Third Circuit Rules Broker’s Forum Selection Clause Doesn’t Override FINRA Arbitration

September 24, 2018
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The Third Circuit Court of Appeals Recently Held that a Forum Selection Clause in a Brokerage Agreement Doesn’t Negate a Requirement to Submit to Arbitration

3rd Circuit Court of Appeals Makes Key Decision Regarding FINRA's Forum Selection Clause
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In a precedential opinion, the Third Circuit Court of Appeals recently held that a forum selection clause in a brokerage agreement doesn’t negate a requirement to submit to arbitration pursuant to Financial Industry Regulatory Authority (FINRA) Rule 12200. The Third Circuit’s decision in Reading Health System v. Bear Stearns & Co. n/k/a J.P. Morgan Securities LLC adds to the growing circuit split on the issue.

Dispute Over Brokerage Agreement Provisions

As FINRA members, broker-dealers are typically required by FINRA Rule 12200 to arbitrate all claims asserted against them by their customers. In response, broker-dealers are increasingly inserting forum-selection clauses in their customer agreements that do not reference the customer’s right to arbitrate. The federal courts are currently split on whether such clauses can actually override FINRA Rule 12200. As the Third Circuit acknowledged, “the Second and Ninth Circuit Courts of Appeals have held that a materially identical forum-selection clause requires the parties to litigate in federal court, while the Fourth Circuit Court of Appeals has held that [FINRA] Rule 12200 requires the parties to arbitrate, notwithstanding the presence of a forum-selection clause.” 

The case before the Third Circuit involved several broker-dealer agreements between Bear Stearns & Co., now known as J.P. Morgan Securities LLC (hereinafter J.P. Morgan), and Reading Health System. The agreements were executed in connection with four separate offerings of auction rate securities (ARS), through which Reading issued more than $500 million in debt. Two of the contracts included forum-selection clauses providing that “all actions and proceedings arising out of” the agreements or underlying ARS transactions had to be filed in the District Court for the Southern District of New York.

After the ARS market collapsed, Reading filed a statement of claim with FINRA, alleging that J.P. Morgan engaged in unlawful conduct in connection with the ARS offerings.  J.P. Morgan refused to arbitrate, arguing that Reading by agreeing to the forum-selection clauses had waived its right to arbitrate.  To resolve the dispute, Reading filed a declaratory judgment action in the District Court for the Eastern District of Pennsylvania to compel FINRA arbitration. In response, J.P. Morgan moved to transfer the action to the Southern District of New York, based on the forum-selection clauses. The Pennsylvania District Court denied the motion to transfer the action and ordered J.P. Morgan to submit to FINRA arbitration.

Third Circuit Compels FINRA Arbitration

The Third Circuit affirmed, ruling that the case should be decided via FINRA arbitration. In reaching its decision, the appeals court noted that two competing rights were at stake — FINRA Rule 12200 grants Reading the right to resolve its substantive claims against J.P. Morgan through FINRA arbitration, while the forum-selection clause grants to J.P. Morgan the contractual right to litigate those claims in District Court.

Agreeing with the Fourth Circuit, the Court concluded that the forum-selection clauses in the broker-dealer agreements are insufficient to waive Reading’s right to arbitrate under FINRA Rule 12200. The Third Circuit cited its decision in Patten Securities Corp., Inc. v. Diamond Greyhound & Genetics, Inc., which held that a broker-dealer agreement containing a provision in which the parties consented to the jurisdiction of the New Jersey courts did not implicitly waive the customer’s right to arbitration under NASD’s compulsory arbitration rule. As the panel explained:

Although Patten involved a forum-selection clause with permissive language, its reasoning leads us to the same conclusion here: Reading did not waive its right to arbitrate by agreeing to the broker-dealer agreements. As in Patten, we begin by noting that any reference to arbitration is “[c]onspicuously absent from” the forum-selection clauses. Without a specific reference to arbitration, the forum-selection clause requiring parties to litigate actions “arising out of” the contract and related transactions lack the specificity required to advise Reading that it was waiving its affirmative right to arbitrate under FINRA 12200. Indeed, the Fourth Circuit stressed in Carilion Clinic that “[n]o word even suggesting supersedence, waiver, or preclusion [of the right to arbitrate] exists” in the forum-selection clause. As we explained in Patten, had J.P. Morgan wanted Reading to waive its right to arbitrate, it should “have made a reference to arbitration” in either the waiver provision or forum- selection provisions of the broker-dealer agreements.

Acknowledging that its decision is at odds with its sister courts, the Third Circuit panel noted that it was necessary to “begin the process of closing this contractual loophole to FINRA’s compulsory arbitration rule.” In further support, the court stated: “By condoning an implicit waiver of Reading’s regulatory right to arbitrate, we would erode investors’ ability to use an efficient and cost-effective means of resolving allegations of misconduct in the brokerage industry and thus undermine FINRA’s ability to regulate, oversee, and remedy any such misconduct.”


Given the growing divide between appellate courts, the U.S. Supreme Court may ultimately decide whether a party can contractually waive the right to arbitrate before FINRA without express language in the agreement. Additionally, more explicit contract draftsmanship in customer agreements could play a role in the future decision.  The Scarinci Hollenbeck Business Law and Litigation Practice Group will continue to follow this issue and post updates as they become available.

If you have questions, contact us

If you have any questions or if you would like to discuss the matter further, please contact me, Paul Lieberman, at 201-806-3364.