SEC Approves FINRA's Proposed Amendment to Discovery Guide

Sunday, September 22, 2013

The SEC has approved a proposed rule change (SR-FINRA-2013-024), filed by the Financial Industry Regulatory Authority, Inc., to amend its Discovery Guide used in customer arbitration proceedings. The amendments provide guidance on electronic discovery issues, product cases and clarify the existing provision relating to affirmations made when a party does not produce documents specified in the Discovery Guide.

Under the revisions, the parties must produce electronic files in a "reasonably usable format." When presented with contested motions about the form of document production, arbitrators can evaluate whether a document produced in a given format is consistent with the form in which it is ordinarily maintained. If not, a party must state the reasons.  Arbitrators can also look at whether the other party’s ability to use the document is impaired (i.e. searchability, metadata, etc.). Arbitrators will have the power to order a different format for production if warranted. In conjunction with the guidance on e-discovery, there will also be guidance on the cost or burden of production. FINRA intends to amend the current provision to give arbitrators the discretion to order a different form of production if it would lessen the cost or burden of producing electronic documents.

With regard to affirmations, which are currently provided for when a party indicates there are no responsive documents, the amendments provided that a party must indicate that they performed a good-faith search and indicate the sources searched.

Publication of the rule change is expected in the Federal Register during the week of September 16th. (Release No. 34-70419)

Schwab's Efforts to Ban Securities Class-Actions Draws Criticism, Calls Into Question Mandatory Arbitration as a Whole

Sunday, September 8, 2013

The Court system has been essentially unavailable to retail investors seeking relief from their broker-dealers since the 1987 U.S. Supreme Court decision in Shearson v. McMahon, which held that a brokerage firm could compel customers to agree to mandatory arbitration. Since that ruling, nearly every brokerage firm has included mandatory arbitration agreements in all new account documents. The one exception to mandatory arbitration is for issues so pervasive, that they warranted class-action status, in which groups of investors could sue a firm or firms, in court.

As the New York Times reports, in 2011, Charles Schwab sought to address this exception, adding a clause to its customer agreement requiring clients to agree not to pursue or participate in class-action litigation. FINRA responded by filing an enforcement action to force Schwab to do away with the provision. Schwab challenged the decision, and won at a panel hearing this past February. FINRA appealed, and the case is set to go before FINRA’s adjudicatory panel shortly.

The decision has caused significant concern among investors (and their lawyers), who worry that if Schwab is successful, other firms will follow, resulting in significant erosion of investor protection. These proceedings, however, have had a more profound impact, calling into question the entire mandatory arbitration process. Investor concerns with the arbitration process range from criticism that arbitrators do not follow the law, concern about arbitrator qualifications and selection process, arbitrators’ perceived unwillingness to award full damages (including punitive damages), and limitations on discovery, including the absence of depositions.

These concerns also come just weeks after a federal judge in Pennsylvania overturned an arbitration decision in August in which Goldman Sachs prevailed, after it became apparent that one of the arbitrators had recently been indicated by a grand jury. FINRA is now ramping up efforts to perform periodic background checks on its arbitrators.

Time will tell whether the ban on class-action proceedings will live on in Schwab’s investor agreements, but if they do other brokerage firms will almost certainly follow Schwab’s lead. If Schwab succeeds, watch for greater pressure to make mandatory arbitration optional.