SEC has finally approved FINRA’s proposed “mid-case referral rule,” which FINRA had been seeking since 2010. Allowing securities arbitrators to voice serious concerns in the middle of a case about possible frauds that could harm investors is a procedure that provides “a necessary means” of alerting FINRA staff to such threats, the SEC wrote in a notice.
Specifically, FINRA Rules 12104 and 13104 have been amended to permit arbitrators to refer to the Director of FINRA Dispute Resolution “any matter or conduct that has come to the arbitrator’s attention during a hearing, which the arbitrator has reason to believe poses a serious threat, whether ongoing or imminent, that is likely to harm investors unless immediate action is taken.” Before the SEC approved these amendments, arbitrators had to wait until the end of a case to alert FINRA staff about any fraud they might have seen.
Notably, if a case is nearing completion, the new rules direct that the arbitrators should wait until the case concludes to make the referral if — in the arbitrators’ judgment — investor protection will not be materially compromised by this delay. Arbitrators are further directed not to make such referrals “during the pendency of a case” based solely on allegations in the statement of claim, counterclaim, cross claim, or third party claim; however, it appears that they could still make referrals based on such allegations after a case has concluded.
Under the new rules, the President of FINRA Dispute Resolution or the Director will evaluate the referral to determine whether to transmit it to other divisions of FINRA.
If an arbitrator makes a mid-case referral, the Director will disclose the referral to the parties. A party may then request that the referring arbitrators recuse themselves, but they must do so within three days after the Director’s notification. If a party fails to make such a request within this time period, he/she forfeits the right to request recusal of the referring arbitrators.
FINRA has agreed to collect statistics on the number of cases in which arbitrators make mid-case referrals for one year after the rule becomes effective and report those figures to the SEC.
A copy of the SEC Order approving FINRA’s new rules can be found here.