FINRA Revises Definition of Public Arbitrator and Proposes Changes to Discovery Guide Concerning Electronic Documents

by Wilson Elser

The Financial Industry Regulatory Authority (FINRA), which provides the arbitration forum for resolving disputes between securities firms and customers, recently announced changes to the arbitrator selection process and proposed amendments to the Discovery Guide. As detailed below, these will impact the strategy and costs associated with defending customer disputes.

Changes to the Definition of Public Arbitrator

FINRA recently released Regulatory Notice 13-21 concerning a rule amendment, effective July 1, 2013, governing the criteria for who can serve as a Public Arbitrator. This rule change is significant because virtually all FINRA customer arbitrations are heard by three-person panels, selected by the parties, that are composed of a Public Chairperson and two additional arbitrators.

The FINRA Codes of Arbitration Procedure originally required that the two additional arbitrators comprise one Public Arbitrator and one Industry Arbitrator. An Industry Arbitrator had been defined as (1) anyone who has worked for a broker-dealer within the past five years, (2) a retired person who spent a substantial amount of time working for a broker-dealer or (3) an attorney who derives at least 20 percent of his or her revenue from representing broker-dealers. A Public Arbitrator was defined as anyone who is not an Industry Arbitrator.

The claimants’ bar complained that the presence of an Industry Arbitrator skewed arbitration results in favor of securities firms and their registered representatives. In response to these claims, FINRA amended its rules in January 2011 to allow customers to opt for an “all public panel,” which most customers have done since then. FINRA’s statistics indicate that there has been a correlative increase in the percentage of cases resolved in favor of claimants. Indeed, since February 1, 2011, customers opting for all public panels have prevailed in 49 percent of cases. In contrast, customers opting for panels composed of public and industry arbitrators have prevailed in 34 percent of cases.

FINRA’s newly adopted definition of Industry Arbitrator, effective July 1, 2013, adds new categories of financial professionals, including anyone who has worked for either a mutual fund or a hedge fund. Furthermore, the new definition requires anyone who previously met the definition of an Industry Arbitrator to wait for two years before qualifying as a Public Arbitrator. Thus, anyone who previously worked for a broker-dealer, mutual fund or hedge fund and any attorney whose firm derived 10 percent or more of its annual revenue from representing broker-dealers and some other financial market clients must wait for two years before qualifying as a Public Arbitrator.

FINRA stated that it amended the definition of Industry Arbitrator to improve customers’ perceptions regarding the “fairness” of the FINRA forum. However, these amendments will have the effect of further curtailing the ability of parties to select arbitrators who understand the underlying issues in the arbitration.

Changes to the Discovery Guide

FINRA has also proposed amendments to the Discovery Guide, which governs FINRA arbitrations. The proposed amendments provide for enhanced disclosure of electronic evidence and additional disclosures in “product cases,” and require additional affirmations when a party does not produce all documents responsive to the Document Lists contained in the Discovery Guide.If the SEC approves these proposed amendments, they could be implemented as early as Fall 2013. These changes will substantially increase the costs of discovery.

Electronic Evidence Guidelines
FINRA’s proposed electronic discovery rule mimics the requirements of the Federal Rules of Civil Procedure and encourages the parties to confer and agree regarding the format of electronic production. However, the proposed rule also suggests that parties should produce documents in the format in which the party keeps the document or a converted “format that does not make the document more difficult to use.” The rule also gives authority to arbitrators to resolve discovery disputes and directs arbitrators to consider “the totality of the circumstances,” which includes examining (1) whether the form of production is different from the original format of the document and (2) whether conversion to a new format affects the documents’ “appearance, searchability, metadata, or maneuverability.”

The rule filing that FINRA submitted to the SEC indicates that if the SEC approves the rule change, FINRA intends to provide guidance to arbitrators that will require parties to produce documents in an electronically searchable format with the metadata intact. However, the rule filing also indicates that FINRA intends to instruct arbitrators to consider the cost of electronic production when confronted with discovery motions. Although the rule filing indicates that FINRA recognizes that “additional guidance would raise arbitrator awareness” of cost issues, FINRA does not provide any insight as to the guidance it intends to provide.

Product Cases Guidelines
FINRA has also proposed amendments to the Discovery Guide to respond to perceived discovery challenges in Product Cases, which it defines as cases involving allegations of “widespread mismarketing or defective development of a specific security or specific group of securities.” FINRA’s rule filing opines that Product Cases generally involve a greater volume of documents, documents concerning due diligence analyses and non-client-specific documents. In addition, FINRA opines that Product Cases are more likely to involve class action claims and are more likely to be the subject of a regulatory investigation.

FINRA has concluded that the Document Lists contained in the Discovery Guide, which set forth a list of presumptively discoverable documents, do not require the production of the documents that are relevant to Product Cases. Notably, however, FINRA’s proposed amendments do not identify any specific documents that should be produced in Product Cases or suggest any specific changes to the Product Lists. Rather, the proposed amendment indicates that FINRA may amend the Document Lists in the future, but in the interim, it reminds arbitrators that the parties may request documents that are not identified on the Document Lists and grants arbitrators the discretion to order production of additional documents in Product Cases.

Finally, the proposed amendments to the Discovery Guide expand the requirement to provide affirmations when documents on the Document Lists are not produced. The current rule requires a party that does not produce any documents identified on the Document Lists to provide an affirmation stating that the party conducted a good faith search and that there are no requested documents. In response to complaints from the claimants’ bar, FINRA is allowing parties to request an affirmation where a partial production has been made. Among other things, the proposed amendment requires parties to (1) affirm that they conducted a search, (2) identify the sources searched and (3) state that the party does not have the documents requested.


FINRA, in its continuing efforts to respond to complaints from the claimants’ bar, has proposed changes that have further eroded its claim that FINRA arbitration is faster and less expensive than court litigation. Indeed, the proposed changes to the Discovery Guide, particularly the changes to the e-discovery rule and the scope of production in Product Cases, will likely increase the cost and scope of discovery.

Moreover, FINRA’s failure to propose actual guidelines creates ambiguity, which will increase the possibility of discovery disputes and provides inadequate guidance to arbitrators about how to resolve such disputes. Accordingly, the process of choosing an arbitration panel is more important than ever. Indeed, in the future, it will be more important to ensure that the Chairperson, who usually hears and resolves all discovery disputes, is an attorney familiar with the costs and burdens of discovery, and e-discovery in particular. In addition, respondents who are sued in court should carefully evaluate whether FINRA arbitration remains the best forum before filing a motion to compel arbitration. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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