Investment advisers should promptly review language used in mandated pre-dispute arbitration agreements in response to Regulatory Notice 21-16 recently issued by the Financial Industry Regulatory Authority (FINRA). The Notice serves as a cautionary yellow light for firms that may be inclined to limit investor protections by improperly including adviser-friendly terms that ignore specific FINRA disclosure requirements.
Among the most common mistakes advisers make when drafting pre-dispute arbitration agreements is to include language that infringes on customer rights to pursue any legal action against the firm, including client rights to file for class action protection. Regulatory Notice 21-16 increases the likelihood that FINRA examiners will review arbitration agreement language used by member firms in the months to come.
Points to Ponder
Disclosure requirements for arbitration clauses fall under FINRA Rule 2628, which generally prohibits provisions that contradict other FINRA rules.
With that in mind, FINRA member firms should refer to the following five-point checklist to avoid potential headaches.
- Don’t try to gain the equivalent of a home-field advantage. FINRA Rule 12213 provides that the Arbitration Director will determine the location for any hearing. Preference is usually given a location nearest the customer. Last summer, a federal judge ruled a FINRA arbitration proceeding could be held over Zoom despite the fact the customer wanted an in-person hearing. Recent progress made against the coronavirus, however, makes Zoom use a moot point.
- Don’t set a self-imposed time limit for customer claims. The U.S. Securities and Exchange Commission (SEC) requires broker-dealers to retain records of all sales and purchases of securities for at least six years. Consistent with SEC regulations, FINRA Rule 12206 states that “no claim shall be eligible for submission to arbitration under the Code where six years have elapsed from the occurrence of the event giving rise to the claim,” adding that “this rule does not extend applicable statutes of limitations.” Using language to set a statute of limitations of less than six years with the idea that a compressed timetable will help your firm will be red-flagged by FINRA.
- Don’t include any provision that limits class-action claims. We’ve all seen the television commercials where law firms cast wide nets with 800-numbers in an attempt to enlist claimants for class-action suits. Lawyers use this tactic because individuals have the right to pursue class-action remedies in court. While FINRA Rule 12204 prohibits class-action claims in arbitration, FINRA Rule 2268 states, in part, that no person “shall seek to enforce any pre-dispute arbitration agreement against any person who has initiated in court a putative class action.”
- Don’t use language that prevents or limits awards by the arbitrator. Don’t succumb to the temptation to include language that keeps customers from filing a claim or add provisions that limit your firm’s liability for consequential or punitive damages. FINRA Rule 2268 prohibits the use of such firm-friendly provisions in pre-dispute arbitration agreements.
- Be careful when using indemnification or hold harmless provisions. Some of your firm’s customer agreements could contain indemnification or hold harmless provisions, such as those that require that the customer indemnify and hold harmless your firm from all claims and losses arising out of the original agreement. But indemnification and hold harmless provisions do not comply with FINRA Rule 2268 if they limit the customer from bringing a claim or receiving an award from a firm or associated person that the customer would otherwise be entitled to receive. These type of provisions should be carefully reviewed by counsel.
The Main Takeaway
Regulatory Notice 21-16 urges FINRA member firms to conduct timely reviews of their policies to ensure all language in pre-dispute arbitration agreements complies with the aforementioned rules. Otherwise, your firm could be subject to FINRA disciplinary action as part of the regulatory body’s ongoing efforts to protect investors.
Jacko Law Group’s team has extensive experience and can help address any potential shortcomings your firm may have in meeting FINRA regulations. To schedule a consultation, call us at (619) 298-2880 or visit us online at www.jackolg.com.
- Managing Partner and CEO
Michelle L. Jacko, Esq. is the Managing Partner and CEO of Jacko Law Group, PC, which offers securities, corporate, real estate and employment law counsel to broker-dealers, investment advisers, investment companies ...
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