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The Securities and Exchange Commission ("SEC") recently announced that it was initiating proceedings to determine whether to approve or disapprove of a proposed amendment to the Financial Industry Regulatory Authority ("FINRA") Code of Arbitration Procedure that would permit arbitrators to make disciplinary/regulatory referrals during the pendency of an arbitration proceeding.  79 Fed. Reg. 101 (May 27, 2014).  In the wake of the Bernie Madoff scandal and other recent financial schemes, FINRA has increasingly become more proactive about implementing measures to assist with early detection and investigation of possible fraudulent conduct in order to protect the investing public.


Beginning with its initial proposal dated July 12, 2010 and subsequent amendments, FINRA has been seeking approval from the SEC to amend Rules 12104 of the Code of Arbitration Procedure for Customer Disputes and Rule 13104 of the Code of Arbitration Procedure for Industry Dispute to allow for mid-case disciplinary/regulatory referrals.


Under the proposed rule change, (a) an arbitrator may make a mid-case referral to FINRA regulators if the arbitrator becomes aware of circumstances that pose an ongoing or imminent serious threat, that is likely to harm investors unless immediate action is taken; (b) a mid-case referral cannot be based entirely upon the pleadings in the case; (c) when the case is nearing completion, the arbitrator should use his/her discretion about allowing the case to reach a conclusion before making a disciplinary/regulatory referral unless the delay would cause harm to investors; (d) when a mid-case referral is made by an arbitrator, the Director of Arbitration is required to notify the parties; (e) upon being notified of a mid-case referral, the parties are entitled to seek recusal of the arbitrator(s) who made the referral; (f) the President or Director of FINRA is charged with determining whether to convey the disciplinary/regulatory referral to the other departments of FINRA for further investigation; and (g) the arbitrators are still authorized to make post-case disciplinary/regulatory referrals to FINRA.


In the Federal Register, the SEC pointed out that its initiation of proceedings to investigate whether to approve or disapprove the proposed rule change is not an indication that the SEC has reached any conclusion about the proposed rule change.  Rather, the SEC is soliciting comments from interested persons on the proposed rule change in order to evaluate the proposed rule.  Nevertheless, the SEC considered the proposed rule change important enough to continue deliberations on the subject matter.  According to an article by Mark Schoeff, Jr. and published by Investment News ( entitled, "SEC raises red flag over FINRA enforcement referral rule," the immediate past FINRA Director of Arbitration, George Friedman advised that it was "rare that the full commission would take an interest in a rule" and added that "[c]learly, one or more of the commissioners has some concerns about the rule filing."


The SEC received 10 submissions of comments from interested persons about the proposed mid-case referral rule change, including a ringing endorsement from Mr. Friedman.  The SEC placed these comments into three separate categories:

  1. two of the letters supported the proposed rule change
  2. three of the letters supported the proposed rule with some modifications
  3. five letters opposed the proposed rule


Somewhat surprisingly, one of the sharpest criticisms of the proposed rule change came from the President of the Public Investors Arbitration Bar Association (“PIABA”), which is an organization comprised of attorneys who represent investors in FINRA arbitration matters.  In his letter dated February 26, 2014, PIABA President Jason Doss expressed concern about the economic effect of the proposed rule change, specifically the fact that the rule would allow for costs associated with the recusal of an arbitrator, including adjournment fees, to be borne equally by the parties.  President Doss suggested that the costs associated with the mid-case referrals should be “borne by either the Industry (Respondent) or FINRA as an advancement of its mandate to detect fraud.”  President Doss even questioned the necessity of a rule allowing for mid-case disciplinary/regulatory referrals and argued that FINRA had not presented any “definitive statistical or empirical data” to support the need for the rule change.  Instead, President Doss pointed out that FINRA provides copies of all statements of claim in promissory note cases to the Central Review Group (“CRG”) and suggested that FINRA expand this practice to include referrals of other statements of claim that contain allegations of serious securities violations to the FINRA Enforcement.  Lastly, President Doss maintained that mid-case referrals would provide another ground to vacate arbitration awards and would cause delays in the cases to the prejudice of the investors.


Certain members of the defense side of the bar have also voiced objections to the proposed mid-case referral rule.  An experienced securities attorney who represents broker-dealers and financial advisors, William D. Nelson, submitted a comment dated March 11, 2014 in which he too expressed serious reservations about the proposed rule change.  Among other things, Mr. Nelson pointed out that the proposed rule change would encourage arbitrators to form “an opinion or belief before all of the evidence has been received and before the parties have had an equal opportunity to be heard,” which is contrary to “fundamental fairness and due process and is not likely something that would sit well with a reviewing court.”


People interested in submitting comments to the SEC about the proposed mid-case referral FINRA rule may do so by one of three methods:

  1. using the SEC's internet comment form, which is available at
  2. sending an email to
  3. sending a letter in triplicate to Secretary, Securities and Exchange Commission, 100 F. Street NE., Washington, D.C. 20549-1090


Parties who choose to submit their comments via email or letter should reference File Number SR-FINRA-2014-005.  The deadline to submit comments to the SEC about the proposed rule is June 26, 2014.