Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, February 21, 2013

FINRA Hearing Panel Finds that Federal Arbitration Act Preempts FINRA Arbitration Rule

Charles Schwab amended its customer agreement to prohibit customers from bringing class actions in court.  FINRA brought a disciplinary proceeding charging that the provision violated FINRA's rules that prohibit any provisions in customer agreements that purport to take away customers' rights to bring class actions in court. FINRA announced the outcome of the FINRA hearing panel today: 

The panel concluded that the amended language used in Schwab's customer agreements to prohibit participation in judicial class actions does violate FINRA rules, but that FINRA may not enforce those rules because they are in conflict with the Federal Arbitration Act (FAA).

In the third cause of action, the panel found that Schwab violated FINRA rules by attempting to limit the powers of FINRA arbitrators to consolidate individual claims in arbitration. The panel further concluded that the FAA does not bar enforcement of FINRA's rules regarding the powers of arbitrators, because the FAA does not dictate how an arbitration forum should be governed and operated, or prohibit the consolidation of individual claims. The panel ordered Schwab to take corrective action, including removing violative language, and imposed a fine of $500,000. 

Schwab previously announced that it was removing the language that prohibited consolidation of claims.

 Unless the hearing panel's decision is appealed to FINRA's National Adjudicatory Council (NAC) or is called for review by the NAC, the hearing panel's decision becomes final after 45 days. 

I certainly hope that the NAC reviews the matter, because I believe that the hearing panel's conclusion that the FAA preempts the FINRA rule is wrong.  For my (and co-author Jill Gross's) analysis of the issues presented in this matter, see Investor Protection Meets the Federal Arbitration Act, 1 Stanford J. Complex Litig. 1 (2012), available on SSRN .

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