Arbitration, Arbitration Requirement, Bonus, Brokerage Firm, Citibank, FINRA, FINRA Rule 13000, Form U-4, Goldman Sachs, Loan Agreement, Mandatory Arbitration, Promissory Note, Stockbroker
What a difference a couple of years can make.
When a stockbroker joins a firm the broker is required to register with the Financial Industry Regulatory Authority (“FINRA”). To do so he must complete and sign a Uniform Application for Securities Industry Registration or Transfer Form U-4 (“Form U-4”). The document contains an arbitration clause, in which the broker agrees to “arbitrate any dispute, claim or controversy that may arise between me and my firm, or a customer, or any other person . . .”
Often times when a broker joins a firm the broker receives a bonus in the form of a forgivable loan. This loan is documented by a promissory note or loan agreement which identifies the repayment terms. Disputes arising from defaults of such loans must be arbitrated. Indeed, the arbitration requirement, in addition to the language in the Form U-4, is mandated and codified by FINRA’s Code of Arbitration (“FINRA Code”) that requires “a dispute must be arbitrated under the [FINRA Arbitration] Code if the dispute arises out of the business activities of a member or an associated person and is between or among: Members; Members and Associated Persons; or Associated Persons.” FINRA Code Rule 13200. FINRA’s interpretive material deems it a violation of its rules and “conduct inconsistent with just and equitable principals of trade” for a member firm to require brokers to waive the arbitration requirement. FINRA IM 13000.
This arbitration requirement was recently enforced in 2012, when Merrill Lynch was fined $1,000,000. The firm attempted to skirt the arbitration requirement by utilizing a third party non-FINRA entity to issue the bonus checks, or forgivable loans to Merrill Lynch’s brokers. Merrill Lynch tried to circumvent the arbitration requirement by having the non-FINRA entity include a forum selection clause requiring any and all disputes relating to the loan to be filed before the New York Supreme Court, New York County.
By its fine to Merrill Lynch, FINRA was letting member firms know it would not tolerate firms failing to comply with the mandated arbitration requirement (and avoid paying FINRA the member charges for the arbitration). It was a shot heard around the securities industry world.
The recent decision of the United States Supreme Court of Appeals for the Second Circuit (“Second Circuit”) in Goldman Sachs & Co. v. Golden Empire Sch. Fin. Auth., No. 13-797-cv (2d Cir. Aug. 21, 2014) and Citigroup Global Mkts. Inc. v. N.C. E. Mun. Power Agency, No. 13-2247-cv (2d Cir. Aug. 21, 2014), which confirmed two lower court federal decisions, has now muted that shot. The decision has far reaching implications with FINRA and will test the regulatory entity’s wherewithal. The Second Circuit’s ruling that member firms may utilize forum selection clauses that supersede FINRA’s arbitration requirements opens a gateway of opportunities for firms to sidestep arbitration as it relates to loan agreements with brokers. By way of example, had the decision been in effect in 2012, it appears all Merrill Lynch needed to do to avoid mandatory arbitration was include a forum selection clause in its promissory notes or loan agreements requiring any and all disputes for any actions or proceedings regarding the note to be filed before the New York Supreme Court, New York County. What a difference two years makes!
It will be interesting to see if FINRA utilizes its enforcement authority to fine Goldman and Citibank for avoiding the arbitration requirement, and counter the ruling in one way or another. Will FINRA take the position that the Second Circuit (and corresponding Ninth Circuit) decision does not apply to the internal rules of the entity? If FINRA does not act, it will confirm to firms that the longstanding arbitration requirement in the FINRA Code is on its deathbed.
The Law Offices of Barry M. Bordetsky represents customers and industry representatives in FINRA arbitrations as well as before state and federal courts. If you have questions regarding the process, please contact The Law Offices of Barry M. Bordetsky by calling Barry Bordetsky at (800) 998-7705 or email firstname.lastname@example.org.