Amendments to the Arbitration Codes to Make Various Clarifying and Technical Changes

Summary

FINRA has amended its Codes of Arbitration Procedure (Codes) to make: (1) changes to the arbitrator list selection process in response to recommendations in the report of independent counsel Lowenstein Sandler LLP (Report) and (2) clarifying and technical changes to requirements in the Codes for holding prehearing conferences and hearing sessions, initiating and responding to claims, motion practice, claim and case dismissals, and providing a hearing record. The amendments are effective for arbitration cases filed on or after March 4, 2024.

Questions concerning this Notice should be directed to:

• Victoria Crane, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8104 or [email protected];
• Mignon McLemore, Associate General Counsel, OGC, at (202) 728-8151 or [email protected]; or
• Kristine Vo, Assistant General Counsel, OGC, at (212) 858-4106 or [email protected].

Background & Discussion

I. List Selection Process Amendments

In June 2022, FINRA published the report from Lowenstein Sandler LLP relating to an independent review and analysis of the FINRA Dispute Resolution Services (DRS) arbitrator list selection process.¹ The Report made several recommendations to provide greater transparency and consistency in the arbitrator list selection process, some of which required amendments to the Code of Arbitration Procedure for Customer Disputes (Customer Code) and the Code of Arbitration Procedure for Industry Disputes (Industry Code).² In response to the recommendations in the Report, FINRA has amended the Codes to implement the Report’s recommendations, as described below.

A. Conflicts of Interest

The Codes provide that a list selection algorithm will randomly generate the lists of arbitrators from the DRS roster of arbitrators for the selected hearing location for each proceeding,³ and exclude arbitrators from the lists based upon current conflicts of interest identified within the list selection algorithm.⁴ In addition, once the lists are generated, DRS conducts a manual review for other conflicts not identified within the list selection algorithm. Prior to the amendments, this manual review was not described in the Codes.⁵In response to a recommendation in the Report,⁶ the amendments codify the manual review by providing that the Director will exclude arbitrators from the list(s) based upon a review of current conflicts of interest not identified within the list selection algorithm.⁷ In addition, the amendments provide that if an arbitrator is removed due to such conflicts, the list selection algorithm will randomly select an arbitrator to complete the list(s).⁸

B. Written Explanation of Director’s Decision

The Report recommended that, to improve transparency, DRS should consider amending its policies to require a written explanation whenever a challenge to remove an arbitrator is granted or denied, if a written explanation is requested by either party.⁹ Effective September 1, 2022, DRS updated its policy to provide a written explanation whenever a party-initiated challenge to remove an arbitrator is granted or denied, regardless of whether an explanation is requested by either party.¹⁰ The amendments codify this practice by providing that the Director shall provide a written explanation of the Director’s decision to grant or deny a party’s request to remove an arbitrator.¹¹ In addition, DRS has updated its guidance to arbitrators to include the most common reasons for granting or denying party-initiated challenges.¹²

C. Challenge to Remove an Arbitrator

Although not a specific recommendation in the Report, the amendments make an additional clarifying change to the Codes relating to party-initiated challenges to remove an arbitrator for cause. While the Codes permit the Director to remove an arbitrator for conflict of interest or bias, either upon request of a party or on the Director’s own initiative, prior to the amendments, the Codes did not expressly specify when the Director may first initiate, or a party may first bring, such a challenge.¹³ The amendments codify DRS’s practice with respect to the timing for such challenges by providing that after the Director sends the arbitrator ranking list(s) generated by the list selection algorithm to the parties, but before the first hearing session begins, the Director may remove an arbitrator for conflict of interest or bias, either upon request of a party or on the Director’s own initiative.¹⁴

II. Procedural Amendments

The Codes include requirements for holding prehearing conferences and hearing sessions, initiating and responding to claims, motion practice, claim and case dismissals, and providing a hearing record. Over the years, DRS has developed practices to help implement these requirements so that arbitration cases are timely and efficiently administered in its forum. The amendments incorporate these practices into the Codes, as described below.

A. Number of Hearing Sessions Per Day

Arbitrators are paid for each hearing session in which they participate.¹⁵ Under the Codes, a “hearing session” is any meeting between the parties and arbitrators of four hours or less, including a hearing or a prehearing conference.¹⁶ To address a misunderstanding among some arbitrators that they may be compensated for time spent outside of the hearing session, such as on lunch breaks, the amendments revise the definition of ‘‘hearing session’’ in the Codes to indicate that, in one day, the next hearing session begins after four hours of hearing time has elapsed.¹⁷In addition, DRS has updated its arbitrator guidance to encourage arbitrators to be efficient in managing the time during hearings to minimize, whenever possible, the number of hearing sessions held.¹⁸

B. Redacting Confidential Information

Under the Codes, when parties submit pleadings and supporting documents to DRS, the parties must redact personal confidential information (PCI) such as an individual’s Social Security number, taxpayer identification number or financial account number to include only the last four digits of such numbers.¹⁹ Prior to the amendments, this requirement did not apply to claims administered under FINRA’s simplified arbitration rules.²⁰ FINRA had not applied the redaction requirement to simplified arbitrations due to concerns that the requirement may prove difficult for pro se customers, in particular.²¹ To address increasing concerns with customers’ identities being used for fraudulent purposes in the securities industry,²² the amendments apply the requirement to redact PCI to parties in simplified arbitrations.²³ In addition, FINRA has updated guidance on its website regarding the steps parties can take to protect PCI to include guidance to investors who represent themselves.²⁴ The updated guidance describes the importance of safeguarding PCI and provides clear, plain English instructions on how to redact PCI from documents filed with DRS.²⁵

C. Update Submission Agreement When Filing a Third Party Claim

The Submission Agreement is a document that parties must sign at the outset of an arbitration in which they agree to submit to arbitration under the Codes.²⁶ Under the Codes, a claim is deficient if the Submission Agreement does not name all parties named in the claim.²⁷ Prior to the amendments, the Codes did not expressly require the respondent to file an updated Submission Agreement with a third party claim. Thus, respondents would often file deficient claims because they would neglect to add the third party to the Submission Agreement.²⁸ To clarify that respondents must file an updated Submission Agreement with a third party claim, the amendments require that if the answer contains a third party claim, the respondent must execute a Submission Agreement that lists the name of the third party and serve the third party with the answer and the Submission Agreement,²⁹ and must file the Submission Agreement with the Director.³⁰

D. Amending Pleadings or Filing Third Party Claims

Prior to the amendments, the Codes did not include express procedures related to the filing of third party claims other than those filed in an answer to a statement of claim.³¹ Rather, FINRA rules relating to amended pleadings governed the filing of third party claims.³² The amendments add the procedures that apply to amended pleadings to the filing and serving of third party claims.³³

Further, the amendments update the Customer Code to expressly authorize a customer in an arbitration to file a third party claim if FINRA notifies a customer that a member or associated person has become inactive after a panel is appointed, as well as after the ranked arbitrator lists are due.³⁴

E. Combining Claims

Before ranked arbitrator lists are due to the Director, the Codes permit the Director to combine separate but related claims into one arbitration.³⁵ The Codes also provide that once a panel has been appointed, the panel may reconsider the Director’s decision upon motion of a party.³⁶ Prior to the amendments, the Codes did not address if a panel has authority to combine separate but related claims into one arbitration, or which panel (if more than one had been appointed to hear the separate but related claims) may reconsider the Director’s decision upon motion of a party.

The amendments codify DRS’s practice that if a panel has been appointed to one or more cases, the panel appointed to the lowest numbered case with a panel may: (1) combine separate but related claims into one arbitration and (2) reconsider the Director’s decision upon motion of a party.³⁷

F. Motion Practice

Prior to the amendments, the Codes did not address the timing of DRS’s delivery of motions, responses, and replies to the panel. In practice, DRS sends all motions, along with all related responses and replies to that motion to the panel after the last reply date has elapsed, unless otherwise directed by the panel. This practice helps ensure that the arbitrators have the complete set of motion papers before they begin considering the motion. The amendments codify this practice by providing that the Director will send all motions, responses, and replies to the panel after the last reply date has elapsed, unless otherwise directed by the panel.³⁸ If the Director receives additional submissions on the motion after the last reply date has elapsed,³⁹ the amendments provide that the Director will forward the submissions to the panel upon receipt and the panel will then determine whether to accept them.⁴⁰

G. Virtual Prehearing Conferences

Under the Codes, prehearing conferences are generally held by telephone.⁴¹ Based on forum users’ experiences during the COVID-19 pandemic, they expressed a preference for holding prehearing conferences by video conference. To accommodate this preference, effective July 1, 2022, DRS updated its policy so that all prehearing conferences are held by video conference. The amendments codify this policy by providing that prehearing conferences will generally be held by video conference unless the parties agree to, or the panel grants a motion for, another type of hearing session.⁴² In addition, DRS updated its guidance on virtual prehearing conferences to help ensure that all participants have the information they need to participate fully in virtual prehearing conferences.⁴³

H. In-Person Hearings

In comparison to prehearing conferences, hearings are generally held in person. Forum users have not similarly expressed a preference for making video conference the default for hearings. Accordingly, the amendments clarify that hearings will generally be held in person unless the parties agree to, or the panel grants a motion for, another type of hearing session.⁴⁴

I. Virtual Option for Special Proceeding

As noted above, simplified arbitrations are generally decided by a single arbitrator based on the parties’ written submissions, unless the customer requests a hearing.⁴⁵In some cases, however, customers want an opportunity to present their case to the arbitrator without the travel and expenses associated with a full hearing. Such an abbreviated telephonic hearing is called a “special proceeding” under the Codes.⁴⁶ The amendments reflect customers’ suggestions that they have the option to conduct a special proceeding by video conference. Specifically, the amendments provide that a special proceeding will be held by video conference, unless the customer requests at least 60 days before the first scheduled hearing that it be held by telephone, or the parties agree to another type of hearing session.⁴⁷ Thus, the amendments make video conference the default for special proceedings; however, customers or claimants have the option to select a telephonic hearing.

J. Witness Lists Shall Not Be Combined with Document Lists

Under the Codes, at least 20 days before the first scheduled hearing, all parties must: (1) provide all other parties—but not the Director or arbitrators—with copies of all documents and other materials in their possession or control that they intend to use at the hearing that have not already been produced;⁴⁸ and (2) provide each other party—as well as the Director—with the names and business affiliations of all witnesses they intend to present at the hearing.⁴⁹ Separately, parties often file a single document with the Director that includes a list of documents and other materials, such as exhibits, they intend to use at the hearing that have not already been produced and their witness list. Because the list of documents and other materials could contain prejudicial or inadmissible material, as a service to forum users, the Director will manually remove this information from the document containing the witness list before forwarding the witness list to the panel. But, at times, the Director may inadvertently disseminate the list of documents and other materials to the arbitrators, which could reveal potentially prejudicial or inadmissible information to the arbitrators before the hearing. The amendments protect against this risk of inadvertent disclosure by expressly providing that if the parties create lists of documents and other materials in their possession or control that they intend to use at the hearing and have not already been produced, the parties may serve the lists on all other parties, but shall not combine the lists with the witness lists filed with the Director.⁵⁰

The official record of an arbitration hearing is the Director’s tape, digital, or other recording of every arbitration hearing.⁵¹ However, if a party chooses to make a stenographic record of a hearing, a panel may decide in advance of the hearing that the stenographic record will be the official record of the hearing.⁵² If the Director’s recording is the official record, the panel may order the parties to provide a transcription of the recording and copies of the transcription must be provided to each arbitrator, served on each party, and filed with the Director.⁵³ If a party’s stenographic record is the official record, a copy must be provided to each arbitrator, served on each other party, and filed with the Director.⁵⁴ Further, the cost of making and copying the stenographic record will be borne by the party electing to make the stenographic record, unless the panel decides that one or more other parties should bear all or part of the costs.⁵⁵ The Codes do not specify, however, which party must provide to each arbitrator, serve on each other party, and file with the Director a copy of the transcription of the official record. The amendments assign that responsibility to the party or parties: (1) ordered to make a transcription of the Director’s recording;⁵⁶ or (2) that elected to make a stenographic record.⁵⁷In addition, FINRA has updated its guidance on requesting a transcription from a party of the Director’s recording.⁵⁸

As noted above, the Director makes a tape, digital, or other recording of every hearing.⁵⁹ As a matter of practice, executive sessions are not recorded because they are not part of the official record of the hearing. Rather, executive sessions are discussions among arbitrators outside the presence of the parties and their representatives, witnesses and stenographers and are intended to be private. The amendments codify this practice by expressly providing that executive sessions held by the panel will not be recorded.⁶⁰

L. Dismissal of Proceedings for Insufficient Service

Under the Codes, parties, except for pro se parties, must serve all pleadings and other documents through the Party Portal, and service is accomplished on the day of submission through the Party Portal.⁶¹ If a party who is served fails to submit an answer, DRS reviews the service history with the panel and asks the panel to decide whether service is complete and sufficient upon the unresponsive party before the case may proceed to hearing.⁶² DRS’s practice permits the panel to dismiss a claim or arbitration without prejudice if it finds insufficient service. The amendments codify this practice by providing that the panel may dismiss without prejudice a claim or an arbitration for lack of sufficient service upon a respondent.⁶³

M. Dismissal of Claimant’s Claims Requires Issuance of an Award

Under the Codes, an award is a document stating the disposition of a case,⁶⁴ is final and is not subject to review or appeal,⁶⁵ and shall be made publicly available.⁶⁶ The Codes permit a panel to grant a motion to dismiss a party’s case at the conclusion of the case in chief.⁶⁷ As the dismissal of all a claimant’s claims disposes of the case, it is DRS’s practice to require the issuance of an award for such dismissals.⁶⁸ The amendments codify this practice by requiring that if a panel dismisses all of a claimant’s claims at the conclusion of the case in chief, the decision must contain the elements of a written award and must be made publicly available as an award.⁶⁹

Effective Date

The amendments are effective for arbitration cases filed on or after March 4, 2024.

Endnotes