Wall Street watchdog steps up vetting of its arbitrators

By Suzanne Barlyn

(Reuters) - Wall Street's industry-funded watchdog is fine-tuning its new policy of checking out its arbitrators, a step viewed as all the more necessary after a court tossed out a ruling involving one who was indicted during a case against Goldman Sachs.

For starters, the Financial Industry Regulatory Authority is running Google searches on arbitrators immediately before appointing them to cases, Linda Fienberg, the regulator's arbitration unit head, said at a recent seminar for lawyers.

FINRA's goal is to prevent arbitration rulings from being invalidated because of problems with arbitrators, including last-minute details that arbitrators did not disclose, Fienberg said. They could include everything from an employment change that could trigger a conflict of interest to being arrested.

FINRA is also gearing up to run yearly background checks on its 6,500 arbitrators, who were previously put through the process only when they applied for the job.

The watchdog's beefed-up focus on arbitrators has been in place since late June, after an investor who lost a $1.4 million case against Goldman Sachs Group Inc asked a federal court to overturn the ruling. The arbitrator, he alleged, did not fully disclose his involvement in a criminal proceeding.

Just hours after Fienberg made her remarks last Thursday, Judge J. Curtis Joyner of the U.S. District Court for the Eastern District of Pennsylvania threw out the Goldman Sachs arbitration ruling in a decision focusing on the arbitrator's misconduct. A FINRA spokeswoman declined to comment at the time.

The opinion was also a stunning rebuke of FINRA. While the new arbitrator checks are a step in the right direction, they are also "too little, too late," Joyner wrote.

"Given that FINRA bills itself as the largest independent securities regulator in the country, one would expect that public confidence in the integrity of the ... process would be of paramount importance," Judge Joyner wrote.

FINRA is making its changes as pressure mounts in Washington to end the practice of brokerages forcing investors to arbitration when a legal dispute erupts. Investors agree to the practice, instead of having the right to go to court, when they sign forms from the brokerage to open an account.

Consumer groups have been lobbying for the U.S. Securities and Exchange Commission to restrict the practice. But a bill introduced last Friday by Representative Keith Ellison, a Democrat from Minnesota, would take a bigger leap: changing the Dodd-Frank financial reform law to ban mandatory arbitration contracts between brokerages and their customers.

"Investors shouldn't have to sign away their rights in order to work with a financial adviser or broker dealer to build a secure retirement," Ellison said in a statement. Passage of such a law, however, is a long-shot. The bill has a 1 percent chance of enactment, according to Govtrack.us, an independent political monitoring site.


State securities regulators, who have long called for ending mandatory arbitration, are throwing their support behind the bill.

"It would ensure that investors, at least, have a choice," said A. Heath Abshure, president of the North American Securities Administrators Association, a Washington-based organization whose members are mostly U.S. state securities regulators. "They can still pick arbitration, mediation or court, but they will pick a forum where they stand a fair shot," Abshure said.

Ellison's legislation would also prohibit restrictions on investors' abilities to file class action claims.

Charles Schwab Corp has been locked in a battle with FINRA since 2012 after it required customers to waive their rights to file class actions in court.

Last year, FINRA lost an enforcement case against Schwab in which it argued that the brokerage violated industry rules that prohibit arbitrators from hearing class actions. FINRA's appeal is pending, and Schwab dropped the waiver language from its customer agreements in May.


Arbitration rulings are typically binding. But parties can ask courts to throw out rulings for limited reasons, such as when the arbitrator shows bias. Those cases are rarely successful.

Beefing up background checks on arbitrators is the latest in a series of measures FINRA is taking to prevent arbitration rulings from being invalidated.

A FINRA newsletter for arbitrators tackled the subject shortly after the challenge to the Goldman ruling, reminding them of an ongoing obligation to disclose certain new developments. For example, arbitrators who are also lawyers should disclose if they take on a case for a brokerage that involve issues similar to those in the arbitration. Other steps by FINRA include email blasts and notices when courts overturn cases, Fienberg said.

FINRA's recent Googling of arbitrators has not turned up anything significant, Fienberg said.

The regulator also hired a vendor to run yearly background checks on each of its 6,500 arbitrators, covering potential criminal violations and other problems, Fienberg said. The program will be ongoing, covering groups of about 540 arbitrators each month, she told Reuters.

While FINRA hopes the effort "goes a long way" to avoid problems after a case ends, lawyers for both parties have a responsibility do their homework about arbitrator candidates, Fienberg said. Many lawyers "think this is the most critical first step," she said.

(Reporting by Suzanne Barlyn; Editing by Linda Stern and Dan Grebler)