FINRA member firms that require customers or associated persons to sign agreements containing forum selection provisions may be subject to stiff penalties or disciplinary action. That is the key takeaway from FINRA Regulatory Notice 16-25 (“Notice”), issued in July 2016.
Customer and Industry Disputes
For customer disputes, FINRA points to Rule 12200, which requires that disputes between member firms and customers must be resolved in a FINRA forum either if a customer requests arbitration in that forum, or if an agreement to arbitrate in that forum exists between the parties. FINRA Rule 2268, in addition, specifies that all predispute arbitration agreements between customers and member firms must contain various specific disclosures, including that the parties acknowledge that they are waiving their rights to sue each other in court.
Regarding industry disputes, FINRA references Code of Arbitration Procedure for Industry Disputes Rule 13200, which explains that if a dispute arises between member firms and associated persons, then that matter must proceed to arbitration in a FINRA forum.
In light of these Rules, FINRA stresses that a member firm’s limitation, or attempted limitation, of a customer’s or an associated person’s right to pursue arbitration at FINRA is subject to increased scrutiny and likely disciplinary action. FINRA also explained in the Notice that member firms cannot use existing non-compliant agreements to allegedly deny a customer’s right to arbitrate claims at FINRA.
FINRA’s Criticism of Appellate Court Decisions
FINRA issued this Notice despite various federal appellate court rulings, which upheld forum selection provisions allowing customers, or associated persons, to arbitrate disputes either in a private arbitration forum, or in state or federal courts.
The Notice focuses on Second Circuit authority, which in FINRA’s view, incorrectly decided that a customer or an associated person could waive the right to resolve disputes in a FINRA forum because that right is “merely contractual.” Because the SEC approves its Rules, FINRA contends that its Rules have the force of federal law, and therefore supersede improper forum selection clauses drafted by member firms.
While the Notice seemingly applies to forum selection clauses contained only in predispute arbitration agreements, FINRA’s interpretation of its Rules and its Code of Arbitration Procedure surprisingly also affects arbitration agreements drafted after a dispute arises. Member firms seeking to avoid disciplinary action should thus closely consider the Notice’s potentially broad consequences.
Four Important Points
The Notice announced four important points member firms should consider.
1. In a predispute arbitration agreement, member firms and customers can agree to dispute resolution outside of the FINRA forum.
2. Parties can also arbitrate outside of the FINRA forum if the parties lack a predispute agreement to arbitrate at FINRA, or if the customer does not request arbitration at FINRA.
3. Forum selection clauses in both customer and industry disputes must include the following language: “This agreement does not prohibit or restrict you from requesting arbitration of a dispute in the FINRA arbitration forum as specified in FINRA Rules.”
4. While the parties’ agreement may modify the arbitration forum, FINRA emphasized that no agreement can waive or otherwise limit a customer’s right to “request FINRA arbitration at any time.”
A reasonable interpretation of FINRA’s position regarding the fourth point is that a customer’s request to arbitrate a dispute at FINRA overrides even an agreed-upon forum selection clause found in a predispute agreement.
The Bottom Line
The enforceability of forum selection clauses will remain unclear until either greater consensus emerges in federal appellate courts or until the United States Supreme Court resolves the conflict. Until that judicial clarity arrives, FINRA will likely begin scrutinizing predispute arbitration agreements containing forum selection provisions. As a result, member firms should immediately review all agreements containing forum selection provisions, and feel free to contact this office with questions regarding potential remedial measures.
A copy of the Notice may be found here.