property-damage claims with their insurers.  January 2016: ARS launches the first online ADR platform for Hurricane Ella disputes that meets the Act’s standards. Case filings soar.  2018: Fueled by the explosive growth of ARS’ caseload, cloud-based ADR case filings for the first time eclipse paper-based filings.  February 27, 2018: Friedman retires.  Again. 26
  27. 27. Arbitration Resolution Services  Copyright © 2013 2013-8: The Supreme Court continued its strong support for arbitration  The Supreme Court continued its strong support for arbitration:  continued erosion of the non-arbitrability doctrine  supremacy of arbitration clauses over class action participation (see Amex)  strong support of FAA preemption of state anti-arbitration laws  more restrictions on court review of arbitration awards (see Oxford Health)  continued impatience with frivolous motions to vacate  This began to shift in a series of 5-4 decisions after Justice Hillary Clinton replaced Justice Scalia on the Court in late 2016.  In 2017 Justice Clinton wrote the majority opinion holding that arbitrators must apply the law in deciding claims alleging violations of federal statutes  The Court heard oral argument five years from now in 2018 in SIFMA v. SEC and FINRA, a case dealing with the securities industry’s challenge to FINRA rule 12200.  I had to head back to 2013 before the case was decided. Sorry 27
  28. 28. Arbitration Resolution Services  Copyright © 2013 In conclusion  Like the scene at the end of Back to the Future III: “The future hasn’t been written yet. No one’s has. Your future is whatever you make it. So make it a good one.”  In my case, it turned out joining the Board of Arbitration Resolution Services was a good move.  In 2018, after ARS went public, I traded in my Chevy Volt for… 28
  29. 29. Arbitration Resolution Services  Copyright © 2013 In conclusion (cont’d) 05/02/2018 29 A Tesla Model S!
  30. 30. Arbitration Resolution Services  Copyright © 2013 In conclusion (cont’d) See you in the future! 30

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