Latest SAC Podcast Tackles “Employment Issues in Securities Arbitration in the Wake of Epic Systems”
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The current state of securities industry employment arbitration, including what the Supreme Court’s Epic Systems decision may mean for the financial services sector, were the core topics discussed recently by an experienced panel of securities arbitration experts in the sixth SAC Podcast.

The video Podcast was moderated by Richard Ryder, Esq., President, of the Securities Arbitration Commentator, and features as panelists former FINRA Director of Arbitration and current SAC Contributing Legal Editor and Board member George H. Friedman, Esq., James L. Komie, Esq., Howard & Howard PLLC, Jeffrey Liddle, Esq., Liddle & Robinson, L.L.P., and Dana Pescosolido, Esq., Pescosolido Mediation and Consulting, LLC. Recorded in August, the video podcast, complete with a PowerPoint, explores the current securities employment arbitration landscape, case filing trends, what's new in the world of raiding and recruiting disputes, the Broker Protocol in flux, and the latest in promissory note cases.

Securities Industry Employment Arbitration: A Changing Landscape

Moderator Ryder set the table by stating that the panel would discuss several major topics and several subtopics, starting with a brief look at the current securities arbitration landscape. “We'll move on to explain the Epic Systems decision, and what it means for the use of class action waivers in securities employment arbitration clauses. In parallel fashion, we'll look at the Schwab case, where class action waivers were outlawed by FINRA in customer cases. Then the Broker Protocol. Is it expiring or evolving? And finally, our customary look down the long road: where will we be three years from now?”


Mr. Ryder noted that the top growth area in disputes right now is expungement, and that it’s also the area in greatest flux (which he said recommends it for coverage in a future podcast). Mr. Pescosolido observed that “the really big news is that, in 2017, FINRA proposed sweeping changes, that I think are going to make it harder and more expensive for brokers to obtain expungement. What you want to be looking at here is Notice to Members 17-42. The comment period is now over -- it ended in February -- and the SEC's Investor Advocate's Office, actually issued a letter in April, generally supporting these changes, making a few comments on them. But I think most of the people who live in this world fully expect most of the changes that have been suggested; they're going to come.”

Promissory Note Cases

Mr. Pescosolido observed that, while the number of promissory note cases is ebbing, it's still pretty significant: “If you look at FINRA’s statistics page, you'll see that about 300 cases were filed in 2017. Still a fair number of cases. That is down about 40 percent from 2014. So, it went from almost 500 cases, down to under 300 cases. Why is this? … No one really knows for sure why this is. I suspect if we get into another hot market for brokers, these cases will come back up, in terms of their number.” Mr. Komie then discussed his idea for improving the Rules: “As our audience may know, promissory note cases have their own special Code provision at FINRA set forth in Rule 13806, which was adopted in 2009. And the idea behind the adoption of a special rule for prom note cases I think was a good one, is to try to simplify and streamline these cases…. At this point, I think FINRA should realize or face up to the fact that the prom note Rule really isn't achieving what it was intended to achieve, and should consider making some additional modifications. Maybe something like the new simplified arbitration Rule, which was recently promulgated, providing for a telephone hearing, with limitations on the length of presentations by each side….”

Employment Arbitration Code Framework

The panel then turned to the current Rules framework governing employment cases generally. Mr. Liddle started with the typical employment case, “where an employee, whether a broker or investment banker, brings a case against a member firm, and in that case, we have the requirement that the three arbitrators be two public and one non-public, and that the arbitrator chairman must be a public arbitrator.” In a promissory note case started by the firm with no counterclaim, said Mr. Liddle, “it’s going to be a one-arbitrator case, and there's a defined number of qualified arbitrators for those cases. If it’s started by the firm, and the associated person brings a counterclaim on some other issue -- failure to pay a bonus, wrongful termination, or some other issue -- the arbitration panel will be, as it is in the normal course of what I described earlier as a regular dispute.” The panel noted that statutory discrimination cases can be heard at AAA or JAMS, but at FINRA the arbitrator's qualifications are specified in Rule 13802. The panelists also discussed panel composition in raiding and expungement cases.

Epic Systems

The discussion turned to the SCOTUS decision in Epic Systems and what it might mean for the employment arbitration cases in the securities field. Mr. Friedman briefly described the case and the core holdings (ed: for more detail, we refer you to our July 9th blog post). He said the key takeaway from the 5-to-4 decision issued last May, authored by Justice Gorsuch, is: “On the question of the apparent conflict or tension between the Federal Arbitration Act and the National Labor Relations Act, the majority said, ‘Well, Congress, if it wants to ban arbitration, knows how to do that. Congress will explicitly say, “No arbitration.’”

… and its Impact: the Schwab Case

Mr. Ryder then moved the discussion to class action waiver use in the securities industry: Before Epic there was Concepcion, another case that held that class action waivers in the consumer context were permitted under the Federal Arbitration Act. After that, Charles Schwab, as you remember, started using waivers in its customer account arbitration agreements. And FINRA went after Schwab.” Mr. Friedman provided some background on the Schwab case, and how it might relate to employment arbitrations: “Schwab then started putting these waivers in their customer agreements. As Rick said, FINRA took objection to that, and said, ‘Look, we have two Rules we think you're violating. Rule 12204, among other things, says the customer can participate in a class action if they so choose. They don't have to go to arbitration. They can't do both, but the customer has an absolute right to participate in the class action or go to arbitration. The problem is compounded by Rule 2268 which says a BD can't limit the right the customers have under the Rules.’ The hearing panel agreed there was a Rules violation, finding that Rule 12204 is quite clear, as is Rule 2268. But the hearing panel agreed with Schwab in part … saying, ‘yes, but the Concepcion decision preempts FINRA from legislating against class action waivers.’ Long story short, the FINRA Board called the case, which it can do…. In a nutshell, the Board agreed with the hearing panel that several Rules had been violated, but they disagreed on FAA preemption and said the Rules on class actions - 12204 and 2268 - are not preempted. So that was the holding, and whether Schwab carries over to employment, I will answer: no, I don't believe it does.”

Can FINRA Bar Class Action Waivers in Employment Contracts?

In response to Mr. Ryder’s request for an explanation, Mr. Friedman said: “Well, there is a Rule 13204 in the Industry Code that clearly governs the rights APs have to participate in a class action if they so choose, but there is no 2268-like Rule on the industry side that says what the industry can and can't do regarding employment arbitration agreements. So while I have no doubt that FINRA would be troubled by a firm starting to put class action waivers in employment agreements, I think it will have a problem challenging that conduct as things now stand. My bottom line view at this stage: in the absence of a 2268-type Rule on the industry side, coupled with the Board's language in Schwab and FINRA's own language in Regulatory Notice 16-25, I think the analogy fails and it does not carry over as the Rules currently exist.” 

Employment Arbitration at other Forums

Mr. Ryder observed that some of the larger houses, it seems, have already adopted class action waivers in their employment agreements and, perhaps coincident with that, they've also looked to other forums to arbitrate their disputes, such as JAMS and AAA. He asked Mr. Liddle to describe the differences among the other major forums, compared to FINRA: “I think that you can probably sum up these forums in one or two sentences each. I think JAMS is a great place, but it's very judge heavy, and the proceedings are very formalistic -- in the sense of rules of evidence, motions for summary judgment, motions to dismiss even, and some amount of deposition discovery. AAA has some discovery and it also has dispositive motions long before the hearing. Both of those forums are lacking, at least in my opinion, one of the things that's crucial to FINRA's success in handling these cases, which is there's no adherence to the arbitration rules of FINRA, which obviously have to be vetted and go through SEC approval. Nor is there any requirement that any of the arbitrators have any type of actual expertise in industry practice. With the advent of so many public arbitrators in these various cases, that's less of an advantage at FINRA than it used to be, but it's still there in virtually every case they hear…. I think FINRA is far superior in that regard. It's also far superior with the limitations that are placed on discovery and the like. To limit the use of dispositive motions represents a real plus for the FINRA forum as well.” 

The Protocol

Several years ago, key broker-dealers entered into a Protocol to address raiding. That Protocol has lasted and shown durability in the last 15 or so years. Mr. Ryder asked Mr. Komie to describe the Protocol and whether it may be expiring or evolving. Said Mr. Komie: “The Protocol sets forth rules for member firms and financial advisors who are moving between firms to follow in connection with transitions, and provides that, if you follow the rules, then there's going to be no litigation.” As to its effectiveness, Mr. Komie believed that the Protocol has worked by and large, but there have been developments over the past year: “At the end of last year -- Morgan Stanley in November and then UBS in December -- dropped out of the Protocol. One of the founding member firms and another very early member of the Protocol! There was some concern that that would lead to the quick unraveling and end of the Protocol. But there really hasn't been the rush for the exits that people were predicting. The other big firms, by and large, have stayed in the Protocol. Mr. Pescosolido suggested that “there's been a lot of discussion about, could there be a Protocol version 2.0 -- that maybe Morgan Stanley and UBS would be willing to sign on to. I don't think that's going to be viable. I think some of the biggest objections that the big firms like Morgan Stanley and UBS had was being victimized, as Jim said, by the RIAs. But also the fact that, even among the bigger firms, there wasn't an all-in for the enterprise concept…. I agree with Jim. The withdrawals from the Protocol have been very few, something like 1,700 members still in it? It's huge.”

The Last Word

Moderator Ryder closed the Podcast by asking the panelists for their views on the future. Mr. Friedman said: “I think FINRA is going to do what I suggest and class action waivers will be banned on the employment side.” Next, Mr. Liddle opined that as between FINRA and the AAA, “there's no question that FINRA will have the most financial industry employment cases. The real question is how many there will be three years from now, because I see a general decline in the number of cases and there are a lot of factors for that, certainly on the institutional side that relates to so much deferred comp being used to settle matters before they get to litigation. On the retail business, it's obviously changing greatly and the issues there are much less frequent, I think, for compensation-related issues.” Mr. Pescosolido added: “I think one thing is clear and that's expungements are going to get tougher. There's probably going to be more careful selection by the brokers’ attorneys about what cases they think they can get it in. I think they already do a pretty good job of that.” The final prediction came from Mr. Komie: “For my crystal ball prediction, I'm going to have to disagree a little bit with Dana about the future of the Protocol. Although the Protocol did not evaporate, I do see continued pressure on the Protocol and changes ahead. The pressure won't come from competitive concerns, but from regulatory exposure on the privacy issues that are inherent in the taking of information that the Protocol allows.”

(ed: *A full write-up of the video podcast is featured in the current issue of the Securities Arbitration Commentator (vol. 2018, no. 5; August 2018). **Click here for a link to the video, and check our Blog for a permanent link to this and future audio and video podcasts.)

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