Finra didn't waste any time last week deciding to appeal a controversial ruling from one of its own hearing panels that upheld The
Charles Schwab Corp.'s use of arbitration agreements to force customers to give up their right to file class actions.
In its ruling the previous week, the panel had agreed with the Financial Industry Regulatory Authority Inc.'s basic claim that Schwab's arbitration agreement violated its rules, but said that it was powerless to act because the federal arbitration statute and subsequent court rulings gave Schwab the legal right to bar class actions.
That ruling was met with protest from lawyers, many of whom make their living bringing class actions on behalf of investors. Be that as it may, they rightly pointed out that every other brokerage firm is likely to follow Schwab's lead and bar investors from filing class actions, forcing them into Finra's arbitration forums.
It can be argued that the lawyers are just trying to protect their fees, which can be substantial in class actions, but state regulators such as Heath Abshure, president of the North American Securities Administrators Association, and William Galvin, Massachusetts' secretary of the commonwealth, also weighed in on preventing investors from bringing class actions.
Calling the decision “absolutely ridiculous,” Mr. Abshure said that he is worried that many small investors will have no remedy for broker fraud if they can't participate in class actions.
This is especially relevant given that more investors are likely to get involved in risky private placements as a result of provisions of the Jumpstart Our Business Startups Act, he said.
Class actions are the “only viable method for small investors to seek redress for the wrongful actions of brokers,” Mr. Galvin said.
Both officials are right.
If class actions are taken off the table, investors who have been victimized by brokers will be hurt. Perhaps just as importantly, a tool that helps keep the brokerage industry honest will no longer be in place.
Schwab and others argue that Finra's arbitration system is the proper venue for investors' grievances. But individual arbitration awards are usually small compared with the multimillion-dollar ones that have come out of class actions.
For example, Schwab agreed to pay $235 million to investors in 2010 to settle a class action in connection with its Yield Plus Bond Fund.
Other brokerage firms have also made large payments in recent years. Presumably, these have more of an influence on firms' future behavior than having to pay an investor an occasional $1 million as a result of an arbitration decision.
If class actions disappear, so will the deterrent value of these payments.
Finra made the right move in appealing its own hearing panel's decision. Unfortunately, reversing it may be an uphill climb, given recent Supreme Court rulings that upheld arbitration agreements in other industries that have also sought to restrict or eliminate class actions.
But just because one industry or company has thwarted class actions doesn't mean that every other will be allowed to do the same thing.
In the event that Finra loses its appeal — and some say this case, too, could end up before the high court — Congress should consider legislation ensuring investors the right to bring class actions. It is the right thing to do, both for them and, ultimately, the securities industry itself.
