The End of Mandatory Arbitration Clauses in Brokerage Agreements?

by Jamie Sadler

State securities regulators and congressional Democrats are urging the Securities and Exchange Commission to end mandatory arbitration clauses in brokerage contracts.  Under the Dodd-Frank Act of 2010, Congress authorized the SEC to prohibit or restrict arbitration agreements for both broker-dealers and investment advisors, however the SEC has not exercised this power.

Proponents of mandatory arbitration clauses in brokerage agreements argue that arbitration is the fastest and most efficient way for investors to bring claims against their brokers or investment advisors. These proponents argue that if claimants are forced to litigate their cases in court, the exorbitant legal fees, which can far exceed the value of the actual claims, would deter many claimants.

State regulators and a group of 37 congressional members who sent a letter to the SEC in early May 2013, argue that investors should have the ability to choose the forum in which to bring their claims. They argue that giving investors this choice is more equitable than forcing investors to bring their claims before an arbitration panel, and ultimately, having that choice will increase participation in capital markets.

This action by state securities regulators and congressional members was largely a response to a FINRA ruling that allowed Charles Schwab to include of a provision in its brokerage agreements that forced its customers to waive their right to participate in class-action lawsuits.  A spokesman for Charles Schwab stated that the company amended its brokerage agreement contracts to include the class action waiver clause because class actions too often benefit class action lawyers rather than their clients. FINRA has a rule that prohibits brokers from limiting class-action suits. However, when FINRA’s enforcement division brought a claim against Charles Schwab for violating the FINRA rule, a hearing panel held that the regulator could not enforce this rule because it was in conflict with the Federal Arbitration Act.

State securities regulators and the congressional members argued that the panel’s decision will likely lead to other brokerage firms to include similar class action waivers. In conjunction with forcing investors to participate in arbitration, the regulators and congressional members argued that a prohibition on the ability to bring class action lawsuits will leave investors with small claims without an economically feasible forum to pursue their claims because of high legal costs.  As such, the regulators and congressional members requested that the SEC overturn the panel’s decision and urged the SEC to get rid of the mandatory arbitration clauses.