Schwab pays $500,000 to settle Finra dispute over class action waivers

Apr 24, 2014 @ 5:15 pm

By Mason Braswell and Mark Schoeff Jr.

charles schwab corp, finra, arbitration
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(Bloomberg News)

In a victory for opponents of mandatory arbitration, Charles Schwab & Co. has agreed to pay $500,000 and remove a controversial provision from customer contracts that would require arbitration of class action claims.

The settlement announced Thursday follows a ruling by the Board of Governors reversing a 2013 decision that claimed such waivers were allowed under the Federal Arbitration Act. In this decision, the board found that Finra's membership agreements, which prevent class action waivers, trumped the Federal Arbitration Act.

“This settlement is a victory for investors,” said Jason Doss, an attorney who represents investors and president of the Public Investors Arbitration Bar Association. “These class action waiver provisions are not going to impact harmed investors if they choose to file a class action.”

The settlement stems from a complaint by the Financial Industry Regulatory Authority Inc. in February 2012 that Schwab had violated Finra rules by including class action waivers in more than 6.8 million customer contracts.

It's unclear how this ruling will affect other securities firms, which include similar language in their contracts.

Today's development marks the latest twist in what has been a very public battle.

In February 2013, a Finra panel ruled that the Federal Arbitration Act superseded the regulator's rules and allowed Schwab to include language in its customer contracts blocking customers from consolidating multiple claims in arbitration or participating in judicial class actions, even when the agreement violated Finra rules.

Both sides appealed to Finra's National Adjudicatory Council. Finra said that its board has the authority to “call for review and issue a decision involving a matter before the National Adjudicatory Council.”

In this case, the board stepped in and overturned the hearing panel's initial decision, finding that “the FAA does not preclude Finra's enforcement of its rules,” the board said in its decision.

Schwab temporarily removed the provision in May last year — pending a final decision on the matter.

Greg Gable, a spokesman for Schwab, suggested the discount brokerage firm had a change of heart and agreed to remove the provision permanently as part of the settlement.

“Over the last year, we heard clearly that a number of our clients and members of the general public have strong feelings about maintaining access to class action lawsuits,” he said in a statement. “We have agreed with Finra to remove the waiver from our account agreements, rather than seeking further legal appeals on the matter.”

Schwab is required to notify customers that the stipulation has been withdrawn from its customer contracts and is no longer in effect.

Mr. Doss said that Schwab could have continued to challenge the board's ruling or fight the decision in federal court, but it would have been costly.

“Maybe they made a decision to cut their losses,” he said.

Former former Finra director of arbitration George Friedman said Schwab was “misreading Supreme Court cases on the class action waiver” and making “a specious argument.” The action by the Finra board is a warning to the industry to tread carefully when it comes to modifying mandatory arbitration.

“The decision is a clarion call to brokerage firms that Finra will not tolerate attempts to make arbitration clauses unfair,” said Mr. Friedman, owner of an eponymous consulting firm.

A group representing state securities regulators said that the decision had put substantial weight behind their calls for an end to mandatory arbitration clauses.

“Schwab's decision to include class action waivers in the arbitration provisions of its customer contracts is yet another example of the harmful effects of mandatory arbitration clauses and heightens the need to pass the Investor Choice Act,” said Russ Iuculano, executive director of the North American Securities Administrators Association. “These agreements, especially when coupled with class action waivers, effectively eliminate any reasonable chance for retail investors with small-dollar claims to have their claims heard in an unbiased and fair forum.”

But S. Lawrence Polk, a partner at Sutherland Asbill & Brennan, said the Finra board decision was a statement about Finra's ability to enforce its own rules and is unlikely to lead to a re-examination of mandatory arbitration, which is included in almost every brokerage customer contract.

“This ruling will not have an impact one way or the other on [attempts] to put to an end to mandatory arbitration,” Mr. Polk said.

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