By Suzanne Barlyn

Jan 28 (Reuters) - A proposal to limit when people with certain ties to the securities industry are called to decide cases of aggrieved investors is a step in the right direction, but does not go far enough to please some arbitration lawyers.

Wall Street's industry-funded watchdog wants to exclude people associated with hedge funds and mutual funds from being on one of two rosters of people who hear - and decide - legal disputes between brokerages and their customers. The Financial Industry Regulatory Authority (FINRA) recently asked the U.S. Securities and Exchange Commission to approve the measure.

The move, however, does nothing to address a longstanding controversy over whether those with previous ties to the securities industry should be allowed to decide cases as "public arbitrators," a category of FINRA arbitrators who are not required to have Wall Street experience. Public arbitrators - who may include other kinds of professionals, like teachers or interior designers - round out the perspectives of the three-person panels that decide most cases.

Until recently, FINRA required those panels to include one non-public arbitrator, who must have significant industry experience. But since 2011 investors have been allowed, in some cases, to choose a panel of all public arbitrators. Yet FINRA allows people who have been out of the industry for at least five years - and who have worked in it as many as 20 years - to serve on such panels.

At issue is whether public arbitrators with Wall Street ties may be biased toward the industry in investor actions. Brokerage agreements typically require clients to resolve legal disputes through arbitration.

Public arbitrators who have left the securities industry may still hold sympathetic views toward brokerages, said Robert Uhl, a securities lawyer in Beverly Hills, California, who represents investors.

"The eye of the needle is fairness and the appearance of non-bias. That's all the public wants," said Uhl, who is also director of the Investor Advocacy clinic at Pepperdine University School of Law.

BABY STEPS

The most recent plan to bypass people associated with hedge funds and mutual funds for its public pool is the latest in a series of measures aimed at improving investor perceptions of fairness, the regulator wrote in its SEC proposal. (FINRA made other tweaks to its public arbitrator rules between 2004 and 2008.)

The plan would also require that other professionals with specific Wall Street ties, including certain lawyers who have advised financial companies in investment disputes, wait two years after ending those affiliations before serving as public arbitrators. Comments to the SEC are due on Feb. 7.

Of FINRA's 6,000 arbitrator candidates, 3,600 are deemed public arbitrators. The proposal formalizes a two-year-old policy and would not affect a significant number of those presently available, a FINRA spokeswoman said.

FINRA does not track how many of its public arbitrators have industry experience, but some lawyers say the figure could be close to 1,000. The regulator does require "cooling off" periods. For example, non-public arbitrators who leave the securities industry must wait five years before transitioning to the public arbitrator list.

Yet the ultimate key to fairness, for many investors' lawyers, is the amount of time public arbitrators spend in the securities industry. Some believe public arbitrators should have no ties to the securities industry, said Scott Ilgenfritz, president of the Public Investors Arbitration Bar Association (PIABA), a group of securities arbitration lawyers who represent investors. Other lawyers have called for a five-year cap on securities industry affiliations.

SELECTION PROCESS

Lawyers have different criteria for selecting arbitrators, depending on their claim, a FINRA spokeswoman said. Some like arbitrators who understand how the industry works, while others do not. Lawyers learn of arbitrators' backgrounds during a selection process and can prevent them from serving, she said. They can strike a limited number of arbitrators from the candidate lists they receive. Some lawyers say they must strike public arbitrators with industry experience in about a third of their cases.

Lawyers for brokerages say bias concerns stem from a faulty assumption that arbitrators with industry ties are inclined to help brokerages, said Marc Dobin, a lawyer in Jupiter, Florida. Arbitrators who are knowledgeable about Wall Street are sometimes even harder on the industry because they understand certain nuances and procedures, he said. Industry knowledge also helps the process move more swiftly - a benefit to both parties, said Terry Weiss, a lawyer for Greenberg Traurig LLP in Atlanta.

Still, FINRA arbitration statistics released for 2012 showed that in 210 cases it reviewed, customers were awarded damages in 49 percent of cases decided by three public arbitrators. Panels including an industry-affiliated arbitrator awarded investors damages in 33 percent of cases.

Thinning the ranks of former industry professionals from the public arbitrator list would lead to even more favorable settlements for investors, says Uhl, the Beverly Hills-based lawyer.

"There's no question that barring any persons who have significant industry experience will further improve the win rates," Uhl said.

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