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.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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