(Reuters) - The U.S. Securities and Exchange Commission has approved a rule that will let securities arbitrators immediately report frauds that may threaten the investing public if they learn about them in the middle of a case.
The agency's approval, published in the Federal Register on Wednesday, ends years of controversy about the proposal, which was sparked by multibillion-dollar Ponzi schemes orchestrated by Bernard Madoff and R. Allen Stanford.
Wall Street's industry-funded watchdog, the Financial Industry Regulatory Authority (FINRA), had been pushing to put the so-called "mid-case referral rule" in place since 2010. Allowing securities arbitrators to voice serious concerns in the middle of a case about possible frauds that could harm investors is a procedure that provides "a necessary means" of alerting FINRA staff to such threats, the SEC wrote in a notice.
Arbitrators must currently wait until the end of a case to alert FINRA staff.
FINRA runs its own securities arbitration system in which investors must resolve their legal disputes with brokerages. The SEC must review all changes to FINRA rules.
Lawyers for brokerages and investors worried how FINRA would handle arbitrators who report suspicious behavior. Arbitrators who continue in a case after referring concerns to FINRA, the lawyers have said, may show bias against certain parties because they already may have come to conclusions before hearing all the evidence. That could make it easier for one party to later challenge a ruling.
Getting a replacement arbitrator up to speed also might prolong a case and increase legal costs.
In January, FINRA withdrew an initial version to tweak it in response to the lawyers' concerns. It refiled the plan with the SEC in February.
FINRA has acknowledged that the rule may cause delays and increase costs in some cases. Nonetheless, "the rule is designed in a way that should make its invocation rare," the SEC wrote. For example, arbitrators must believe that the conduct involved poses a serious threat that is "likely to harm investors unless immediate action is taken," the SEC wrote.
The SEC and FINRA plan to monitor mid-case proceedings in response to concerns. FINRA has agreed to collect statistics on the number of cases in which arbitrators make mid-case referrals for one year after the rule becomes effective, the SEC wrote. The watchdog will then report those figures to the SEC.
It is unclear when the rule will become effective. A FINRA spokeswoman was unable to immediately comment.
Reporting by Suzanne Barlyn; Editing by Cynthia Osterman