The Use of FINRA Arbitration Procedures to Resolve Disputes Between Financial Advisers

The Financial Industry Regulatory Authority (FINRA) is a nongovernmental, independent regulatory authority that creates and enforces rules covering member brokers and broker-dealers. Its mission is to “. . .safeguard the investing public from fraud and bad practices” , and most FINRA arbitrations involve conflicts between members of the investing public and FINRA member brokers and broker-dealers; however, FINRA arbitration panels also resolve disciplinary issues involving broker-dealers and brokers, and, occasionally, disagreements between brokers.

A common issue that arises between brokers occurs when a practice is sold by one broker to another. Each broker, over the course of a career, develops customers and customer loyalty. This customer loyalty translates into ongoing revenue. When a broker decides to retire or otherwise leave his or her practice, this “book of business” constitutes a valuable asset. Of course, investors are always free to leave a broker, and investors leave on a daily basis. The broker does not have an ownership interest over any investor. What is actually sold is “good-will”. The seller of a practice, in essence, is selling the opportunity for the purchaser of the practice to retain the practice’s customers.

We were recently engaged to represent a broker in this type of dispute. After developing a practice, the broker decided to seek other challenges by working in-house with a major brokerage company. She therefore sold her practice to another broker who she believed would treat her investor clients as well as she had treated them. During the negotiations for the sale of the business, the issue of a “non-compete” clause was discussed; however, the seller was unwilling to sign a non-compete clause because she did not want to be foreclosed from returning to the industry. Instead, the parties agreed to a “non-solicitation” clause, meaning the seller would not solicit her former investor clients.

Thereafter a couple of things happened. First, the purchaser of the business was not able to deliver the services the investors had come to expect, and a number of customers left the business. Next, the seller of the business decided that working at the corporate headquarters was not for her, and she left the broker to re-enter to financial services industry as a broker. She never solicited business from her former clients; however, many of her former clients returned to her when they learned that she was once again advising investors.

After attempts to negotiate a resolution to the dispute failed, the purchaser of the business instituted an arbitration with FINRA against the seller. Arbitration is an alternative to litigation before a court with jurisdiction. There are various types of arbitrations available to parties: the American Arbitration Association (AAA) is the most common arbitration organization in the United States, but FINRA provides arbitration services in some circumstances. Most often, parties will agree to arbitration in an agreement or contract, and if the agreement is properly drafted, it will designate the organization and rules to apply to the arbitration. Occasionally, the parties will agree to arbitrate a dispute after the dispute has arisen even if it was not required by the contract. In the United States, most arbitration clauses are enforceable under the Federal Arbitration Act (FAA).

In determining whether to agree to arbitration, whether it be before or after a dispute has arisen, the parties must consider the pros and cons of an agreement to arbitrate. On the “pro” side, arbitrations are relatively quick and relatively inexpensive (although they are not cheap). Many times, the arbitration rules will provide for the confidentiality of filings. Discovery and motions practice are limited.

Under FINRA rules, an arbitration is commenced with the filing of a Statement of Claim and the payment of the required fee. Motions to dismiss and for summary judgment are disfavored. Discovery is limited to the exchange of relevant documents and requests for information related to the identification of individuals, entities, and time periods related to the dispute, and there are no depositions. Finally, and perhaps most important, the decision of the arbitrators is, for all practical purposes, final. There is no appeal to a court, except in limited circumstances, and there is no appeal to the appellate courts. Litigation in court can take years, and appeals can add years to the already lengthy process. Arbitration provides quicker finality in most cases.

On the other hand, arbitration does have its drawbacks. Because motions are disfavored, it is not usually possible to have a meritless claim dismissed before the arbitration hearing. Also, the arbitrators may not be lawyers and may not understand the technical aspects of complex areas of the law (like the difference between a non-compete and a non-solicit clause in an agreement). The decision of the arbitrators is final, and, even if there is clear error of law, an appeal is usually not possible. Our experience has shown that FINRA arbitrators attempt to be fair and follow the law.

In the case mentioned above, the first issue to consider was whether to agree to a FINRA arbitration. Unlike many (perhaps most) agreements, the agreement in this case did not contain an arbitration clause, and there would have been no basis for the opposing party to compel arbitration. However, because the cost of arbitration is generally cheaper and we believed the facts were clear, the seller of the business opted to proceed with a FINRA arbitration.

A review of the documents indicated to us quite clearly that the sales agreement for the business contained a “non-solicit” agreement which, by its own terms, prohibited the seller from soliciting any business. She was perfectly free to operate a business in the local area, and, in fact, the claimant never argued that she could not operate a business. The issue therefore came down to whether she had actually approached any of her prior clients and asked for her business. Several customers testified they had not been solicited. They also testified that they left the claimant because he failed to provide them with the service they expected.

Following the conclusion of the hearing, the arbitrators entered an award completely favoring our client. A redacted copy of the award is attached. The decision to proceed with arbitration proved to be the correct decision. The client’s victory before the arbitration panel was complete, and the cost of the arbitration was a fraction of what the cost to litigate the case in the state courts of Maryland would have been.

FINRA provides a forum for resolving disputes that arise within the financial services industry. In most circumstances, these disputes involve issues between investors and investment advisors. However, FINRA rules are also relevant for resolving issues between members of the financial services industry. In some circumstances a FINRA arbitration may be the appropriate forum for resolving these issues.