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FINRA Appeals Schwab’s Big Win Regarding Customer Class-Action Waivers

In October 2011, Charles Schwab & Company, Inc. (“Schwab”) amended its customer Account Agreement by adding language to include a Waiver of Class Action or Representative Action clause (“Waiver Clause”), which required Schwab customers to waive their right to participate in a class action lawsuit against the firm, and instead arbitrate any disputes with the broker-dealer on an individual basis before the Financial Industry Regulatory Authority, Inc. (“FINRA”). This amendment, which was reportedly sent by Schwab to approximately 7 million customers, is extremely significant because if the Waiver Clause becomes effective, Schwab will eliminate the risk of customer class actions. It is conceivable that every other broker-dealer would follow suit, and eventually every customer of a SEC regulated broker-dealer would be precluded from bringing a class action. This makes sense because class actions are costly and expose the broker-dealer to significant potential liability. However, Schwab provides an alternative basis in explaining why it amended its customer Account Agreement to include the Waiver Clause: “[Schwab] believes customers are better served through the existing FINRA arbitration process and that class action lawsuits are cumbersome and less effective means of resolving disputes-for both parties. See

In February 2012, the FINRA Department of Enforcement (“FINRA Enforcement”) filed a Disciplinary Proceeding Complaint against Schwab alleging that the Waiver Clause in the amended Account Agreement violated various FINRA Rules. See FINRA Disciplinary Proceeding No. 2011029760201. Specifically, the first and second causes of action in the Complaint alleged that Schwab’s Waiver Clause violated FINRA Rules 2268(d)(3) and 2010 which prohibits a member firm from including a condition in a predispute arbitration agreement that, “limits 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,” or that “limits or contradicts the rules of any self-regulatory organization.” FINRA Enforcement further alleged that Schwab’s Waiver Clause violated FINRA Rule 12204 which permits customers to bring and participate in class actions before FINRA. The third cause of action in the Complaint alleged that the Waiver Clause violated FINRA Rules 2268(d)(3) and 2010 in that it prohibited the ability of arbitrators from consolidating claims of more than one party, which is permitted pursuant to FINRA Rule 12312.

Recently, a FINRA Hearing Panel, which was comprised of three neutral panelists appointed by the FINRA Office of Hearing Officers, issued a Hearing Panel Decision Granting In Part and Denying In Part the Parties’ Cross-Motions For Summary Dispositions (“Decision”). The FINRA Hearing Panel Decision dismissed the first and second causes of action and determined that even though the Waiver Clause in Schwab’s amended customer Account Agreement violates FINRA rules, “the Federal Arbitration Act bars enforcement of those rules to the extent that they require that customers be given the option to bring their claims in court in the form of judicial class actions, despite any pre-dispute agreement to resolve disputes in arbitration.” See Hearing Panel Decision, dated February 21, 2013. As such, the FINRA Hearing Panel determined that FINRA could not prevent Schwab from requiring customers to waive their rights to participate in class-action lawsuits since the recent United States Supreme Court Decision, AT&T Mobility LLC vs. Concepcion, 131 S.Ct. 1740 (2011), held that, pursuant to the Federal Arbitration Act, class action arbitration waivers in consumer contracts are enforceable, even when class action participation would be preempted.

With regard to the third cause of action FINRA Enforcement brought against Schwab, the FINRA Hearing Panel determined that Schwab violated FINRA rules by attempting to limit arbitrators’ ability to consolidate individual claims in arbitration. As a result, the FINRA Hearing Panel fined Schwab $500,000 and ordered the firm to remove the language purporting to limit the authority of the arbitrators from its arbitration agreements, and send notice of such to its customers.

On February 19, 2013, FINRA released the following statement regarding the FINRA Hearing Panel’s Decision: “the language used in Schwab’s customer agreements to prohibit participation in judicial class actions does violate FINRA rules, but that FINRA may not enforce those rules because they are in conflict with the Federal Arbitration Act.”

This Decision has drawn significant attention with financial services professionals and regulators. Indeed, Massachusetts Secretary of the Commonwealth, William F. Galvin, wrote a letter to Schwab on February 26, 2013 requesting that Schwab rethink the use of the waiver language in its customer agreement since he believes class actions are often, “the only viable method for small investors to seek redress for the wrongful actions of their brokers.” Mr. Galvin’s letter stated, “I . . . am calling upon your firm as a good corporate citizen to re-evaluate its position on pre-dispute arbitration clauses that deny investors the choice of a class action lawsuit.”

Lax & Neville LLP effectively assists investors, on both a regional and national level, that may have suffered losses as a result of their broker dealer sales practice abuses in FINRA. Please contact our team of securities fraud attorneys for a consultation at (212) 696-1999.

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