FINRA’S SUITABILITY RULE AND UNINTENDED CONSEQUENCES

securities-arbitration-300x174The history of securities arbitration, a creation of the brokerage industry, is also a story of unintended consequences.  One of those unintended consequences is known as the Suitability Rule, the cornerstone of customer consumer protection in securities arbitration.

The story began in the 1930′s when, following the Great Depression, Congress passed the Securities and Exchange Acts to prevent another depression.  Included within those Acts were provisions which gave the investors the right to sue independent financial advisors for breach of fiduciary duty and, in the case of brokers, intentional fraudulent conduct.

The National Association of Security Dealers (NASD), the prior of Financial Industrial Regulatory Authority (FINRA), also had a relatively benign rule that stated that brokers could only make recommendations to customers that were appropriate for their individual circumstances.  “The Suitability Rule”, as it is commonly known, is relatively harmless because customers are unable to use it as a basis to sue a broker in court. In legal terms, the Suitability Rule does not allow or support a private cause of action in court.

The legal rights of investors under the SEC Acts have remained unchanged.  What has changed, however, is the shift from the courts to arbitration as the forum for legal claims by customers against brokerage houses.

The shift began when brokerage houses started including mandatory arbitration clauses in customer account agreements.  The U.S. Supreme Court agreed that those clauses were valid and enforceable.  Two results followed that were unforeseeable and unintended.

First, a small group of lawyers became specialists in representing customers in securities arbitration.  An organization of lawyers called Public Investors Arbitration Bar Association (PIABA) was formed. I am a proud member of PIABA.

Second, the vast majority of arbitration claims assert the violation of FINRA’s Rule of Suitability. Although the brokerage industry never intended that result, that is exactly what has happened. Thousands of cases have been successfully prosecuted in arbitration that otherwise never would have been litigated and the customer would not have received any compensation. The salutary effect on the industry is palpable.

In FINRA arbitration, securities arbitration lawyers assert the Suitability Rule as the industry standard.  FINRA arbitrators have inherent and equity power to enforce the industry’s own rules to address violations and award damages.

Securities arbitration is replete and riddled with problems, some of which have been discussed in prior articles, but once in a while the brokerage industry is held to the standard they profess to have. In sum, the brokerage industry never anticipated that a relatively few lawyers around the country would organize and have a positive impact on FINRA arbitration.  Nor did they anticipate the cases that are routinely filed in arbitration that could never have been filed in court.  We have made some progress, but there is still much to be done.