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Schwab loses lawsuit to halt FINRA action


A federal court judge threw out a lawsuit by Charles Schwab Corp that had sought to stop its regulator from disciplining the brokerage for trying to take away customers’ rights to sue it in class actions.

Magistrate Judge Elizabeth Laporte of the U.S. District Court for the Northern District of California late on Friday granted a request by the Financial Industry Regulatory Authority to dismiss a lawsuit that Schwab filed against the regulator in February.

Schwab sued FINRA, Wall Street’s industry-funded watchdog, a day after the regulator announced an enforcement case against the San Francisco-based company.

FINRA alleged that Schwab added a new provision to more than 6.8 million customer account agreements in October that would preclude them from starting or joining class-action lawsuits against the brokerage.

The case raised significant investor protection issues, according to lawyers.

Class actions are a common way for small investors to band together in a court case to recover their losses. A win by Schwab would have set the stage for a showdown that could lead other companies to change their arbitration agreements and potentially weaken FINRA’s hold over its own enforcement process, lawyers said.

Schwab also required customers to agree that industry arbitrators would not have the authority to consolidate claims from multiple parties. Such consolidated cases are common, but typically include far fewer claimants than those in class actions. Both types of cases often involve investors with smaller claims, typically under $10,000, according to lawyers.

“It’s a good decision for all investors and customers of Charles Schwab,” said Ryan K. Bakhtiari, president of the Public Investors Arbitration Bar Association, a Norman, Oklahoma-based group of securities arbitration lawyers. “The rules are clear and unequivocal that Schwab did not have the right to prohibit class actions, he said.

Judge Laporte, in a 21-page opinion, agreed with FINRA that Schwab is required to follow its procedures for disciplinary cases. That process ultimately includes a review by a federal court judge.

FINRA, in addition to being Wall Street’s regulator, runs the arbitration forum where customers and brokerage firms typically must resolve legal disputes. FINRA arbitration rules do not allow arbitrators to hear class action cases.

FINRA rules also restrict brokerages from limiting investors’ rights to file court cases in certain situations.

Schwab’s agreement would effectively leave investors in a bind, in which many would not have access to a legal process for recovering their losses, lawyers said.

Schwab had argued, among other things, that it would be “irreparably harmed” by using FINRA’s process, which the company said could take up to four or more years. But delay is not an adequate reason for avoiding FINRA’s process, the court wrote. Schwab did not show it was “entitled to an exception” from FINRA’s process, according to the opinion.

The court’s dismissal of Schwab’s lawsuit against FINRA, however, leaves some questions unresolved while FINRA continues its disciplinary case against the brokerage, said William Jacobson, a professor at Cornell Law School’s Securities Law Clinic in Ithaca, New York.

Schwab must now decide whether to continue using a provision in its customer agreement during those proceedings “that amounts to, in effect, a continued, knowing violation,” he said. It is also unclear what would happen if Schwab tried to enforce the class action waiver agreement in a case against a customer, Jacobson said.

A spokesperson for Schwab was not immediately available for comment. A FINRA spokeswoman declined to comment.