Code of Arbitration Procedure

The arbitration codes handle the bulk of customer and intra-industry private disputes, distinct from the regulatory disciplinary process driven by FINRA investigations and the Code of Procedure.

Two Parallel Codes

The two codes have parallel structure with corresponding provisions. For example, the customer-arbitration mandate parallels the industry-arbitration mandate, and the customer-side simplified arbitration parallels the industry-side simplified arbitration. The two tracks line up provision-for-provision throughout.

Failure to Act Under the Codes

The Interpretive Material to each code states that failure of a member or AP to comply with any provision of the Code (including failure to honor an arbitration award, failure to participate in arbitration, or failure to comply with awards) is conduct inconsistent with just and equitable principles of trade, sanctionable under FINRA's disciplinary rules.

• An AP who refuses to pay an arbitration award is exposed to disciplinary suspension under the Code of Procedure, not just contractual enforcement
• The interpretive material lets FINRA enforce arbitration awards through its regulatory authority, in addition to the customer's separate path through the courts

Agreement of the Parties

The parties' arbitration agreement is enforceable under the Code; parties may modify Code provisions by written agreement, but they may not eliminate any party's right to arbitration required by the Code (e.g., they may not waive a customer's right to compel FINRA arbitration or an AP's right to industry-code arbitration).

The non-waivable nature of the customer-arbitration right and the industry-arbitration right is the central pillar of the Code: predispute waivers cannot defeat the forum.

Customer Arbitration (Unilateral Right)

Parties must arbitrate a customer dispute under the Customer Code if:

• Arbitration is required by a written agreement between the parties, OR
• The customer requests arbitration, AND
• The dispute is between a customer and a member or AP, AND
• The dispute arises in connection with the business activities of the member or AP, except insurance business activities of a member that is also an insurance company

The Unilateral Customer Right

Customers have a unilateral right to compel arbitration at FINRA against members and APs, even without a written predispute agreement.

• The customer can demand arbitration; the member must comply
• The reverse is not true: a member cannot compel a customer to FINRA arbitration absent a written predispute arbitration agreement signed by the customer
• This is the asymmetry that defines the customer-vs-broker arbitration system

Elective Arbitration

Parties may agree in writing, after the dispute arises, to submit a dispute to FINRA arbitration that is otherwise not required to be arbitrated.

• Common use: A dispute that falls outside the customer-arbitration mandate (e.g., a dispute related to insurance business activities, or a non-customer dispute)
• Parties can opt into FINRA arbitration post-dispute, even if they could not have been compelled into it pre-dispute

Exam Tip: Gotchas

• Customers have a unilateral right to FINRA arbitration under the Customer Code, even without a predispute agreement. Members and APs must arbitrate at FINRA if the customer requests it. The reverse is NOT true: a member cannot compel a customer to FINRA arbitration absent a written predispute arbitration agreement signed by the customer.
• The insurance exception is specific to a member that is also an insurance company. A fixed-annuity sale alone does not establish the exception. For an actually excluded dispute, assess elective arbitration by post-dispute agreement or another available forum.

Industry Arbitration (Mandatory)

Disputes must be arbitrated under the Industry Code if:

• The dispute arises out of the business activities of a member or AP, AND
• Is between or among members, members and APs, or APs

Common Industry-Code Disputes

• Employment claims: compensation disputes, defamation on Form U5, restrictive covenants, breach of employment contract
• Branch-separation / promissory-note disputes: a rep who leaves a firm and is then sued on a promissory note tied to upfront recruiting compensation
• Member-vs-member disputes: clearing-firm disputes, branch-transition disputes between firms

Predispute Waivers Are Themselves Violations

Predispute agreements that purport to waive industry-code arbitration at FINRA are violations of FINRA rules and inconsistent with just and equitable principles of trade.

• A member firm that puts a "you must arbitrate at AAA / JAMS / a state court" clause in its rep employment contracts is itself violating FINRA rules
• The industry-code forum mandate is non-waivable in advance

Exam Tip: Gotchas

• A predispute arbitration agreement that purports to waive industry-code arbitration at FINRA is itself a violation of FINRA rules. Members cannot use employment contracts to push industry disputes (compensation, defamation on Form U5, partner separations) to a non-FINRA forum. The industry-code forum mandate is non-waivable in advance.

Simplified Arbitration

For claims involving $50,000 or less, exclusive of interest and expenses, the Codes apply a simplified arbitration procedure.

Customer Control of the Hearing Right

In a Customer Code simplified arbitration, the customer retains the right to demand a hearing. The respondent member does not have an equivalent unilateral right to demand a hearing. Members preparing for $50K-or-less customer claims should expect the customer to control whether there is a hearing.

Exam Tip: Gotchas

• Customer Code simplified arbitration defaults to a paper-only proceeding decided on the pleadings. The customer retains the right to demand a hearing. The respondent member does NOT have an equivalent unilateral right. Members preparing for $50K-or-less customer claims should expect the customer to control whether there is a hearing.
• The $50,000 simplified-arbitration threshold is exclusive of interest and expenses. A claim for $48,000 in damages plus $5,000 in pre-award interest is still within the simplified procedure if the underlying damages are at or below $50,000. The threshold is calculated on damages alone, not the total potential award.

Default Proceedings

A claimant may request default proceedings against a respondent that:

• Falls within the default-proceedings categories (e.g., a member whose membership has been terminated, suspended, canceled, revoked, or expelled), AND
• Fails to file an answer within the time provided by the Code

How Default Proceedings Work

The default mechanism handles the practical reality that suspended or expelled firms often disappear from the process. The claimant still has to prove the case on submitted materials; nonappearance is not itself sufficient grounds for an award.

What Should You Check on Exam Day?

• Do you know a customer can compel FINRA arbitration without a predispute agreement, but a member cannot compel a customer without one?
• Can you state the simplified arbitration threshold: claims of $50,000 or less get a single arbitrator deciding on the pleadings unless the customer requests a hearing?
• Can you distinguish disputes the Industry Code requires, such as compensation and Form U5 defamation, from statutory discrimination claims, which are not required to be arbitrated?
• Do you know an arbitrator in a default proceeding may not award damages based solely on the respondent's nonappearance?