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From Securities Regulation Daily, April 25, 2014

Schwab settles FINRA action over anti-class action terms in customer agreements

By Mark S. Nelson, J.D.

Charles Schwab & Co. (Schwab) has agreed to pay $500,000 and to remove mandatory class action waiver language from customer agreements in order to resolve an enforcement matter contesting its imposition of these arbitration terms on its customers. The settlement follows a decision yesterday by the Financial Industry Regulatory Authority (FINRA) Board of Governors (Board) that reversed a ruling by a hearing panel that found the Federal Arbitration Act (FAA) preempted enforcement of the hearing panel’s finding that Schwab ran afoul of NASD and FINRA rules when it required customers to waive the ability to bring or participate in judicial class action suits.

The Board also affirmed the hearing panel’s findings regarding consolidation of claims, but said the fine imposed on Schwab for that violation must be held in abeyance until the hearing panel determines any fines for Schawb’s class action waiver violation. According to a FINRA press release, however, Schwab’s agreement to settle the matter removed the need to remand the matter to the hearing panel.

Customer statements. Schwab sent new customer agreement terms to its customers in their September 2011 monthly statements. The new terms said customers could not bring or participate in class action suits against Schwab. Under the revised terms, Schwab’s customers also were asked to waive an arbitrator’s authority to consolidate multiple parties’ claims. The upshot of the revised customer agreement was to require Schawb’s customers to accede to bilateral arbitrations of any disputes they might have with Schwab.

The hearing panel concluded that although Schwab’s class action language violated NASD and FINRA rules then in force, the FAA barred enforcement of these rules against Schwab. The hearing panel also found that Schwab’s new customer agreement violated NASD and FINRA rules regarding consolidation of arbitrated claims. For this violation, the hearing panel fined Schwab $500,000 and told the broker to strip the offending language from the customer agreement and tell its customers the provision at issue was void.

No FAA preemption. The Board said the hearing panel erred by finding the FAA barred enforcement of the relevant NASD and FINRA rules. Specifically, the Board said the hearing panel had erred in its conclusion that Congress must directly limit arbitration agreements in a specific law. The Board also rejected Schwab’s argument, which it understood to be that the NASD and FINRA rules at issue are unenforceable because Congress did not give the SEC authority to approve them.

The Board said that several opinions by the Supreme Court reinforce the FAA’s federal policy in favor of arbitration. These decisions also permit limits on arbitration that can arise from external sources, including a contrary Congressional command.

Here, the Board said the Congressional mandate giving the SEC authority to approve the FINRA rules at issue in the Schwab matter is contained in legislation that created the Exchange Act Sec. 15A regulatory framework for broker-dealers. Treating NASD and FINRA rulemaking history as equivalent to legislative history, the Board found no support for FAA preemption of rules barring class action waivers. The Board said the history of the relevant rules indicated a desire to prevent broker-dealers from invoking arbitration agreements to avoid judicial class actions.

Investor protection legislation. The North American Securities Administrators Association (NASAA) said it was pleased with the Board’s decision. Russ Iuculano, executive director of NASAA, noted the Board’s decision would protect the rights of brokerage customers with small claims.

Said Iuculano,”[s]tate securities regulators are pleased that today’s decision by FINRA’s Board of Governors recognizes the danger in Charles Schwab’s attempt to unilaterally change its customer account agreements to force its clients to waive their rights to participate in class-action lawsuits.” He added, “[i]nvestors should be free to join with other investors through the representative class action process to resolve claims that are too costly to bring independently.”

Iuculano also urged passage of the Investor Choice Act of 2013 (H.R. 2998), which would amend the Exchange Act and the Investment Advisers Act to bar mandatory pre-dispute arbitration agreements that, among other things, bar class action suits. The bill, introduced last fall by Rep. Keith Ellison (D-Minn), has 29 co-sponsors and has been referred to the House Financial Services Committee.

The complaint is No. 2011029760201.

Companies: Charles Schwab & Co.; Financial Industry Regulatory Authority; North American Securities Administrators Association

MainStory: TopStory BrokerDealers Enforcement FederalPreemption FINRANews InvestmentAdvisers NASAANews

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