FINRA Panel Rules on Charles Schwab's Challenge to FINRA Rules Prohibiting Class Action Waiver Clauses

In October 2011, Charles Schwab ("Schwab") began inserting into its customer Account Agreements a class action waiver clause.

Schwab's Account Agreements require arbitration of any dispute arising out of a customer's use of Schwab's services. The waiver language that Schwab began inserting states that:

You and Schwab agree that any actions between us and/or Related Third Parties shall be brought solely in our individual capacities. You and Schwab hereby waive any right to bring a class action, or any type of representative action against each other or any Related Third Parties in court."

Schwab's insertion of this waiver language followed the United States Supreme Court's decision in AT&T Mobility v. Concepcion in which the Supreme Court held that the Federal Arbitration Act preempted state laws that might otherwise limit the ability of companies to include a class action waiver clause in an arbitration agreement.

The AT&T Mobility decision invalidated a California Supreme Court decision, Discover Bank, which had placed some limits on the ability to enforce class action waiver clauses in arbitration agreements. The United States Supreme Court reasoned that the Federal Arbitration Action preempted such state laws.

The Financial Industry Regulatory Authority, Inc. ("FINRA") instituted a disciplinary proceeding against Schwab taking the position that the Schwab class action waiver clause violated FINRA's rules.

It is FINRA's position that it:

has enacted, and the SEC has approved, two applicable rules: first, that class actions cannot be arbitrated in the FINRA forum; and second, that member firms may not limit the rights of public investors to go to court for claims that cannot be arbitrated."

On February 21, 2013, a FINRA arbitration panel ruled on FINRA's and Schwab's cross-motions for summary judgment (Department of Enforcement v. Charles Schwab & Company). The panel found that:

Enforcement [of the FINRA rules preserving judicial class actions] is foreclosed by the Federal Arbitration Act, as construed by the Supreme Court in Concepcion and other decisions. Those decisions hold that adjudicators must enforce agreements to go to arbitration to resolve disputes and must reject any public policy exception that disfavors arbitration, unless Congress itself has indicated an exception to the Act." 

However, the panel also ruled that Schwab's arbitration language violated FINRA Rule 2268(d)(1). Rule 2268(d)(1) specifies the circumstances in which arbitrators may arbitrate consolidated claims. The panel noted that since FINRA rules prohibit arbitration on a class action basis,

it is clear that consolidation [under Rule 2268(d)(1)] is a non-representative type of procedure, distinguished from class actions." 

The panel reasoned that the Federal Arbitration Act does not bar enforcement of Rule 2268(d)(1) because the Act does not dictate how an arbitration forum should be governed and operated or prohibit the consolidation of individual claims. Therefore, Schwab was, inter alia, ordered to "cease using the portion of the Waiver purporting to delimit the authority of the arbitrators" to consolidate individual (non-representative) claims and notify customers that such a limitation is not effective. In addition, the panel fined Schwab $500,000.

While the dispute involved the arbitration provision in Schwab's customer agreements, the panel's decision potentially opens the door for the insertion of similar class action waiver clauses in employment agreements for those working in the financial services industry.

The panel's decision is subject to appeal to, and/or review by, FINRA's National Adjudicatory Council within 45 days.

District Court Finds Class Action Waiver Clauses in Employment Agreements Are Permissible Under FINRA Rules 13204(a) and (b)

On December 4, 2012, in Cohen v. UBS Financial Services, Inc., et al, 12-CIV-2147 ("Cohen"), the United States District Court for the Southern District of New York addressed whether Rules 13204(a) and (b) of the FINRA Code of Arbitration Procedure precluded enforcement of class action waiver clauses in arbitration agreements with financial advisors.

In Cohen, financial advisors filed a putative class action alleging claims for purported violations of the Fair Labor Standards Act, the California Labor Code, and the California Unfair Competition Law.  The financial advisors' compensation plan included an arbitration provision that provided as follows:

[Y]ou and UBS agree that any disputes between you and UBS including claims concerning compensation, benefits or other terms or conditions of employment . . . Will be determined by arbitration . . . By agreeing to the terms of this Compensation Plan . . . , you waive any right to commence, be a party to or an actual or putative class member of any class or collective action arising out of or relating to your employment with UBS . . ."

Rules 13204(a) and (b) of the FINRA Code of Arbitration Procedure state that "class action claims may not be arbitrated under the Code" and that "[a]ny claim that is based upon the same facts and law, and involves the same defendants as in a . . . Putative class action . . . shall not be arbitrated under the Code." 

The financial advisors argued that these rules precluded enforcement of the class action waiver clauses.

The Court disagreed stating that "Plaintiffs' selective reading of the Code as absolutely prohibiting class and collective waiver is incorrect." The Court reasoned that Rule 13204 also provides that its subparagraphs:

do not otherwise affect the enforceability of any rights under the Code or any other agreement. [emphasis in Court's Order.] The rule therefore: (1) recognizes that parties may choose to enter into additional agreements beyond the scope of the Code; and (2) provides that the Code does not affect the enforceability of these additional agreements. That the arbitration agreements here would preclude Plaintiffs from pursuing a class or collective action does not change the Court's view."

FINRA and Charles Schwab Battle over Class Action Waiver Clauses

Last October, Charles Schwab & Company ("Schwab") began inserting into its customer Account Agreements a class action waiver clause.

Schwab's Account Agreements require arbitration of any dispute arising out of a customer's use of Schwab's services. The waiver language that Schwab began inserting states that:

You and Schwab agree that any actions between us and/or Related Third Parties shall be brought solely in our individual capacities. You and Schwab hereby waive any right to bring a class action, or any type of representative action against each other or any Related Third Parties in court."

Schwab's insertion of this waiver language followed the United States Supreme Court's decision in AT&T Mobility v. Concepcion in which the Supreme Court held that the Federal Arbitration Act preempted state laws that might otherwise limit the ability of companies to include a class action waiver clause in an arbitration agreement. 

The AT&T Mobility decision invalidated a California Supreme Court decision, Discover Bank, which had placed some limits on the ability to enforce class action waiver clauses in arbitration agreements. The United States Supreme Court reasoned that the Federal Arbitration Action preempted such state laws.

The Financial Industry Regulatory Authority, Inc. ("FINRA") instituted a disciplinary proceeding against Schwab taking the position that the Schwab class action waiver clause violated FINRA's rules. 

It is FINRA's position that it:

has enacted, and the SEC has approved, two applicable rules:  first, that class actions cannot be arbitrated in the FINRA forum; and second, that member firms may not limit the rights of public investors to go to court for claims that cannot be arbitrated." 

On the same day that FINRA instituted the disciplinary proceeding, Schwab filed a lawsuit, Charles Schwab v. Financial Industry Regulatory Authority, Inc., in United States District Court, Northern District of California, seeking a declaration that FINRA may not enforce its rules to limit class action waiver clauses in arbitration agreements on the ground that such rules run afoul of the Federal Arbitration Act. 

FINRA has noticed a motion to dismiss Schwab's complaint that is currently scheduled for hearing on April 3, 2012. In turn, Schwab has filed a motion for a preliminary injunction against FINRA that is also scheduled for April 3, 2012.   

Barger & Wolen will continue to follow this case as it can impact other financial service and insurance companies. If you have any questions, please contact Gregory Eisenreich at geisenreich@bargerwolen.com.