Scarinci Hollenbeck, LLC
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201-896-4100 info@sh-law.comFirm Insights
Author: Scarinci Hollenbeck, LLC
Date: May 25, 2021
The Firm
201-896-4100 info@sh-law.comBecause Financial Industry Regulatory Authority (FINRA) recently issued Regulatory Notice 21-16 highlighting several practices that could lead to disciplinary action, advisors and firms under FINRA oversight should review the predispute arbitration provisions of their customer agreements.
Under legislation introduced on April 15, 2021, mandatory arbitration would be banned completely in any client agreement with a broker, dealer, or investment advisor. The Investor Choice Act of 2021 (ICA) would also prohibit provisions that stipulate arbitration forums and prohibit class actions.
“Issuers, brokers, dealers, and investment advisers hold powerful advantages over investors, and mandatory arbitration clauses leverage those advantages to severely restrict the ability of defrauded investors to seek redress,” the legislation states. Investors “should be free to either choose arbitration to resolve disputes if they judge that arbitration truly offers them the best opportunity to efficiently and fairly settle disputes and pursue remedies in court should they view that option as superior to arbitration.”
The ICA would specifically amend the Securities Exchange Act of 1934, the Securities Act of 1933, and the Investment Advisors Act of 1940 to impose new requirements on certain investor agreements. Specifically, the legislation:
The bill’s provisions regarding customer agreements between investor and advisers/brokers would apply retroactively. Accordingly, provisions that mandate arbitration, include forum selection clauses, or limit class actions would be void.
Similar legislation was introduced in the past and failed to gain enough support to become law. The 2021 version has been introduced in both the House and Senate. While the Investor Choice Act has several Democratic co-sponsors, no Republicans have signed on to support the bill. The legislation, however, is endorsed by North American Securities Administrators Association (NASAA), American Association for Justice (AAJ), Public Citizen, and Public Investors Advocate Bar Association. New SEC Chair Gary Gensler has also expressed support for banning mandatory arbitration in investor agreements.
On April 15, 2021, the Public Investors Advocate Bar Association (PIABA) issued a Press Release supporting the ICA of 2021 as protecting Main Street Investors who are disadvantaged by mandatory arbitration by providing a right to choose forums[1]. The Securities Industry and Financial Markets Association (SIFMA) published a responsive Press Release to PIABA’s statement stating that “the securities arbitration system has worked effectively for decades because it is subject to public oversight…”
FINRA Regulatory Notice 21-16 reminds member firms about their compliance obligations when using predispute arbitration agreements for customer accounts and that failing to comply may subject member firms to disciplinary action. “FINRA has become aware that customer agreements used by some member firms contain provisions that do not comply with FINRA rules,” the Notice states. “Member firms with customer agreements that include provisions that do not comply with FINRA rules should take prompt steps to ensure that their customer agreements fully comply with FINRA rules.”
As set forth in the Notice, FINRA rules establish minimum disclosure requirements when member firms use mandatory arbitration clauses. Because class action claims are not allowed in FINRA arbitration, FINRA rules also prohibit member firms from incorporating provisions that would prevent customers from bringing or participating in judicial class actions by adding waiver language into customer agreements (class action waivers) and prohibit member firms from enforcing arbitration agreements against members of a certified or putative class action.
Under FINRA Rule 2268, which became effective May 10, 1989, predispute arbitration clauses must be highlighted in the member’s customer agreement, immediately preceded by disclosures that the customer agreement contains such a clause and describe the consequences of agreeing to arbitration. In addition, FINRA Rule 2268 prohibits any predispute arbitration agreement from including any condition that: (1) limits or contradicts the rules of any self-regulatory organization (SRO); (2) limits the ability of a party to file any claim in arbitration; (3) limits the ability of a party to file any claim in court permitted to be filed in court under the rules of the forums in which a claim may be filed under the agreement; or (4) limits the ability of arbitrators to make any award.
The Notice provides examples of non-compliant provisions in customer agreements:
Although it is premature to assess the likelihood of passage of the ICA through Congress, FINRA’s notice is a sufficient reminder for member firms to assess their current dispute resolution provisions in their customer agreements.
If you have any questions or if you would like to discuss these issues further,
please contact Paul A. Lieberman or the Scarinci Hollenbeck attorney with whom you work, at (201) 896-4100.
[1] Also endorsing the legislation was the N.A. Securities Administrators Association (NASAA), and American Association for Justice (AJA).
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