Forum Selection Provisions Involving FINRA Member Firms

 

Earlier this month, FINRA issued Regulatory Notice 16-25 (Notice) concerning forum selection provisions and FINRA member firms.  The Notice reaffirms the right of customers and associated persons to arbitrate disputes with FINRA member firms in the FINRA arbitration forum and under FINRA arbitration rules.  We examine this Notice and identify some takeaways below.

Background:  Predispute Arbitration Agreements Under FINRA Rules

FINRA Rule 12200 of the FINRA Code of Arbitration Procedure for Customer Disputes (Customer Code) requires parties to arbitrate their dispute in three circumstances:  (i) arbitration under the Customer Code is required by a written agreement or requested by the customer; (ii) the dispute is between a customer and a member or associated person of a member, and (iii) the dispute arises in connection with the business activities of a member or associated person, except in certain cases involving insurance-related activities.

Predispute arbitration agreements are standard fare in customer account opening documents. FINRA Rule 2268 sets forth requirements that apply to these agreements.  This rule requires that the predispute arbitration clause must be highlighted in the account opening documents and preceded by a disclosure that the agreement contains a predispute arbitration clause and that by signing arbitration agreement the parties agree as follows:

  1. All parties to this agreement are giving up the right to sue each other in court, including the right to a trial by jury, except as provided by the rules of the arbitration forum in which a claim is filed.
  2. Arbitration awards are generally final and binding; a party’s ability to have a court reverse or modify an arbitration award is very limited.
  3. The ability of the parties to obtain documents, witness statements and other discovery is generally more limited in arbitration than in court proceedings.
  4. The arbitrators do not have to explain the reason(s) for their award unless, in an eligible case, a joint request for an explained decision has been submitted by all parties to the panel at least 20 days prior to the first scheduled hearing date.
  5. The panel of arbitrators may include a minority of arbitrators who were or are affiliated with the securities industry.
  6. The rules of some arbitration forums may impose time limits for bringing a claim in arbitration. In some cases, a claim that is ineligible for arbitration may be brought in court.
  7. The rules of the arbitration forum in which the claim is filed, and any amendments thereto, shall be incorporated into this agreement.

FINRA Rule 2268(d) prohibits predipsute arbitration agreements from including any condition that (i) limits or contradicts the rules of any self-regulatory organization, or (ii) limits the ability of a party to file any claim in arbitration.

With respect to disputes between firms and associated persons (so-called industry disputes), FINRA Rule 13200 states that these disputes must be arbitrated under the FINRA code, as well.

The Notice

In its Notice, FINRA warned member firms in fairly stern terms that they cannot contract out of arbitration rules via private agreement.  In particular, the Notice reminds member firms that “customers have a right to request arbitration at FINRA’s arbitration forum at any time and do not forfeit that right under FINRA rules by signing any agreement with a forum selection provision specifying another dispute resolution process or an arbitration venue other than the FINRA arbitration forum.”  The Notice also reminds member firms that FINRA rules “do not permit member firms to require associated persons to waive their right to arbitration under FINRA’s rules in a predispute agreement,” either.

Background:  Appellate Court Decisions Hold Forum Selection Clauses Supersede Rule 12200

FINRA appears to have issued the Notice in the wake of several federal appellate court decisions that held that forum selection clauses superseded the requirements of FINRA Rule 12200.  The forum selection clauses at issue in these cases purported to require customers to arbitration in a private arbitration forum, to litigate in state or federal court, etc.  See, e.g., Goldman, Sachs & Co. v. Golden Empire Schs. Fin. Auth., 764 F.3d 210 (2d Cir. 2014) (holding forum selection clause requiring all actions and proceedings to be brought in federal court supersedes agreement under FINRA Rule 12200 to arbitrate customer disputes); Goldman, Sachs & Co. v. City of Reno, 747 F.3d 733 (9th Cir. 2014) (holding forum selection clause in broker-dealer agreements between the parties superseded the “default obligation” to arbitration under FINRA rules).

Background:  Firms Using Private Ordering in Industry Disputes, Too?

While the Notice does not make mention of specific firms, specific cases, or specific practices, industry observers have noted that the Notice also follows a lawsuit by former Credit Suisse brokers that alleges that the company engaged in arbitration shopping in violation of industry rules when it filed notice to withhold deferred compensation from former employees who jumped to other firms. Morgan Stanley also reportedly had increased its use of private arbitration forums in recent times.

FINRA Arbitration Rules Cannot be Waived, Modified Via Contract

In the Notice, FINRA rejects the assumption underlying the Appellate court decisions cited above that the duty to arbitrate under FINRA Rules is contractual in nature and thus can be waived or superseded.  In this regard, the Notice states that (i) the Securities and Exchange Act of 1934 requires most firms to be members of FINRA; (ii) FINRA’s rules are approved by the Securities and Exchange Commission; and (iii) FINRA’s rules are binding on member firms and associated persons and “have the force of federal law.”

Takeaways

  1. FINRA member firms may face disciplinary action if they seek to prevent customers from bringing disputes before a FINRA arbitration forum.
  2. Firms that intend to use a forum selection provision in a predispute arbitration agreement with a customers should include language making it clear that the forum selection clause does not prohibit or restrict the customer from requesting arbitration in the FINRA arbitration forum as specified in FINRA rules.
  3. Firms should remember that any attempt to override the requirements of Rule 13200 in industry disputes would violate FINRA rules, as well.
Christine Chung

Christine Chung

This blog is edited by Christine Sgarlata Chung, Associate Professor of Law at Albany Law School, and Co-Director, Institute for Financial Market Regulation. In addition to her work in academia, Professor Chung previously served as a Branch Chief in the Enforcement Division of the Securities and Exchange Commission and as a partner at a large Boston-based law firm.
Christine Chung