Saturday, April 26, 2014

FINRA Board of Governors Upholds FINRA Rules Prohibiting Class Action Waivers in Customer Contracts

FINRA and NASD rules have long provided that customers must arbitrate individual disputes with their brokers, but that class claims can be brought in court (and are not subject to arbitration).

In 2011, after the Supreme Court’s decision in AT&T Mobility v. Concepcion, the brokerage company Charles Schwab amended all of its customer agreements to require that the customer waive the right to bring class claims and agree to resolve all disputes in individual arbitration.

FINRA brought an enforcement action against Charles Schwab for violation of its rules, and in 2013, a hearing panel concluded that the FINRA rules were unenforceable because they conflicted with the Federal Arbitration Act.

On Thursday, that decision was overruled by the FINRA Board of Governors.  FINRA concluded that its rules, promulgated in conjunction with, and under the oversight of, the SEC, represent valid exercises of regulatory authority that override the FAA.

 Obviously, this conclusion raises a lot of interesting legal questions about the authority of the SEC to abrogate the FAA, and conflicts between the Exchange Act and the FAA (Barbara Black and Jill I. Gross have written extensively on this issue).

But the part that immediately interests me is FINRA’s conclusion that even though it is – in its view – merely a private actor, it is subject to restrictions imposed by the FAA. 

The FAA requires that contracts for arbitration be deemed as valid/enforceable as any other contract.  As a result, the FAA has been interpreted to preempt any state law – statutory or common – that purports to invalidate arbitration agreements or render them unenforceable, and the Supreme Court has – at least in recent years – steadfastly refused to find that federal statutory rights are implicitly ill-suited for arbitration.

But if FINRA is a private actor – a point to which I’ll return in a moment – it is difficult to see how the FAA comes into play.  The FAA does not inhibit private actors from reaching whatever contracts they desire – including, in FINRA’s case, contracts with its member organizations to prohibit them from imposing certain contractual conditions on its customers.  If FINRA is a purely private actor, it has no power to make any customer contract imposed in violation of its membership rules any less enforceable or valid than any other contract – all it has is the power to exclude brokerages from its membership and impose fines for violation of its membership rules.  One thing has nothing to do with the other.  Otherwise, arbitration clauses would be more than any other contract clauses – they’d be superclauses, areas of law over which parties are not permitted to bargain.  Nothing in the FAA suggests that it was intended to impede private parties’ bargains – to arbitrate or not – and there is no precedent suggesting that the FAA prohibits private actors from arranging their affairs as they wish.  Cf. Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395 (1967) (“the purpose of [the FAA] was to make arbitration agreements as enforceable as other contracts, but not more so”).   

The only reason that the FAA is implicated in this dispute, in my view, is because FINRA is not a purely private actor – as an SRO, it exercises “quasi-governmental powers.” DL Capital Group, LLC v. Nasdaq Stock Mkt., Inc., 409 F.3d 93 (2d Cir. 2005).  For example, it enjoys from governmental immunity from lawsuits, and – as the Schwab decision itself highlights – its rules have the status of regulations.  In this very case, a district court held that it did not have “jurisdiction” to entertain Charles Schwab’s objections to the FINRA complaint until Charles Schwab “exhausted” its remedies with FINRA, see Charles Schwab & Co v. Fin. Indus. Regulatory Auth., 861 F. Supp. 2d 1063 (N.D. Cal. 2012) – not exactly the kind of power private parties can exercise.  It is precisely because FINRA exercises governmental and regulatory authority that it is capable of running afoul of the FAA.

The Schwab decision, it seems to me, represents a curious case of FINRA trying to have it both ways – to insist that it is merely a private entity whose membership agreements are purely matters of contracts, but also to insist that the rules that govern those entities have the force of government authority behind them.

Ann Lipton | Permalink


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