March 5, 2013 / 7:40 PM / 6 years ago

COMPLY-SEC arbitration stance may leave investors in the lurch

March 5 (Reuters) - The top U.S. securities regulator has the power to fix what many say is a long-standing problem for investors. There is just no sign that it actually will, at least any time soon.

Currently, a little-noticed line in most agreements investors sign when opening their brokerage accounts bars them from going to court with their complaints. Instead, clients are forced to use arbitration. The Securities and Exchange Commission has authority to restrict this practice, but numerous other responsibilities mean it could be a while before it even considers the question.

Even a recent ruling, which could allow brokerages to impose even more restrictions on customers’ access to courts, is unlikely to spur the SEC to action, say lawyers and investor advocates.

The SEC’s delay to address the issue could eliminate a key tool for making sure brokerages treat them fairly, they say.

“I don’t think the SEC can afford to wait too long,” said Massachusetts’ top securities regulator, William Galvin.


When investors open brokerage accounts, language typically buried in lengthy agreements leads them to agree to resolve potential legal disputes with brokerages through arbitration.

Now, the Financial Industry Regulatory Authority (FINRA), Wall Street’s industry regulator, is in a standoff with Charles Schwab Corp about how far those agreements should be allowed to go.

Charles Schwab, in late 2011, required 8.8 million customers to waive class action rights in customer agreements. The right of investors to participate in class action suits is a long-standing exception to mandatory securities arbitration.

FINRA, which runs the forum that hears arbitration cases against brokerages, filed a disciplinary case against Schwab in 2012 about those agreements. But a hearing panel upheld Schwab’s measure on Feb 21. FINRA rules, it said, conflict with a federal arbitration law allowing such waivers.

Now FINRA may need a hand in its battle to halt Charles Schwab - and possibly other brokerages - from banning investors from taking part in class action suits. While it appeals the decision - which could take more than a year - Schwab’s maneuver could lead to an industrywide practice of class action waiver agreements, say lawyers.

Calls are growing louder for the SEC - one of the few entities with power to tackle the issue - to step in. A string of U.S. Supreme Court decisions, since 2010, allows more arbitration pact restrictions, including through class action waivers, said Christine Hines, consumer and civil justice counsel at watchdog group Public Citizen. Other types of financial advisers are now also requiring arbitration, say state securities regulators.

An SEC spokesman declined to comment on whether or when it would tackle the issue.

A Schwab spokesman has said the arbitration process offers low filing fees for small claims, among other benefits. It is better for investors than class actions where the plaintiff’s lawyers reap the lion’s share of the settlement, he said. FINRA has long said that its arbitration forum provides investors with a fair, efficient and cost-effective process.


The battle over class action suits could have been avoided if the SEC exercised a power granted to it in the 2010 Dodd-Frank financial reform law, say lawyers and consumer advocates. That law was designed to bar or limit the use of mandatory arbitration clauses if the move serves investors’ best interests.

To be sure, the SEC, which is undergoing a leadership change after Mary Schapiro stepped down and former federal prosecutor Mary Jo White was nominated to succeed her, is already behind on developing many rules the Dodd-Frank Act requires.

Doing more with less could be another obstacle. The SEC’s $1.32 billion annual budget could face a $108 million cut, according to a White House Office of Management and Budget estimate. That is due to automatic government spending cuts of $85 billion recently set in motion. Only Congress can stop the process through an agreement.

A sweeping, 72-page request from the SEC to the financial services industry on Friday about possibly aligning ethical standards for two key types of advisers included some questions about investor claims filed through both arbitration and court proceedings.. But the direction of that inquiry is unclear. Analysis and change could take years.


SEC inaction comes after years of disagreements about the issue in Congress. U.S. lawmakers have grappled with changing a federal arbitration law, known as the Federal Arbitration Act, which would make it illegal for companies to make their customers comply with mandatory arbitration agreements.

The most recent effort, the Arbitration Fairness Act of 2011, died in a committee, along with versions in 2007 and 2009. Its key sponsor, Democratic Representative Hank Johnson, will introduce it again this year, a spokesman said.

In the meantime, other regulators and investor advocates are calling upon brokerage customers to protect themselves. Galvin, Massachusetts secretary of commonwealth, last Tuesday urged investors to call their brokerages to “vehemently object” to class action bans.

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