FINRA Arbitration Requirements Take Priority over Forum Selection Clause

The Third Circuit Court of Appeals recently ruled that Bear Stearns must comply with the Financial Industry Regulatory Authority (FINRA) rules that require arbitration of a customer’s claims despite the existence of a forum selection clause. That ruling, in Reading Health System v. Bear Stearns & Co., n/k/a J.P. Morgan Securities, LLC, involved a broker-dealer agreement between Bear Stearns (now J.P. Morgan Securities) and Reading Health System regarding offerings of certain securities by Reading Health through which J.P. Morgan Securities served as broker-dealer and underwriter. The agreement provided that any actions and proceedings arising out of the agreement or the underlying transactions had to be filed in the U.S. District Court for the Southern District of New York. However, FINRA Rule 12200 generally requires FINRA members to arbitrate disputes with customers at the customers’ request if arbitration is required by written agreement or requested by a customer.

Reading Health filed a Statement of Claim with FINRA, alleging that J.P. Morgan Securities engaged in improper conduct in conjunction with the offerings. J.P. Morgan Securities refused to participate in FINRA arbitration. It cited the forum selection clause in its agreement with Reading Health. In response, Reading Health filed a declaratory judgment action to address the arbitration issue. 

The U.S. District Court ordered J.P. Morgan Securities to arbitrate. On appeal, the Third Circuit affirmed. The court found J.P. Morgan Securities’ argument unpersuasive that, in agreeing to the forum selection clauses included in the broker-dealer agreements, Reading Health waived the right to FINRA arbitration under Rule 12200. The Third Circuit found that the forum selection clause, which did not refer to arbitration, lacked the specificity to support a finding of waiver. Although waiver of FINRA Rule 12200 might be found under different facts, the assertion of waiver would need to be supported by explicit language waiving the specific right to FINRA arbitration. 

The court found that Reading Health System had not waived its right to compel Bear Stearns to arbitrate under FINRA’s rules. 

The deadline to file a writ of certiorari to the U.S. Supreme Court in this case is 90 days from the entry of judgment on August 7, 2018. This ruling widens a circuit split. The Second and Ninth Circuits have enforced forum selection clauses, while the Fourth Circuit has held that the FINRA Rule requires arbitration even in the face of a forum selection clause.

Labor Department Sets New Fiduciary Standard for Retirement Advice

The U.S. Department of Labor, which regulates tax-advantaged retirement savings accounts, is holding more financial advisors to a "fiduciary standard," which requires financial advisors to put clients' best interests ahead of profits. A new set of rules regulates any investment advice that is a recommendation to a plan, plan fiduciary, plan participant and beneficiary and IRA owner for a fee or other compensation, as to the advisability of buying, holding, selling or exchanging securities or other investments, including recommendations as to the investment of securities or other property after the securities or other property are rolled over or distributed from a plan or IRA, recommendations as to the management of securities or investment property, including recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice/investment management services, selection of investment account arrangements and recommendations with respect to rollovers, transfers, or distributions from a plan or IRA.

Until now, financial advisors were subject to a fiduciary standard on an ad hoc basis, depending on state law, and when registered as investment advisors with the SEC. Many brokers and other self-described financial advisors are held only to a “suitability standard,” under which they need only make investment recommendations that are suitable for their clients, but not necessarily the best option.

Highlights of the rule include:

• Financial brokers must now act in clients' "best interest" when giving retirement investment advice. 
• Firms must ban financial incentives for advisers not to act in the client's best interest. 
• Firms must disclose compensation arrangements on a webpage and by making sure customers are aware of their right to all fee information. 
• Firms and advisors may continue receiving the most common forms of compensation for offering investment advice to retail customers and small-plan sponsors. The rule also does not limit the types of assets they can invest in. 
• Firms are allowed to sell insurance products like variable and indexed annuities under the best interest rule. 
• The rule allows firms and their advisers to recommend proprietary products. 
• Education is not included in the definition of retirement investment advice, allowing advisers to offer basic information without acting as fiduciaries. 
• Under the rule, financial advisers may communicate with potential clients before signing a contract. However, firms must eventually tell new clients in writing that they are acting in their best interest, and any advice given before a contract is signed must be covered by the contract and meet the best interest standard. 

Firms have a year or more to adjust to the new rule. It will take effect in part on April 2017, with full implementation in January 2018.