Schwab Class Action Lawsuit Prohibition Approved by FINRA

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By: Martha Garcia | Published: February 25th, 2013

In what may be a landmark decision, a panel of arbitrators through the Financial Industry Regulatory Authority (FINRA) has ruled that a ban on class action lawsuits against Charles Schwab, which was recently inserted into customer agreements, will be permitted to stand, even though it limits the options for customers who have a claim against the brokerage firm.

FINRA is an independent regulator for all securities firms doing business in the United States, providing arbitration services for claims against stock brokers and serving to protect investors by making sure the securities industry operates fairly and honestly. The organization oversees about 4,275 brokerage firms, about 161,495 branch offices and more than 630,000 securities representatives.

A hearing was recently held on three counts brought against Charles Schwab Corp. over changes made last year to customer agreements, which limited individuals’ ability to participate in class action lawsuits. The revision affected more than 8.8 million Schwab customers at the time.

While the panel determined that the Schwab customer agreements violate FINRA rules, it concluded that FINRA is unable to enforce those rules due to a conflict with the Federal Arbitration Act (FAA), thus upholding the use of the agreement.

While the panel dismissed 2 of 3 counts brought against Schwab, the final count was ruled against the company. FINRA found Schwab violated FINRA rules by trying to limit the ability of arbitrators to consolidate individual claims in arbitration. Schwab was ordered to pay a $500,000 fine, remove the language which specifies this from arbitration agreements and notify customers.

FINRA has not said whether it will be reviewing the decision and appealing to the National Adjudicatory Council.

The Securities Exchange Commission (SEC) delegates authority over brokers directly to FINRA and requires all broker-dealers to be members of FINRA. Additional all brokers who sell securities must be licensed by FINRA.

The decision may lead other U.S. Brokerage firms to follow suit and revise their own customer agreements to prohibit clients from participating in class action lawsuits.

Schwab modified their customer agreements after paying more than $100 million to settle class action lawsuits over misleading marketing materials associated with their YieldPlus funds, which were ultra-short bond funds sold as conservative investment alternatives to money market funds. The lawsuits were filed after the fund lost more than 30% of its value between June 2007 and June 2008, resulting in huge losses for investors who claimed that Schwab failed to adequately disclose the nature of the risks.

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