FINRA Member Firms Promptly Should Review Predispute Arbitration Provisions in Customer Agreements

Morgan Lewis
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Morgan Lewis

Pursuant to FINRA Regulatory Notice 21-16 that was issued on April 21, 2021, FINRA has observed certain practices that could subject firms to disciplinary action concerning predispute arbitration provisions in customer agreements. Given the expense and possible negative publicity associated with such disciplinary actions, firms would be well-advised to promptly review their customer agreements and make any necessary modifications prior to receiving a FINRA inquiry letter. Based on the specific but non-exhaustive areas of concern identified in Notice 21-16 (below), it should be expected that FINRA Staff members will soon be looking at this issue in more detail.

The basis for Notice 21-16 can be found in FINRA Rule 2268, which governs requirements when using predispute arbitration agreements for customer accounts. Rule 2268(a) delineates specific disclosure language that must be used in any customer agreement that contains a predispute arbitration clause.[1] Rule 2268(b) further requires that specified disclosure language be highlighted in the customer agreement and precede the customer signature line. Rule 2268(c) also requires firms to provide a copy of the agreement to customers and other information if requested. In addition, Rule 2268(d) contains broad prohibitions for firms that use predispute arbitration clauses in customer agreements, discussed below.

As a non-exhaustive starting point, however, Notice 21-16 explains that the following provisions in customer agreements could subject firms to FINRA disciplinary action:

  • Provisions that restrict or dictate the location of a potential arbitration hearing
  • Agreements that attempt to limit applicable statutes of limitations, which are distinct from the six-year eligibility period to submit a claim for arbitration under FINRA Rule 12206[2]
  • Agreements that are designed to limit a customer’s right to pursue or participate in a class action lawsuit unless and until the conditions outlined in FINRA Rule 2268(f) are satisfied
  • Provisions that would limit a customer’s ability to file a claim or limit the arbitrator’s ability to make an award, e.g., limiting a firm’s liability to reckless or intentional misconduct[3]
  • Agreements that contain hold harmless or indemnification provisions

In addition to these specific prohibitions, firms should consider the broader prohibitions that are outlined in Rule 2268(d). For example, FINRA Rule 2268(d)(1) prohibits any condition that “limits or contradicts the rules of any self-regulatory organization.” Under Notice 21-16, FINRA asserts that it is unethical, and therefore a violation of just and equitable principles of law under FINRA Rule 2010, for a member firm to seek recovery from a customer the attorney fees that the firm paid as a result of a regulatory review of the member. As a result, there is opportunity for broad regulatory interpretations of FINRA Rules 2010 and 2268(d)(1), among others, which could serve as the basis for disciplinary action in this area if the guidance is not properly followed.

Finally, and similar to the issues identified in Notice 21-16, FINRA Rule 2268(d) prohibits provisions in predispute arbitration agreements that include conditions that:

  • limit the ability of a party to file a claim in arbitration;
  • limit the ability of a party to file any claim in court permitted to be filed in court under the rules of the forums in which a claim may be filed under the agreement;
  • limit the ability of arbitrators to make any award.[4]

Based on Notice 21-16, the likelihood that FINRA soon will be conducting reviews in this area, and the attendant costs and negative publicity associated with a disciplinary action, firms promptly should commence a review of their customer account agreements and make any necessary modifications.

 

[1] See also Rule 2268(f) regarding mandatory disclosure language concerning potential class actions.

[2] See FINRA Rule 12206 (further noting that Rule 12206 does not extend applicable statutes of limitation).

[3] Choice of law provisions are permissible so long as there is a nexus to the governing law. See Notice 21-16.

[4] See Rule 2268(d).

[View source.]

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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