Securities Regulator OKs Schwab Ban on Class Actions by Clients

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Charles Schwab Corp. can ban its clients from bringing class action lawsuits, a securities industry regulatory panel ruled Thursday in a sweeping decision that is likely to influence other U.S. brokerage firms to follow Schwab’s policy.

Schwab last year told customers it was modifying their 8.8 million account agreements to prohibit class action suits and to modify their ability to have arbitration cases consolidated. The decision followed settlements of class action litigation by Schwab in which it agreed to pay $235 million for misleading marketing of its high-interest YieldPlus money-market fund between May 2006 and March 2008.

A Financial Industry Regulatory Authority hearing panel said in a 48-page ruling that the class action ban is consistent with federal law and recent Supreme Court interpretations of the Federal Arbitration Act.

The ruling by the industry panel is a blow to FINRA, a private group that regulates broker-dealers and administers arbitration panels. It is also a setback for class action lawyers.

Last February, FINRA’s enforcement department charged Schwab with violating its rules by limiting clients’ class action and arbitration rights. The hearing panel on Thursday agreed that the class-action ban violates the self-regulator’s rules but found that the rules are not enforceable because they conflict with the Federal Arbitration Act.

“Schwab is pleased with the panel’s decision,” the San Francisco-based firm said in a statement. “The company believes customers are better served through the existing FINRA arbitration process and that class action lawsuits are a cumbersome and less effective means of resolving disputes – for both parties.”

A FINRA spokeswoman said the group was reviewing the decision, and could not yet comment on whether it would appeal the ruling to its appellate body, the National Adjudicatory Council.

Securities industry executives view arbitration hearings as quicker and less expensive than courtroom battles, and said it is likely many firms will now attempt to revise their customer account agreements.

“FINRA could appeal, but you have a fairly well-developed decision here,” said Kevin Carroll, associate general counsel of the Securities Industry and Financial Markets Associations, broker-dealers’ main trade group. “It’s up to our individual members to determine if they will adopt a class action ban.”

Plaintiffs’ lawyers said an appeal is almost certain and will be in the best interests of brokerage firm clients.

“It’s a significant step backwards for consumers,” said Ryan K. Bakhtiari, a partner at Aidikoff, Uhl & Bakhtiari in Beverly Hills, California, and past president of the Public Investors Arbitration Bar Association. “I would expect FINRA to move to protect its turf.”

Scott Ilgenfritz, his successor as president of the plaintiff lawyers’ trade group, said he is bracing for a wave of changes in brokerage contracts. “You’ll see every major broker-dealer and some of the independent contractor shops putting these in. Why wouldn’t they?” said Ilgenfritz, a partner at Johnson, Pope Bokor, Ruppel & Burns in Tampa, Florida.

Some lawyers said it is far from certain that a single hearing panel can determine far-reaching law. “This ruling threatens most securities class actions, but the panel does not usually make the law,” said John Coffee, a securities law professor at Columbia Law School.

In spite of the ruling, FINRA can tell broker-dealers that if they want to remain members they still have to abide by its “fair-play” rules that include access to the courts, he said. The Securities and Exchange Commission, which delegates regulatory authority over brokers to FINRA, requires all broker-dealers to be members and all brokers who sell securities to be licensed by FINRA.

FINRA prevailed in one of its three actions against Schwab. The panel said Schwab violated FINRA rules by limiting the powers of its arbitrators to consolidate individual client claims in hearings.

The federal arbitration law does not dictate how arbitration forums should be run, the panel ruled, and fined Schwab $500,000. It also ordered the broker to take corrective action and remove the violative language from its customer agreements.

Schwab removed the language from client accounts in January, a Schwab spokesman said.

The company, he added, is pleased that it prevailed “on the central class action waiver issue.”