SAC Board Member and Contributing Legal Editor
[This guest blog post is derived from a feature article by the same name appearing in 2018:3 Securities Arbitration Commentator]
In a 5-4 decision split along ideological lines, the Supreme Court on May 21 held in Epic Systems Corp. v. Lewis, No. 16-285, that the Federal Arbitration Act (“FAA”) permits employers to use arbitration clauses containing class action waivers, notwithstanding the National Labor Relations Act’s (“NLRA”) protections of workers’ rights to act collectively. Justice Neil Gorsuch authored the majority Opinion, joined by Justices Alito, Kennedy, and Thomas, and Chief Justice Roberts. The Court’s liberal wing dissented in a blistering Opinion authored by Justice Ginsburg, joined by Justices Breyer, Kagan, and Sotomayor. This blog post covers what the decision may mean for the securities industry.
The Issues in Epic Systems
Epic consisted of three consolidated cases involving whether the FAA prevails over the NLRA when it comes to enforcing class action waivers in employment arbitration agreements. The issue under review: The National Labor Relations Board and some Circuits had held that class action waivers in employment predispute arbitration agreements (“PDAAs”) violate NLRA section 8(a)(1), because they interfere with the employees’ statutory right to “concerted activities.” Other Circuits had ruled to the contrary, resulting in a split. In the Epic decision, the Supreme Court holds: “As a matter of policy these questions are surely debatable. But as a matter of law the answer is clear. In the Federal Arbitration Act, Congress has instructed federal courts to enforce arbitration agreements according to their terms – including terms providing for individualized proceedings.” What of the NLRA language protecting workers’ rights to collective action and the tension with PDAAs containing class action waivers? Say the majority, if in enacting the NLRA Congress intended to preclude these PDAAs it would have said so explicitly.
What Epic Means for Securities Industry Arbitration: Don’t Assume Anything
Where do we go from here? Now that SCOTUS has elevated the FAA over the NLRA and permits the rest of American employers to use class action waivers, many observers assume that FINRA will not block the brokerage industry from exercising the same right now enjoyed by the rest of American employers. Others say that the Authority’s 2014 ruling in the Charles Schwab disciplinary action, barring class action waivers in customer cases, will carry over to employment contracts. I’m not which analogy works… or whether either does (see “confusion” below). As discussed belie, my view is that FINRA has not closed the door on class action waivers in the employment context, as it has in the customer arena.
The Schwab Ruling
Some time after the Supreme Court issued its ruling in AT&T Mobility LLC v. Concepcion, upholding class action waivers in consumer contracts based on FAA preemption of conflicting State law, Charles Schwab Corp. started inserting class action waivers in its customer agreements. FINRA in early 2012 brought an enforcement action against Schwab, contending that brokerage firms cannot use class action waivers in customer contracts notwithstanding Concepcion. Schwab countered that FINRA’s rules on class actions were preempted by the FAA in line with Concepcion. At the Hearing Panel level in February 2013, FINRA prevailed on its claim that Schwab had violated the Authority’s rules, but lost on FAA preemption. The FINRA Board eventually “called” the case and in April 2014 ruled against Schwab on both issues. In a nutshell, the Board agreed with the Hearing Panel that Schwab had violated several FINRA rules by including a class action waiver, but disagreed that the FAA preempted FINRA’s rules on class actions.
On violation of investor-protection Rules, the Board found: FINRA Rule 2268(d)(1) states that “[n]o predispute arbitration agreement shall include any condition that . . . limits or contradicts the rules of any self-regulatory organization.” Moreover, Rule 2268(d)(3) prohibits member firms from placing “any condition” in a customer predispute arbitration agreement that “limits the ability of a party to file any claim in court permitted to be filed in court under the rules of the forums in which a claim may be filed under the agreement.” Because Rule 12204(d) provides that a customer may opt out of arbitration to participate in a class action, Schwab’s class action waiver “limits or contradicts” Rule 12204 of the Customer Code.
On FAA preemption, the Board’s rationale was that FINRA rules have “the force and effect of a federal regulation for the purposes of resolving federal conflicts of law. See Credit Suisse First Boston Corp. v. Grunwald, 400 F.3d 1119, 1132 (9th Cir. 2005) (explaining that FINRA rules have the force and effect of federal law because they are derived from the Exchange Act).” What of the conflict with the FAA? Said the Board: “In reconciling the conflict between FINRA arbitration rules that prohibit use of a predispute arbitration agreement to eliminate judicial class actions and the FAA’s enforcement of class action waivers, we find -- based on the SEC’s approval orders -- that FINRA’s rules are in furtherance of the Exchange Act’s protection of investors. This core aspect of the Exchange Act prevails over the FAA.”
In other words, to protect investors FINRA rightly asserted that it could promulgate reasonable policies and regulations governing the securities industry, even ones that might impinge on a statutory right enjoyed by the securities industry. But as discussed below, FINRA’s rules protecting customers are not identical to those applicable to employees.
Don’t Assume FINRA’s Rules Must Treat Employment Arbitration the Same as Customer Arbitration
While the Customer and Industry Rules both allow the investor/employee to opt out of arbitration to participate in a class action, they differ as to PDAA use. Rule 2268 governs the use of PDAAs in customer agreements, setting up stringent requirements for what can and cannot be included, and even regulating placement of the PDAA. And indeed, Schwab was found to have violated this Rule, because Schwab’s class action waiver use contradicted and limited Rule 12204.
However, there’s no Rule 2268 analog in the Industry Rules governing PDAA use in the employment context. This is not just my observation. The FINRA Board said the same thing in its Schwab decision:
Schwab argues that several cases involving class-action waivers inserted in employment agreements between firms and employees direct the outcome here... We disagree that these cases are controlling over disputes with customers. The cases upon which Schwab relies analyze Rule 13204 of the Industry Code. While Rule 13204(a)’s text 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.
The bottom line? The absence of a Rule 2268 analog for employee PDAA use, coupled with the Board’s own language, pretty much destroys any analogy suggesting that the Schwab holding carries over to the employment side.
So, What Should FINRA Do?
It's clear from the foregoing discussion that, if FINRA sits tight and does nothing, broker-dealers will take (and some already have taken) advantage of the Epic Systems ruling and insert class action waivers in their employment agreements, just as other business sectors throughout the country have been doing. In view of the current state of FINRA’s Rules and policies in this area, what should FINRA do at this juncture? I offer three long, intermediate, and short-term steps FINRA should take: 1) give employees a choice; 2) regulate PDAA use in the employment context; and 3) quickly articulate the Authority’s views.
Long Run: Give Employees a Choice
I’m certain that pressure to permit employment PDAAs with class action waivers will be brought to bear on FINRA by the securities industry in the wake of Epic Systems, similar to what happened after Concepcion. And as it did in that circumstance, I think FINRA should stick to its guns by just making a few rule changes, making the analogy to Schwab complete. Securities industry employees in my view should have the same class action waiver protections as customers. I’m aware that, whereas FINRA has a clear statutorily-defined authority to protect investors, a mandate to protect employees is not self-evident, but it would seem that FINRA has a fair amount of leeway in regulating the industry, even as to employees. It’s certainly worth a try, given that the Commission has approved other rule proposals clearly aimed at protecting employees.
Intermediate Run: Regulate PDAA Use in the Employment Context
In my opinion, FINRA needs to promulgate a rule governing PDAA use in the employment context similar to Rule 2268. Such a rule would allow for a complete analogy to Schwab: 1) a SCOTUS decision saying class action waivers are permissible, but: 2) FINRA rules allowing the weaker party to opt out of arbitration and into a class action; 3) a rule governing the content and placement of PDAAs; and 4) a FINRA policy stating that, despite the Supreme Court’s holding allowing industry in general to use class action waivers in employment PDAAs, the Authority’s rules and policies prohibit such class action waiver use by an industry party it regulates.
And, although FINRA’s employee protection mission is not nearly as clear as its investor protection authority, I think in this day of the #MeToo movement, the Commission would be reluctant to disapprove a FINRA rule proposal aimed at protecting employees.
Short Run: FINRA Should Articulate its Views
Whatever FINRA does do, in my view Epic demands that FINRA clarify what its position will be going forward. Some firms already use class action waivers in employment agreements. For example, the court decisions cited in the Schwab ruling indicate that UBS and Ameriprise already have enforced existing class action waivers in the employment context. Morgan Stanley has as well, as indicated in Frazier v. Morgan Stanley, 16 Civ. 804 (S.D. N.Y. 2016). What’s to say more brokerage firms, emboldened by Epic Systems and silence on FINRA’s part, won’t force the issue and start using class action waivers in employment PDAAs? And what’s to say courts post-Epic Systems won’t back up the firms? In fact, it’s happening already. In Laver v. Credit Suisse Securities (USA), LLC, the District Court on June 21st – citing Epic Systems – held that FINRA Rule 13204 does not nullify a class action waiver in an employment agreement.
Moreover, the groundwork for FINRA action is already there. In July 2016, the Authority issued Regulatory Notice 16-25, Forum Selection Provisions Involving Customers, Associated Persons and Member Firms. As the title indicates, a good part of the Notice focused on employment PDAA use:
FINRA is also concerned that member firms are including in predispute agreements with associated persons provisions that have the effect of waiving the associated person’s right to obtain FINRA arbitration of any disputes arising out of the agreement. For example, these provisions might require associated persons to resolve employment, business, commercial, or competition disputes at a private arbitration forum or in civil litigation. In FINRA’s view, FINRA rules do not allow for the waiver of the Industry Code requirement to arbitrate disputes at FINRA in advance of a dispute (footnote omitted).
How did FINRA address in the Regulatory Notice the lack of a 2268-type Rule in the employment context? It asserted authority derived from other parts of its Rules: “Moreover, the absence of a provision similar to FINRA Rule 2268(d)(1) in connection with predispute agreements under the Industry Code does not lead to the result that a member firm can require an associated person to waive the requirements of FINRA Rule13200. Under the Industry Code, FINRA IM-13000 states that ‘[i]t may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2010 for a member to require an associated person to waive the arbitration of disputes contrary to the provisions of the Code of Arbitration Procedure’…”
Moreover, I Suggest that FINRA Act Now, Even Before it Considers Changes to the Rules.
Nature abhors a vacuum, and silence will lead to confusion. Whether it ultimately permits or bans class action waivers in employment arbitration clauses, it behooves FINRA to make public its policy. A two-step approach might make sense, given the issues involved. An immediate Regulatory Notice might say, in effect, “We are aware of Epic and are evaluating the use by member firms of arbitration clauses with class action waivers for employees. Members should bear in mind that, as set forth in Regulatory Notice 16-25, FINRA believes it has the authority to regulate arbitration agreement use in Associated Person employment contracts. Until we decide our final policy, we ask firms to maintain the status quo.” A later Notice would articulate any final policies. This will avoid confusion caused by assumptions and presumptions.
And there is precedent. NASD in 1999 issued Notice to Members 99-09 announcing a temporary moratorium on arbitrator-ordered expungements. This gave the SRO time to evaluate its long-term policy, and thereafter to promulgate new rules governing expungements. But the message was clear: “For now, no expungements until you hear further from us.” A similar directive on class action waivers in employment arbitration agreements is warranted in my opinion.
To put it mildly, things are a bit muddled right now. Silence from FINRA on this issue will only lead to confusion for both employees and the industry. And assumptions and presumptions… And disputes. Sound leadership calls for action now.
*George H. Friedman, Chairman of the Board of Directors of Arbitration Resolution Services, Inc. and an ADR consultant, retired in 2013 as FINRA’s Executive Vice President and Director of Arbitration, a position he held from 1998. In his extensive career, he previously held a variety of positions of responsibility at the American Arbitration Association, most recently as Senior Vice President from 1994 to 1998. He is an Adjunct Professor of Law at Fordham Law School. Mr. Friedman serves on the Board of Editors and is a Contributing Legal Editor of the Securities Arbitration Commentator. He is also a member of the AAA’s national roster of arbitrators. He holds a B.A. from Queens College, a J.D. from Rutgers Law School, and is a Certified Regulatory and Compliance Professional.
 517 U.S. 333 (2011).
 See https://www.finra.org/sites/default/files/NACDecision/p496824.pdf <Apr. 24, 2014>.
 Also at issue was Schwab’s attempt to limit the Arbitrators’ authority to consolidate related claims. It lost on that count, too.
 For example, a major tool used to encourage arbitration award payment is FINRA Rule 9554, which allows the Authority to suspend industry parties for not paying arbitration awards, unless they raise a valid defense to non-payment, such as filing a motion to vacate. Rule 12904 requires that the broker file the motion to vacate within 30 days or face suspension or termination. FAA section 12 allows a party opposing the award three months to file a motion to vacate. An industry party insisting on taking the full time allowed by the FAA faces suspension.
 See FINRA Rules 12204 (customer) and 13204 (industry).
 For example, FINRA Rule 2263(2) requires firms to advise APs that sexual harassment claims are arbitrable only via a pre- or post-dispute PDAA and not via the U4. And, Rule 2263(3) states that a dispute “arising under a whistleblower statute that prohibits the use of predispute arbitration agreements is not required to be arbitrated under FINRA rules. Such a dispute may be arbitrated only if the parties have agreed to arbitrate it after the dispute arose.”
 No. 18-cv-00828 (N.D. Ca. June 21, 2018).