I. Introduction

On July 1, 2016, Financial Industry Regulatory Authority, Inc. (“FINRA”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) ^[1] and Rule 19b-4 thereunder,^[2] a proposed rule change to amend FINRA Rule 12403 (Cases with Three Arbitrators) of the Code of Arbitration Procedure for Customer Disputes (“Customer Code”) relating to the panel selection process in arbitration. The proposal was published for comment in the Federal Register on July 15, 2016.^[3] The comment period closed on August 5, 2016. The Commission received eight (8) comment letters on the proposal.^[4] On August 12, 2016, FINRA extended the time, until October 13, 2016, for Commission action on the proposal.^[5] FINRA responded to the comment letters on August 18, 2016.^[6] This order approves the proposed rule change.

II. Description of the Proposed Rule Change

FINRA allows parties to participate in selecting the arbitrators who serve on their cases. Parties select their arbitration panel from computer generated lists of arbitrators that FINRA sends them. Under current FINRA Rule 12403(a), in customer cases with three arbitrators,^[7] FINRA sends the parties three lists: a list of ten (10) chair-qualified public arbitrators, a list of ten (10) public arbitrators, and a list of ten (10) non-public arbitrators.^[8] The parties select their panel through a process of striking and ranking the arbitrators on the lists.^[9] Under current Rule 12403(c)(2), each party is allowed to strike up to four (4) arbitrators on the chair-qualified public list and four (4) arbitrators on the public list. At least six (6) names must remain on each list. However, Rule 12403(c)(1) provides for unlimited strikes on the non-public list so that any party may select a panel of all public arbitrators in a customer case.^[10]

Under the Customer Code, when parties collectively strike all of the non-public arbitrators from the list, FINRA fills all three panel seats from the two 10-person lists of public arbitrators.^[11] When parties collectively strike all of the arbitrators appearing on the non-public list, FINRA returns to the public list to select the next highest ranked available arbitrator to fill the seat.^[12] If no public arbitrators remain available to fill the vacancy, FINRA returns to the chair-qualified public list to select the next highest ranked public chair.^[13] In doing so, there is a likelihood that FINRA will appoint an arbitrator who the parties accepted, but ranked lower on the public or chair-qualified public lists.^[14] FINRA believes that where parties collectively strike all the non-public arbitrators ( i.e., where they desire an all-public panel), the parties should have greater choice of public arbitrators.^[15]

Consequently, FINRA is proposing to amend Rule 12403(a)(1) to increase the number of arbitrators on the public arbitrator list FINRA sends the parties from ten (10) to fifteen (15). FINRA believes this amendment would provide the parties with greater choice of public arbitrators during the panel selection process.^[16]

FINRA is also proposing to amend Rule 12403(c)(2) to increase the number of strikes to the public arbitrator list from four (4) to six (6), so that the proportion of strikes is the same under the amended rule as it is under the current rule. FINRA believes that increasing the number of strikes the parties can make to the newly increased public list will improve the likelihood that the parties' preferred arbitrators will be appointed to the panel.^[17]

III. Summary of Comments and FINRA's Response

The Commission received eight (8) comment letters on the proposed rule change,^[18] and a response letter from FINRA.^[19] As discussed in more detail below, six (6) commenters expressed support for the proposal as filed,^[20] one (1) commenter generally supported the proposal while expressing additional concerns,^[21] and one (1) commenter proposed an alternative approach for panel selection in customer cases.^[22] The sections below outline the support, concerns raised and alternatives proposed by commenters, as well as FINRA's response.

Support for the Proposal

Six (6) commenters supported the proposed increase in the number of arbitrators on the public arbitrator list from ten (10) to fifteen (15), as well as the proportional increase from four (4) to six (6) strikes that parties may make to the public arbitrator list. These commenters stated, among other things, that the proposal would provide parties ( printed page 64565) with a greater choice in the arbitrator selection process, increasing the likelihood that an arbitrator preferred by both parties would be appointed to the panel.^[23] Consequently, these commenters generally believe that the proposed rule change “is a fair, equitable and reasonable approach[,]” ^[24] “is an important step towards protecting the investing public[,]” ^[25] “will greatly enhance the fairness of the forum to both the investing public and FINRA members[,]” ^[26] “results in more equitable arbitration proceedings,” ^[27] and “benefits all parties, with a particularly positive impact on modest-means investors.” ^[28]

Additional Concerns

One (1) commenter generally supported the proposal, but also expressed concerns about other aspects of the arbitrator selection process.^[29] Specifically, this commenter believes that FINRA should address the shortage of local arbitrators by intensifying its efforts to recruit suitable local individuals to serve as public and chair‐qualified arbitrators, particularly in locations with shallow arbitrator pools.^[30] In addition, this commenter recommends that FINRA increase the transparency of its list-selection process.^[31]

In response, FINRA stated that it believes this commenter's suggestions are outside the scope of the proposal.^[32] Therefore, FINRA did not address them in its response.^[33]

Alternative Proposal

One (1) commenter did not directly oppose the proposal but did recommend that FINRA adopt an alternative approach for panel selection in customer cases. Among other things, this commenter suggested that FINRA maintain the three current ten-person lists of non-public, chair-public and public arbitrators. Each party could strike all of the names on the non-public list, and four names on each public list. Each party would then submit to FINRA one combined list of ranked chair-public and public arbitrators. FINRA would appoint the highest ranked chair-qualified arbitrator as chair. If the parties collectively struck all of the non-public arbitrators, FINRA would then appoint two public arbitrators from those remaining on the parties' combined list (regardless of whether they are chair-qualified).^[34] The commenter believes that this proposal would benefit parties to an arbitration because, among other things, they would not need to vet the proposed additional five public arbitrators.^[35]

In its response, FINRA stated that forum users generally prefer greater choice during the arbitrator selection process.^[36] FINRA also stated that unlike the commenter's suggestion, the proposed rule change would provide parties greater choice by adding five (5) public arbitrators to the panel selection process.^[37] In addition, FINRA believes that the commenter's approach to panel selection would be complex and difficult for parties to navigate, especially parties or party representatives that do not use the forum on a regular basis.^[38] Accordingly, FINRA did not amend the proposal to reflect the commenter's recommended amendments.

IV. Discussion and Commission Findings

The Commission has carefully considered the proposal, the comments received, and FINRA's response to the comments. Based on its review of the record, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities association.^[39] In particular, the Commission finds that the proposed rule change is consistent with Section 15A(b)(6) of the Act,^[40] which requires, among other things, that FINRA's rules be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest. FINRA believes, and the Commission agrees, that the proposed rule change would protect investors and the public interest by providing greater choice for parties in customer cases with three arbitrators during the panel selection process.

As discussed above, the proposal would amend Rule 12403(a)(1) to increase the number of arbitrators on the public arbitrator list that FINRA sends the parties from ten (10) to fifteen (15).^[41] It would also amend Rule 12403(c)(2) to increase the number of strikes to the public arbitrator list from four (4) to six (6), so that the proportion of strikes is the same under the amended rule as it is under the current rule.^[42]

The Commission has considered the eight (8) comment letters received on the proposed rule change,^[43] along with FINRA's response to the comments.^[44] The Commission notes that most of the commenters support the proposed rule change, expressing the belief that the proposal would increase parties' choice among public arbitrators during the arbitrator selection process,^[45] and thereby benefit parties in arbitration and enhance the fairness of the forum.^[46] However, the Commission also recognizes commenters' concerns and suggestions.^[47]

While the Commission acknowledges that FINRA's proposed amendments to Rule 12403 might result in an increased burden in vetting additional arbitrators, the Commission agrees with FINRA that parties would benefit from having greater choice in selecting public arbitrators, and that the benefits of this greater choice would outweigh the cost of additional vetting.^[48] The Commission additionally agrees with FINRA's assessment that the proposed alternative arbitrator selection process suggested by one commenter ^[49] would not provide the benefit of greater choice and would unnecessarily complicate the arbitrator selection process.^[50]

In addition, the Commission agrees with FINRA's assessment that the “shortage of local arbitrators” and the transparency of FINRA's arbitrator list-selection process ^[51] are outside the scope of the proposal.^[52]

For the reasons stated above, the Commission finds that the proposed rule change is consistent with the Act ( printed page 64566) and the rules and regulations thereunder.

V. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,^[53] that the proposed rule change (SR-FINRA-2016-022) be, and hereby is, approved.

For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.⁵⁴