As one Court has recently observed, “herculean efforts” by securities broker-dealers “to avoid resolution of disputes through arbitration” is not new.

The brokerage industry is responsible for the creation of mandatory arbitration. Arbitration agreements are contained in virtually every customer agreement with every broker-dealer carrying securities in America. The duty to submit to arbitration all disutes with public customers before Financial Industry Regulatory Authority (“FINRA”) is a condition of FINRA membership.

The brokerage industry, however, does not want to be in arbitration.

Motions to dismiss, except in very limited circumstances are not permitted in arbitration.

The brokerage industry would rather be in court. Courts are more likely to enforce statutes of limitation, and the Rules of Evidence. In court, cases can be dismissed as a matter of law without an evidentiary hearing. The brokerage industry is very much afraid of jury trials.  However, they also know that cases may never make it to a jury because Motions to Dismiss, at the pleading stage, and for Summary Judgment, particularly involving larger cases in federal court, are too often granted based upon legal technicalities.

In Arbitration, and particularly FINRA Securities Arbitration, which is supposed to be an equitable forum, investors are given their “day in court.”    In September 2008, the Securities and Exchange Commission approved Rule 12206 of the Code of Arbitration Procedure, which became effective January 23, 2009, and which specifically provides that pre-hearing Motions to Dismiss are limited to three circumstances on which to grant the motion: if the parties settled their dispute in writing; “factual impossibility,” meaning the party could not have been associated with the conduct at issue; or the existing 6-year time limit on the submission of arbitration claims.”  In connection with the promulgation of the new Rule, “FINRA emphasize[d] that these exceptions do not constitute an invitation to parties to file motions to dismiss.”  See, e.g., FINRA Notice to Parties, September 26, 2007 (“In many instances dispositive motions were being used to needlessly delay arbitration hearings, which resulted in investors not getting cases heard on a timely basis and incurring extra costs,” said Linda Fienberg, President of FINRA Dispute Resolution. “We believe the proposed revisions will curb any abuses and ensure that investors maintain the right to have their arbitration claims heard.”)(

Recently in the case of Reading Health System v. J.P. Morgan Securities, Civil Action No. 16-4234 (3rd Cir. 2018)(Roth, J.), The United States Court of Appeals For the Third Circuit,
“addressed an emerging trend in the brokerage industry. Ordinarily, broker-dealers, as members of the Financial Industry Regulatory Authority (FINRA), are required by FINRA Rule 12200 to arbitrate all claims brought against them by a customer.

Seeking to avoid this obligation to arbitrate, broker-dealers have begun inserting forum-selection clauses in their customer agreements, without mentioning the customer’s right to arbitrate. This practice, which has been condoned by several of our sister circuits, deprives investors of the benefits associated with using FINRA’s arbitral forum to resolve brokerage-related disputes.

This case concerns such a forum-selection clause. The facts are as follows:

Over the course of several years, Bear Stearns & Co., now known as J.P. Morgan Securities LLC (hereinafter J.P. Morgan), a broker-dealer and FINRA member, executed several broker-dealer agreements with Reading Health System. The agreements were executed in connection with four separate offerings of auction rate securities (ARS), through which Reading issued more than $500 million in debt.

Reading is a not-for-profit health system located in Berks County, Pennsylvania. Reading issued ARSs on four occasions in 2001, 2003, 2005, and 2007, offering a total of more than $500 million in debt to finance capital projects relating to the Reading Hospital and Medical Center Project. Allegedly, when the broker-dealers stopped propping up the market in early 2008, the ARS market collapsed. As a result, Reading filed various state law claims against J.P. Morgan relating to the ARS offerings and demanded that those claims be arbitrated before FINRA.

In February 2014, Reading filed a statement of claim with FINRA, asserting claims against J.P. Morgan relating to the ARS offerings and demanding that J.P. Morgan arbitrate those claims in FINRA’s arbitral forum. That demand was made pursuant to FINRA Rule 12200, which requires a FINRA member, such as J.P. Morgan, to arbitrate any dispute with a customer, such as Reading, at the customer’s request. J.P. Morgan refused to arbitrate. In J.P. Morgan’s view, the forum-selection clauses in the 2005 and 2007 broker-dealer agreements constituted a waiver of Reading’s right to arbitrate under FINRA Rule 12200.

In March 2015, Reading filed a single-count declaratory judgment action in the District Court for Eastern District of Pennsylvania.RA, arguing that it was entitled to arbitrate those claims. Invoking the forum-selection clauses in the 2005 and 2007 broker-dealer agreements, J.P. Morgan filed two motions: a motion to transfer the declaratory judgment action to the Southern District of New York and, in the event transfer was denied, a cross-motion to enjoin the FINRA arbitration.

Among the several contracts, including the agreement to open a securities account, that parties had signed a variety of agreements, including an agreement relating to the sale of the auction rate securities, which contained a forum selection clause, which stated:

The parties agree that all actions and proceedings arising out of this Broker-Dealer Agreement or any of the transactions contemplated hereby shall be brought in the United States District Court in the County of New York and that, in connection with any such action or proceeding, submit to the jurisdiction of, and venue in, such court.

The case is particularly interesting because what was decided by the Court, in substantial part, was not whether a subsequent agreement containing a forum selection clause “trumps” (poor word choice), the contractual duty, by operation of FINRA Rules, and as a condition of membership, that all such claims by public customers must be subject to arbitration.

Rather, this case was about whether the proper court to hear and determine the issue of arbitrability, was the United States District Court for the Southern District of New York or the Eastern District of Pennsylvania, and whether specifically the Eastern District was required to enforce the forum selection clause by transferring a declaratory action seeking to compel arbitration to United States District Court for the Southern District of New York.

Transfer to New York was a death sentence for Reading’s arbitration claim. The Court notes that the Second Circuit takes the view that the forum-selection clauses supersede the right to arbitrate under FINRA Rule 12200. See Goldman, Sachs & Co. v. Golden Empire Schools Fin. Auth. (Golden Empire), 764 F.3d 210, 212 (2d Cir. 2014).

Other jurisdictions, do not.

Admittedly, the Court Circuit stated that the District Judge in connection with a motion to transfer need only to assess the “various public-interest considerations,” and the other factors set out in 28 U.S.C. § 1404(a), and was not necessarily bound by the Supreme Court’s holding in Atlantic Marine Construction Company, Inc. v. United States District Court for the Western District of Texas, 134 S. Ct. 568 (2013).

The Court gives away its final decision in its first footnote, citing Goldman, Sachs & Co. v. City of Reno, 747 F.3d 733, 737 (9th Cir. 2014)(“FINRA is a self-regulatory organization (SRO) that is statutorily authorized “to exercise comprehensive oversight over all securities firms that do business with the public.” Goldman, Sachs & Co. v. City of Reno, 747 F.3d 733, 737 (9th Cir. 2014)(internal quotation marks omitted).

However, as the Court points out, “attempts to reconcile the tension between a broker-dealer’s right to litigate pursuant to a forum-selection clause and a customer’s corresponding right to arbitrate under FINRA Rule 12200 have divided our sister circuit courts. The Second and Ninth Circuit Courts of Appeals have held that a materially identical forum-selection clause requires the parties to litigate in federal court, while the Fourth Circuit Court of Appeals has held that Rule 12200 requires the parties to arbitrate, notwithstanding the presence of a forum-selection clause. We agree with the Fourth Circuit that the forum-selection clauses in the broker-dealer agreements are insufficient to waive Reading’s right to arbitrate under FINRA Rule 12200.

The Third Circuit decision is a win for investors.

The Court expressly recognized that:

FINRA’s authority includes regulatory oversight over securities arbitration. Indeed, “[t]he SEC has long viewed the option of securities arbitration for investors as an important component of its investor protection mandate” and, since its inception, “has urged the SROs it regulates to provide an alternative dispute resolution forum for customers.” In furtherance of that mandate, FINRA now hosts the largest arbitration forum in the United States for resolving such disputes, which, according to FINRA and amicus,* provides investors with a “fair, efficient and economical alternative to litigation.”

Given this conclusion, we need not address whether an explicit waiver of the right to arbitrate would be invalid and unenforceable under Section 29(a) of the Exchange Act, as amicus* and Reading argue. See 15 U.S.C. § 78cc(a) (providing that any contractual “provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, or of any rule of a self-regulatory organization, shall be void” (emphasis added)); S. REP. NO. 111-176, at 114 (2010) (amending the Act to ensure “equal treatment for the rules of all SROs under Section 29(a)”); see also McMahon, 482 U.S. at 228-30; Gross, supra note 19, at 388.

*Counsel for Amicus Appellee, Public Investors Arbitration Bar Association, Robert C. Port, Esq. Gaslowitz Frankel LLC, 303 Peachtree Street, N.E. Suite 4500, Atlanta, GA 30308, Counsel for Amicus Appellee Public Investors Arbitration Bar Association.

Nicholas J. Guiliano has over twenty years experience representing investors before the Financial Industry Regulatory Authority, the New York Stock Exchange and before the National Association of Securities Dealers, Office of Dispute Resolution. Over the last twenty years, he has represented more than a thousand investors from all across the United States and from several foreign countries, in claims against stockbroker and broker-dealers for fraud, breach of fiduciary duty, churning or excessive trading, the sale of unsuitable investments, the sale of defective investments, the sale of unregistered securities, and the failure to supervise. He is frequently quoted in the national media on securities and investment related issues, most recently on National Public Radio. He offers his services on purely a contingent fee basis, and is also a member of Public Investors Arbitration Bar Association. Mr. Guiliano however did not participate in the Amicus Brief.

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