Archive for the ‘Binding arbitration’ Category

Charles Schwab has given up – at least for the moment – on forcing its customers to waive their right to a class action lawsuit in case of a dispute. While it’s hand was forced by the Financial Industry Regulatory Authority (FINRA), Schwab could have retained the class action ban in its securities agreements until its dispute with FINRA is fully resolved.

As reported by The Wall Street Journal, FINRA brought a compliant against Schwab early last year, alleging that the the class action ban was against FINRA rules. FINRA rules prohibit the use of class action waivers by brokerages and investment banking firms and requires firms to only require arbitration of individual claims.

In February, part of the FINRA complaint against Schwab was dismissed as the FINRA panel hearing the dispute said that it couldn’t stop Schwab from forcing its customers to waive those rights. FINRA has appealed that decision.

Then came the Schwab decision to modify its customer agreements to remove the class-action ban beginning May 15 and “in the foreseeable future.” Of course, if they ultimately win they are likely to reinstate the class action ban — a company spokesperson said, “We have chosen to voluntarily remove the waiver going forward until the issue is resolved by the appropriate regulatory and/or court decision.”

Regardless of the outcome of this dispute, it’s clear that the binding arbitration system in securities dispute needs to be throughly examined and eventually discarded by the federal Securities and Exchange Commission (SEC).

FINRA is the administrator and a major stakeholder in the current binding arbitration system, which requires customers of brokerage and investment banking firms to arbitrate disputes rather than take them to court. I’ve written about binding arbitration, which is biased against consumers, unfair and serves to abrogate the right of investors to access the U.S. justice system in a post entitled SEC should end mandatory arbitration clauses in brokerage contracts.

According to the consumer rights group Public Citizen, more than 7 million Schwab customers have been affected by the class action ban. In a letter urging new SEC Chairwoman Mary Jo White to take up the subject of either banning or modifying the use of arbitration in brokerage contracts, Public Citizen and 14 other organizations, including AARP, Consumer’s Union and the Consumer Federation of America, notes that “The 2008 financial crisis, the effects of which the country continues to wrestle with five years later, should be enough to motivate the Commission to restore investors’ legal rights.

“Brokerage firms were responsible for many fraudulent actions that led to or arose from the financial crisis. Indeed, the Commission identified Schwab as one of the firms that misled investors and ‘concealed the extent of risky mortgage-related and other investments in mutual funds and other financial products.’ Ensuring that investors can choose the forum in which to resolve disputes with broker-dealers and investment advisors is critical to both to remedying those past abuses and deterring future misconduct.”

Truth.

When an investor affiliates with a new financial advisor, a take it or leave it mandatory arbitration clause is part of the contract. This means that investors must submit any disputes to arbitration run by the financial services industry self-regulating agency, FINRA. 

In arbitration, investors and financial advisors and broker-dealers must submit to their dispute to a panel of arbitrators, a potentially expensive process that circumvents the traditional judicial system. Mandatory binding arbitration has been a sacred cow of the investor-financial advisor relationship for decades.

Until, perhaps, now. The Wall Street Journal reported that federal Securities and Exchange (SEC) Commission Luis Aguilar has called for an end to binding arbitration clauses. Aguilar cites the 2010 Dodd-Frank Act, which authorizes the SEC prohibit or restrict these types of agreements for broker-dealers and investment advisors. 

I started writing about binding arbitration clauses in business to consumer contracts nearly 10 years ago and believe it’s an inherently unfair practice for consumers and investors. I don’t object to arbitration per se, when arbitration contracts are freely entered into by parties with equal power in a relationship, such as in business to business contracts.

But when they are forced on consumers and investors en mass and the consumers and investors have few if any choice but to accept mandatory binding arbitration clauses in a contract, they just aren’t fair. This country was founded with a judicial process meant to provide the maximum amount of fairness to all parties involved. It’s not perfect, but consumers and advisors deserve to have the ability to avail themselves of it to solve disputes.

Instead, investors and advisors are forced into what is essentially a private judicial process with it’s own opaque rules and procedures, where conflicts of interest on the part of arbitrators are difficult, if not impossible to determine and decisions aren’t fully explained and are incredibly difficult to appeal, regardless of the justice of the ultimate verdict.

So I’m with Commission Aguilar: end binding arbitration in investment advisor and broker-dealer to consumer contracts. Now.