United States: Third Circuit Upholds Customer's Right To FINRA Arbitration Despite Brokerage Agreements' Forum-Selection Clause Providing Right To Litigate In Federal Court

On August 7, 2018, the U.S. Court of Appeals for the Third Circuit affirmed a district court order compelling defendant, a broker-dealer and member of the Financial Industry Regulatory Authority (FINRA), to submit to FINRA arbitration, even though the broker-dealer agreements with plaintiff contained a forum-selection clause providing that all actions and proceedings arising out of the agreements and underlying transactions had to be filed in federal court in New York.  See Reading Health Sys. v. JPM Secs., No. 16-4234 (3d Cir. Aug. 7, 2018).  The Court held that, because the forum-selection clauses in broker-dealer agreements did not explicitly reference arbitration, it lacked the specificity required to advise plaintiff that it was waiving its affirmative right to arbitrate under FINRA's rules. 

Over the course of several years, defendant entered into broker-dealer agreements with plaintiff in connection with four offerings of auction rates securities ("ARS") through which plaintiff issued over $500 million in debt.  The broker-dealer agreements at issue in this case included a forum-selection clause, which provided that "all actions or proceedings arising out of" the agreements or underlying ARS transactions had to be filed in the U.S. District Court for the Southern District of New York.  After the ARS market collapsed, plaintiff filed a statement of claim with FINRA, alleging that defendant engaged in unlawful conduct in connection with ARS offerings and demanding that those claims be resolved through FINRA arbitration.  Defendant refused to arbitrate, contending that plaintiff had waived its right to arbitrate by agreeing to the forum-selection clauses.  To resolve this standoff, plaintiff filed a declaratory judgment action in the U.S. District Court for the Eastern District of Pennsylvania to compel FINRA arbitration.  In response, defendant moved to transfer the action to New York, based on the forum-selection clauses.  The district court denied the motion to transfer and ordered defendant to submit to FINRA arbitration. 

On appeal, the Third Circuit affirmed the district court's order.  First, the Court ruled that the district court properly denied defendant's motion to transfer because plaintiff's declaratory judgment action did not "arise out of" any contractual rights under the broker-dealer agreement.  Instead, the only right that plaintiff sought to enforce in its declaratory judgment action was its right to arbitrate its claims against defendant.  That right, the Court ruled, did not originate from the broker-dealer agreement, but from FINRA Rule 12200, which gives plaintiff the right to demand FINRA arbitration.  Because plaintiff's declaratory judgment action to compel arbitration did not "arise out of" the broker-dealer agreement, the Court ruled that it did not fall within the forum-selection clause and there was no basis to transfer the action to New York.

Second, the Third Circuit ruled that the district court properly required defendant to submit to FINRA arbitration because the forum-selection clause did not waive plaintiff's right to arbitrate the dispute under FINRA Rule 12200.  The Court noted that the case required it to reconcile the tension between the broker-dealer's right to litigate pursuant to a forum-selection clause and a customer's corresponding right to arbitrate under FINRA 12200.  The Court also noted that the issue had divided other federal courts of appeal, with the Second and Ninth Circuit ruling that a materially identical forum-selection clause required the parties to litigate in federal court, while the Fourth Circuit ruling that FINRA Rule 12200 required the parties to arbitrate notwithstanding the forum-selection clause.  The Third Circuit sided with the Fourth Circuit, ruling that forum-selection clauses in broker-dealer agreements are insufficient to waive plaintiff's right to arbitrate under FINRA Rule 12200.  The Court held that, because the forum-selection clause did not specifically reference arbitration, it lacked the specificity required to advise plaintiff that it was waiving its affirmative right to arbitrate under FINRA Rule 12200.  The Court also ruled that it was reluctant to find an implied waiver because plaintiff's right to arbitrate was not contractual in nature but instead arose out of a regulatory rule that had been adopted by FINRA and approved by the United States Securities and Exchange Commission.

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