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.