I. Introduction

On October 5, 2023, the Financial Industry Regulatory Authority, Inc. (“FINRA”) filed with the Securities and Exchange Commission (“SEC” or “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 the FINRA Code of Arbitration Procedure for Customer Disputes (“Customer Code”), the Code of Arbitration Procedure for Industry Disputes (“Industry Code”), and the Code of Mediation Procedure (“Mediation Code”) (collectively, the “Codes”), to revise and restate the qualifications for representatives in arbitrations and mediations in the forum administered by FINRA Dispute Resolution Services (“DRS”).

The proposed rule change was published for public comment in the Federal Register on October 13, 2023.^[3] The public comment period closed on November 3, 2023. The Commission received comment letters related to this filing.^[4] On November 9, 2023, FINRA consented to an extension of the time period in which the Commission must approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to approve or disapprove the proposed rule change to January 11, 2024.^[5] On January 8, 2024, FINRA responded to the comment letters received in response to the Notice.^[6] This order approves the proposed rule change.

II. Description of the Proposed Rule Change

A. Background

The Codes currently permit parties to arbitrations and mediations in the DRS forum to represent themselves, to be represented by an attorney at law in good standing, or to be represented by a non-attorney representative (“NAR”).^[7] Some NARs receive compensation in connection with their representation of parties (“compensated NARs”).^[8] Other NARs assist parties with their cases without compensation (“uncompensated NARs”).^[9] In addition, although the practice is not specifically addressed by the Codes, law students sometimes represent parties while practicing under the supervision of an attorney through securities arbitration clinics (“SACs”).^[10]

In response to DRS forum users' concerns regarding the conduct of compensated NARs, FINRA reviewed their representation of parties in arbitrations and mediations in the DRS forum.^[11] FINRA found that compensated NARs represent customers in a small percentage (one percent) of the customer cases in the DRS forum.^[12] Nevertheless, FINRA identified several allegations of improper conduct by compensated NARs in connection with their representation of parties in the DRS forum.^[13] In contrast, FINRA did not identify any allegations of improper conduct by uncompensated NARs or law students.^[14] FINRA expressed concern that parties may be harmed when compensated NARs are found to be engaged in the unauthorized practice of law under the law of the relevant United States (“U.S.”) jurisdiction.^[15] FINRA highlighted that compensated NARs have, for example, been enjoined from continuing their representation of parties during pending arbitrations after courts determined that the representation constituted the unauthorized practice of law.^[16] DRS arbitrators have also issued awards dismissing claims, or finding against investors, after determining that a compensated NAR's representation of an investor constituted the unauthorized practice of law in the jurisdiction.^[17]

Moreover, FINRA expressed concern that NARs are not subject to professional qualification requirements, ethical rules, disciplinary processes, and client protections that the states and other U.S. jurisdictions apply to attorneys who represent parties in the DRS forum.^[18] As such, customers of compensated NARs do not benefit from the client protections and disciplinary processes that apply to attorneys and may have limited recourse if they are harmed by the misconduct of compensated NARs.^[19]

For the reasons discussed above, FINRA filed the proposed rule change to revise and restate the qualifications for representatives of parties using the DRS forum, as described below.^[20]

B. Proposed Rule Change

FINRA Rules 12208(c), 13208(c), and 14106(c) currently prohibit compensated and uncompensated NARs from representing parties in arbitration and mediation if: (1) state law prohibits such representation; (2) the prospective representative is currently suspended or barred from the securities industry in any capacity; or (3) the prospective representative is currently suspended from the practice of law or disbarred.^[21] FINRA Rules 12208(d), 13208(d), and 14106(d) further provide that issues regarding the qualifications of a person to represent a party in arbitration or mediation are governed by applicable law and may be determined by an appropriate court or other regulatory agency.^[22]

1. Disallowing Compensated NARs in the DRS Forum

The proposed rule change would prohibit a person who is not an attorney and who receives compensation in any manner in connection with the representation ( i.e., a compensated NAR) from representing a party at any stage of an arbitration or mediation proceeding. Specifically, the proposed rule change would state that any party in an arbitration or mediation proceeding held in a U.S. hearing location may be represented by “a person who is not an attorney, who has not received, and will not receive, compensation in any manner in connection with the representation.” ^[23]

To help ensure that a NAR is not receiving compensation in connection with their representation of a party in the DRS forum, proposed Rules 12208(b)(1)(C), 13208(b)(1)(C), and 14106(b)(1)(C) would require the NAR and the party being represented to attest that the NAR is not receiving compensation. Specifically, the proposed rule change would state that a party could be represented in arbitration or mediation by an uncompensated NAR, provided that “prior to the representation, the person or the party files with the Director through the Party Portal a written statement, signed by the person and the party, attesting that the person has not received, and will not receive, compensation in connection with the representation.” ^[24]

2. Codifying the Role of Law Students and SACs

The Codes do not specifically address the representation of parties in the DRS forum by law students supervised by attorneys through SACs.^[25] The proposed rule change would amend the Codes to codify the current practice of allowing a party to be represented by an enrolled law student participating in a law school clinical program or its equivalent and practicing under the supervision of an attorney.^[26] Specifically, the proposed rule change would state that any party in an arbitration or mediation proceeding held in a U.S. hearing location may be represented by “a student enrolled in a law school participating in a law school clinical program or its equivalent and practicing under the supervision of an attorney.” ^[27]

3. Persons Prohibited From Representing Parties in the DRS Forum

The Codes currently provide that non-attorneys may not represent a party if state law prohibits such representation, the person is currently suspended or barred from the securities industry in ( printed page 3483) any capacity, or the person is currently suspended from the practice of law or disbarred.^[28] The proposed rule change would retain the substance of these provisions, while also stating that the laws of U.S. jurisdictions that are not states may also disqualify the person from representing a party.^[29] The proposed rule change would also apply these prohibitions generally to all persons, including attorneys.^[30] Furthermore, the proposed rule change would specifically preclude a person who is currently suspended from or denied the privilege of appearing or practicing before the Commission from representing a party in the DRS forum.^[31]

Specifically, the proposed rule change would state that no person may represent a party in an arbitration or mediation proceeding held in a U.S. hearing location if: “(A) the laws of a state of the United States, the District of Columbia, or commonwealth, territory, or possession of the United States with jurisdiction over the representation prohibit the representation; (B) the person is currently suspended or barred from the securities industry in any capacity; (C) the person is currently suspended from the practice of law or disbarred; or (D) the person is currently suspended from or denied the privilege of appearing or practicing before the Securities and Exchange Commission.” ^[32]

4. Determinations of Qualifications of Representatives

The Codes currently provide, in part, that “[i]ssues regarding the qualifications of a person to represent a party in arbitration [or mediation] are governed by applicable law and may be determined by an appropriate court or other regulatory agency.” ^[33] The Codes also currently provide that “[i]n the absence of a court order, the arbitration [or mediation] proceeding shall not be stayed or otherwise delayed pending resolution of such issues.” ^[34] To improve the clarity of these provisions, the proposed rule change would make non-substantive changes to them.^[35] Specifically, the proposed rule change would state that “[a] challenge to the qualifications of a representative made outside of the [arbitration or mediation] proceeding shall not stay or otherwise delay the [arbitration or mediation] proceeding in the absence of a court order.” ^[36]

III. Discussion and Commission Findings

After careful review of the proposed rule change and the comment letters, the Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder that are applicable to a national securities association.^[37] Specifically, as explained in more detail below, the Commission finds that the proposed rule change is consistent with Section 15A(b)(6) of the Act, which requires, among other things, that FINRA 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.^[38]

A. Disallowing Compensated NARs in the DRS Forum

1. General Prohibition

As noted above, FINRA is proposing to amend the Codes to revise and restate the qualifications for representatives of parties using the DRS forum to disallow compensated NARs from representing parties in the DRS forum. FINRA is proposing these rule changes in response to several allegations of improper conduct by compensated NARs in connection with their representation of parties in the DRS forum ( e.g., compensated NARs aggressively soliciting customers to bring claims in the DRS forum).^[39] Specifically, FINRA stated that compensated NARs have a pecuniary incentive to engage in misconduct when seeking new client relationships or bringing claims in the DRS forum, and that parties harmed by such conduct lack recourse against compensated NARs who are not directly regulated.^[40] Nevertheless, while FINRA acknowledged that as a result of disallowing compensated NARs, some parties may have difficulty in obtaining counsel, FINRA stated that the proposed rule change “balances the need for parties, including investors, to be able to avail themselves of representation in the DRS forum with protecting those parties, the integrity of the DRS forum, and the public interest generally from the potential harmful conduct and lack of recourse that may come from representation by compensated NARs.” ^[41]

Commenters generally supported the proposed rule change.^[42] One commenter stated that “it is in the best interest of investors to disallow compensated [NARs] from representing customer claimants in FINRA arbitration.” ^[43] A second commenter similarly stated that the proposed rule change would “reduce the risk that parties, including investors, may be significantly harmed by the activities of compensated ( printed page 3484) NARs.” ^[44] A third commenter stated that “NARs have a greater propensity than attorneys to engage in improper or disruptive conduct.” ^[45] A fourth commenter agreed with each of FINRA's concerns, stating that the proposed rule change is “important and necessary to protect investors from improper conduct by compensated [NARs,] . . . who are not governed by the same constraints as licensed attorneys or law students under the supervision of licensed attorneys. . . . [A]nd individuals who fall prey to incompetent representation by a NAR may not have any method of recourse.” ^[46]

Compensated NARs represent claimants in a small percentage of the overall customer cases in the DRS forum but have demonstrated a higher propensity to engage in improper conduct in connection with their representation than their counterparts, including uncompensated NARs.^[47] Similarly, compensated NARs are less likely to be subject to professional qualification requirements, ethical rules, disciplinary processes, and client protections than attorneys who represent parties in the DRS forum.^[48] Further, compensated NARs' interactions with customers are not subject to regulation like the state disciplinary rules on lawyer advertising ( e.g., failure to disclose disciplinary history or assuring customers that they would recover investments).^[49] Thus, to the extent compensated NARs aggressively solicit customers to bring claims in the DRS forum, pursue frivolous claims, charge clients non-refundable fees, or engage in additional misconduct, including the unauthorized practice of law, customers generally would not have recourse that would be available had they engaged an attorney.^[50] By prohibiting compensated NARs from representing parties in the DRS forum, the proposed rule change removes the participation of individuals who have a financial incentive to engage in improper conduct in connection with their representation of parties in the DRS forum. As such, excluding compensated NARs from the DRS forum is a reasonable approach to help ensure that persons representing claimants in the DRS forum for compensation adhere to professional standards and can be held to account when they do not ( e.g., attorneys) or lack the pecuniary incentive to engage in improper conduct ( e.g., uncompensated NARs).

The Commission recognizes that some claimants with smaller claims who might have otherwise considered representation by a compensated NAR may have more difficulty obtaining representation as a result of the proposed rule change. Similarly, claimants with smaller claims may incur additional costs to retain an attorney or risk worse outcomes by representing themselves at a hearing. However, these concerns are outweighed by the threat of harm, including harm to investors, presented by compensated NARs whose interactions with customers are not subject to professional standards of conduct. Furthermore, because compensated NARs represent only a small percentage (one percent) of parties in the DRS forum, the potential impact of the proposed rule change on representation within the DRS forum may be limited and is thus a reasonable way for FINRA to prevent potential harms caused by compensated NARs without unduly impacting representation within the DRS forum.

2. Statement of No Compensation for Uncompensated NAR Representation

As noted above, the proposed rule change provides that a party could be represented in arbitration or mediation by an uncompensated NAR, provided that prior to the representation, the uncompensated NAR or party files the required written attestation with the Director of DRS. Commenters generally supported the proposed rule change.^[51]

The proposed rule change requiring a written attestation that a NAR has not received and will not receive compensation in connection with its representation of a party is a reasonable obligation that would permit FINRA to verify that the NAR is uncompensated and help to ensure that all parties are aware of this requirement, thus supporting the regulatory goal of excluding compensated NARs from the DRS forum. For these reasons, the proposed rule change is reasonable.

B. Codifying the Role of Law Students and SACs

As noted above, FINRA stated that it is proposing to amend the Codes to codify the current practice whereby a party may be represented by a student enrolled in a law school participating in a law school clinical program or its equivalent and practicing under the supervision of an attorney. FINRA stated that SACs and the law students who participate in these programs provide an inexpensive option for customers who qualify and may not be able to find or afford an attorney. Moreover, these representations may be regulated by state rules that govern the performance of legal services by law students and the attorneys who supervise them.^[52] Accordingly, FINRA stated that it would be appropriate to codify the role of law students in providing representation to investors through SACs.^[53]

Commenters generally supported the proposed rule change.^[54] One of these commenters stated that for a clinic that provides pro bono representation to investors who otherwise are unable to find an attorney due to the size of their claims or the uncertainty of collectability, “it is critical that law school students in clinic programs remain able to represent customers in the DRS forum to fill the access to justice gap with ethical representation for investors who cannot otherwise afford it.” ^[55] Similarly, a second commenter stated that it supports the proposed rule change “because it benefits both the parties and the system by helping to assure that parties have access to expertise that they may lack or cannot afford to pay for.” ^[56] In order to improve parties' access to representation in the DRS forum, this commenter recommended that FINRA study what it means to be the “equivalent” to a law school clinic within the meaning of the proposed rule change. Specifically, the commenter suggested that FINRA (1) determine if such institutions exist and, if they do, (2)(a) consider what qualifications or restrictions may be necessary to allow them to represent parties in the DRS forum and (b) consider and publish standards for programs that would satisfy the “or equivalent” provision in proposed Rule 12208(b)(1)(B).^[57] In response, FINRA stated that it included the “or equivalent” provision in the proposed rule change “to account for flexibility in law school programs ( e.g., a law school without a formal clinical program, but that has students ( printed page 3485) providing legal services under the supervision of a law school professor).” ^[58] Further, while FINRA is not aware of any such programs at this time, should one arise, FINRA would “make an evaluation on a case-by-case basis and provide guidance as appropriate.” ^[59]

Currently, a party in arbitration or mediation may be represented by a student enrolled in a law school participating in a law school clinical program or its equivalent and practicing under the supervision of an attorney. This practice, however, is not currently codified in the FINRA rulebook. Accordingly, parties may not be aware that this option is available when they are seeking representation. The proposed rule change should help make customers seeking to use the forum aware of this alternative option for representation. Similarly, it should also provide clarity to law school students and the attorneys that supervise them. Law school clinical programs lack the pecuniary incentive to engage in the conflicted conduct described above and are under the supervision of attorneys, thus helping to ensure that a customer's representative is subject to professional standards of conduct. As such, the proposed rule change reasonably balances the needs of customers who might otherwise be unable to obtain legal representation with protecting parties from the conflicts associated with compensated NARs.

C. Persons Prohibited From Representing Parties in the DRS Forum

As noted above, the Codes currently provide that non-attorneys may not represent a party if state law prohibits such representation, the person is currently suspended or barred from the securities industry in any capacity, or the person is currently suspended from the practice of law or disbarred.^[60] The proposed rule change is retaining the substance of the current provisions but would expand the scope of the rule in three ways.

First, the proposed rule change would add that the laws of U.S. jurisdictions that are not states ( i.e., the District of Columbia, or a commonwealth, territory, or possession of the United States) may also disqualify the person from representing a party.^[61] FINRA stated that the current rule's prohibition on representing a party if state law prohibits the representation does not fully address FINRA's concerns with the unauthorized practice of law by compensated NARs because it is not always clear in advance of the arbitration or mediation whether a compensated NAR's representation of a party in arbitration or mediation in a particular jurisdiction is legally permissible. As such, incorporating this new, broader standard into the proposed rule change would help protect the integrity and quality of the DRS forum and protect investors by incorporating the disqualification provisions of all relevant jurisdictions.^[62]

Second, the proposed rule change would prohibit all persons, not just non-attorneys, from practicing in the DRS forum who meet the aforementioned conditions.^[63] FINRA stated that all persons, including attorneys, should be prohibited from practicing in the DRS forum if these conditions apply.^[64]

Third, the proposed rule change would preclude a person who is currently suspended from, or denied the privilege of, appearing or practicing before the Commission from representing a party in the DRS forum.^[65] As with the above changes, FINRA stated that incorporating this standard into the proposed rule change would help protect the integrity and quality of the DRS forum and protect investors.^[66]

Commenters generally supported the proposed rule change.^[67]

The proposed rule change's expansion of the categories of persons prohibited from representing parties in the DRS forum are reasonable to help prohibit problematic representatives from appearing in the DRS forum. Specifically, expanding the rule to provide that the laws of any U.S. jurisdiction, and not only states, may disqualify the person from representing a party helps ensure that persons in all relevant jurisdictions are covered by the rules' prohibitions. Similarly, expanding the prohibitions to apply to all persons, not just attorneys, helps ensure that any person with a demonstrated track record of misconduct would be precluded from representing parties in the DRS forum. Further, precluding a person who is currently suspended from, or denied the privilege of, appearing or practicing before the Commission from representing a party in the DRS forum precludes another group of persons with a demonstrated track record of misconduct from representing parties in the DRS forum. By excluding problematic representatives from, and at the beginning of, the DRS process, the proposed change is a reasonable way to help enhance the integrity of those individuals representing parties in the DRS forum.

D. Determinations of Qualifications of Representatives

As noted above, the proposed rule change would make some clarifying changes to the current provision that prevents delay of a proceeding while a challenge to the qualifications of a person to represent a party is resolved outside of the DRS forum. Specifically, the proposed rule change would simplify the Codes' language to state that a challenge to the qualifications of a representative made outside of the arbitration proceeding shall not stay or otherwise delay the proceeding in the absence of a court order. Commenters generally supported the proposed rule change.^[68] The proposed change makes no substantive changes to the rule, and reasonably clarifies the language regarding challenges outside of the DRS forum that could affect the progression of an active proceeding.

IV. Conclusion

For the reasons set forth above, the Commission finds that the proposed rule change is consistent with Section 15A(b)(6) of the Act, which requires, among other things, that FINRA rules be designed to prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, and, in general, protect investors and the public interest.^[69]

It is therefore ordered pursuant to Section 19(b)(2) of the Act ^[70] that the proposal (SR-FINRA-2023-013), be and hereby is approved.