Third Circuit Holds That FINRA Arbitration Requirement Trumps Forum Selection Clause

Michael J. Betts LLC

A panel of the Court of Appeals for the Third Circuit recently rejected an attempt by J.P. Morgan Securities LLC to enforce a forum selection clause, holding that J.P. Morgan Securities was required to submit to FINRA arbitration under FINRA Rule 12200. Reading Health System v. Bear Stearns & Co. n/k/a J.P. Morgan Securities LLC, No. 16-4234 (3d Cir. Aug. 7, 2018).

The case arose out of broker-dealer agreements between Bear Stearns (later acquired by J.P. Morgan Securities) and Reading Health System regarding multiple offerings of auction-rate securities (ARS) by Reading Health. J.P. Morgan Securities served as the underwriter and broker-dealer for each offering. The agreements provided that any actions and proceedings arising out of the agreement or the underlying ARS transactions had to be filed in the United States District Court for the Southern District of New York. Following the collapse of the ARS market, Reading Health filed a statement of claim with FINRA, alleging that J.P. Morgan Securities engaged in wrongful conduct with respect to the ARS offerings. J.P. Morgan Securities refused to participate in FINRA arbitration, relying on the forum selection clause, and Reading Health filed a declaratory judgment action to resolve the issue of arbitrability. The district court ordered J.P. Morgan Securities to arbitrate.

In its recent ruling, the Panel affirmed the order of the district court requiring J.P. Morgan Securities to participate in the FINRA arbitration. The Panel ruled that FINRA Rule 12200 – generally requiring FINRA members to arbitrate disputes with their customers at the customers’ request – controlled. The Panel rejected J.P. Morgan Securities’ argument that in agreeing to the forum selection clauses included in the broker-dealer agreements Reading Health waived the right to FINRA arbitration that it otherwise would have had under FINRA Rule 12200. Applying general principles of waiver, the Panel held that the forum selection clauses, which did not refer to arbitration, lacked the specificity that was required in order to support a finding of waiver. The Panel suggested that although waiver of FINRA Rule 12200 might be found in an appropriate case, the assertion of waiver would need to be supported by specific language referring to a waiver of that specific right. The Panel addressed J.P. Morgan Securities’ position that an implied waiver could be found, ruling that the concept of implied waiver would not be applied when the right in question – submitting disputes to FINRA arbitration – arises out of a binding, regulatory rule that has been adopted by FINRA and approved by the SEC.

The Panel acknowledged a split among the circuits on this issue. In particular, as noted by the Panel, the Second and Ninth Circuits have held that forum selection clauses required litigation of the disputes, while the Fourth Circuit has held that FINRA Rule 12200 requires arbitration notwithstanding the presence of a forum selection clause.

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