FINRA Withdraws Proposed Changes in Discovery Rules

Representing Investors Nationwide

A recent WallStreet Journal article reports that the Financial Industry Regulatory Authority (FINRA) has decided not to move forward with changes to its arbitration discovery rules. The proposed changes came under sharp criticism from Plaintiff’s lawyers who believe the proposal would have put more too much additional burden on the brokerage firm clients. The news of FINRA’s reversal has been well received by the Claimants’ bar.

The text of the full article appears below:

It looks like the Financial Industry Regulatory Authority took to heart all the criticism about a proposal that would have obliged investors in arbitration to disclose more of their financial histories.

It quietly withdrew the plan.

Finra’s decision may have been influenced by the times, in which many investors have lost a third or more of their portfolio values in the market drop and some have lost even more in frauds like Bernard L. Madoff’s $50 billion Ponzi scheme.

Seth E. Lipner, an attorney and law professor at Baruch College in New York, says it’s “a lousy time” to require that investors submit more information to justify arbitration claims against brokerages. “Wall Street was as inept at managing their own portfolios as they were in managing clients’ money,” he said.

Finra’s proposal, filed with the SEC in March, would have changed the terms for lists of information that parties must exchange during arbitration. Document lists vary depending on the type of claim, but the proposal would have required, among other changes, that investors always submit five years of complete tax returns instead of three years of certain pages and schedules. It also would have required loan histories, among other papers.

The SEC received more than 50 comment letters about the proposal, including one from Lipner who likened the discovery process in securities arbitration to a “financial colonoscopy.” That process, he says, also comes too late in a brokerage’s relationship with an investor. “If they asked for this stuff when they made the recommendations, then it would already be in their files,” he said in an interview Thursday.

Finra filed a two-page notice with the SEC, withdrawing the rule proposal, on May 21. The notice is buried among numerous 2008 filings posted on Finra’s Web site.

Brendan Intindola, a Finra spokesman said that “a review of the comment letters submitted indicates that the consensus reached was not broad enough.” Finra is working on a new proposal that is “informed by the comments submitted,” he said.

Laurence S. Schultz, a securities arbitration attorney in Troy, Mich., says he applauds Finra’s withdrawal, but is bothered the decision isn’t more prominently featured on Finra’s Web site given the substantial debate the proposal fueled. “They’re not proud of it,” he says.

Brokers didn’t like some aspects of the proposal. The Securities Industry and Financial Markets Association, a trade group, described parts of it as “fundamentally unfair,” criticizing a provision that required brokers to produce their entire trading history in cases about unauthorized and excessive trading, even with customers unrelated to the claim.

A Sifma spokesman said the industry broadly supports reforming the arbitration discovery process, but the proposal raised many issues, which it hopes can now be addressed outside of the rulemaking process.

Brian Smiley, president of the Public Investors Arbitration Bar Association, or Piaba, a Norman, Okla.-based group of attorneys who represent investors, says investor advocates perceived many provisions as being “overburdensome.” But some are worth salvaging, such as a provision that would give certain investors more information about broker commissions. “I hope those will get into the new revision,” he says.

Lawrence S. Polk, a securities attorney with Sutherland in Atlanta who represents brokerages, says the debate over documents will likely continue, regardless of the economic climate.

“We’re constantly being asked to give more documents, yet claimants don’t want to make that type of disclosure,” he says. “It seems the discovery system is becoming unbalanced.”

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