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A federal court in California dismissed a complaint filed by Charles Schwab Corp. that tried to block regulators from disciplining the brokerage firm for embedding a clause in its customer account agreements that precludes class-action lawsuits.

FINRA Complaint Filed

The Financial Industry Regulatory Authority (FINRA) alleged in a complaint filed in February with its Office of Hearing Officers that Schwab added a “Waiver of Class Action or Representative Action” to more than 6.8 million customer account agreements in October 2011 that would prohibit customers from starting or joining class-action lawsuits against the brokerage firm.

The complaint said that the class action waiver would incorrectly lead millions of Schwab customers to believe that they did not have the right to bring or participate in class action against Schwab, or to consolidated their claims before an arbitration panel, rights customers clearly have per FINRA rules.

Schwab responded to FINRA’s complaint by filing a complaint of its own one day later in the U.S. District Court for the Northern District of California. On May 11, Magistrate Judge Elizabeth Laporte granted FINRA’s motion to dismiss Schwab’s complaint, according to a report from Reuters.

Lawyers Familiar With the Case

The Reuters report quoted lawyers familiar with the case as saying it raised significant investor protection issues.

“Small investors often have no way to recover losses from fraud or other misconduct unless they band together in a class action because their claims may not be worth enough to pursue individually in a cost effective way. The waivers in Schwab’s customer account agreements would leave many investors with no access to a legal process for recovering their losses”, the lawyers said.

“If Schwab had succeeded in blocking FINRA’s disciplinary action, it could have led other firms to include class action waivers in their arbitration agreements, which could weaken FINRA’s control over its own enforcement process”, the lawyers told Reuters.

Schwab also placed a provision in its account agreements that required customers to agree that arbitrators would have no authority to consolidate claims from multiple parties.

“These consolidated claims are common”, according to the lawyers interviewed by Reuters. “Such arbitrations usually have far fewer claimants than class action suits, but both consolidated arbitrations and class actions typically involve claims under $10,000, and both are ways to make the pursuit of smaller claims cost effective.”

Ryan K. Bakhtiari, president of the Public Investors Arbitration Bar Association, an Oklahoma-based group of securities arbitration lawyers, told Reuters that “the court’s decision was a great one for investors, and that FINRA rules are clear and unequivocal: Schwab does not have the right to prohibit class actions”.

FINRA’s complaint stated that FINRA’s Code of Arbitration Procedure makes it clear that class action suits are permitted under its rules of arbitration. The rules state that an arbitration agreement may not be enforced against a claimant if the claimant is part of a putative class, and that an arbitration may only proceed it the class is not certified, de-certified, or if that particular claimant is excluded or withdraws for some reason.

The Code of Arbitration also specifically states that one or more parties may consolidate multiple claims together in the same arbitration.

Moreover, the complaint said other FINRA rules prohibit any member firm from including any condition in a pre-dispute arbitration agreement that contradicts the rules of any self-regulatory organization such as FINRA.

The district court agreed with FINRA that Schwab must follow FINRA procedures for disciplinary actions. These actions are reviewable by federal courts if necessary, the Reuters report said.

FINRA, the self-regulatory organization responsible for oversight of brokerage firms, also runs the forum for arbitration through which customers and firms most often resolve their legal disputes.

The Charles Schwab Lawsuit is Dismissed

Schwab tried to enjoin the disciplinary proceeding, arguing that it would be irreparably harmed by using FINRA’s process because it could take as long as four years or more. The court held that delay was not a sufficient reason to avoid FINRA’s process, however, “Schwab failed to show it was entitled to be excepted from the processes of its regulator”, the opinion said.

Now that Schwab’s lawsuit has been dismissed, what will happen with the class-action and consolidated claim waivers in Schwab’s account agreements is an open question.

William Jacobson, a professor at Cornell Law School’s Securities Law Clinic in Ithaca, N.Y., told Reuters that Schwab has to decide if it should keep using the waivers, which could be considered a continued, knowing violation.

In addition, there is no clear answer regarding what would happen if Schwab tried to enforce the waivers, Jacobson added.

Guiliano Law Group

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