Last week the United States Supreme Court issued its opinion in American Express v. Italian Colors Restaurant affirming that arbitration clauses containing class action waivers are enforceable when pursuing federal statutory rights. But for broker dealers regulated by the Financial Industry Regulatory Authority (FINRA)—AmericanExpress is not the end of the story.
Class-Action Waivers Are Enforceable Under the FAA
In American Express, several merchants filed a class action against American Express alleging violations of federal antitrust laws. American Express moved to compel individual arbitration, as the parties’ arbitration agreement prohibited class arbitration. The merchants argued that individual arbitration prevented “effective vindication” of their federal statutory rights because the cost of pursuing the claims far outweighed the potential recovery—it could only effectively be done on a class-wide basis.
The district court enforced the arbitration agreement. On appeal, the Second Circuit reversed because individual arbitration was cost-prohibitive and the merchants could not vindicate their rights in individual arbitration. The Court ruled that the Second Circuit was wrong.
Under the FAA, agreements to arbitrate are contracts to be “rigorously” enforced. Here, the claims under antitrust laws could be arbitrated, and did not require class actions: “The Sherman and Clayton Acts make no mention of class actions,” and were enacted before Rule 23 procedures were created. The Court also rejected the merchants’ “effective vindication” argument. Nothing in the arbitration clause at issue prevented the merchants from asserting their statutory rights in individual arbitration—what mattered was the right to pursue the claim, not whether it is costly to do so. The Court's view on class arbitration and small individual claims was summed up in a footnote: “The FAA’s command to enforce arbitration agreements trumps any interest in ensuring the prosecution of low-value claims.”
In dissent, Justice Kagan accused the majority of elevating form over substance. The overall effect of the entire arbitration agreement foreclosed federal antitrust claims from being pursued in individual arbitrations. No “rational actor” would file a claim due to the cost of prosecution, claims could not be joined or consolidated with others’ claims to save time and money, confidentiality provisions prevented sharing an expert’s work product, and there was no mechanism to shift the merchants’ costs to American Express if they prevailed. Any recovery would be eaten up by the costs of pursuing it; why would anyone bother?
American Express Does Not Have All of the Answers for FINRA Members and Mandatory Arbitration
On the issue of class action waivers in broker dealers’ customer agreements, however, American Express does not provide a clear-cut solution. Broker dealers are closely watching another case, FINRA Department of Enforcement’s appeal in the Charles Schwab & Co. (Schwab) enforcement action.
After AT&T Mobility, Schwab included provisions in its arbitration agreement that waived a customer’s right to bring a class action in court and denied arbitrators the right to consolidate or join claims. A FINRA hearing panel ruled that Schwab’s judicial class-action wavier clauses were enforceable, but Schwab could not prevent arbitrators from consolidating or joining similar claims. The Department of Enforcement appealed to the National Adjudicatory Council (NAC), FINRA’s appellate body. The NAC will look to AT&T Mobility and American Express, but must also consider how these cases affect FINRA’s arbitration code.
American Express will likely have no effect on FINRA Rules 12204(a) and 12312. FINRA Rule 12204(a) already prohibits customers from filing class actions under the arbitration code. FINRA already won on the issue of Schwab’s prohibition on consolidation. See FINRA Rule 12312 (FINRA has expressly granted arbitrators the right to consolidate “separate but related claims” into one arbitration).
But American Express may have an effect on how the NAC addresses the judicial class-action waiver in Schwab’s arbitration agreements. Under FINRA Rule 12204(d), FINRA prevents members from enforcing arbitration agreements against customers where the customer is a member of a certified or putative class action. Members can only enforce arbitration agreements if class certification is denied, the class is decertified, the member is excluded by the court, or the member opts out. Schwab’s judicial class-action waiver ran afoul of Rule 12204(d), but the hearing panel concluded that AT&T Mobility trumped that rule.
Certainly, American Express reinforces the hearing panel’s decision to enforce broad principle in AT&T Mobility over FINRA’s rules. Nevertheless, the NAC may criticize the hearing panel’s reasoning. FINRA members, by virtue of their membership in FINRA, agree to be bound by FINRA’s rules—including the rule that prevents them from enforcing arbitration agreements against putative class members. Setting aside AT&T Mobility and American Express, the NAC should address this apparent conflict to provide clarity to its members: Can members agree to be bound by FINRA rules, like Rule 12204(d), and also require that customers forgo their right to participate in a judicial class action, which Rule 12204(d) otherwise allows?
Congressional Action May Undo Mandatory Arbitration
If the waters were not muddy enough for financial service providers, members of Congress have chimed in on the mandatory arbitration issue. Under Dodd-Frank, Congress empowered the SEC to study mandatory arbitration agreements and take action to restrict or prohibit mandatory arbitration clauses with customers. Speaking for several Congressional Democrats, Senator Al Franken recently wrote to SEC Chairman White, “We are deeply concerned that the Commission’s failure to respond to the dangers posed by widespread forced arbitration will weaken investor protections.” SEC action to curtail mandatory arbitration would have a dramatic effect on broker dealer’s compliance, legal and risk management activities.
But restricting or eliminating mandatory arbitration between may not have the effect that Congress intends. FINRA provides distinct advantages to customers that customers would not have in court: limited opportunities for pre-trial or summary dismissal of unmeritorious claims, mandatory production of several categories of documents (paper and electronic), and recognition and recovery for claims that would not survive a Rule 12 motion to dismiss. Moreover, with the addition of the optional all-public panel, the rate at which customers recover has been on the rise. Eliminating mandatory arbitration may favor FINRA members over their customers; perceptive claimants may ultimately choose to arbitrate anyway.
American Express provides additional support for the freedom to contract between companies and their customers on dispute resolution processes. It also underscores the Court’s and Congress’ recognition that arbitration has distinct benefits of being as fair, cheaper and more efficient than litigation. For FINRA members, however, the NAC’s decision in the Schwab enforcement case will have a much more immediate effect on the arbitration landscape.