Two Years & Still Waiting for the SEC to Address the Enforceability of Mandatory Pre-Dispute Arbitration Agreements in Customer-Broker Disputes Under Section 921 of Dodd-Frank

The Dodd-Frank Wall Street Reform Act of 2010 (“Dodd-Frank”), Pub. L. No. 111-203, 124 Stat. 1376, was enacted on July 21, 2010, to provide for, among other thing, comprehensive financial regulatory reform to protect consumers and investors.  During the Dodd-Frank legislative process, there were significant concerns that mandatory pre-dispute arbitration agreements were unfair to investors.  Concerns raised included “high upfront costs; limited access to documents and other key information; limited knowledge upon which to base the choice of arbitrator; the absence of a requirement that arbitrators follow the law or issue written decisions; and extremely limited grounds for appeal.” Senate Committee on Banking, Housing, and Urban Affairs on S. 3217, S.Rep. No.111-176, at 110.  As a result of these concerns, buried in Section 921 is an often overlooked provision which could have a dramatic effect on customer disputes with their brokerage firms which are subject to arbitration agreements.

Section 921 of Dodd-Frank amends Section 15 the Exchange Act, 15 U.S.C. § 78o, to provide the Securities Exchange Commission (“SEC”) with the discretionary rulemaking authority to restrict mandatory pre-dispute arbitration.  Section 921(a) states, in relevant part, that

The [SEC], by rule, may prohibit, or impose conditions or limitations on the use of, agreements that require customers . . . to arbitrate any future dispute between them arising under the Federal securities laws, the rules and regulations thereunder, or the rules of a self-regulatory organization if it finds that such prohibition, imposition of conditions, or limitations are in the public interest and for the protection of investors.

15 U.S.C. § 78o(a) (emphasis added).  Over the past 5 years, there have been four thousand to seven thousand arbitrations filed per year with the Financial Industry Regulatory Authority (“FINRA”).  Section 921 could have the impact of sending a large number of these case to federal courts throughout the country.  However, nearly two years after the Dodd-Frank was passed, there is no sign that the SEC will take rulemaking action to curb the enforceability of mandatory pre-dispute arbitration agreements.

FINRA is the self-regulatory organization for the broker-dealers of the United States.  FINRA’s mission is to protect investors and the integrity of the market through regulation and complementary compliance and technology-based services.  FINRA rules require members and their associated persons to arbitrate any eligible dispute upon demand by a customer, even in the absence of a pre-dispute arbitration agreement.  See Rule 12200 of the FINRA Code of Arbitration Procedure for Customer Disputes.

Although FINRA rules do not require customers to arbitrate disputes, virtually all investors with brokerage accounts have signed an arbitration agreement, as a condition to opening their account.  The typical arbitration agreement encompasses all disputes arising under federal and state law.  Indeed the United States Supreme Court has held that that customers who sign pre-dispute arbitration agreements with their brokers may be compelled to arbitrate claims arising under the Securities Exchange Act of 1934 (“Exchange Act”), the Securities Act of 1933 (“Securities Act”), and state law claims.  See Shearson/American Express, Inc. v. McMahon, 482 U.S. 222 (1987) (Exchange Act claims); Rodriquez de Quijas v. Shearson/American Express, 490 U.S. 477 (1989) (Securities Act claims); Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213 (1985) (state law claims).

After the Dodd-Frank was enacted, the SEC began accepting comments concerning mandatory pre-dispute arbitration agreements from the public.  To date, over eighteen comments have been submitted and published by the SEC concerning Section 921.  SEC Officials also held informal meetings with the public on April 4, 2011 and September 14, 2011. The majority of the comments favor abolishing mandatory pre-dispute arbitration agreements generally arguing that the FINRA arbitration forum is unfair to the public. See Comment of Barry D. Estell, Esq. dated July 30, 2010; Comment of Tim Canning dated Aug. 18, 2010; Comment of Melinda Steuer dated Aug. 18, 2010; Comment of Diane Nygaard, Esq. dated Aug. 20, 2010; Comment of Z. Jane Riley dated Aug. 23, 2010; Comment of Kurt Arbuckle dated Aug. 24, 2010; Comment of Richard M. Layne dated Aug. 25, 2010; Comment of PIABA dated Dec. 3, 2010; Comment of Sonn dated Dec. 3, 2010; Comment of Irene Rutledge date Feb. 22, 2011.

However, several comments support mandatory arbitration or at least the continued availability of the arbitration forum for investors.  See Comment of Bruce D. Oakes dated July 27, 2010; Comment of M.K., Esq. dated Aug. 6, 2010; Comment of James B. Eichberg dated Aug. 12, 2010; Comment of David M. Sobel, Esq. dated Aug. 30, 2010; Comment of SICA dated Mar. 28, 2012.

In January 2011, the SEC, as required by Section 913 of Dodd-Frank, issued a Study on Investment Advisers and Broker-Dealers (“SEC Study”).  The SEC Study evaluated the obligations of brokers, dealers, and investment advisers including the effectiveness of existing legal or regulatory standards of care for providing personalized investment advice and recommendations about securities to retail customers.  Although the SEC Study discussed the current FINRA arbitration framework for resolving customer-broker disputes, SEC Study at pp. 133-134, the SEC Study did not address the legitimacy of mandatory pre-dispute arbitration agreements.

The SEC’s Division of Trading and Markets (the “Division”) is responsible for establishing and maintaining standards for fair, orderly, and efficient markets.  The Division oversees broker-dealers and self-regulatory organizations including FINRA.  See 17 C.F.R. § 200.19a.

Currently, the Division is responsible for implementing aspects of Dodd-Frank including certain mandatory rulemaking provisions including highly controversial Section 619, often referred to as the “Volcker Rule;” Section 621, which restricts certain conflicts of interest concerning activities involving asset-backed securities; and Section 956, which required joint rulemaking with other regulators concerning incentive-based compensation of broker-dealers and investment advisers.  The Division is also responsible for reviewing and recommending proposals to the SEC concerning Section 921.

To date, the SEC had not proposed or adopted any rules concerning Section 921 in the two years since Dodd-Frank was enacted.  The SEC indicates on its website that the timeframe for addressing pre-dispute arbitration agreements is uncertain.  Given the focus on more controversial areas of rulemaking under Dodd-Frank, it appears that there will not be any action in the near future.

* Jay Eng is a securities attorney in the Palm Beach Gardens office of Berman DeValerio.  He publishes the Securities Attorney Law Blog. Berman DeValerio prosecutes class actions nationwide on behalf of institutions and individuals, chiefly victims of securities fraud and antitrust law violations.

What are Broker-Dealer FOCUS Reports and Why Net Capital is Important

Brokerage firms required to follow rules intended to minimize the chances of financial failure and protect customer assets if they do fail. Rule 15c3-1 promulgated under the Securities Exchange Act of 1934 requires firms to maintain certain levels of their own liquid assets (the “Net Capital Rule). The minimum net capital a firm must have depends on its size and business.

Under SEC Rule 17a-5, broker-dealers are required to file with FINRA reports concerning their financial and operational status using SEC Form X-17A-5, also known as a Financial and Operational Combined Uniform Single Report or “FOCUS” Report.

FOCUS reports include:
(a) Statement of Financial Condition.
… (b) Statement of Income (Loss).
… (c) Statement of Changes in Financial Condition.
… (e) Statement of Changes in Stockholders’ Equity or Partners’ or Sole Proprietors’ Capital.
… (d) Statement of Changes in Liabilities Subordinated to Claims of Creditors.
… (e) Computation of Net Capital.

The information in FOCUS reports can be critical in determining whether a firm can satisfy an arbitration award.

Florida Securites Fraud Class Action Dismissed Against The St. Joe Company

Northern District of Florida Judge Richard Smoak dismissed a securities fraud class action complaint filed by class action attorneys representing shareholders of The St. Joe Company.  The complaint concerned alleged misrepresentations of the value of properties the company owned in the Florida panhandle.

St. Joe is now one of the largest real estate development companies in Florida. The company operates its business in four segments: (1) residential real estate; (2) commercial real estate; (3) rural land sales; and (4) forestry.  St. Joe allegedly failed to timely take an impairment charge which caused it to overstate the value of its assets when the real estate market crashed in recent years.

In dismissing the complaint, the court stated:

Plaintiff’s claims of misrepresentation are insufficient to meet the standard of pleading fraud with particularity because they fail to allege that Defendants acted with the requisite scienter and made statements that they knew were materially false at the time. Additionally, Plaintiff has failed to establish loss causation.

See the Order on Motion to Dismiss Class Action Securities Fraud Complaint.

Meyer v. The St. Joe Company, 11-cv-27 (N.D. Fla.) (Smoak, J.).


The Federal Housing Finance Agency as conservator for Fannie Mae and Freddie Mac filed suit against a number of financial institutions. The suits allege, among other things, violations of federal securities laws and common law in the sale of residential private-label mortgage-backed securities. The entities sued include:

1. Ally Financial Inc. f/k/a GMAC, LLC
2. Bank of America Corporation
3. Barclays Bank PLC
4. Citigroup, Inc.
5. Countrywide Financial Corporation
6. Credit Suisse Holdings (USA), Inc.
7. Deutsche Bank AG
8. First Horizon National Corporation
9. General Electric Company
10. Goldman Sachs & Co.
11. HSBC North America Holdings, Inc.
12. JPMorgan Chase & Co.
13. Merrill Lynch & Co. / First Franklin Financial Corp.
14. Morgan Stanley
15. Nomura Holding America Inc.
16. The Royal Bank of Scotland Group PLC
17. Société Générale

What is FINRA Arbitration?

Arbitration is a contractual process to resolve disputes between parties in a private forum.  Typically, brokerage firms and customers will enter into a contractual agreement before the customer opens their brokerage account.  Most agreements include a provision which compels the parties to resolve certain disputes through arbitration rather than a judicial proceeding such as a lawsuit in a state or federal court.

The arbitration process is not public and imposes significant restrictions on a parties’ ability to conduct discovery, such as document requests and depositions.  Parties also lose the benefit of procedural and due process mechanisms such as appellate review.

In arbitration, a person or group of person is appointed to serve as the arbitration panel.  The arbitrators hear the arguments and review the evidence of all sides and then decides how the matter should be resolved.  Arbitrators are not required to be attorneys.  Finally, arbitration awards issued by arbitration panels are subject to review by a court only on a very limited basis.

What is Securities Litigation and Securities Arbitration

Securities attorneys and lawyers can practice is a wide variety of areas.

Transactional Securities Attorneys

Certain securities attorneys focus on transactional securities work which includes counseling issuers, underwriters and placement agents in private and public offerings under the Securities Act of 1933; advising on mergers and acquisitions or going private transactions; and preparing regulatory filings required under state and federal securities laws under the Securities Exchange Act of 1934, Sarbanes Oxley and the Dodd-Frank Act.

Securities Litigation and Arbitration Attorneys

Other securities laws may focus on securities litigation and arbitration. Securities litigation and arbitration cases are prosecuted and defended by securities attorneys on behalf of various parties including shareholders, private and publicly-traded companies, officers, directors, and senior management,  individuals and institutional investors, stock brokers, brokerage firms, broker-dealers, underwriters, investment banks, pension funds, and hedge funds.

In addition to recouping lost assets, private securities litigation also augments the efforts of federal regulators to pursue wrongdoers and to provide a deterrent to future violations.

Derivative Actions

Derivative actions are lawsuits brought by shareholders on behalf of the company against senior managers and officers.  Generally, the claim is brought where the shareholders believe that the senior managers are breaching their fiduciary duties to the company through malfeasance.  Plaintiffs may seek both injunctive relief (directing the end of the wrongful acts) and may seek compensatory damages to be paid  by the rogue managers directly to the company.

State & Federal Lawsuits

In lawsuits and arbitration, securities lawyers may allege violations of state or federal securities laws and may also allege common law claims including breaches of fiduciary duty or fraud depending on the factual scenarios.  Retaining a securities attorney to initiate a securities lawsuit may be the only means for for a shareholder to recover asset or investment losses caused by corporate fraud or malfeasance.  Such actions may be filed in state or federal court depending upon the type of claims asserted.

Class Actions

In addition to individual lawsuits, securities class actions may be filed on behalf of classes of shareholders who have similar interests and similar claims.  Because of the significant expense in engaging in securities litigation against large, publicly-traded companies, class actions provide means for recovery for shareholders with a small financial stake in the litigation.

Securities class actions are filed by securities attorneys who represent individuals who seek to serve as class representatives.  Class representatives must have claims similar to the other members of the class and must be approved by the court.  If a settlement is achieved between the class representative and the defendants, class members generally have three options:  (1) participate in the settlement for their pro-rata share; (2) opt-out of the settlement (and pursue their claims in separate litigation); (3) participate in the settlement, but object to certain parts of the settlement – such as the allocation of the settlement or object to the amount of attorney’s fees sought by the class attorneys.


Some securities disputes arise in the context of a stock broker/client relationship.  In most circumstances, a customer will enter into an agreement to arbitrate any disputes that arise between him and his broker in connection with his brokerage account.  For example, a dispute may arise when a broker is involved with the solicitation or sale of an unregistered security which leads to a loss of the customer’s investment.  Often the brokerage agreements specify that such disputes will be resolved before FINRA dispute resolution.  Arbitration can differ drastically than litigation in state and federal courts for securities attorney.  For example, there is no jury in FINRA arbitration, there are very limited rules of procedure and discovery and there are very limited grounds to appeal a FINRA arbitration award.



According to Reuters, attorneys at the Securities and Exchange Commission (“SEC”) have reportedly begun making requests for information concerning proprietary algorithmic trading data as part of its authority to examine financial firms for compliance with federal regulations according to officials and outside lawyers.  Reuters reports that “the unusual requests for algo code and other computerized trading strategies really ramped up this year and have targeted stock-trading firms such as broker dealers and hedge funds.”


Enforcement attorneys at the Securities and Exchange Commission (“SEC”) filed a civil action against a former portfolio manager at the hedge fund investment adviser Diamondback Capital Management, LLC.  The SEC complaint alleges that the former portfolio manager used inside information to trade ahead of the November 29, 2009 announced acquisition of Axcan Pharma Inc. The SEC also names Diamondback as a relief defendant

Interestingly, in September 2007, Diamondback was appointed as a lead plaintiff in the securities class action case Technical Olympic USA, Inc. (TOUSA) Securities Litigation, No. 06-cv-61844, in the Southern District of Florida.  Shortly thereafter (and after vigorously pursuing its appointment), Diamondback moved to withdraw from this high profile position merely stating that “Diamondback no longer wishes to undertake take the responsibilities of Lead Plaintiff because it believes that doing so could be detrimental to Diamondback’s overall business.”  The Court granted this motion in an Order dated May 22, 2008.