Forum Selection Involving Customers & Associated Persons

Based upon recent federal appellate court and Second Circuit decisions, the Financial Industry Regulatory Authority (“FINRA”) released guidance regarding forum selection provisions between member firms and their customers and employees (Regulatory Notice 16-25).  The guidance was the result of an apparent conflict between the court decisions and FINRA rules regarding arbitration.

In the federal appellate court decisions, the courts have held that forum selection clauses in agreements between member firms and customers supersede the requirements of FINRA Rule 12200, permitting member firms to require customers to arbitrate in a private arbitration forum or to litigate in state or federal court.  The holdings of these courts rest on the assumption that the duty to arbitrate under FINRA rules, or to arbitrate in FINRA’s arbitral forum, is merely “contractual” and can be superseded or waived.  This assumption is inconsistent with the fact that the Exchange Act requires most broker-dealers to be members of FINRA and that FINRA’s rules are approved by the Securities and Exchange Commission (SEC), binding on FINRA member firms and associated persons, and have the force of federal law.  FINRA rules are not mere contracts that member firms and associated persons can modify.

With respect to the Second Circuit decision, the court stated that even though FINRA Rule 13200 by its terms requires arbitration in a FINRA forum, that requirement can be waived in a predispute agreement to arbitrate in a private, non-FINRA arbitral forum.  The court pointed to several cases in which it has held that an SRO’s arbitration provisions are default rules which may be overridden by more specific contract terms.  In addition, the court stated that although FINRA Rule 13200 states that employee-related disputes must be arbitrated “under the Code,” it does not address the issue of whether arbitration in a FINRA forum may be waived before a dispute arises.  The court noted that “[h]ad FINRA wished to clearly state that Rule 13200 cannot be waived, it could have done so. In the customer-member context, FINRA requires that a predispute arbitration agreement not include any condition that ‘limits or contradicts the rules of any self-regulatory organization.’ Rule 2268(d)(1).”

With respect to the guidance, it is targeted at FINRA member firms requiring arbitration and or litigation in other forums with either customers or employees.  To that end, with respect to customer agreements, it was noted that FINRA Rule 2268(d) prohibits any predispute arbitration agreement from including any condition that: (1) limits or contradicts the rules of any self-regulatory organization (SRO), or (2) limits the ability of a party to file any claim in arbitration.  To that end, these requirements make clear that predispute arbitration agreements must preserve the rights of the contracting parties under SRO rules and that arbitration must be a choice for the parties as a means of dispute resolution.  Additionally, in the SEC’s judgment these rules serve the public interests delineated in the Exchange Act is entitled to significant weight.  Thus, preserving a customer’s right to arbitration under FINRA Rule 12200 is necessary for the protection of investors and as a matter of public policy.

With respect to employee agreements, the absence of a provision similar to FINRA Rule 2268(d)(1) in connection with predispute agreements under the Industry Code does not lead to the result that a member firm can require an associated person to waive the requirements of FINRA Rule13200. Under the Industry Code, FINRA IM-13000 states that “[i]t may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2010 for a member to require an associated person to waive the arbitration of disputes contrary to the provisions of the Code of Arbitration Procedure,” or to “fail to submit a dispute for arbitration under the Code as required by the Code.”

Through IM-13000, FINRA has made clear to member firms and associated persons that they have the mandatory and non- waivable duty to arbitrate disputes, and (with certain exceptions) to arbitrate them before FINRA.  Thus, any attempt to override the requirement of FINRA Rule 13200 in a predispute agreement by more specific contractual terms would violate FINRA rules.

Ultimately, whether you are looking at customer agreements or employee agreements, FINRA’s position is that FINRA rules set forth specific requirements relating to predispute arbitration agreements and when a customer or employee dispute must be arbitrated at FINRA. They are not default rules that may be overridden by more specific or separate contractual terms without consequences under FINRA rules.  Therefore, FINRA states that any member firm’s denial, limitation or attempt to deny or limit a customer’s or employees right to request FINRA arbitration, even if the customer or employee seeks to exercise that right after having agreed to a forum selection clause specifying a venue other than a FINRA arbitration forum, is a violation of FINRA Rules 2268, 12200 and or 13200.  Finally, FINRA’s position is that the failure to submit a dispute to arbitration under the Customer Code for customers, or the Industry Code for associated person as required by the Code would also violate FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade).