FINRA Considering Whether Firms Should be Required to Carry Insurance to Pay Arbitration Awards

The Financial Industry Regulatory Authority (“FINRA”) is reportedly considering whether to require brokerage firms to purchase and maintain errors and omissions insurance policies that would be used to pay investors following arbitration.  According to the organization’s Executive Vice President of Regulatory Operations, Susan Axelrod, many investment firms never pay arbitration awards and other legal claims issued to investors.  Instead, the companies often close down – leaving claimants empty handed.

About 11 percent, or $51 million, in arbitration awards issued against brokerage firms in 2011 currently remain unpaid.  As of July 1st, nearly 1,000 securities firms reported fewer than $50,000 in assets.  At this time, the nation’s Securities and Exchange Commission (“SEC”) requires small brokerage firms to maintain at least $5,000 in capital assets.  Such thin margins have apparently left a number of state regulators nervous.  For example, Texas-based Provident Royalties LLC allegedly operated a $485 million Ponzi scheme that involved multiple brokerage firms.  Although FINRA took disciplinary action against any investment firms that failed to perform proper due diligence regarding the company, at least $150 million worth of Provident Royalties LLC shares were sold by now-defunct brokerages.  Still, Securities Investor Protection Corporation President, Stephen Harbeck, said the organization does not cover arbitration awards or “compensate people for a decline in value of a security, even if that decline was a result of fraud.”

We would love to hear your thoughts.  Should FINRA require brokerage firms to carry insurance that would be used to pay arbitral awards?