United States: FINRA Reminds Broker-Dealers Of Predispute Agreement Responsibilities

On July 21, 2016, the Financial Industry Regulatory Authority ("FINRA") issued Regulatory Notice 16-25, which will have broad effects on an issue of interest to any firms operating a broker-dealer.

In general, the regulatory notice reminded member firms of their obligations under FINRA's arbitration rules, which prohibit firms from imposing exclusive forum selection provisions on their customers or associated persons in predispute agreements that deny or limit such persons' ability to access FINRA's arbitration forum. FINRA pointed out that its securities dispute resolution forum exists to remediate any discrepancies between customers, associated persons and member firms and does so in a fair, efficient and economical manner that allows customers and associated persons to resolve cases more quickly, at lower cost and without counsel. As such, the notice warned that customers and associated persons retain the right to initiate FINRA arbitration at any stage – regardless of any agreement or language that may seek to prevent them from doing so.

The self-regulatory body also reminded members that failure to comply with its predispute arbitration agreement rules, or failure to file a dispute to FINRA arbitration as required, may result in disciplinary action. Forum selection provisions are common within predispute agreements between member firms and their customers or associated persons. However, in light of this regulatory notice, these agreements should be reviewed to ensure compliance with FINRA's rules. In particular, FINRA recommends member firms use specific non-exclusive language in forum-selection provisions.

As background, FINRA summarized Rule 12200 of its Code of Arbitration Procedure for Customer Disputes, which details the requirement for parties to arbitrate a dispute under the code in certain circumstances, regardless of whether or not it is explicitly required in a separate agreement. Specifically, the rule requires arbitration when

  • Arbitration is either required by a written agreement or requested by the customer.
  • The dispute is between a customer and a member or associated person of a member.
  • The dispute arises in connection with the business activities of the member or the associated person, except disputes involving the insurance business activities of a member that is also an insurance company.

In addition, the notice reminded members of FINRA Rule 2268(d), which specifically prohibits predispute agreements from including any language limiting a party's right to arbitration.

The notice also summarized FINRA Rule 13200 of the Code of Arbitration Procedure for Industry Disputes, which generally requires a dispute to be arbitrated under this code if the dispute arises out of the business activities of a member or an associated person and is between or among FINRA members, FINRA members and associated persons, and associated persons.

Despite the existence of these rules, FINRA issued the reminder following a series of federal appellate court decisions that ruled predispute forum selection agreements between member firms and their customers supersede FINRA's own rules. While the court's decisions treat FINRA's rules as "contractual" agreements that may be waived or superseded by other agreements between parties, the regulatory notice argued that the Securities Exchange Act of 1934 requires most broker-dealers to be members of FINRA, its rules are approved by the Securities and Exchange Commission, and the rules have the force of federal law, making them more than "mere contracts" that can be modified through separate agreements. As such, the notice asserted FINRA's rules should be given prominence as a "matter of public policy" in order to protect investors and their right to arbitration.

Notwithstanding the federal appellate court's recent decisions, FINRA's decision to issue the regulatory notice indicates its focus on enforcing its predispute arbitration agreement rules in order to protect its arbitration process and the rights of investors. As a result, broker-dealers should confirm that their customer agreements and their agreements with associated persons are consistent with FINRA rules and protect such persons' access to the arbitration process.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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