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News, Regulation, enforcement & litigation
By Gontran de Quillacq
On February 5, 2022

A Fault at FINRA?

"It’s unconscionable that FINRA would stack the deck against American investors", says PIABA, the plaintiff attorney association. A judge has excoriated FINRA for having helped Wells Fargo manipulate the arbitrator selection, and letting the arbitration panel take away a plaintiff's due process.

Finra-Entrance-LogoThere is a big piece news in securities law circles: a bank manipulated FINRA’s arbitrator selection process, and FINRA apparently supported it.

Joseph Pfeifer, the former PIABA director, stated yesterday:

It’s unconscionable that FINRA would stack the deck against American investors who have had their livelihoods turned upside down and their retirement savings stolen from them. The ruling in Georgia highlights FINRA’s improper ‘special relationship’ with the financial services industry, which many have long suspected to be corrupt. It’s my hope that Congress and the SEC get to the bottom of this immediately so we can begin to sort out how many arbitration cases need to be revisited.

That bank happens to be Wells Fargo. You may remember that they just went through a scathing scandal of forced selling to customers and of atrocious mismanagements of the issues, with the responsibilities going to the top of the command chain. The firm paid $3bn to settle the scandal with the South Carolina authorities, but still has many private litigations running.

What is FINRA?

  • FINRA is the Self Regulated Organization (SRO) which handles all conflicts between broker-dealers, and their conflicts with their employees and their customers. The SRO handles many cases of customers accusing their brokers of faults, as well as U5 expungements and compensations claims.
  • Arbitrator Disclosure ReportThe conflicts brought to the organization are resolved via private arbitrations, where a panel of (usually) three arbitrators looks at the the facts, listens to the parties, and makes a decision based on the law.
  • Anybody can be an arbitrator, provided that he/she goes through a solid background check, completes multiple training courses and maintains a list of all employers and business relations to avoid possible conflicts.
  • Ranking and StruckAt the start of each case, a short list of arbitrators is randomly selected by a FINRA computer among the entire roaster, after which both sides can strike and rank their favorites. The three arbitrators surviving the selection form the panel and handle the process going forward, with the support of FINRA specialists. One of the panelist, usually more experienced, is selected as the panel’s chair.
  • That entire arbitration process is codified at every step (discovery, dismissals, deadlines, rules, hearings, motions, witnesses, testimonies, depositions…), just like a court procedure. The overall process is simpler nevertheless, as well as cheaper and faster, than court venues. All the hearings are recorded.
  • FINRA statisticsThere are typically 4,000 FINRA claims every year, but most (85+%) settle before reaching the hearing stage. FINRA maintains extensive statistics on the number of claims, types, related assets, and publishes the outcome here.
  • Hearings can take days or weeks, depending in the complexity of the case. The panelists then discuss between themselves and produce a verdict, an ‘award’, like ‘ this one‘. Unless specifically requested, the panel doesn’t explain how it came to its conclusion, like judges do.
  • While the arbitrations are private, the awards are public. They are scrutinized by the legal professionals, to detect trends and new jurisprudence. There are dedicated websites (Securities Arbitration Alert), newsletters and technologies to review and rank of arbitrators, like ARBchek.
  • A court then validates this award, but the parties can ask for it to be vacated if there is evidence of
      1. corruption/fraud,
      2. evident partiality,
      3. misconduct in the handling of the process,
      4. or if the arbitrators exceed their powers.
  • Once validated, those awards are final. Appeal are very rare – only if there is a serious flaw in the form.

The system is essentially funded by the banks, and rumors of a bias in their favor have circulated for years (your author is in no way competent to opine on this).

The process of this case.

Here is what happened in this specific case, according to the judge who reviewed the case, Brian Leggett & Bryson Holdings vs Wells Fargi Clearing Services and Jay Windsor Pickett III:

  • Brian Leggett had accused his broker, Wells Fargo Advisors, of a loss of $1.2 m incurred in 2015/16. The broker, Jacob McKelvey, would have over concentrated the portfolio into a single merger arbitrage trade. After the account suffered losses, the broker was replaced by Jay Pickett.
  • The investor became concerned that Wells Fargo was still mishandling their account, and filed a complaint at FINRA in 2017 for failure to supervise, breach of duties and violations of the Georgia Securities Act.
  • Arbitrator-removalFINRA generated the initial list of potential panelists and asked the parties to rank and strike the possible candidates, at which point Wells Fargo asked that one of the candidate be removed due to an alleged personal bias against their counsel.
  • It happened that in a previous case that counsel had tried to strike out the same panelist for bias. Due to a lack of proof, the panelist was kept. The hearings went on. The counsel lost the case, and he eventually asked the award to be vacated because of the panelist’s bias. The judge then listened to the audio recordings of those hearings and concluded that it was the counsel who was agitated, not the panelist. The award was confirmed.
  • In the Wells Fargo case, this counsel unfortunately put in writing that an undisclosed agreement with FINRA was allowing him to never have this panelist in any of his future cases. He also inadvertantly copied the investor’s attorney in that request, who then asked for details of this tacit agreement to teh Director of Disoute Resolution, of the counsel’s rights, of any other panelist being refused, etc.
  • FINRA’s Director of Dispute Resolution never replied to that letter, but stroke the panelist out. The parties went on to agree on the final list.
  • But Wells Fargo’s counsel then requested that a second arbitrator candidate be removed for cause, again due to a potential bias. This second arbitrator had filed a case against Wells Fargo. Again, the investor argued that no rule or jurisprudence permitted such removal.
  • But FINRA’s Director of Dispute Resolution again stroke that second candidate, and provided a short list to replace him. A new arbitrator was then appointed.
  • Piles-of-papersWells Fargo then produced 1,882 pages of documents four days before the hearing, while the rules specify that disclosures must be done a minimum of seven days before the start of the hearings. The investor requested a delay to digest the documents.
  • Again, FINRA denied the request and refused to adjourn the hearing.
  • During the hearing, Wells Fargo’s counsel left the hearing at a critical point of the broker’s deposition, arguing of a medical emergency. The arbitrators stopped the hearings, which restarted 9 months later.
  • When continuing his deposition, the broker significantly changed his statements. The wording he used clearly indicated that he had received legal advice during the period, which was not authorized.
  • The panel then refused an expert witness to testify in the new hearing, although he had been authorized in the previous hearing.
  • Wells Fargo also presented hundreds of pages of new evidence during the hearing. The investor’s attorney declared not being in a position to review them during a break.
  • Court-TestimonyThe defense’s expert who had written the document was unable to explain those documents.
  • The panel’s chair nevertheless admitted the documents as evidence.
  • The Wells Fargo counsel failed to produce a critical document, despite being asked by the panel to produce it multiple times.
  • The counsel eventually produced it, but only after the closing arguments had been made. At that time, the document was not available anymore for review or argumentation.
  • The same defense counsel, who had selected against fees and costs before the hearing, then produced new evidence to request a change of opinion, again after the hearings.
  • The panel accepted this post-hearing evidence.
  • The panel then rejected the plaintiff’s case,
  • The panel even awarded the fees and costs against the plaintiff, again against rules.
  • The investor asked for the fees to be reduced according to the official table of hearing costs.
  • The panel chair denied this last motion.

The judge’s ruling

hammer-scaleThe judge reviewed the plaintiff’s five claims to vacate the award. Here are the judge’s opinion on each of these claims:

  1. FINRA violated the arbitrator selection process, in favor of Wells Fargo and its counsel.
  2. The arbitrators violated the plaintiff’s right for an adjournment to review documentary evidence.
  3. The panel misconducted by allowing the broker to change his testimony, by preventing two testimonies to be presented, while permitting a Wells Fargo witness to testify at the last minute, and by prevented his cross-examination.
  4. Wells Fargo and its counsel committed fraud by misrepresenting records (during the interruption), and by refusing to turnover a key document until after the close.
  5. The panel violated the law in awarding fees & costs.

Each of these findings by itself was sufficient to vacate the award, and that the judge indeed vacated the award. To be more precise, the judge “excoriated” the arbitration panel, the counsel and FINRA, who “manipulated” the process.

The first reactions

  • FINRA denies the existence of any tacit agreement, and confirms that its forum is fair.
  • Wells Fargo “adamantly” denies, and will appeal.
  • PIABA-LogoPIABA, the association of plaintiff attorneys for the securities industry, states that FINRA had issues in the 90’s in its manual selection of panelists, but did a good job at turning into an automated process. This being said, the judgement is “shocking”.
  • Joseph Peiffer, the former head of PIABA, asks that FINRA’s Dispute Director testifies in front of Congress and the SEC to clear the many suspicions of corruption. “How many other arbitration panels have been tainted?”
  • Wells Fargo attorney, Terry Weiss, has declined to comment.
  • The investor’s attorney, Craig Kuglar, has declined to comment.
  • The SEC has declined to comment.

It is pretty sure that we will hear more about this judgement, both in the legal journals, as well as in the headline news…

References

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