Today, a Financial Industry Regulatory Authority (“FINRA”) hearing panel ratified Charles Schwab’s inclusion of a clause in their customer agreement that prevents customers from pursuing class action claims against the firm. After agreeing to pay $225 million to settle a class action lawsuit in connection with the beleaguered YieldPlus ultra short-term bond fund, Schwab promptly modified their customer agreement preventing customers from participating in class actions and requiring all disputes to be submitted to FINRA’s securities arbitration dispute resolution program. At this early stage, it is unclear whether FINRA’s Department of Enforcement will appeal the ruling. However, it is safe to assume that other brokerage firms may soon be following Schwab’s lead and amending their customer agreements to prevent class actions.
What Does This Mean for Investors?
According to a statement issued by Schwab, customers are better served through FINRA’s arbitration process because class action litigation is “cumbersome” and a “less effective” means of resolving disputes. Schwab is partially correct. As noted in a previous blog post, customers with meritorious cases may be able to recover a larger percentage of their losses in arbitration. See Securities Arbitration vs. Class Actions: Which is More Financially Rewarding?
From an investor’s perspective, class actions are anything but “cumbersome.” Very little is required of investors who elect to become members of the class action. In return for this low level of participation, investors usually reap much smaller potential rewards. Arbitration, on the other hand, requires the investor to prove their case on an individual basis. In return for this added level of commitment, customers with valid arbitration claims can expect greater potential rewards.
The investors who have the most to lose are those with claims that are too small to justify the added burden of filing an individual arbitration claim. Although FINRA offers a simplified arbitration program for claims under $50,000, some customers with very small or questionable claims would be better off taking a “pennies on the dollar” class action settlement.
The Bottom Line
While it is true that investors are getting cut off from another avenue of relief, little has changed for most investors. FINRA’s dispute resolution program–flawed as it may be–still offers the best option for investors who have meaningful claims.
Updated February 27, 2013: FINRA Appeals Charles Schwab Class Action Ban