In the last few years, the U.S. Supreme Court has issued sweeping decisions enforcing class action waivers contained in arbitration agreements, finding enforcement mandated under the preemptive force of the Federal Arbitration Act (FAA). For employers in the financial services industry, however, the interpretation by the Financial Industry Regulatory Authority (FINRA) of its own rules has loomed over the heads of broker-dealers that sought to maintain and enforce class and collective action waivers of employee claims.
FINRA’s board of governors issued a decision in April finding that a broker-dealer’s inclusion of class action waivers in customer agreements violates FINRA rules, and that enforcement of those rules is not preempted by the FAA. Department of Enforcement v. Charles Schwab & Co., Inc. This decision leaves open the question of the propriety of class action waivers contained in arbitration agreements with employees.
This article briefly summarizes FINRA’s Schwab decision and considers its potential application to class and collective action waivers in the employment context.
The Schwab Decision
In Schwab, the board considered two issues: (1) whether Schwab’s inclusion of a class action waiver in its customer account agreements violated FINRA rules; and (2) if so, whether enforcement of those rules was preempted by the FAA.
1. The Class Action Waiver Violated FINRA Rules
As the board recognized, there is nothing in the FINRA rules that expressly prohibits class action waivers. Nonetheless, reading customer rule 2268 together with 12204, it determined that Schwab’s inclusion of the waiver in its predispute customer agreement did violate the FINRA rules. Customer rule 2268, which has no corollary in the industry rules that govern employment arbitration, prohibits members from incorporating into a predispute arbitration agreement a provision that “limits the ability of a party to file any claim in court permitted to be filed in court.” Customer rule 12204(d), which has an exact corollary in industry rule 13204(a), provides that a member “may not enforce any arbitration agreement against a member of a certified or putative class action” until class certification issues are decided. According to the board, because rule 12204(d) “presupposes that judicial class actions are possible,” class actions are “permitted to be filed in court” within the meaning of rule 2268. Therefore, a predispute arbitration provision limiting the ability of a customer to pursue a class action claim violates rule 2268.
Notably, the board rejected Schwab’s reliance on federal district court cases enforcing class action waivers in employment agreements between members and employees, finding that those cases are not controlling over disputes with customers. Those employment cases analyze only rule 13204 of the industry code. As the board explained, “While Rule 13204(a)’s test is identical to Rule 12204 of the Customer Code, there are no restrictions upon firms regarding the content of predispute arbitration agreements with employees, unlike the strict parameters set forth by FINRA Rule 2268 for predispute arbitration agreements with customers.” Without venturing an opinion as to whether employee class action waivers would be permissible, the board concluded that “this difference makes the employment agreement cases inapplicable to this dispute.”
2. The FAA Does Not Preempt Enforcement of the Rules
The next question for the board was whether FINRA’s enforcement of the rules, through disciplinary action against Schwab, was preempted by the Federal Arbitration Act.
As a threshold matter, the board recognized that the FAA applied to FINRA’s enforcement of its rules. However, the board noted that the FAA’s mandate that arbitration agreements be enforced according to their terms is not absolute and may be overridden by a “contrary congressional command.” The board then focused on FINRA’s delegated authority under the Exchange Act. While the Exchange Act itself does not prohibit class action waivers, the board concluded that FINRA’s customer rules 2268 and 12204, promulgated under delegated authority from the U.S. Securities and Exchange Commission, sufficiently demonstrate a “statutorily authorized intent to overcome the FAA.”
The board explained that Congress need not restrict arbitration agreements directly in a statute, but rather could pass a statute that grants authority to an agency to restrict predispute arbitration agreements. The Exchange Act empowered the SEC to review the FINRA rules that govern arbitration and to approve them only if they are consistent with the goals of the Exchange Act. According to the board, this delegated authority under the Exchange Act is sufficient to constitute a “congressional command” that overcomes the FAA.
The board noted that it was not basing its FAA preemption determination on the argument that class actions are necessary for small claim plaintiffs to effectively vindicate their statutory rights under the Exchange Act. That argument, the board recognized, is precluded by the Supreme Court’s decision in American Express v. Italian Colors Restaurant.
Impact for FINRA-Registered Employers
There are several important distinctions between the Schwab case and a class and collective action waiver in the employment context. Due to differences between the customer and the industry rules, strong arguments can be made that (a) the mere inclusion of a waiver in an employee arbitration agreement and (b) the enforcement of the waiver in collective actions (such as Fair Labor Standards Act [FLSA] actions) do not violate the FINRA rules. Moreover, even if FINRA found a rule violation by a class or collective action waiver in an employment agreement, the preemption analysis in the Schwab decision—focusing on FINRA’s delegated authority under the Exchange Act—should have no application in the employment context. Hence, FAA preemption should preclude FINRA from enforcing its rules to the extent they prohibit class and collective action waivers in the employment context.
1. FINRA Rules in the Employment Context
♦Inclusion of Waiver in Employment Agreement: Schwab had not enforced the class action waiver in its customer agreement, and so the issue before the board was whether simply including that provision in its predispute agreement violated the FINRA rules. The board’s determination that it did hinged on customer rule 2268, which specifically prohibits members from including certain information in a customer predispute arbitration agreement. That prohibition does not exist in the industry rules applicable in the employment context. Indeed, in distinguishing district court cases in the employment context, the board itself emphasizes this distinction. Hence, the mere inclusion of a class action waiver in an employment arbitration agreement should not be considered to violate any FINRA Rule.
♦Enforcement in a Class Action: The question of whether the enforcement of a waiver in an employment agreement would be a FINRA rule violation may turn on whether the action is a class action or a collective action (such as a claim under the FLSA). These two types of representative actions are addressed in two different subparagraphs of industry rule 13204.
Subparagraph (a) addresses class actions. In language identical to customer rule 12204 (which was at issue in Schwab), rule 13204(a) provides that a member may not enforce “any arbitration agreement” against a member of a class action prior to resolution of class certification issues. However, it also provides that nothing in that subparagraph affects the enforceability of any rights under “any other agreement.” Several federal district courts have concluded that this latter provision permits agreements to waive class proceedings as the waiver is an “other” agreement. See Cohen v. UBS Financial Services, Inc. (S.D.N.Y. 2012). In other words, while rule 13204(a) will not allow an employer to enforce individual arbitration in the face of a class action, there is nothing in the text of the rules that prevent employers and employees to agree to waive the class action procedure.
While this argument may be appealing to the federal courts, the board in Schwab expressly rejected that interpretation of the same language in the customer rule. The board explained that the prohibitory language applies to “any arbitration agreement.” Therefore, the phrase “any other agreement” means “an agreement other than the predispute arbitration agreement with a customer.” It therefore did not save Schwab’s waiver, which was part of its arbitration agreement.
♦Enforcement in a Collective Action: With regard to collective actions, the prohibitory language is different. Rule 13204(b) provides that a member may not enforce “an agreement to arbitrate in this forum” against a member of a collective action prior to resolution of collective action issues. By its plain language, that subparagraph should be construed to apply only to agreements to arbitrate before FINRA. And the rule also provides that nothing in that subparagraph affects the enforceability of any rights under “any other agreement.” Hence, a compelling argument can be made that enforcement of a waiver of collective actions claims in an agreement to arbitrate before AAA, JAMS or any provider other than FINRA does not violate the FINRA rules.
2. FAA Preemption in the Employment Context
The most critical distinction between the Schwab case and class action waivers in the employment context is the FAA preemption analysis. In Schwab, the entire focus of the preemption analysis was the Exchange Act. The board concluded that the authority FINRA was granted under the Exchange Act to determine rules on arbitration, subject to the approval of the SEC, constitutes a “congressional command” sufficient to overcome FAA preemption.
Even as applied to customer claims, with the underlying dispute having some potential relationship to the Exchange Act, this expansive reading of a “congressional command” is questionable. As to employment claims, arising under statutes and common law doctrines independent of the Exchange Act, it should have no application at all. It is well-established that the federal employment statutes—such as Title VII of the Civil Rights Act, the Fair Labor Standards Act and the Age Discrimination in Employment Act—do not contain language that exempt those claims from the FAA. FINRA is hardly in a position to express a “congressional command” on the arbitrability of statutory discrimination claims because of delegated authority it was given under the Exchange Act. Nor does the SEC’s oversight lend any credence to such a position, since the SEC’s review is to ensure that FINRA’s rules advance the goals of the Exchange Act, not of the employment discrimination statutes.
The critical outstanding question in light of the Schwab decision is whether FINRA will take the position that, regardless of the underlying dispute, the Exchange Act allows it to create arbitration rules applicable to its members and associated persons that will trump the FAA. If it does, given recent Supreme Court precedent, that position would not likely be sustained by the federal courts.
For financial services employers, the water is still muddy on class action waivers.
Trish Higgins is an employment attorney in the Sacramento office of Orrick, Herrington & Sutcliffe. Her practice focuses on complex employment litigation and counseling, and she has particular expertise representing companies in the financial services industry. Lisa Lupion is an employment attorney in the firm’s New York office. She has experience litigating a variety of employment issues and regularly represents employers in FINRA proceedings.