Defining 'Customer': A Survey of Who Can Demand FINRA Arbitration

• Author: Jason W. Burge - Lara K. Richards
• Position: Associate, Fishman Haygood Phelps Walmsley Willis & Swanson, L.L.P. - Associate, Fishman Haygood Phelps Walmsley Willis & Swanson, L.L.P.
• Pages: 173-211

Defining “Customer”: A Survey of Who Can Demand

FINRA Arbitration

Jason W. Burge∗

Lara K. Richards∗∗

INTRODUCTION

Over the past 20 years, courts and legislators have limited the

rights of plaintiffs to assert securities claims in federal courts in

response to complaints about abusive litigation.1 The prosecution of

securities claims has grown more difficult as the Supreme Court has

Copyright 2013, by JASON W.BURGE AND LARA K.RICHARDS.

∗Associate, Fishman Haygood Phelps Walmsley Willis & Swanson, L.L.P.

The authors would like to thank Martha Thibaut, Lowell Dyer, Andrew Gerow,

Victoria Bagot, and Kaja Stamnes for their research assistance, as well as their

helpful comments and edits on earlier drafts of this Article. Special thanks to

Emmy Gill and the editors of the Louisiana Law Review for both the opportunity

to contribute this Article, as well as for the editors’ skillful edits.

∗∗Associate, Fishman Haygood Phelps Walmsley Willis & Swanson, L.L.P.

1. See Richard Painter, Responding to a False Alarm: Federal Preemption

of State Securities Fraud Causes of Action, 84 CORNELL L.REV. 1, 32 (1998)

(describing the “battle” over the merits of securities lawsuits where “plaintiffs’

lawyers accuse issuers, underwriters, and accountants of pervasive fraud, and

they, in turn, charge plaintiffs’ lawyers with greed and opportunism”). Critics of

the private right of action under the federal securities laws have contended that

these cases are time-consuming and expensive, only transfer wealth between

shareholders, and are often merely strike suits that do not benefit shareholders.

See Janet Cooper Alexander, Do the Merits Matter? A Study of Settlements in

Securities Class Actions, 43 STAN.L.REV. 497, 546 (1991) (stating that

“[s]ecurities cases are large, complex and expensive to litigate, and take a long

time to resolve” and finding that class actions generally took from 43 to 68

months from filing to settlement approval and a single case could cost over $1

million for the plaintiff to litigate (footnote omitted)); Richard A. Booth, The

Future of Securities Litigation, 4 J.BUS.&TECH.L.129, 143–44 (2009)

(arguing that securities fraud class actions “suffer from circularity” because “(1)

the costs fall on the corporation and thus its stockholders (even though the

company gained nothing from the fraud), (2) settlements account for a very

small percentage of total investor losses, and (3) the settlement is effectively

paid by investors who held shares at the time of the fraud to investors who

bought during the fraud period” and suggesting that securities class actions

should be brought derivatively (footnote omitted)); Jill E. Fisch, Class Action

Reform: Lessons from Securities Litigation, 39 ARIZ.L.REV. 533, 533 (1997)

(“One of the most damaging accusations made against class action litigation,

particularly securities litigation, is the claim that it is ‘lawyer-driven litigation.’

In the parlance of, among others, the proponents of the Republican Contract

with America, lawyer-driven litigation is inherently abusive.” (footnotes

omitted)).

174 LOUISIANA LAW REVIEW [Vol. 74

chipped away at the private right of action.2 Similarly, Congress has

passed a series of laws targeted at raising the pleading bar for

plaintiffs in securities actions3 and forcing large securities cases into

federal court.4

While litigating securities claims has become more difficult for

plaintiffs, a rise in the use of pre-dispute arbitration agreements

(PDAAs) has led to a significant growth in securities arbitration

under the auspices of the National Association of Securities Dealers

2. See, e.g.,Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver,

N.A., 511 U.S. 164 (1994) (barring private plaintiffs from asserting claims for

aiding and abetting securities fraud); Dura Pharm., Inc. v. Broudo, 544 U.S. 336,

338 (2005) (raising the pleading standards for loss causation in private securities

actions); Stoneridge Inv. Partners v. Scientific-Atlanta, 552 U.S. 148, 159–60

(2008) (barring private plaintiffs from asserting claims against third-party actors

under a “scheme liability” theory).

3. In 1995, Congress passed the Private Securities Litigation Reform Act

(PSLRA), Pub. L. No. 104-67, 109 Stat. 737. The explicit goal of the PSLRA

was to “protect investors, issuers, and all who are associated with our capital

markets from abusive securities litigation.” H.R.REP.NO. 104-369, at 32 (1995)

(Conf. Rep.), reprinted in 1995 U.S.C.C.A.N. (104 Stat.) 730, 731. See Matthew

O’Brien, Choice of Forum in Securities Class Actions: Confronting “Reform” of

the Securities Act of 1933, 28REV.LITIG.845, 858 (2009) (“In particular,

Congress wanted the PSLRA to curtail ‘strike suits’—‘meritless class actions

alleging fraud in the sale of securities . . . .’” (footnote omitted)). Among other

provisions, the PSLRA instituted a mandatory stay of discovery until after the

resolution of an initial motion to dismiss, 15 U.S.C. § 77z-1(b) (2012), and

greatly increased the pleading burden for plaintiffs by requiring a particularized

pleading of misrepresentations and scienter. Id. § 78u-4(b).

4. In 1998, in response to concerns that plaintiffs were avoiding the

PSLRA by filing lawsuits in state court, Congress passed the Securities

Litigation Uniform Standards Act (SLUSA). See H.R. REP. No. 105-803, at 2

(1998) (Conf. Rep.) (“[I]n order to prevent certain State private securities class

action lawsuits alleging fraud from being used to frustrate the objectives of the

Private Securities Litigation Reform Act of 1995, it is appropriate to enact

national standards for securities class action lawsuits involving nationally traded

securities, while preserving the appropriate enforcement powers of State

securities regulators and not changing the current treatment of individual

lawsuits.”).SLUSA prevents securities class actions from proceeding in state

court and prevents parties from asserting class actions alleging violations of

state securities laws. See Segal v. Fifth Third Bank, N.A., 581 F.3d 305, 309

(6th Cir. 2009) (“After PSLRA became law, some claimants responded by

‘avoid[ing] the federal forum altogether,’ bringing ‘class actions under state law,

often in state court’ instead. That apparently was not what Congress had in

mind. In 1998, it sought to close the gap in coverage by enacting SLUSA. To

‘prevent certain State private securities class action lawsuits alleging fraud from

being used to frustrate the objectives of’ PLSRA, SLUSA expressly prohibits

certain state law class actions. . . .’” (internal citations omitted) (quoting Merrill

Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 82 (2006)). See

generally William B. Snyder, Jr., The Securities Act of 1933 after SLUSA:

Federal Class Actions Belong in Federal Court, 85 N.C.L.REV.669, 676–77

(2007).

2013] DEFINING “CUSTOMER” 175

(NASD) and its successor, the Financial Industry Regulatory

Agency (FINRA), the self-regulatory authorities that oversee the

securities industry and its arbitral forum.5 At the same time that

courts were raising the bar for securities litigation, FINRA altered its

own rules to make the forum more attractive to investors.6 Not

surprisingly, in recent years a fair amount of litigation has arisen

around the issue of arbitrability, in which securities industry

members seek to deny plaintiffs access to FINRA’s arbitral forum

and force plaintiffs to bring their claims in court.7

FINRA arbitration is available to any customer of a FINRA

member for any claim that arises out of that member’s business

activities, either based upon a written agreement between the parties

5. See Catherine Moore, The Effect of the Dodd-Frank Act on Arbitration

Agreements: A Proposal for Consumer Choice, 12 PEPP.DISP.RESOL.L.J.503,

511 (2012) (“[W]hile the investment market has expanded, the number of

arbitration forums has shrunk to one—FINRA. Thus, there are more consumers

signing predispute arbitration agreements and only one forum in which they can

settle their disputes.” (footnote omitted)).

6. Two recent pro-customer changes to FINRA rules include allowing

customers to request an all-public arbitration panel, which does not include an

industry representative and also limiting motions to dismiss prior to the

arbitration hearing. See Optional All Public Panel RuleFINRAR.

12403(c)(1)(A) (2013), available at http://finra.complinet.com/en/display

/display_main.html?rbid=2403&element_id=4141 (“Rule 12403 . . . provides

for limited strikes on the public and public chairperson lists and unlimited

strikes on the non-public list. In optional all public panel cases, the panel may

consist of three public arbitrators or two public arbitrators and one non-public

arbitrator. Under this option, either party can ensure that the panel will have

three public arbitrators by striking all of the arbitrators on the non-public list.”)

The Optional All Public Panel Rule went into effect on January 31, 2011. See

Optional All Public Panel Rules, FINRA,http://www.finra.org/arbitration

andmediation/arbitration/rules/ruleguidance/noticestoparties/p123997; see also

FINRA R. 12504(a) (2013), available at http://finra.complinet.com/en

/display/display_main.html?rbid=2403&element_id=7377; News Release,

FINRA, SEC Approves FINRA Rule to Drastically Limit Motions to Dismiss in

Arbitration (Jan. 8, 2009), available at http://www.finra.org/Newsroom

/NewsReleases/2009/P117686 (“By narrowing significantly the grounds for

granting dispositive motions before investors present their case, the new rule

will ensure that claimants in arbitration have a full opportunity to argue their

case. Under the new rule, a motion to dismiss before a claimant’s case is

presented can only be granted on three specific grounds, and there are stringent

new sanctions against parties for engaging in abusive case-dismissal

practices.”). FINRA Rule 12405 went into effect on February 23, 2009.

7. See Barbara Black, The Irony of Securities Arbitration Today: Why Do

Brokerage Firms Need Judicial Protection?, 72 U.CIN.L.REV. 415, 416, 419–

31 (2003) (outlining situations in which FINRA members have gone to court to

enjoin arbitration). “Illustrating a classic example of ‘be careful what you wish

for,’ brokerage firms no longer find arbitration entirely to their liking.

Increasingly they turn to the courts to resist arbitration, to interfere with ongoing

arbitration, or to undo the results of arbitration.” Id.