First, Floyd Norris’ business column in the New York Times today discusses a New York federal appeals court case, where the court seems poised to establish new rules on who can be convicted of insider trading. These are rules that sophisticated hedge fund managers will quickly learn in order to avoid prosecution and small unsophisticated investors likely won’t understand. Mr. Norris is not happy about this.
But if he’s concerned about the small investor, he should (hopefully) be happy about the decision issued yesterday by the Board of Governors of the Financial Industry Regulatory Authority (FINRA) “finding Charles Schwab & Co., Inc. violated FINRA rules when the firm attempted to keep investors from participating in judicial class actions by adding waiver language to customer account agreements.” (See our earlier coverage here.) Specifically,
Schwab, the San Francisco-based pioneer discount brokerage, has agreed to pay $500,000 to the Financial Industry Regulatory Authority for violating the group's arbitration rules when it barred clients in 2011 from joining class actions. It had more than 6.8 million clients then, and now has more than 9 million.
In 2013, a FINRA hearing panel said Schwab's class-action ban was valid under the Federal Arbitration Act, even though the ban violated the group's own rules. On Thursday, FINRA's board overturned that finding, determining that the federal act does not preclude FINRA from enforcing its rules.
A little background from Susan Antilla at NYT Dealbook:
Investors generally have not been able to use the public court system for their disputes with their stockbrokers since 1987, when the Supreme Court ruled in Shearson v. McMahon that a brokerage firm could force customers to agree to arbitration. Since then, virtually every firm has added a so-called mandatory arbitration agreement to its new-account documents.…
In the seven months through the end of July, arbitrators granted awards to only 39 percent of claimants, the lowest win rate in five and a half years, based on Finra’s statistics.
Class-action lawsuits, though not always successful, have been one recourse for groups of investors who lose money on the same investment.
So Schwab did what any bad corporate citizen might do:
[I]n 2011, Schwab added a clause to its customer agreement that required clients to agree not to pursue or participate in class-action suits.
That move, however, didn’t sit well with the Financial Industry Regulatory Authority, the private corporation that is the brokerage industry’s self-financed policing arm. The enforcement division of Finra filed a disciplinary action against Schwab [in 2012] to force the firm to do away with the provision on class-action suits. (Schwab has since removed the clause until the Finra proceeding, or possible court appeals, are completed.)
Schwab challenged Finra’s decision and won at a panel hearing on Feb. 21. Finra appealed,
After the ruling in favor of Schwab in February, state securities regulators, investor advocates and Democratic members of Congress took up the cause. The nonprofit advocacy group Public Citizen started an online petition entitled “Stand Up to Chuck: Demand That Charles Schwab Corporation Stop Denying Its Customers’ Rights,” collecting 17,000 signatures.
Had the class action waiver been upheld, “'small, unsophisticated investors [would] have a tougher time preparing to pursue claims against brokers,' said A. Heath Abshure, president of the North American Securities Administrators Association, an organization of state securities regulators. Without class actions as an option, 'no attorney is going to take a securities fraud case for a chance to recover 30 percent of $10,000' in arbitration, Mr. Abshure said."
It would be a welcome surprise to investor advocates if the S.E.C. went as far as to stop brokers from requiring arbitration, but few expect the agency will take such a bold step.
The agency has made no public move to use its authority. John Nester, an S.E.C. spokesman, said in an e-mail that Mary Jo White, the agency’s new chairwoman, was committed to discussing the issues regarding mandatory arbitration agreements with fellow commissioners and staff, but offered no timeline.
But in the meantime, a little rejoicing. Said “Christine Hines, consumer and civil justice counsel at watchdog group Public Citizen, which organized a public campaign to oppose the Schwab waivers and mandatory arbitration clauses in consumer contracts, ‘It's a huge victory for investors.’”