Virtually all brokerage firms’ customer agreements require arbitration of disputes in the Financial Industry Regulatory Authority (FINRA) forum.  FINRA regulates the contents of these predispute arbitration agreements (PDAAs) and prohibits broker-dealers from requiring customers to give up the right to bring class actions in court.  A FINRA hearing officer, however, recently ruled that FINRA’s prohibition on class action waivers was unenforceable because it conflicted with the Federal Arbitration Act (FAA), as interpreted by the U.S. Supreme Court in AT&T Mobility v. Concepcion.  Unless reversed on appeal, this ruling is a crippling blow to FINRA’s authority to adopt arbitration rules designed to balance the benefits of arbitration with the need to promote investor confidence.  We believe the hearing officer’s analysis gave short shrift to the important question involved in this case and in other recent proposals to eliminate securities class actions through mandatory arbitration: Does the FAA limit the ability of federal regulators acting pursuant to congressional authority to impose conditions and limitations on the use of arbitration provisions in order to ensure fairness? In our law review article published just before the FINRA decision, entitled Investor Protection Meets the Federal Arbitration Act, 1 Stanford J. Complex Litig. 1 (2012), we address that question.  We argue that the Securities Exchange Act supplants the FAA’s general “pro-arbitration” mandate and gives FINRA the authority to regulate the securities arbitration process to make it fairer and promote investor confidence.

Since Shearson/American Express v. McMahon, Inc., which held that PDAAs were enforceable with respect to federal securities laws, FINRA, whose rules are subject to SEC review and approval, has engaged in ongoing reform of its arbitration rules and strictly regulates the content of PDAAs in order to make arbitration a fairer process for investors. FINRA has two rules specifically addressing class action claims.  First, FINRA has a long-standing rule barring class arbitrations in its forum because it views courts as better equipped to handle complex procedures.  Rule 12204: (1) bars the forum from accepting class action claims; (2) bans arbitration of individual claims based on the same facts and law and involving the same defendants as in a class-certified or putative class action unless the claimant established that he was not participating in the class action; and (3) precludes a broker from enforcing any arbitration agreement against a member of a certified or putative class action until a court denied class certification or the member was excluded or withdrew from the class.  FINRA’s predecessor, NASD, initially proposed the rule in 1992 in response to the SEC’s concern that investors should have access to the courts in appropriate cases, including class actions, and made clear its view that investor protection policies required the preservation of investors’ opportunity to pursue class claims in court.  In approving the rule, the SEC expressed its agreement with NASD’s position: “. . . The Commission believes that investor access to the courts should be preserved for class actions. . . .”

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