- FINRA’s Mandatory Arbitration Provisions
The Financial Industry Regulatory Authority (“FINRA”) is a self-regulatory organization that is mandated to oversee the activities of its member brokerage firms, educate investors, and work with the Securities and Exchange Commission (“SEC”). Additionally, FINRA operates the largest securities arbitration forum in the country, with over 3,500 cases filed last year.[1] A unique feature of FINRA arbitration is its prohibition of forum selection clauses. These provisions stipulate the agreed-upon court where an injured party to a contract may dispute the matter. Consequently, these types of clauses clash with FINRA’s mandatory arbitration requirement. In a dispute between a customer and a broker-dealer, FINRA Rule 12200 mandates arbitration if arbitration is “[r]equested by the customer” and “[t]he dispute arises in connection with the business activities of the member.”[2] FINRA Rule 13200 requires arbitration in an intra-industry dispute such as between a broker-dealer and an employee.[3]
- The Judicial Split and Regulatory Notice 16-25
In recent judicial decisions, various federal circuit courts have challenged FINRA’s long-standing position on forum selection clauses. The Ninth Circuit upheld significantly similar forum selection clauses that waived FINRA arbitration.[4] These forum selection clauses stated that “all actions and proceedings … shall be brought in the … United States District Court for the District of Nevada.”[5] The clauses referenced a federal judicial forum, were of a mandatory nature (containing “shall”), and contained the “all actions and proceedings” phrase (with arbitration falling into this category).[6] All these factors contributed to the court’s holding that the parties had a reasonable expectation that any disputes would be litigated in federal court.[7] While an express waiver of FINRA arbitration in the provision may be preferable, it was not mandatory.[8] Instead, the contract was only required to “clearly indicate” the parties’ agreement not to use FINRA’s arbitration forum in the event of a dispute.[9] Following the Ninth Circuit, the Second Circuit upheld the enforcement of a waiver for FINRA arbitration, noting the importance of that clause’s mandatory and all-inclusive factor.[10] Conversely, the Third and Fourth Circuits have deviated from the Second and Ninth Circuits and focused on whether the clauses mention arbitration, the customer’s knowledge of the FINRA arbitration rule, and the waiver of this right.[11] This approach, however, does not explicitly prohibit forum selection clauses.[12] The Fourth Circuit rejected one forum selection clause, which was similar to the one examined by the Ninth Circuit in City of Reno, and noted that there was no reference to FINRA arbitration being superseded, waived, or displaced by the provision.[13] The Third Circuit emphasized the need for specific language to allow a customer, who should be well-informed of his or her right to arbitrate under FINRA rules, to decide whether to allow the waiver.[14] Further, the recognition of an implicit waiver would negatively impact investors.[15]
FINRA has pushed back against some of these court decisions and stated that the application of arbitration waivers in forum selection clauses is against public policy.[16] It issued Regulatory Notice 16-25 which reiterates that customers have the affirmative right to request FINRA arbitration and is a protection that cannot be contracted away.[17] However, there are two considerations worth noting. First, this guidance has not gone through the FINRA rule-making process, meaning that the legal standing here is still largely based on the FINRA rules themselves. Second, some courts are aware of FINRA’s position but still uphold clauses that waive arbitration. For instance, the Second Circuit noted that there have been cases “where the arbitration provisions of a self-regulatory organization, such as FINRA, ‘may be overridden by more specific contractual terms.’”[18]
- Reconciling the Judicial and FINRA Divergences
FINRA’s current recommendation is for parties to use non-exclusive forum selection provisions which state that a customer can always request FINRA arbitration.[19] In light of this proposal, the approach taken by the Third and Fourth Circuits serves a feasible middle ground between the other circuits and FINRA. A forum selection provision, which includes an explicit reference to waiving arbitration and ensures that the customer clearly understands this, seems more likely to pass both judicial and FINRA scrutiny. Allowing such a clause would remain aligned with FINRA’s major objective of ensuring customer protection, especially for customers who seek this option as bargained-for consideration.[20] Regardless of what language in forum selection clauses is ultimately deemed acceptable, it is important to find a reconcilable solution to promote consistency and provide clear standards across the federal jurisdictions for both broker-dealers and the investing public.
[1] FINRA, Dispute Resolution Statistics, http://www.finra.org/arbitration-and-mediation/dispute-resolution-statistics (last visited Jan. 20, 2019).
[2] FINRA Rule 12200, http://finra.complinet.com/en/display/display.html?rbid=2403&element_id=4106.
[3] FINRA Rule 13200, http://finra.complinet.com/en/display/display.html?rbid=2403&element_id=4203.
[4] Goldman, Sachs & Co. v. City of Reno, 747 F.3d 733, 736–37 (9th Cir. 2014).
[5] Id.
[6] Id. at 744, 746–47.
[7] Id.
[8] Id. at 744.
[9] Id. at 741.
[10] See Credit Suisse Sec. (USA) LLC v. Tracy, 812 F.3d 249, 254 (2d Cir. 2016) (stating that “[w]e have held in several cases that an SRO’s arbitration provisions are default rules which may be overridden by more specific contractual terms”); see also Goldman, Sachs & Co. v. Golden Empire Schs. Fin. Auth., 764 F.3d 210, 215 (2d Cir. 2014).
[11] Reading Health Sys. v. Bear Stearns & Co., 900 F.3d 87, 102–03 (3d Cir. 2018); UBS Fin. Servs., Inc. v. Carilion Clinic, 706 F.3d 319, 328 (4th Cir. 2013).
[12] Reading Health Sys., 900 F.3d at 103; UBS Fin. Servs., Inc., 706 F.3d at 328 (noting that “the obligation to arbitrate under FINRA Rule 12200 can be superseded and displaced by a more specific agreement between the parties”).
[13] UBS Fin. Servs., Inc., 706 F.3d at 329–30.
[14] Reading Health Sys., 900 F.3d at 103.
[15] Id.
[16] Final Report and Recommendations of the FINRA Dispute Resolution Task Force (Dec. 16, 2015), page 49.
[17] FINRA, Regulatory Notice 16-25: Forum Selection Provisions (July 2016).
[18] Merrill Lynch, Pierce, Fenner & Smith Inc. v. Oliver, 681 Fed. App’x 64, 66 (2d Cir. 2017) (internal citations omitted); see also FINRA, FINRA Rulemaking Process, http://www.finra.org/industry/finra-rulemaking-process (last visited Jan. 20, 2019).
[19] FINRA,Regulatory Notice 16-25: Forum Selection Provisions (July 2016).
[20] FINRA, Customer Information Protection, http://www.finra.org/industry/customer-information-protection (last visited Jan. 21, 2019).
