Ninth Circuit, FINRA Arbitration and Exchange Act Commands

Last week, the Court of Appeals for the Ninth Circuit decided two issues important in the field of securities arbitration — one of which I believe flatly ignores the Securities Exchange Act of 1934, as amended by Dodd-Frank. The case, Goldman, Sachs & Co. v. City of Reno, __ F.3d __, 2014 WL 1272784 (9th Cir. Mar. 31, 2014), arose out of Goldman’s underwriting and advising services for the City of Reno’s issuance of auction-rate securities (ARS) in 2005 and 2006.  When the market for ARS and thus Reno’s ARS collapsed, Reno initiated a FINRA arbitration against Goldman alleging a whole host of common law and statutory claims.

Goldman resisted arbitration in the courts, and the case went up to the Ninth Circuit. First, the Court ruled that the City of Reno was a “customer” of Goldman  within the meaning of Rule 12200 of FINRA’s Code of Arbitration Procedure for Customer Disputes, and thus Goldman had a duty to arbitrate disputes upon the demand of a “customer.”  However, the Court also ruled that forum selection clauses (District of Nevada) in the relevant agreements trumped Goldman’s duty to arbitrate.  Thus, the case could proceed in federal court.

The Court’s conclusion that Reno is a “customer” of Goldman is not all that controversial in my view, as the court adopted the Second Circuit’s definition from UBS v. WVUH, 660 F.3d 643 (2d Cir. 2011) (“a ‘customer’ is a non-broker and non-dealer who purchases commodities or services from a FINRA member in the course of the member’s FINRA-regulated business activities, i.e., the member’s investment banking and securities business activities”).   I blogged about that Second Circuit case here.

The second holding troubles me.  Sec. 29(A) of the Exchange Act voids “any condition, stipulation, or provision binding any person to waive compliance … with any provision of the Exchange Act or its rules.” Prior to Dodd-Frank (2010), the statute also applied to rules issued by securities exchanges; Dodd-Frank amended § 29(a) to include rules issued by all SROs.  Thus, for the first time, § 29(A) explicitly invalidates provisions in brokerage agreements that require customers to waive compliance with FINRA rules.  To the extent courts have held in the past that parties could contract around FINRA rules, that line of cases seems to be vitiated by amended § 29(A).

It seems to me that this recently amended provision of the ’34 Act voids the parties’ forum selection clause.  I wonder why the City of Reno did not pursue this argument (I saw no mention of it either in the district court’s or Court of Appeal’s decision)?  I also wonder why FINRA’s Enforcement Division did not pursue Goldman; FINRA IM-12000 states that it “may be deemed conduct inconsistent with just and equitable principles of trade and a violation of [FINRA Conduct] Rule 2010 for a member… to…(a) fail to submit a dispute to arbitration under the [FINRA Arbitration] Code.”

This issue is similar, although not identical to, the issues raised in the FINRA v. Schwab disciplinary case (whether FINRA rules void a class action waiver in an arbitration clause in a brokerage firm’s customer agreement), which is still pending on appeal to FINRA’s National Adjudicatory Council.  See here, hereherehere and here.

The issue also brings to mind a larger question raised a decade ago by Prof. Barbara Black:  why do brokerage firms shun FINRA arbitration when institutional investors sue them, but mandate arbitration when individual investors sue them??  See Barbara Black, The Irony of Securities Arbitration Today: Why Do Brokerage Firms Need Judicial Protection?, 72 U. Cinc. L. Rev. 415 (2003).


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