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Arbitration rules may up legal costs
New financial industry rules preserve
frivolous claims, critics charge.
By Sheri Qualters / Staff reporter
National Law Journal
02 February 2009
Lawyers predict that new Financial Industry Regulatory Authority (FINRA) arbitration rules that sharply restrict when firms facing claims can file dismissal motions will drive up legal costs for financial companies defending employment and investor claims.
The U.S. Securities and Exchange Commission (SEC) approved the changes to the rules on Dec. 31, 2008. FINRA published an official regulatory notice on Jan. 23, and the rules become effective on Feb. 23.
FINRA member firms generally require their brokers and licensed securities professionals to arbitrate employment disputes at FINRA. Financial companies also typically have policies requiring customers to arbitrate claims at FINRA.
Attorneys who defend financial companies in FINRA arbitration filed by ex-employees or investors say the new rules make it nearly impossible to dismiss frivolous cases before an expensive hearing. They also worry that the rule requiring a written explanation of the dismissal will give claimants' lawyers fodder to challenge the dismissal in court.
"It takes the most unmeritorious claims and allows them to become far more expensive than they should be," said David A. Picon, deputy chairman of the financial services practice group at New York's Proskauer Rose, who defends financial companies facing investor claims.
The new rules
Lawyers who represent claimants say the rules are fair because investors and financial company employees are required to bring disputes to arbitration, which affords far fewer protections to claimants than a plaintiff would enjoy in a court proceeding.
Under the new arbitration rules, a FINRA arbitration panel can grant a motion to dismiss before hearing the claimant's case for only one of three reasons: the parties have a written settlement; the claim involves a "factual impossibility," usually because the claimant has fingered the wrong company; and the six-year eligibility rule for claims has passed.
A party that loses a motion to dismiss filed before the hearing must now pay fees and costs related to the motion. Also, the losing side must pay the other side's costs and attorney fees related to the dismissal motion if the panel deems the motion frivolous.
The new rules also require three-member arbitration panels to make a unanimous decision to dismiss a claim and to issue a written decision.
A FINRA announcement stated that the rule "responds to investor concerns regarding abusive and duplicative filing of motions to dismiss."
"In recent years, there has been an increase in motions to dismiss by respondents, even before individual claimants presented their cases," said FINRA Dispute Resolution President Linda Fienberg, in a statement. "Although arbitrators rarely grant such motions, it is costly and time-consuming for parties to defend motions to dismiss."
'Virtually impossible'
The new rules will make it "virtually impossible" for financial services firms to get frivolous claims dismissed, said Lloyd B. Chinn, a labor and employment partner at Proskauer Rose who defends financial services companies.
There are many tort and contract claims in the employment arena that would be dismissed easily in court but will now have to go to a full hearing in a FINRA arbitration, Chinn said.
FINRA and its predecessors have been clamping down on motions to dismiss in the past couple of years while the proposed rule was circulating, but the final rule adds a new degree of difficulty for defense attorneys, Chinn said.
In July 2007, the National Association of Securities Dealers Inc. and New York Stock Exchange arbitration functions were merged to form FINRA.
"Even then, a case that was totally frivolous had a chance to be tossed out on a motion to dismiss," Chinn said. "This new rule makes that completely impossible."
Motions to dismiss in FINRA arbitrations were "always an uphill battle," but they were sometimes granted, said Marshall Fishman, a partner at New York's Kramer Levin Naftalis & Frankel who represents financial institutions in investor cases.
Even when companies have very good legal grounds to have a case dismissed, they now won't be able to do so, Fishman said.
"Now everyone has to go through a hearing at great time, effort and expense, and it may be at the end of the day that the claimant loses anyway," Fishman said. "A motion to dismiss may be a better test of whether everyone should go through discovery or hearings."
The financial services industry "pushed very heavily" for arbitration, which deprives claimants of some protections of litigation, such as depositions and an in-depth period of discovery, said John Singer, a partner at New York-based Singer Deutsch, which represents investors and former employee claimants.
Despite this, firms facing claims want to "inject some of the traditional tools of litigation in the process" that would benefit their side, such as prehearing motions to dismiss, Singer said.
"What the defense is trying to do is have its cake and eat it, too," Singer said. "They're trying to limit plaintiffs from having litigation tools and at the same time using tools themselves."
Singer said the rules are a major victory for lawyers who represent claimants, after years of debate and colloquy among the agencies and attorneys that bring or defend cases.
"It's a huge win for the plaintiffs' bar," Singer said.
An issue for clearing firms
So-called clearing firms, which process trades, are also sometimes erroneously named as respondents in arbitrations when the introducing brokerage is out of business, Picon said.
Clearing firms are almost always released from such claims on a motion to dismiss because a long line of court cases says they're not responsible for wrongdoing by an introducing broker, but the new rule bars them from getting the case dismissed before a hearing, Picon said. "Why should clearing firms spend a lot of money retaining counsel and going through an exercise that's a futile exercise?"
Even in the rare instances when a respondent secures a prehearing dismissal, the new rule requiring arbitration panels to issue a written opinion gives claimants another weapon, Fishman said. Fishman fears that claimants will be able to use the opinions as a basis for asking federal or state courts to vacate the dismissals.
With the rules, FINRA is "really trying to put a chilling effect on the defense bar in making these motions," he said.
