Posted on: 9/26/2011
Glenn E. Davis, Gallop Johnson & Neuman
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On April 27, 2011, the Supreme Court issued its opinion in AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011) holding that state law impediments to enforcement of class action waivers in arbitration agreements are preempted by the Federal Arbitration Act. The decision raises a number of important questions on the interplay of federal, state, and regulatory rules directed to arbitration of securities issuer and industry class actions.
In many business contexts, including the securities and consumer finance sectors, courts and litigants have struggled with the appropriateness of arbitration for class action claims and the enforceability of waivers in customer agreements that purport to prohibit individuals from pursuing class actions in arbitration. On October 28, 1992, the Securities Exchange Commission (SEC) approved amendments to the NASD Code of Arbitration Procedure and Rules of Fair Practice to exclude class actions from submission to arbitration of both public and members' disputes.The overarching purpose of the amendments was to ensure that claimants were not excluded from class actions by mandatory arbitration, unless the claimant is voluntarily or involuntarily excluded from the class or certification is denied.
FINRA's Customer Code, which applies to all claims filed after April 16, 2007, carries on the same regimen. Under Section 12204(a), "[c]lass action claims may not be arbitrated under the code." SR-FINRA-2008-021 eff. Dec. 15, 2008. A FINRA arbitration panel will decide whether a dispute is part of a class action unless a party seeks a ruling from the court administering the class action within 10 days of the date the Director refers the issue to the panel. Section 12204(c). Members may not enforce customer arbitration agreements against a member or consumer in a putative class unless the class is not certified or decertified, or the claimant lawfully declines to participate and withdraws from the class proceeding.
Why Arbitrability of Class Action Matters Raises High Stakes Questions
The economic incentives
When a class action against a brokerage firm exists, customers face a choice—wait and accept the benefits of a class action case or proceed individually in arbitration. The choice is impacted by the interplay of federal law, state law, and the industry regulatory scheme as well as practical considerations. According to National Economics Research Associates' (NERA) recent study the median settlement rate for class actions, although there are many variables, was 2.5 cents for every dollar of estimated damages. Another economic consulting firm, Cornerstone Research, came to essentially the same conclusion, pegging the rate at 2.3 percent of estimated damages. Two researchers, Edward S. O'Neal and Daniel R. Solin, after analyzing 14,000 securities arbitration awards from 1995 to 2004, concluded that the recovery in a large arbitration claim against a major brokerage firm was 12 percent of the claimants' estimated damages. Claims against brokerage firms outside the top ten, approximated 40 percent of the damages sought.
So the incentives seem to favor individuals going it alone, rather than accepting potential class action relief. This may or may not be in the interests of brokerage firms and investment advisors, depending on the factual situation and a careful assessment of defense costs.
Perhaps ironically, industry firms have on occasion sought to circumvent individual arbitrations by seeking to compel investors to participate in class action settlements. For example, in 2011 Ameriprise agreed to add $27 million to a class settlement for claims against one of its units, Securities America, bringing the total to $48 million, against a total loss claim exceeding $400 million. Securities America, a division of Ameriprise, is one of the largest advisory firms in the country. It sold hundreds of millions in private placement notes that turned out to be a fraud. An SEC investigation, several state investigations, hundreds of individual arbitrations, and, of course, large class actions promptly followed.
In connection with a proposed class settlement, Securities America asked a federal court in Dallas to halt investor arbitrations and state investigations and the district court did enter a temporary injunction staying pending arbitrations and state matters to avoid legal defense expense that otherwise could threaten the class settlement. This was not an academic matter; in January 2011, arbitration proved successful for at least one investor who sued Securities America. In January 2011, FINRA awarded an individual claimant nearly $1.2 million ($730,000 actual damages) for her private placement claim.
The state regulators harshly criticized the injunction. The NASAA amicus brief argued that "the request by the [class action] plaintiffs to enjoin the state regulators will not only terminate the efforts of the Massachusetts and Montana regulators, but it will have a chilling effect on all state securities regulators in that, despite their clear statutory authority to take steps necessary to police illicit conduct in their states, they potentially face having that authority impaired by defendants who would run to federal courts to plead poverty."
On March 18, at the hearing on approval of the settlement, Securities America did plead that it lacked funds to satisfy all potential arbitration awards as one of the reasons to approve the $48 million settlement, but the district court nonetheless disapproved the settlement and dissolved its injunction order. This opens the way for two state enforcement actions and the FINRA arbitrations to proceed and vindicated the ability of investors to elect to proceed on an individual basis
The Availability of Class Friendly Arbitration Forums
Brokerage firms historically have resisted aggregation of investors' claims in class actions. The FINRA rules reflect that tradition. Nonetheless, other arbitral forums (i.e. the AAA) do not exclude class actions categorically from disputes they are willing to administer. See AAA, Supplementary Rules for Class Arbitrations (effective Oct. 8, 2003), online at http://www.adr.org/sp.asp?id=21936. There remains public interest group pressure on the industry to accept alternative forums for arbitration other than FINRA procedures. Class action waivers thus remain a potential option to avoid class treatment, and some firms' customer agreements have included class action waivers. Lower courts have treated these types of provisions inconsistently and the growing trend among state appellate courts has been to reject them as contracts of adhesion and unconscionable. Does the AT&T v. Concepcion Case Offer Meaningful Guidance? Does it Offer a Way Out of Securities and Consumer Class Actions? AT&T v. Concepcion answers some but not all of the many issues relating to the tension between state law and the Federal Arbitration Act.
The Concepcions, a California couple, sued AT&T in federal court in California, charging the company with fraud for improperly billing them $30.22 in state sales tax on the full price of cell phones that AT&T provided free when customers signed a service plan contract. The contract contained a collective-arbitration waiver provision prohibiting class arbitrations while offering significant inducements for bilateral arbitration, including provisions prohibiting AT&T from recovering its attorney's fees and awarding the customer a $7500 premium in arbitrations where the award exceeded AT&T's final settlement offer. The arbitration agreement also required AT&T to cover all arbitration costs for non-frivolous claims. Moreover, customers could proceed individually in small claims court.
The federal district court held the provision was unconscionable – and therefore unenforceable - under California law, allowing the Concepcions to participate in a federal class action lawsuit. Relying on the California Supreme Court's decision in Discover Bank v. Superior Court, 36 Cal. 4th 148, 113 P. 3d 1100 (2005), the district court interpreted the arbitration provision as unconscionable because AT&T had not shown that bilateral arbitration adequately substituted for the deterrent effects of class actions.
The Ninth Circuit affirmed, also finding the provision unconscionable under California law in light of Discover Bank. Laster v. AT&T Mobility LLC, 584 F. 3d 849, 855 (9th Cir.2009). Moreover, it reasoned that the Discover Bank rule was not preempted by the Federal Arbitration Act (FAA) because that rule was simply "a refinement of the unconscionability analysis applicable to contracts generally in California." 584 F.3d at 857.
In response to AT&T's argument that the Concepcions' interpretation of California law discriminated against arbitration, the Ninth Circuit rejected the contention that "`class proceedings will reduce the efficiency and expeditiousness of arbitration'" and noted that "`Discover Bank placed arbitration agreements with class action waivers on the exact same footing as contracts that bar class action litigation outside the context of arbitration.'" Id., at 858 (quoting Shroyer v. New Cingular Wireless Services, Inc., 498 F. 3d 976, 990 (CA9 2007)). The FAA, which makes arbitration agreements "valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract," 9 U.S.C. § 2, did not preempt its ruling. The Supreme Court reversed.
In recent years, many state courts, in addition to California, favored consumers by holding that consumer contract arbitration provisions disallowing collective-arbitrations are unconscionable because they discourage the prosecution of small claims. Missouri was among them. See Brewer v. Missouri Title Loans, Inc., 323 S.W.3d 18 (Mo.2010)(en banc)(class arbitration waiver in loan agreement was unconscionable and voided the arbitration agreement). The primary rationale is that large companies with presumably superior bargaining power can scheme to mislead or defraud large numbers of consumers out of individually small sums of money. And do so without fear that consumers or their attorneys will be inclined to bring a claim when the cost of prosecution outstrips the claim's value.
The Supreme Court Majority Analysis
Justice Scalia, writing for a deeply divided Court (5-4), held that the FAA pre-empted California state law. The Court noted that California cases invalidating collective-arbitration waivers could be applied to permit any consumer an unfettered right to bring a class arbitration. Instead, the Court focused on the primary objectives of the FAA, noting judicial favor of contractual arbitration, and lionizing the speed and efficiency of individual arbitration proceedings as well as the ability to register and enforce arbitration awards in the same manner as a judicial judgment. The Court went even further, stating that class arbitrations, because they present many of the same procedural difficulties as class action lawsuits, are fundamentally inconsistent with the FAA's goals of efficient, economical and informal dispute resolution.
An important theme in the AT&T case is the Supreme Court's approval of contractual arbitration provisions, even when those provisions may eliminate consumers' otherwise available prerogative to bring class arbitrations. The FAA preempts inconsistent common law rules. Similarly, the AT&T opinion makes it clear that federal courts will look to federal law validating contractual arbitration provisions, particularly the FAA, rather than state laws eroding the ability to arbitrate. As Justice Scalia noted: "the FAA 'establishes that, as a matter of federal law, any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration, whether the problem at hand is the construction of the contract language itself or an allegation of waiver, delay or a like defense to arbitrability.'" Quoting Moses H. Cone Memorial Hosp. v. Mercury Const. Corp., 460 U.S. 1, 24 (1983).
The Significance & the Future
Future cases will undoubtedly test the Court's AT&T analysis in circumstances involving more one-sided pro -business arbitration provisions with less artfully crafted waivers. For now, however, the AT&T opinion allows businesses utilizing consumer contracts to place greater reliance on collective-arbitration waivers as long as their arbitration provisions also permit individual consumers to arbitrate disputes bilaterally. Accordingly, courts must place arbitration on the same plane as other agreements and enforce their terms as written and enforce them as written. Buckeye Check Cashing, Inc. v. Cardegna, 546 U. S. 440, 443 (2006); Volt Information Sciences, Inc. v. Board of Trustees of Leland Stanford Junior Univ., 489 U. S. 468, 478 (1989).
At the heart of the dispute is a stark conflict between state law and the FAA. But important aspects of the arbitration-class action conflict remain unresolved. The Supreme Court's decision in AT&T v. Concepcion does not answer the question whether a federal court has the power to declare a class arbitration waiver unconscionable. Although not on this precise issue, the Court has granted certiorari on a related issue concerning the enforceability of arbitration agreements that preclude class actions. The issue presented in CompuCredit Corp. v. Greenwood, No. 10-948 is "Whether claims arising under the Credit Repair Organizations Act, 15 U.S.C. § 1679 et seq., are subject to arbitration pursuant to a valid arbitration agreement."
This would-be class action involves a potential conflict between two competing federal laws, the FAA and the Credit Repair Organizations Act (CROA). The Ninth Circuit held that a class arbitration waiver was void "because the CROA specifically prohibits provisions disallowing any waiver of a consumer's right to sue in court for CROA violations." In reaching that conclusion, it held that the statute's reference to a "right to sue" was an express statement of Congressional intention to preclude waivers of consumer's rights to bring a lawsuit in court, thus falling within an exception to the otherwise liberal policy favoring arbitration. This scenario could well impact the non-waiver provisions of other federal laws, including the Securities Exchange Act.
The case is on Court's docket for the October 2011 term.
Securities Industry Take-Aways and Practical Guidance
Brokerage firms and investment advisors, in the wake of AT&T, should consider the following:
1. Immediate review of customer agreement arbitration provisions, whether they include collective action waivers or not;
2. Consider potential ways to build into class waivers specific language that the Firm is not agreeing to arbitrate class claims;
3. Limit the arbitral forums to FINRA or incorporate by reference the FINRA rules whether the arbitration is conducted under its program or not;
4. Consider the provisions AT&T used to diminish the appearance of unconscionability by offering financial incentives (advancement or coverage of forum costs); and
5. Although it may be blasphemy—in light of the economic incentives—analyze your Firm's records to determine whether you are better off with arbitration or without it.
6. A case can be made, particularly when legal issues predominate, that courts are more likely to dismiss claims and investors are more unlikely to formally sue a defendant than proceed with an arbitration; and
7. Limit arbitration waivers solely to disputes that are within the scope of the arbitration agreement.
Glenn E. Davisis a shareholder at Gallop Johnson & Neuman LC in St. Louis, Missouri. He can be reached at 314-615-6217 or firstname.lastname@example.org.