Loyola University Chicago School of Law, JD 2023
Throughout the history of the financial services industry, broker-dealers and investment advisory firms have typically required harmed investors to dispute matters through arbitration rather than the court system. Arbitration disputes between broker-dealers and former clients are generally kept confidential and decided by a purportedly impartial three-person panel; the panels are hand-selected by the parties from a randomly generated list of arbitrators employed by the Financial Industry Regulatory Authority (FINRA). FINRA utilizes a computer algorithm, the Neutral List Selection System (NLSS), which creates a list of potential arbitrators to review the matter based on the type of case. However, a recent court decision overturning a 2019 FINRA arbitration award in favor of Wells Fargo has flooded the financial services industry with widespread allegations of fraud and misconduct. In addition to vacating the arbitration award, Fulton County Superior Court Judge Belinda Edward criticized FINRA’s arbitration selection procedures as well as Wells Fargo for their role in altering the process. Wells Fargo is set to appeal the decision while FINRA now faces immense regulatory pressure to address its failure to facilitate a fair arbitration selection process.
The underlying dispute
Former Wells Fargo client, Brian Leggett, filed a FINRA arbitration claim in 2017 contending that the firm failed to effectively supervise two advisors who allegedly mismanaged his account. However, Wells Fargo prevailed on the claim in 2019 as three FINRA arbitrators denied Leggett’s allegations against the firm. Leggett chose to appeal the arbitration award. On appeal, Judge Edwards reversed the award and scrutinized FINRA and Wells Fargo. Specifically, Judge Edwards criticized FINRA for permitting Wells Fargo and its attorney Terry Weiss to manipulate the arbitrator list so that the panel would ultimately favor the brokerage firm over the client. According to the court order, FINRA enabled Weiss to modify FINRA’s “neutral list” of arbitrators in the Leggett dispute, which illustrates unfairness in the process. “Permitting one lawyer to secretly red line the neutral list makes the list anything but neutral, and calls into question the entire fairness of the arbitral forum,” said Judge Edwards in her decision to vacate Wells Fargo’s 2019 arbitration award.
How will Judge Edwards’ decision impact the industry?
In a previous post, I examined the Investor Choice Act, which was approved by the House of Representatives’ Financial Services Committee in 2021. The Investor Choice Act, or H.R. 2620, aims to prohibit broker-dealers and investment advisors from incorporating pre-dispute binding arbitration clauses in their client account agreements. H.R. 2620 is set to receive heightened attention on Capitol Hill after FINRA’s failure to fairly adjudicate Brian Leggett’s dispute with Wells Fargo. In fact, Congress sent a letter to FINRA CEO Robert Cook on February 9, 2022, asking a series of questions relating to how FINRA intended to respond to Judge Edwards’ decision. In his response, Cook indicated that the self-regulator planned to hire outside legal counsel to independently investigate whether FINRA’s Dispute Resolution Services (DRS) adhered to its policies and procedures in the Leggett dispute. Cook additionally announced that the law firm would report its findings to the Audit Committee of FINRA’s Board of Governors. However, FINRA’s response was underwhelming in the eyes of Congress, according to a follow-up letter sent to Cook on March 7, 2022. In the March 7 letter, Congress criticized Cook for failing to answer several questions pertaining to the conduct of Wells Fargo, FINRA’s arbitration selection process, and communications between Wells Fargo and FINRA officials. Congress signaled that it is seeking clarity on several issues including whether FINRA will publicly release the law firm’s findings, whether the review will investigate other cases in addition to the Leggett dispute, and whether FINRA will conduct a new arbitration in the Leggett case. FINRA is required to respond to the follow-up letter by March 22, 2022.
Additionally, FINRA is facing criticism from numerous investor advocacy groups and bar associations, such as the Public Investors Advocate Bar Association (PIABA). PIABA President, Michael Edmiston, released a February 2022 statement calling for a congressional review as well as a Securities and Exchange Commission (SEC) investigation into FINRA’s arbitration selection process. FINRA and Wells Fargo will continue to be in the spotlight as the industry awaits Cook’s response to Congress’ letter. Cook’s answers could potentially serve to ease Congress’ concerns relating to the fairness of FINRA’s arbitration forum. However, another unsatisfactory response may lead to a congressional investigation and an intensified focus on The Investor Choice Act, which could potentially cause an upheaval to FINRA’s arbitration system.