FINRA Department of Enforcement recently brought an
enforcement action against Charles Schwab (“Schwab”) after the
firm amended its customer account agreement to include provisions
that would require customers to waive their rights to bring or
participate in judicial class actions against the firm. The amended
agreement also required customers to agree that an arbitrator would
not have authority to consolidate more than one party’s claims.
In the first two causes of action, FINRA alleged that
Schwab’s pre-dispute arbitration agreements which force customers
to waive rights to participate in judicial class claims violate FINRA
Rules 2268(d)(1) and (d)(3) which state, “(d) No pre-dispute
arbitration agreement shall include any condition that: (1) limits or
contradicts the rules of any self-regulatory organization; and (3)
limits the ability of a party to file any claim in court permitted to
be filed in court under the rules of the forums in which a claim may
be filed under the agreement.” FINRA argued that Schwab’s
agreement interfered with FINRA Arbitration Rule 12204(d) which
preserves a customer’s option to file claims as a part of a
judicial class action. Since FINRA has separate rules that prohibit
class actions in arbitrations, customers would be barred from
bringing a class action against Schwab in any forum.
FINRA alleged in its third cause of action that
requiring customers to agree that arbitrators lack authority to
consolidate parties’ claims violates FINRA Rule 2268(d)(1). FINRA
contended that such a provision limits or contradicts FINRA
Arbitration Rule 12312 which covers specific circumstances in which
an arbitrator may consolidate claims.
The parties had differing opinions on how the Federal
Arbitration Act (“FAA”) played a role in the matter. Enforcement
argued that the FAA was irrelevant and inapplicable because the only
determination that need be made when imposing sanctions is whether
Schwab violated FINRA Rules. Schwab’s position was that even if the
waiver violated FINRA Rules, the FAA preempts FINRA rules and bars
their enforcement.
In the Hearing Panel’s order,
the first two claims were dismissed. While the Panel found that
Schwab’s amendments to the customer agreements did violate FINRA
Rules 2268(d)(1) and (d)(3), the rules cannot be enforced in light of
the FAA, as construed by the United States Supreme Court in AT&T
Mobility, LLC v. Concepcion. The Panel stated that the Supreme
Court disfavors rules that override agreements to arbitrate and that
such hostility to arbitration is unenforceable. The Concepcion
case specifically established that class actions are no exception
to the general rule and that a party to an arbitration agreement
cannot undermine the agreement by participating in class actions.
In regard to Enforcement’s third cause of action, the
Panel found that the language which limits the power of arbitrators
to consolidates cases violates FINRA Rule 2268(d)(1) in that the
agreement:
(i) “undermines the fundamental operation of rule
12312 and, in fact, the overall operation of FINRA Arbitration Rules
generally, by depriving FINRA of its authority to grant and
circumscribe the power of arbitrators in FINRA’s forum; and (ii)
the consolidation language undermines the specific authority given to
the arbitrators to join individual claims in specified circumstances.
The Panel also found that the FAA did not bar
enforcement of the rules in this instance because the FAA does not
govern how arbitration forums operate.
Therefore, Schwab was ordered to take corrective action
by removing the language regarding an arbitrator’s power to
consolidate claims and notify customers that such language is not
effective. Schwab was also ordered to pay a fine of $500,000.
FINRA still has the option of appealing to the National
Adjudicatory Council within 45 days of the hearing panel’s
decision. Thus, as it stands, while pre-dispute arbitration
agreements that require a customer’s waiver of class claims may be
volatile of FINRA Rules, such rules cannot be enforced to allow
sanctions against FINRA member firms. Essentially, firms could
effectively avoid being subject to class claims in any forum. This
may prompt FINRA to reevaluate class arbitration rules.
