United States: Leveraging FINRA Rules 12504(a)(6)(B) And 13504(a)(6)(B) For An Early Motion To Dismiss

The Financial Industry Regulatory Authority (FINRA) administers the world's largest dispute resolution forum for securities-related arbitrations. Although FINRA arbitration proceedings are expedited and generally less costly than standard court proceedings, FINRA arbitration nonetheless can be a time-consuming distraction, especially when claims are not meritorious. While motions to dismiss are disfavored in FINRA arbitrations, FINRA Rules 12504(a)(6)(B) and 13504(a)(6)(B) (the Rules) provide one route for an early dismissal by permitting an arbitration panel to dismiss a claim before the conclusion of the case in chief when "the moving party was not associated with the account(s), security(ies), or conduct at issue." Although not as broad as Rule 12(b)(6) of the Federal Rules of Civil Procedure, the FINRA rules can nevertheless be used in appropriate circumstances to dispose of improper claims against respondents, particularly in the third-party context.

Background

FINRA has two uniform sets of rules for arbitrating disputes: the FINRA Code of Arbitration Procedure for Customer Disputes and the FINRA Code of Arbitration Procedure for Industry Disputes. The former applies to disputes between FINRA members and their customers; the latter to disputes involving two or more FINRA members or Associated Persons (e.g., disputes between brokers or between FINRA-registered employees and their member firm employers).

FINRA Customer Code Rule 12504 and FINRA Industry Code Rule 13504 govern motions to dismiss in arbitration. These rules, which contain parallel language, were adopted in 2009 to curb the increasing use of motions to dismiss in customer cases and to address FINRA's concern that "if left unregulated," such motion practice would "limit investors' access to the forum." FINRA Regulatory Notice 09-07 (Jan. 23, 2009). Previously, motions to dismiss were governed by Rules 12503 and 13503, which apply to motions in FINRA arbitrations generally, but FINRA, with the SEC's approval, promulgated more limited rules specific to motions to dismiss in response to FINRA's belief that respondents were filing prehearing motions routinely and repetitively in an effort to delay scheduled hearing sessions on the merits, increase investors' costs, and intimidate less sophisticated claimants. Id.

Rules 12504(a) and 13504(a) apply to motions filed before the conclusion of a party's case in chief; motions filed after the conclusion of a party's case in chief are referred to as 12504(b) or 13504(b) motions. Id. In particular, Rules 12504(a)(6) and 13504(a)(6) state that the panel cannot act upon a motion to dismiss a party or claim prior to the conclusion of a case in chief unless the panel determines that one of the following circumstances applies:

Rules 12504(a)(6) and 13504(a)(6).

A motion to dismiss under Rules 12504(a) or 13504(a) must be made in writing, filed separately from the answer, and made only after the answer is filed. See Rules 12504(a)(2); 13504(a)(2). Absent party agreement or the determination of a panel, motions must be served at least 60 days before a scheduled hearing, and opposing parties have 45 days to respond to the motion. Id. at (a)(3). Replies must be made within five days of the response. Id. The full panel must decide whether to grant the motion only after a prehearing conference on the motion is held unless the parties waive the conference. Id. at (a)(4-5). The decision to grant a motion must be unanimous and accompanied by a written explanation. Id. at (a)(7). If the motion is denied, the panel must assess fees associated with hearings on the motion against the moving party. Id. at (a)(9). If the motion is deemed frivolous, the panel must also award reasonable costs and attorneys' fees to any party opposing the motion. Id. at (a)(10).

FINRA Rules 12504(a)(6)(B) and 13504(a)(6)(B) Explained

FINRA Rules 12504(a)(6)(B) and 13504(a)(6)(B) permit the arbitration panel to dismiss a claim when "the moving party was not associated with the account(s), security(ies), or conduct at issue." While FINRA's guidance states, "FINRA intends this exception to apply in cases involving issues of misidentification," Rules 12504(a)(6)(B) and 13504(a)(6)(B) have been interpreted more broadly and applied to contexts beyond mere mistaken identity. FINRA Regulatory Notice 09-07 (Jan. 23, 2009). For example, in NDV Inv. Co. v. APEX Clearing Corp., No. 14 Civ. 923 (RMB), 2015 WL 151043, at *2 (S.D.N.Y. Jan. 8, 2015), the court affirmed a FINRA arbitration panel's dismissal on the basis of Rule 12504(a)(6)(B) and rejected petitioners' argument that this rule was strictly limited to cases involving "truly mistaken identity."¹ In that action, respondent Apex was alleged to be a successor-in-interest after having acquired certain assets from co-respondent Penson. Although not directly referenced in the court's decision, nor in the arbitration award, the filings describe several facts that likely supported the panel's finding that Apex "was not associated with the accounts, securities or conduct at issue." NDV v. Apex Clearing Corporation, FINRA Office of Dispute Resolution, Arbitration No. 13-00303 (June 20, 2016). Likely relevant facts include: (i) Apex did not acquire the two accounts at issue, (ii) the companies continued to operate as distinct entities after the limited transfer of assets, (iii) Apex did not commence operations until several years after the losses and transfers at issue occurred, and (iv) Apex installed a new management team and board of directors that had no affiliation with Penson. See Memorandum of Law in Opposition to Plaintiffs' Motion to Vacate and in Support of Defendant's Cross Motion to Confirm the Arbitration Award, NDV Inv. Co. v. Apex, 14-Civ-923 (S.D.N.Y. Jan. 8, 2015). In other words, while Apex was the correct party such that this was not a case of mistaken identity, Apex's relationship to the relevant accounts was sufficiently tenuous such that the panel reasonably concluded that it was not "associated" with the accounts at issue.

In other cases, Rules 12504(a)(6)(B) and 13504(a)(6)(B) have been used to dismiss claims when a respondent parent company did not exist at the time of the conduct, when a parent company made the purchase at issue rather than the respondent, and when the security in question was originally purchased through another firm before being transferred to respondent, among others. See, e.g., Preis v. American General Securities Incorporated, FINRA Office of Dispute Resolution, Arbitration No. 16-00553 (March 27, 2017) (granting Rule 13504(a)(6)(B) motion to dismiss because parent companies "did not exist during the timeframe when [c]laimant was ... employed by them"); Morris v. Woodbury Fin. Servs., Inc., FINRA Office of Dispute Resolution, Arbitration No. 12-04141 (July 25, 2013) (granting 12504(a)(6)(B) motion to dismiss because "the security in question was purchased ... through another firm" before being transferred to movant); Wang v. UBS Fund Services (USA) LLC, FINRA Office of Dispute Resolution, Arbitration No. 13-00038 (July 5, 2013) (granting 12504(a)(6)(B) motion to dismiss because the bond purchase at issue was made through the parent company and respondent was "not associated with the ... conduct at issue"); Torres v. Hartford Life Distribs., FINRA Office of Dispute Resolution, Arbitration No. 09-05958 (March 7, 2011) (granting 13504(a)(6)(B) motion to dismiss because "the moving party was not associated with the accounts, securities, or conduct at issue, at the time the wrongful conduct was alleged to have occurred"). While FINRA arbitration awards are limited in their detail and reasoning, these decisions suggest that Rules 12504(a)(6)(B) and 13504(a)(6)(B) apply beyond cases of mistaken identity.

The rules can also be effective in disposing of claims against third-party respondents that are "not associated with the ... conduct at issue." (emphasis added). For example, the rules may be used to assert a motion to dismiss where the original respondent to a FINRA complaint lodges claims against a third-party broker-dealer as a way to delay resolution or insert third parties with deep pockets into the proceeding. Third-party respondents can argue that the original complaint against the respondent (now the third-party claimant) defines the contours of what the third-party respondent can be liable for to the third-party claimant. In other words, the third-party respondent must be liable to the third-party plaintiff (the original respondent) for the third-party plaintiff's potential liability to the original plaintiff. Therefore, if the original complaint does not implicate the allegations of the third-party claim, the third-party claim should be dismissed under Rules 12504(a)(6)(B) or 13504(a)(6)(B) as it is "not associated with the ... conduct at issue."

Successful dismissal of FINRA claims under Rules 12504(a)(6)(B) and 13504(a)(6)(B), whether in the third-party context or generally, is a highly fact-sensitive and technical practice. Although FINRA rules are designed to limit motions to dismiss before the case in chief, properly used, such motions can be effective in curtailing an otherwise lengthy arbitration.

*Liam Cutler contributed to this Advisory. Liam is a graduate of the Fordham University School of Law and is employed at Arnold & Porter's New York office. Liam is not admitted to the practice of law in New York.

Footnote

1. Courts will vacate a FINRA arbitration award, including a grant of a motion to dismiss, only in "very unusual circumstances." NDV Inv. Co., 2015 WL 151043 at *1 (citation omitted). "An award should be upheld as long as there is even a 'barely colorable justification for the outcome reached.'" Id. (citation omitted).

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