FINRA Arbitration vs. SEC Enforcement.

No. While arbitration and enforcement proceedings may involve similar subject matter, they have different primary purposes. Arbitration is the method used by securities industry participants to resolve private claims; enforcement actions focus on regulatory accountability. Customer arbitration and FINRA enforcement are also distinct, although the same underlying misconduct can trigger both. For example, allegations of securities fraud can lead to customer arbitration and a FINRA enforcement investigation. Broker-dealers and investment advisors can face SEC and FINRA enforcement actions concurrently as well. While FINRA investigates a firm for regulatory violations, the SEC may pursue parallel civil enforcement for additional violations. In fact, all forms of federal securities litigation and enforcement can arise from the same act of misconduct. For a single instance of alleged securities misconduct, the outcome could include customer arbitration, FINRA disciplinary action, SEC enforcement, and DOJ prosecution. The Financial Industry Regulatory Authority (FINRA) is an independent, nonprofit securities self-regulatory organization (SRO). It is not a government agency; rather, it has been delegated regulatory authority under federal law. FINRA sets and enforces compliance standards, manages registration and licensing for industry professionals and firms, and handles investor complaints. FINRA also administers both industry and customer arbitration. Industry arbitrations under FINRA’s rules can include cases involving employment disputes, trade secrets, customer lists, and challenges to information disclosed on Form U5s. While FINRA enforcement has its own unique procedures, SEC enforcement involves either administrative proceedings or civil litigation in the United States District Court. The SEC pursues enforcement action under the Securities Act of 1933, which governs registration of federal securities offerings, and other key federal statutes.

Who participates, and what can each proceeding accomplish?

Customer Arbitration

Customers may initiate FINRA arbitration proceedings against brokerage firms and registered representatives. Customers generally may also initiate arbitration against advisors. Arbitration can also be a means of resolving disputes between brokerage firms and their former representatives. The scope of a customer arbitration is determined by the claim filed with FINRA and the arbitration agreement which must be complied with in order to seek a remedy.

The primary goal of customer arbitration is to obtain compensatory damages for any monetary losses incurred as a result of the securities-related harm alleged. As such, damages are an available remedy in customer arbitration.

In customer arbitration, the registered representative is typically the one accused of wrongdoing.

FINRA Enforcement

FINRA enforcement proceedings investigate member firms and their associated persons. When a violation of FINRA’s rules is alleged, FINRA will assign an enforcement attorney to investigate. As a results of an enforcement investigation, a member firm or its associated personnel may be subject to disciplinary action and sanctions. A member firm or its associated representative can be either the one accused of misconduct or the one who is disciplined.

SEC Enforcement

The SEC brings civil enforcement action under federal securities laws. The SEC’s authority is very broad and covers not just broker-dealers and registered representatives, but also issuers, registered investment advisors, investment companies, funds, banks, and other financial institutions, as well as corporate executives, promoters, and other private individuals.

The SEC does not have the authority to adjudicate customer claims for compensatory damages, and the purpose of SEC enforcement is not to provide customers with any remedy. Rather, SEC enforcement is about imposing regulatory accountability and protection of investors.

FINRA vs. SEC

The SEC and FINRA overlap to a great extent. However, FINRA primarily regulates brokerage firms and their associated persons. Similarly, a contested FINRA disciplinary complaint will proceed to a three-member hearing panel if an investigation by FINRA reveals information that warrants further enforcement. As a result, disciplinary proceedings against the subjects are conducted by a professional hearing panel. FINRA arbitrations (both customer and industry) are conducted by an arbitration panel composed of arbitrators.

How can one securities dispute trigger multiple investigations?

Customer arbitrations often involve allegations of churning, unsuitability, and unauthorized trading; they can also involve allegations of supervisory failures. All of these allegations can potentially trigger enforcement by both FINRA and the SEC.

FINRA enforcement is generally the first to be filed. Often, a customer arbitration is resolved before FINRA is able to pursue an enforcement action. However, if FINRA believes that evidence discovered during the arbitration could show that a registered representative has committed a violation of federal securities law, FINRA may refer the matter to the SEC.

FINRA investigations are often initiated because of information received from customers, whistleblowers, other federal regulators, or from surveillance and market information. FINRA enforcement can result from inquiries which are then expanded into a full-scale investigation. For this reason, it is very important to have a clear understanding of FINRA’s investigative process and how to effectively defend against FINRA’s allegations.

While the SEC does not bring criminal cases, the DOJ is the federal government’s criminal prosecutorial authority. Parallel criminal securities cases brought by the DOJ are not uncommon, especially in cases involving criminal securities fraud.

Regulation Best Interest (Reg BI) is another topic that can give rise to three-fold exposure for broker-dealers and registered representatives. In addition to enforcement by FINRA and the SEC, Reg BI is a frequent target of customer arbitration and other litigation.

An SEC or FINRA examination may uncover issues that result in an enforcement referral. During an SEC examination, examiners may uncover issues that will result in enforcement. Likewise, a FINRA examination can uncover issues which will result in a FINRA enforcement action. SEC and FINRA examinations are the primary trigger for enforcement proceedings against broker-dealers and other industry participants.

FINRA’s Investigative Process

FINRA may initiate an inquiry after receiving information about an alleged violation of its rules. This may trigger a full-scale investigation which may then lead to the filing of a disciplinary complaint. At this stage, FINRA is conducting a fact-finding mission. In this stage, if you need to defend against an investigation, it is important to understand the nature of FINRA’s investigation, what FINRA knows about you, and what you need to show in order to convince the regulator not to pursue an enforcement case.

During the investigative process, you are facing civil consequences; however, it is important to keep in mind that the DOJ may pursue parallel criminal securities fraud charges. At Spodek Law Group, our attorneys. Attorneys and DOJ prosecutors work with you to protect you from the possibility of criminal charges.

FINRA’s enforcement attorneys can also conduct an initial inquiry that may grow into a formal investigation if they feel the evidence gathered supports further inquiry. Our attorneys represent broker-dealers and representatives during FINRA investigations and the enforcement process.

How do evidence-gathering powers differ across these proceedings?

FINRA Arbitration

In customer arbitration, FINRA Rule 12506 requires parties to exchange specific documents and Rule 12510 does not allow discovery in the form of depositions. Under Rule 12510, depositions are strongly discouraged in arbitration and are permitted only under very limited circumstances, such as to preserve the testimony of an ill or dying witness, to accommodate an essential witness who is unable or unwilling to travel, in certain sexual assault, sexual harassment, or statutory employment discrimination claims, or where the panel determines that extraordinary circumstances exist. As a result, discovery is significantly limited in arbitration.

Arbitrators can also issue subpoenas to non-parties under FINRA Rule 12512. This allows arbitrators to compel the attendance of witnesses, the production of books and records, and the certification of documents.

FINRA Enforcement

Under FINRA Rule 8210, registered firms and registered representatives are required to respond to FINRA’s demands for testimony, books, records, and information. These Rule 8210 requests are a fundamental part of FINRA’s enforcement program. If you have received a Rule 8210 request, it is important to preserve all relevant evidence and to keep in close contact with your defense counsel.

Rule 8210 demands can often be broad. However, registered firms and representatives must timely and accurately comply. Failure to timely and accurately comply can be grounds for expulsion from FINRA, and FINRA can impose sanctions against a firm or person subject to FINRA’s jurisdiction, including a formerly registered person. With respect to nonparticipation, FINRA also has the ability to impose sanctions against a subject of a FINRA enforcement action in absentia.

SEC Enforcement

Under Section 21(b) of the Exchange Act, the SEC may issue subpoenas for testimony, books, records, or other documents to a non-party to an SEC enforcement action. Section 21(c) of the Exchange Act gives the SEC the ability to seek enforcement of its subpoenas through a United States District Court.

This authority also applies to witnesses. Subpoenas can be issued to witnesses as well, and this information will be made available during SEC civil litigation. The SEC does not need to show “good cause” to issue subpoenas.

What deadlines and review rights could control my case?

FINRA Arbitration

Under FINRA Rule 12206, FINRA arbitration claims generally are ineligible if they “arise out of events occurring more than six years before the date of filing.” Even though a claim is eligible for FINRA arbitration under Rule 12206, this eligibility does not replace otherwise applicable statutes of limitations.

With respect to review of arbitration awards, there are few grounds for vacatur or modification of arbitration awards, and there is no appeal of errors in the arbitration proceedings. The Federal Arbitration Act (FAA), 9 U.S.C. §§ 1 et seq., generally governs domestic arbitration awards, while the New York Convention applies to qualifying international awards. Section 10 of the FAA, 9 U.S.C. § 10, outlines grounds for vacatur of arbitration awards, and this is the primary statutory source of review for arbitration awards in federal courts. The FAA also sets forth strict time limits for vacating, modifying, or correcting arbitration awards. Section 12 of the FAA, 9 U.S.C. § 12, generally requires vacatur motions to be filed within three months.

FINRA Enforcement

Under the Securities Exchange Act of 1934, the SEC reviews final FINRA disciplinary actions. There are two levels of review of a FINRA disciplinary decision: first, an appeal to FINRA’s National Adjudicatory Council (NAC), and second, after the NAC decision becomes final, a petition for review filed with the SEC. In both cases, there are strict time limits for filing petitions for review and appealing.

As a result, if you are facing a FINRA enforcement action, you must understand both the Securities Exchange Act of 1934 and the FINRA Rulebook. The grounds for appellate review are limited, and it is possible for FINRA to impose sanctions in absentia. This makes it imperative to seek immediate representation from FINRA defense counsel in any case that involves potential FINRA enforcement action.

SEC Enforcement

The United States Code (U.S.C.) contains multiple statutes of limitation for civil enforcement by the SEC. 28 U.S.C. § 2462, which is often cited by the SEC, generally prohibits civil penalty assessments five years after the accrual of a cause of action. As a result, the SEC must commence its action before this five-year window closes.

If an SEC enforcement action is appealed, there are two ways a party can challenge its outcome: first by appealing through an administrative process (if an administrative proceeding was conducted) and second by filing a petition for review with a United States Circuit Court of Appeals. Exchange Act § 25, 15 U.S.C. § 78ze, generally allows a party to file a petition for judicial review within 60 days after receipt of the final order.

What becomes public or appears on my BrokerCheck record?

Customer Arbitration

Under FINRA Rule 8312, FINRA draws the disclosures it releases through BrokerCheck, formerly known as the Public Disclosure Program, from the Central Registration Depository (CRD). Customer arbitration information generally shows up on BrokerCheck once the claim is reported on Form U4, while the arbitration is still pending and before any award is issued.

Under FINRA Rule 12904(h), all customer arbitration awards are made publicly available, and FINRA posts them to its Arbitration Awards Online database; publication is automatic and does not depend on a request by the parties. Under FINRA Rule 12904(g), if all parties jointly request an explained decision at least 20 days before the first scheduled hearing, the panel chairperson will write a fact-based decision stating the general reasons for the award.

The publication of arbitration awards is separate from disclosures in FINRA’s BrokerCheck system, which draws data for Customer Arbitration, Regulatory Action, and Employment Separation.

FINRA Enforcement

Under FINRA Rule 9270, FINRA can accept a member firm’s or associated person’s offer of settlement to resolve a disciplinary complaint. Such acceptance will result in the publishing of the disciplinary action. A member firm or associated person that settles an enforcement action with FINRA will likely avoid the need to go through the full disciplinary hearing process.

Rule 9216 provides another procedural mechanism for resolving a FINRA disciplinary complaint. Under Rule 9216, a member firm or its associated person can settle the dispute without accepting liability for the alleged misconduct. Settlements obtained under Rule 9216 commonly include a stipulation of the facts and acceptance of the sanction provided that the subject does not “admit or deny” liability.

SEC Enforcement

SEC settlements ordinarily appear in SEC complaints filed in federal court, in administrative order proceedings, or in final consent judgments in federal court. This means that any SEC settlement will almost certainly involve a public filing.

The DOJ prosecutes criminal cases under federal securities statutes as well. Criminal investigations can trigger SEC enforcement investigations, and criminal prosecutions can trigger FINRA enforcement actions.

FINRA BrokerCheck

FINRA publishes BrokerCheck information and information in the Public Licensing and Regulatory Disclosure. This information is drawn from the Central Registration Depository (CRD), and it includes a record of all customer complaints and disciplinary actions, as well as all pertinent information on a registered representative’s Form U5 (including, among others, termination information). FINRA collects this information for its regulatory enforcement action, while the broker-dealer itself collects this information for licensing and registration purposes. The Securities Exchange Act of 1934 gives the SEC, a federal securities regulator, the authority to require that registered firms collect and submit this information for purposes of securities enforcement.

Can investors recover money through more than one proceeding?

FINRA Enforcement

FINRA sanctions can include fines, restitution, censures, suspension, bars, and expulsion, and monetary sanctions can be imposed against either a registered representative or a registered firm in a FINRA enforcement proceeding. For example, FINRA might suspend an associated person and fine a registered firm for a regulatory violation. The same registered firm or associated person could also be the one required to pay restitution to an injured investor as a result of the investor’s loss.

Customer Arbitration

In customer arbitration, the claimant may seek compensatory damages, punitive damages, attorney fees, and court costs. Compensatory damages are most common, as the damages typically represent the amount of monetary losses suffered by the investor. The goal of customer arbitration is to make the investor whole by seeking a monetary remedy. While it is rare for a party to seek multiple types of damages (e.g., both compensatory and punitive), this is possible.

SEC Enforcement

The SEC does not issue private awards to investors. As with FINRA enforcement, investors do not play any direct role in SEC enforcement. However, in some cases, investors may be able to recover money that is disbursed by the SEC to a Disgorgement Fund. Sarbanes-Oxley Section 308 permits a Fair Fund to be created using the fine, interest, and other penalties imposed by the SEC, combined with disgorgement and a prepayment of any restitution owed to injured investors.

If the SEC settles an enforcement action and has authority to seek restitution on behalf of an investor, restitution might also be available in these cases.

Interaction of these proceedings

As previously noted, FINRA and the SEC often handle restitution cases together, and the restitution calculations are generally applied cumulatively between these federal regulators. However, restitution is calculated based on actual uncompensated losses. For example, if an investor received compensation as a result of customer arbitration, the investor’s uncompensated losses would then potentially be what would be a subject of restitution ordered by a federal regulator in a subsequent enforcement case.

The SEC’s distribution plan, the order establishing a Fair Fund, and the FINRA Rules are subject to the same logic. The SEC and FINRA each make clear that any amounts received by the investors from other sources in excess of their losses will be offset against restitution payments.

When an investor wins a customer arbitration, the investor’s award is then typically subject to FINRA’s collection process. Under Rule 9554, FINRA has the authority to expeditiously suspend a member firm for failure to pay customer arbitration awards.

Receiving an SEC distribution from a Fair Fund does not make the receiving investor a party to an SEC enforcement action. The recipient of an SEC award from a Fair Fund has no right to seek further monetary compensation based on the findings of a final SEC enforcement order.

Talk to Spodek Law Group

Every case turns on its own facts, and general information is no substitute for advice about yours. Todd Spodek, managing partner of Spodek Law Group, and the firm's attorneys defend federal criminal and white collar matters nationwide. Reach the firm at 212-300-5196.