By: William M. Dailey

For the Moment, FINRA Arbitration with Customers is Not Mandatory, So Say Two Federal Appeals Courts

In August 2014, the Court of Appeals in the 2nd Circuit (i.e., NY and CT) joined its brethren in the 9th Circuit (i.e., CA, NV, OR, WA, MT, ID, AK and HA) in holding that a FINRA member firm and its customer may agree to settle disputes in court and not in FINRA arbitration.  Meanwhile, the Court of Appeals in the 4th Circuit (i.e., MD, WV, VA, NC and SC) ruled the opposite in 2013 under similar facts.  Resolution of this circuit split would have to come from the U.S. Supreme Court – not a certainty.


FINRA Rule 12200 provides as follows:

Parties must arbitrate a dispute under the Code if:

  • Arbitration under the Code is either:

    (1) Required by a written agreement, or
    (2) Requested by the customer;

  • The dispute is between a customer and a member or associated person of a member; and
  • The dispute arises in connection with the business activities of the member or the associated person, except disputes involving the insurance business activities of a member that is also an insurance company.

[Emphases added.]

In 2013, the 4th Circuit rejected efforts by units of Citigroup and UBS (FINRA member firms) to block arbitration of auction-rate bond-related claims brought by Virginia-based Carilion Clinic. UBS Fin. Servs., Inc. v. Carilion Clinic, 706 F.3d 319 (4th Cir.2013).  Carilion had hired UBS and Citigroup to underwrite and broker its auction-rate bond offerings starting in 2005.  Carilion alleged that UBS and Citigroup misled Carilion by neglecting to mention that they had a practice of placing supporting bids in such auction, so as to prevent the failure of such auctions.  When such auction markets collapsed in 2008 and the brokers withdrew their supporting bids, Carilion lost millions of dollars when it was forced to refinance its debt at much higher rates.  Carilion filed statements of claim against UBS and Citigroup in FINRA arbitration in 2012, and UBS and Citigroup quickly filed in federal court to block same.

First, UBS and Citigroup effectively argued that Carilion was too sophisticated to be a “customer” under FINRA rules.  The 4th Circuit disagreed, finding Carilion to be a “customer” under FINRA rules.

Next, UBS and Citigroup argued that the forum selection clauses in the agreements with Carilion clearly said that district court in New York City would be the forum for disputes under the agreement.  The 4th Circuit held that FINRA arbitration rules mandating FINRA as the forum for disputes with customers trumped such forum selection clauses, especially since there was no specific waiver by Carilion of its right to arbitration.

In March 2014, the 9th Circuit essentially disagreed with the 4th Circuit’s holding in Carilion.  In an auction-rate security case, the court held that “the forum selection clauses superseded Goldman’s default obligation to arbitrate under the FINRA Rules and that, by agreeing to these clauses, Reno disclaimed any right it might otherwise have had to the FINRA arbitration forum.”  Goldman, Sachs & Co. v. City of Reno, 747 F.3d 733 (9th Cir.2014).

In August 2014, the 2nd Circuit followed suit in yet two more auction-rate security-related cases, and took the unusual step of stating “We thus disagree with the contrary conclusion reached by the Fourth Circuit in Carilion Clinic.”   Goldman, Sachs & Co. v. Golden Empire Schools Financing Authority, No. 13-797-cv and Citigroup Global Markets Inc. v. North Carolina Eastern Municipal Power Agency, No. 13-2247-cv (August 21, 2014).  The 2nd Circuit held that, “Under our precedent, the forum selection clause at issue in these cases is plainly sufficient to supersede FINRA Rule 12200.”


These circuit splits mean that mandatory FINRA arbitration is alive and well in some parts of the country, but not others (including, as of August 2014, the important jurisdiction of New York).  These decisions remind both firms and their clients not to gloss over the standardized template language at the end of their agreements, especially forum selection clauses and integration clauses.

What the courts do not mention (nor need to, for their purposes) is FINRA IM-12000, which essentially gives FINRA enforcement power to pursue any member firms that “fail to submit a dispute for arbitration under the Code as required by the Code.” FINRA IM-12000(a).  It remains unknown as of this writing whether FINRA is investigating the above member firms for violations of FINRA Rule 12200, or will do so.  Firms like the ones above that fight FINRA arbitration as a forum for disputes with customers, do so at their own peril.

Tags: Joseph Pastore, Securities Arbitration, Security