FINRA’s Class Action Rule, Not as Simple as it Seems

By Ted Anderson, Esquire, Managing Director, Kilgore & Kilgore PLLC

On the face of it, the “class action rule” issued by the Financial Industry Regulatory Authority (“FINRA”) is straightforward: class action claims may not be arbitrated in a FINRA forum. But the rule has been the subject of litigation and debate, and its presence requires persons bringing claims against FINRA members to make strategic decisions that could have profound implications on the outcome of their cases.

FINRA is the largest independent regulator of securities firms and their representatives doing business in the United States. The self-regulatory organization issues rules governing the conduct of its members, provides an arbitration forum and code of procedure for dispute resolutions, and brings disciplinary actions for violations of its rules.

FINRA normally prefers arbitration over litigation. In general, FINRA Rule 13200 requires all business-related disputes between its members to be arbitrated in a FINRA forum. Rule 12200 says that business-related disputes between FINRA members and their customers are also required to be arbitrated in a FINRA forum if the customer so requests or a written agreement between the customer and the member so provides.

The biggest exception to FINRA’s presumption in favor of arbitration is the “class action rule,” which is contained in both FINRA Rule 13204 (covering disputes among members) and Rule 12204 (covering disputes with customers). The rule categorically states that class action claims may not be arbitrated under the applicable FINRA code of arbitration procedure. It goes on to say that any claim that is based upon the same facts and law, and involves the same defendants as in a court-certified class action or a putative class action, may not be arbitrated in a FINRA forum unless the party bringing the claim opts-out of the class action, i.e., agrees not to participate in the class action or receive any reward resulting from the class action, or formally withdraws from the class.

The presence of a pre-dispute arbitration agreement does not change this result. FINRA Rule 13204 and 12204 provide that a plaintiff involved in a class action lawsuit against a FINRA member cannot be forced to arbitrate in a FINRA forum despite the existence of a pre-dispute arbitration agreement between the parties. So if a FINRA member or customer is part of a putative or certified class, until they opt out of the class, are excluded from the class or the class is decertified or denied, they cannot be forced into FINRA arbitration.

The Charles Schwab brokerage firm recently tried to do an end-run around the FINRA class action rule. Starting in October 2011, the firm began requiring its customers to sign a waiver of their right to participate in class action litigation. However, FINRA brought an enforcement action against Schwab in early February for violating the combined provisions of FINRA Rule 2268, which prohibits member firms from placing any condition in a pre-dispute arbitration agreement that contradicts its rules, and FINRA Rule 12204, which provides that customers may participate in class action claims in court. The outcome of this litigation could have a far-reaching impact on FINRA members and their customers, so the industry is keeping a close eye on the proceedings.

Another subject of litigation has been whether “collective actions” are covered by FINRA’s prohibition against class action arbitration. FINRA staff previously took the position that collective actions, which require participants to affirmatively “opt-in” to the litigation, are covered by Rules 13204 and 12204 as they now stand. Therefore, FINRA asserted that collective actions may not be arbitrated in a FINRA forum.

However, every federal district court (including the Southern District of New York) that has addressed this issue has disagreed with FINRA, with each declaring that the FINRA class action rule does not preclude the arbitration of collective actions. As a result, collective actions are currently subject to the same FINRA arbitration requirements as individual actions, meaning that members can be forced to arbitrate, and customers are allowed to arbitrate, their collective claims. FINRA, however, has responded by proposing an amendment barring collective actions from arbitration, and that amendment may take effect soon.

What all of this means is that persons with potential claims against FINRA members will have to take the FINRA class action rule and its various interpretations into consideration when developing a strategy in cases where other persons may have similar claims against the same defendant.

For example, a person with a large claim may want to ensure that he or she has opted out of any pending class action in order to preserve the right to bring an individual arbitration claim in a FINRA forum in hopes of having more control over the proceedings and reaping a larger award. In contrast, a person with a smaller claim may want to link up with other claimants and bring a class action in federal court in order to share litigation costs, minimize the amount of personal time spent on the matter, and realize the benefits of a federal court system experienced in dealing with class action claims.

If you are a FINRA member, or customer of a FINRA member, and think you have a claim against a FINRA member or may be named as a defendant, feel free to contact Bess Masterson at for more information or call (866) 496-0136.

1This was recently confirmed by the New York State Appellate Division, First Department, in Gomez v Brill Sec., Inc., a case where a group of 50 stockbrokers brought a class action suit against Brill Securities for unpaid overtime. The brokerage firm attempted to defeat the class action by arguing that the stockbrokers were required to arbitrate pursuant to the standard FINRA “U-4 Agreement” each had signed. The court, however, shot down Brill’s argument, ruling that FINRA Rule 13204(d) specifically prohibits enforcement of any arbitration agreement against a member of a putative class action with respect to any claim that is the subject of the class action until certain conditions, inapplicable in the Brill case, are met.

2Schwab responded by going to federal court and seeking an injunction to prevent FINRA from moving ahead with its disciplinary proceeding. FINRA has moved to dismiss that complaint, arguing that Schwab cannot use the court system to prevent FINRA from exercising its regulatory authority over the firm.

3Absent FINRA Rule 12204, a pre-dispute arbitration agreement requiring FINRA customers to waive their right to participate in class action litigation would most likely be enforceable. Last year, the U.S. Supreme Court held in AT&T Mobility LLC v. Concepcion that a California rule rendering arbitration agreements containing class action waivers unenforceable was preempted by the Federal Arbitration Act. However, because FINRA is generally considered to be a private member organization, the AT&T decision most likely does not provide a legal basis to challenge the FINRA rule. Moreover, FINRA rules may themselves have preemptive power over conflicting state laws.

4The most recent of these decisions was handed down in Velez v. Perrin Holden & Davenport Capital Corp. by the United States District Court, S.D. New York. As with all other federal courts that have ruled on the issue, the court held that a “collective action” is not encompassed within the term “class action” as that term is used in FINRA’s rules. It therefore ruled that Velez’s Fair Labor Standards Act collective action claims must be brought in FINRA arbitration.