Broker Dealers Try to Avoid FINRA Arbitration: Heads I Win, Tails You Lose

There has been a spate of litigation in recent years over whether broker dealers can contract out of FINRA arbitration and litigate in court instead. Goldman, Sachs & Co. v. Golden Empire Schools Financing Authority, 764 F.3d 210 (2d Cir. 2014) is a recent example in the Second Circuit. Since 1989 the courts have blessed industry mandated FINRA arbitration as contained in the industry’s standard form customer agreement. Thus, investors effectively have no choice but to resolve investment disputes through arbitration. The industry has benefited from less costly and efficient arbitration and the avoidance of jury verdicts, and until recently, the FINRA rule requiring an industry representative on every panel. The trade off to enforcement of mandatory arbitration in favor of the industry was supposedly a fair and more efficient dispute resolution process for the investor.

Now, however, as FINRA reforms over the years have made arbitration more fair for investors, and as the cases brought against broker dealers have become larger and more complex, the industry is shifting strategy and attempting to have large and complex cases litigated in court. The means of choice for the industry to accomplish this are court forum selection clauses in contracts brokers obtain from the investor in an effort to trump any FINRA arbitration requirement.

Why would the industry like to be able to escape FINRA arbitration in a large and complex case? The answer lies in the nature of the investment documents usually associated with these cases which investors are required to sign as part of complex investment purchases. These investments typically have standard form risk disclosures which investors must acknowledge before investing. Such disclosures can sometimes be fatal to a court claim where they often form the basis for a motion to dismiss the case before discovery or trial, based on the more stringent pleading requirements of court litigation. In FINRA arbitration, on the other hand, absent rare circumstances, the investor is guaranteed a hearing on her case and motions to dismiss are not allowed.

In addition, in court the broker dealer can not only move to dismiss before trial, if it loses a large case it can move to set it aside before the trial court or on appeal. In FINRA arbitration, any court challenge must meet a very high burden and such challenges are rarely successful.

Why should the industry be able to cherry pick the disputes under which arbitration is required? The court decisions, like the Goldman decision referred to above, turn on principles of contract interpretation, often with no reference or discussion of the basic fairness and public policy implications of giving the industry an escape clause from its own mandated regime, whereas the investor can’t escape. Nor do the court cases adequately, or sometimes not at all, consider the role FINRA arbitration plays to help keep the industry playing by its own rules while avoiding the onerous legal hurtles and costs many investors would face in court.