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Voicing Concern for Low Income Claimants Securities Arbitration Clinic Students Challenge Proposed Rule Change

Friday, June 20, 2014

The Ponzi schemes perpetrated by Bernard Madoff and R. Allen Stanford left investors across the globe reeling. In response to this widespread harm, the Financial Industry Regulatory Authority, Inc. (FINRA)— a private, independent regulator for securities firms doing business in the U.S.—took a hard look at the rules governing the arbitration system it runs to help brokerages and investors resolve legal disputes. 

One of the rules it identified as an impediment to preventing financial losses to a potentially large group of investors, and to protecting public investors generally, is one that requires arbitrators to wait until the end of a case before alerting FNRA's staff to possible fraudulent activity they learn about during arbitration. So starting in 2010, and over the next four years, FINRA crafted and re-crafted a proposed rule change to permit arbitrators to make these referrals to FINRA mid-case under narrowly defined circumstances. It also allows a party to request recusal of an arbitrator within three days of being notified of a mid-case referral.

Pursuant to established procedure, the proposed rule change, as amended, was published for comment in the Federal Register on February 12, 2014. Christine Lazaro, Director of the Law School’s Securities Arbitration Clinic, flagged the proposal as a potential concern to clients the clinic typically represents—low income claimants who would otherwise go without legal representation in their disputes with brokerages. With the clinic’s Assistant Director, Francis J. Facciolo, Professor Lazaro asked student clinicians Daniel Coleman ’15, Christian Corkery ’15, and Ryan Jennings ’15 if they wanted to draft a comment letter on the rule proposal on the clinic’s behalf.

“It just so happened that the cases Dan, Ryan, and I were working on were in their final stages, which afforded us time to research and write a comment letter,” Christian said. “We were surprised by the unintended consequences to the small investor that FINRA seemed to be ignoring in crafting the mid-case referral rules. Our goal was to identify these issues through the public comment opportunity.” The students found the process challenging, but rewarding. “The comment process isn't so much about raising every conceivable argument about a rule proposal as it is about making sure that all of the voices of those who feel strongly about it are heard,” Daniel explained. “We wanted to make sure that another voice was added in support of clients like ours.”

In their comment letter, the students assert that FINRA’s attempt to combat widespread fraud in the marketplace is commendable, but misses the mark by unduly burdening the individual investor. Instead of putting the financial onus on individual claimants, they suggest that FINRA impose costs of increased fraud protection on clearing firms and exchanges that can better bear them. “Our experiences in the clinic gave us insight into just how big of a difference a small amount of money can make to low income claimants,” said Ryan. “When we thought about how a mid-case referral could affect our clients, the potential harm was very apparent.”   

FINRA’s published response to the submitted comments repeatedly refers to the St. John’s comment letter and amended original proposal. “Working on the comment letter allowed the students to be active participants in the rule making process and to have a voice in it,” Professor Lazaro said. “In considering the arbitration process from the perspective of their clients, the small investors, they also gave voice to a perspective that may otherwise never be heard.”

The SEC has solicited additional comments from the public on the rule proposal as amended as well as any rebuttals to any prior comments or submissions that any member of the public might want to make. These comments and rebuttals have to be submitted in July.