Schwab's class action win a blueprint for other firms

More brokerage firms are expected to demand that customers give up their right to file class actions against them

Feb 24, 2013 @ 12:01 am

By Dan Jamieson

More brokerage firms are expected to follow the lead of The Charles Schwab Corp. and demand that customers give up their right to file class actions against them.

A legal door for the industry to kill class actions was cracked open last Thursday when a hearing panel of the Financial Industry Regulatory Authority Inc. upheld Schwab's use of arbitration agreements that force customers to bring all disputes into Finra-run arbitration forums.

Finra brought charges against Schwab a year ago, claiming that Schwab's arbitration agreement violated its rules. The hearing panel agreed, but said the Federal Arbitration Act prevented Finra from enforcing those rules.

Finra does not allow class-action claims in its arbitration system, and so precluding customers from pursuing class claims in court effectively kills them.

Kevin Carroll, associate general counsel at the Securities Industry and Financial Markets Association, said he was not aware of any other firms using an agreement like Schwab's but anticipated that other firms will craft similar arbitration agreements.

“However, we expect many firms would wait to see if [the decision] is appealed,” Mr. Carroll added.

Representatives of Morgan Stanley Smith Barney, TD Ameritrade Inc. and Wells Fargo Advisors declined to comment. Spokespersons for Bank of America Merrill Lynch and Fidelity Investments did not respond to requests for comment.

Finra enforcers have 45 days from last Thursday to appeal the finding to Finra's National Adjudicatory Council. Finra spokeswoman Nancy Condon said officials at the self-regulatory organization had not decided whether to appeal.

Calling the 48-page hearing-panel decision “robust,” Mr. Carroll said the panel “went to some pains to spell out the rationale and detail its decision in a way to make it more difficult to overturn.”

“The potential consequences [of the case] are huge, because every broker-dealer would like to insulate themselves,” said Joel Beck, founder of The Beck Law Firm LLC and a former Finra attorney.

Because of the importance of the case, Mr. Beck noted that he'd “be surprised if it stands without further review.”

The hearing panel cited a key 2011 Supreme Court case, AT&T Mobility LLC v. Concepcion, which held that a party to an arbitration agreement has no right to participate instead in a class action.

“I certainly understand why the panel ruled the way it did,” said Scott Ilgenfritz, president of the Public Investors Arbitration Bar Association and a partner at Johnson Pope Bokor Ruppel & Burns LLP.

“But it's not a good thing for investors or consumers,” he said. “Every broker-dealer in the country is going to put class action waivers in their arbitration agreements. Why wouldn't they?”

The decision is “a damn train wreck — absolutely ridiculous,” said Heath Abshure, president of the North American Securities Administrators Association and the Arkansas securities commissioner.

He said he is worried that many small investors will be buying risky private placements, thanks to provisions in the Jumpstart Our Business Startups Act, but will have no legal remedies for fraud if they can't participate in class claims.

Plaintiff's attorney Andrew Stoltmann said the Finra panel ruling will lead to more product-failure frauds on a broader scale.

“Typically, 70% to 80% of folks who are defrauded never come forward” with an arbitration claim, he said.

Class actions, however, can be a different story.

In November 2010, Schwab settled a class case, agreeing to pay $235 million to investors who lost money in its ill-fated YieldPlus bond fund.

Mr. Carroll said he doubted that the hearing panel's decision will harm investors, who he said do better in arbitration than court proceedings.

Any harm from the hearing panel decision is to class action lawyers, not investors, Mr. Carroll said.

Regarding the conflict between the Federal Arbitration Act and Finra's rule, “that's a fix Congress has to make,” Mr. Abshure said.

“Good luck with that,” Mr. Ilgenfritz said, given the partisan divide in Washington.

Meanwhile, the hearing panel did not give Schwab a total victory. It found that the company violated Finra rules by attempting to limit the ability of arbitrators to consolidate individual claims in arbitration, and fined it $500,000.

Schwab spokesman Greg Gable said the company has already fixed the offending language in its agreements.

“Schwab is pleased with the panel's decision, which ruled in the company's favor on the central class action waiver issue,” he said in a statement.


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