United States: FINRA: The FAA Requires Enforcement Of Judicial Class Action Waiver In Pre-Dispute Arbitration Agreement But Does Not Preempt FINRA Rules Permitting Consolidation Of Multiple Parties' Claims

On February 21, 2013, the Financial Industry Regulatory Authority (FINRA) issued a written decision finding that the Federal Arbitration Act (FAA) bars FINRA from enforcing FINRA Rules intended to preserve judicial class actions when a customer executes a pre-dispute agreement waiving a right to class action claims. However, FINRA ruled that the FAA does not preclude FINRA arbitrators from consolidating claims of multiple parties.


On February 1, 2012, FINRA's Department of Enforcement (FINRA Enforcement) brought a disciplinary action against Charles Schwab & Company, Inc. (Schwab) challenging the enforceability of certain provisions in Schwab's customer account agreements relating to the arbitration of customer claims, namely the "Waiver of Class Action or Representative Action" (Waiver). The Waiver required any claim against Schwab to be arbitrated, and to be arbitrated solely on an individual basis.

The Waiver provided that customers "waive any right to bring a class action, or any type of representative action" against Schwab or any related third party "in court," effectively eliminating judicial class actions. The Waiver also provided that FINRA arbitrators could not join or consolidate individual claims in arbitration, stating that "the arbitrator(s) shall have no authority to consolidate more than one parties' [sic] claims in arbitration."

FINRA Enforcement argued that the language requiring customers to waive their right to bring or participate in judicial class actions was prohibited by FINRA Rule 2268(d)(3), which states that "[n]o predispute arbitration agreement shall include any condition that limits the ability of a party to file any claim in court under the rules of the forums in which a claim may be filed under the agreement." Specifically, FINRA Enforcement argued that because FINRA Arbitration Rule 12204(d) of the Code of Arbitration Procedure for Customer Disputes references class action claims in "court," the complete waiver of any ability to file class action claims in court constituted a prohibited "limit" on a "claim" within the meaning of FINRA 2268(d)(3). In response, Schwab argued that the Waiver did not conflict with FINRA Rules because a class action is a type of procedure, not a claim. FINRA Enforcement further claimed that by requiring customers to waive their right to judicial class actions, the Waiver contradicted FINRA Rule 12204(d) of the Customer Code and thus violated FINRA Rule 2268(d)(1), which prohibits any condition in a pre-dispute arbitration agreement that contradicts a FINRA Rule. Schwab argued that its Waiver did not "contradict" Rule 12204(d), because the Rule does not expressly authorize class actions but, rather, provides only that if a claim is included in a judicial class action the claimant may not simultaneously pursue the claim in an arbitration proceeding.

FINRA Enforcement also challenged the language in the Schwab customer agreement prohibiting arbitrators from consolidating claims of more than one party. Specifically, FINRA Enforcement claimed that this language violated FINRA Rule 12312 of the Customer Code, which provides that one or more parties in an arbitration proceeding may submit multiple claims jointly and grants arbitrators the final authority to decide whether to arbitrate on a consolidated basis. Schwab maintained that its Waiver did not affect the ability of customers to submit claims jointly and that the language was intended to prevent arbitrators from rendering the Waiver ineffective by using consolidation to create class actions.  

The Office of Hearing Officers' Decision

The FINRA Office of Hearing Officers ("Hearing Panel") agreed that Schwab's Waiver contradicted and violated FINRA's Rules "designed to preserve the option of pursuing customer claims in judicial class actions in preference to arbitration." Nonetheless, the Hearing Panel dismissed FINRA Enforcement's challenges to the language precluding customers from bringing their claims as judicial class actions. Although it found that this language contradicted FINRA Rules, the Hearing Panel ruled that these Rules are unenforceable because the FAA forecloses FINRA from enforcing rules that would allow customers who are parties to a pre-dispute arbitration agreement to avoid arbitration. The Hearing Panel explained that "[r]ules 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 repeatedly found inappropriate and unenforceable under the FAA." In reaching its conclusion, the Hearing Panel primarily relied on the Supreme Court's decision in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011) in ruling that "countervailing policy concerns that might counsel against arbitration of a particular kind of dispute – whether state or federal, statutory or regulatory – cannot override the FAA's mandate unless there is a clear expression of congressional intent to carve out an exception to the FAA." Because the Hearing Panel found no clear expression of congressional intent to preserve judicial class actions as an option for customer claims where there is an agreement providing for arbitration of those claims, the Hearing Panel granted Schwab's motion for summary disposition, in part, and dismissed the first two causes of action concerning judicial class actions.

With respect to FINRA Enforcement's claim that the language from Schwab's agreement denying arbitrators the power to consolidate claims in arbitration conflicted with FINRA's Rules, the Hearing Panel found for FINRA Enforcement. The Hearing Panel ruled that the FAA did not preclude enforcement of FINRA's Rules governing the powers of FINRA arbitrators and the procedures for FINRA arbitration. The Hearing Panel explained that the "focus" of the FAA is "on requiring those who have agreed in advance to resolve their disputes by arbitration to go to arbitration after a dispute arises and enforcing any decision the arbitrators may reach, not on regulating the governance of arbitrator forums or arbitration procedures." The Hearing Panel found that the language in Schwab's agreement prohibiting the consolidation of claims related primarily to the "governance of arbitrator forums and arbitration procedures" and improperly attempted to circumscribe the power of FINRA arbitrators. Consequently, the Hearing Panel imposed sanctions in the amount of a $500,000 fine and ordered Schwab to remove the violative language and notify all customers whose agreements contained the language that the provision was void.

Implications for Employers

Although this decision concerned a consumer pre-dispute arbitration agreement, the Hearing Panel's ruling, which becomes final after 45 days in the absence of an appeal to FINRA's National Adjudicatory Council, also affects members of the financial services industry who seek to avoid class action claims with employees who are subject to FINRA's jurisdiction. As a result of this decision, agreements prohibiting class or collective actions of disputes required to be arbitrated in FINRA will likely be enforced by a FINRA arbitration panel. Consequently, employees in the financial services industry will likely be foreclosed from pursuing any type of class action in FINRA because FINRA arbitrators are not permitted to hear such claims.

The Hearing Panel's decision is consistent with a recent ruling by a New York state court judge in Spann v. Bishop Rose & Co. Inc., No. 651910/2011 (Sup. Ct., N.Y. Cnty. Jan. 16, 2013), compelling arbitration of a stockbroker's overtime and wage claims on behalf of himself and others "similarly situated" where his employment agreement called for arbitration of all employment-related disputes under the auspices of FINRA. In that case, an employee sought to avoid FINRA arbitration by maintaining that the class claims were non-arbitrable under the arbitration agreement and FINRA rules, and litigation of the class action in state court was required. The judge found that the stockbroker could not avoid a FINRA rule that prohibits the regulatory body from hearing class actions by styling his claims as a class action.  

Financial services employers also should pay attention to the Hearing Panel's imposition of sanctions for attempting to circumscribe the arbitrators' authority to consolidate claims. As a result, employers in this industry should avoid arbitration agreement language that could be construed as an attempt to circumscribe the powers of FINRA arbitrators with regard to the consolidation of multiple parties' claims.


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