Feb 21, 2013: FINRA announced today that a Hearing Panel issued a Decision in the case of FINRA's Department of Enforcement v. Charles Schwab & Co., Inc. In doing so, the Hearing Panel dismissed two of three causes of the action against Schwab, and found for Enforcement on the remaining cause. The Panel imposed a fine of $500,000 and ordered that Schwab take specific corrective action. The Panel Decision was issued today (2/21/13) and is not final. It may be appealed by either party, or it may be called for review by FINRA's National Adjudicatory Council. I don't know how the case will finally end, but the ending will be very significant to the industry and investors.
The Hearing Panel Decision is about 49 pages long, and takes some time to go through. Here's my attempt at a down and dirty summary based on a quick review (links to the press release and the decision itself are above, so you can access the documents yourself if you are interested):
If I understand it correctly based on a quick read, in the first and second cause of action, Enforcement essentially alleged that amendments to an account agreement(s) (the waiver)between the firm and its clients required clients to waive rights to bring any class action or any type of representative action in court. It would effectively eliminate judicial class actions against the firm. Further, it would put all cases in arbitration, and since arbitration rules prohibit class actions against a broker-dealer in any form, the end result would effectively mean no class action or representative actions at all. The issue here was whether the elimination of judicial class actions violates FINRA rules that "operate to preserve a customer's option to participate in a judicial class action" even when an account agreement contains a pre-dispute arbitration clause.
The panel found that the waiver violates FINRA rules but that the Federal Arbitration Act (the FAA) bars FINRA from preserving judicial class actions as an option despite a pre-dispute arbitration agreement. The Panel's holding was based on Supreme Court cases involving the FAA and applicability of class action waivers.
In the third cause of action, it appears to me that Enforcement alleged that language in the waiver held that the arbitrator(s) would not have authority to consolidate or join more than one party's claims in arbitration before FINRA, despite FINRA rules that grant arbitrators authority to determine joinder and consolidation issues themselves. The issue was whether FINRA has the authority to determine the powers of arbitrators operating under the FINRA arbitration system.
The panel found that this was an attempt to dictate the powers of the arbitrators and was inconsistent with "fundamental operation of FINRA Rule 12132" as well as a requirement that broker-dealers comply with FINRA rules as they are amended from time to time. The panel found that the FAA did not bar FINRA from granting, or modifying, the powers of FINRA arbitrators. For this violation, the panel imposed sanctions.
As mentioned above, the panel decision is not final. Either side could appeal it, or the NAC could call it for review on their own initiative. If the case goes to the NAC, the NAC can affirm, reverse or modify any of the panel's findings.
We'll have to watch and see if this becomes final or goes up on appeal or a call for review. The end result - whatever that is - will be significant. And I expect that if the panel decision stands in its current form, broker-dealers will scramble to modify their own pre-dispute arbitration clause to eliminate judicial class action participation for customer claims against the firm.
Update on Feb 27th: Investment News has reported that FINRA's Department of Enforcement has appealed the hearing panel decision. This means the case will go before the NAC. The case will not be scheduled for an appeal and it will likely be many months before the appeal gets to the NAC, and then many months before a NAC decision is released.
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