Schwab prefers no regulation

Schwab prefers no regulation

By Amy Radon, Staff Attorney

We talk a lot around here about the class action. How it’s a mechanism consumers sometimes need available to them to challenge corporate greed. The same holds true for investors.

Securities brokerage firms have long resisted government regulation of the broker/dealer industry on the ground that self-regulatory organizations, like the Financial Industry Regulatory Authority (FINRA), can promulgate and enforce rules to protect investors. Apparently this system of self-regulation did not suit Charles Schwab, which recently decided to ignore FINRA’s rules that preserve investor class actions in court when it made the decision to scrap class actions altogether. Schwab, it seems, prefers no regulation to self-regulation.

This all began a few years ago. In October 2011, Schwab stuffed a notice into one of its mailings to its 6.8 million existing account holders that amended its investor contracts to ban class actions. Schwab’s decision to ban investor class actions flew largely under the radar at the time because few if any of the broker’s customers were aware of the existence of the notice or the effect it would have on their ability to hold the company accountable for wrongdoing in the future. Investors would soon learn that Schwab had decided to ban class actions in spite of the fact that the company long ago agreed, as a condition of FINRA membership, to abide by FINRA rules that preserve judicial class actions. According to Schwab, the Federal Arbitration Act (FAA) preempts FINRA rules.

It’s unsurprising that Schwab would want to ban class actions. The company had recently spent $320 million to resolve investor claims of state and federal securities law violations, which arose after the Securities and Exchange Commission found that executives at Schwab misled investors about the risks of one of the company’s funds, and committed fraud. But just because a brokerage company wants to avoid accountability for violating laws that protect investors doesn’t mean it should act on that idea, especially when it signed a contract with FINRA promising to follow FINRA’s rules.

Indeed, no other FINRA member firm has followed Schwab’s lead in banning class actions, and for good reason: if brokerage firms are allowed to ignore FINRA’s rules at their choosing, then investors and government regulators will lose all faith in the industry’s self-regulatory system and its ability to adequately protect investors from broker/dealer misconduct. The last thing that these brokerage firms want is to lose their self-regulatory system because the alternative would be increased government regulation and oversight. Schwab’s short-sighted decision to ban class actions, then, not only harms investors who will have no remedy for claims too small or complex to pursue on an individual basis, but it threatens the continued viability of the self-regulatory system.

All is not lost, however. FINRA’s Department of Enforcement is pursuing an enforcement action against Schwab for violating FINRA’s rules that preserve judicial class actions, and Public Justice, along with the AARP and the National Consumer Law Center, filed an amici brief challenging Schwab’s position. Our brief explains that the FAA simply does not extend to cases — such as this one — involving the right of a self-regulatory organization (like FINRA) to contractually oblige its own members to follow FINRA rules as a condition of FINRA membership. Our brief also explains that, if brokerage firms like Schwab are able to ban class actions, investors will have no remedy for broker fraud unless their claims are economically viable on an individual basis. Many are not.

Also, after we filed our brief, Schwab announced that it is “eliminate[ing] the existing class action lawsuit waiver” for any conduct that occurs on or after May 15, 2013. Even though Schwab is not giving up its fight to ban class actions, perhaps this decision to refrain from enforcing the ban while the issue is pending is Schwab’s way of recognizing that it may have gone too far.

If the self-regulatory system is expected to protect investors, Schwab must not be permitted to exempt itself from one of the most — if not the most — significant mechanisms that FINRA has for holding brokerage firms accountable for misconduct: the judicial class action.

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