A FINRA hearing panel has ruled that FINRA rules contravene the Federal Arbitration Act and are unenforceable to the extent that they forbid customer agreements to waive the right to bring class actions. Charles Schwab & Co., FINRA Disciplinary Proceeding No. 2011029760201 (Feb. 21, 2013). The panel interpreted the FINRA rules to preserve judicial class actions as an alternative to arbitration, even when there is a pre-dispute arbitration agreement between a FINRA member firm and its customer. However, rules that override an agreement to arbitrate and allow a party to an arbitration agreement to avoid arbitration represent the kind of hostility to arbitration that the Supreme Court has found unenforceable under the FAA, according to the panel, and these provisions of the rules may not be enforced.
The panel also found, however, that the customer agreement violated FINRA rules when it provided that arbitrators would have no authority to consolidate parties' claims in arbitration. FINRA rules preserve the right to have claims consolidated, and this provision, the panel ruled, is not precluded by the FAA. Consolidated claims are not class actions or representative claims brought on behalf of a group, but are similar individual claims brought by individual claimants. The panel ordered corrective action and a fine of $500,000, but did not impose a censure.
The ruling naturally raises the question whether broker-dealers now can revise their customer agreements and thereby avoid the risk of future customer class actions. FINRA's Department of Enforcement does have the right to appeal to the National Adjudicatory Council, and it is also possible that a FINRA Governor could call for further review by the Board of Governors. If the Council or the Board reverses the panel's ruling, there could also be further appeals to the Securities and Exchange Commission and to a U.S. Court of Appeals. It is far from clear what the ultimate result of any appeals will be; the panel decision itself acknowledges that the interplay of arbitration and class actions remains controversial, and a forthcoming article in the Stanford Journal of Complex Litigation argues that the Securities Exchange Act of 1934 trumps the application of the FAA to FINRA rules. Barbara Black & Jill I. Gross, Investor Protection Meets the Federal Arbitration Act (2013). It should also be noted that the SEC has the authority, under Section 15(o) of the 1934 Act (as added by the Dodd-Frank Act), to limit the use of arbitration agreements, if it finds that such limitations are in the public interest and for the protection of investors.
The FINRA press release announcing the ruling, with a link to the ruling itself, is at
The forthcoming law journal article by Black & Gross is currently available as a working paper, at
John M. Baker
Stradley Ronon Stevens & Young, LLP http://www.stradley.com<http://www.stradley.com/>
1250 Connecticut Avenue, NW, Suite 500
Washington, DC 20036
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