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March 12, 2019 Articles

Circuit Split Widens over Waiver of FINRA Arbitration Rights

Four circuit courts of appeals are split over whether a forum selection clause related to “all actions and proceedings” encompasses FINRA arbitration.

By Beth Graham

A circuit split has recently widened regarding whether a securities broker-dealer may use a forum selection clause to deny clients access to the Financial Industry Regulatory Authority (FINRA) arbitral forum. Under FINRA Rule 12200, a dispute between a “member or associated person of a member” and a “customer” must be arbitrated at the customer’s request so long as the dispute “arises in connection with the business activities of the member or the associated person.” Broker-dealer attempts to avoid FINRA arbitration are being met with mixed results in the circuit courts of appeals.

Reading Health System

In Reading Health System v. Bear Stearns & Co., No. 16-4234 (3d Cir. Aug. 7, 2018), Reading Health, a Pennsylvania-based not-for-profit health care system, issued millions of dollars in capital campaign debt using auction rate securities (ARS) that were distributed by securities brokerage Bear Stearns between 2001 and 2007. As part of issuing the ARS, Reading executed a number of contracts with the securities brokerage. Two of those agreements contained a forum selection clause that required the parties to resolve any disputes arising out of the contracts through litigation in the Southern District of New York.

After the ARS market collapsed, Reading Health filed a request for arbitration with FINRA over the brokerage’s purported mishandling of Reading Health’s ARS offerings. The securities brokerage responded by claiming Reading Health waived its right to arbitration when it executed the ARS contracts that contained a forum selection clause. Reading Health then filed an action in the Eastern District of Pennsylvania seeking to compel the securities brokerage to submit to arbitral proceedings before FINRA. The securities brokerage filed a motion to transfer the case to the Southern District of New York and a motion to enjoin FINRA arbitration. The Pennsylvania district court denied the brokerage’s request to transfer the case and ordered the parties to engage in FINRA arbitration. The broker-dealer then filed an interlocutory appeal with the Third Circuit Court of Appeals.

On appeal, the Third Circuit ruled that the “district court properly resolved the transfer dispute before the arbitrability dispute.” Because the forum selection clause included in the parties’ contracts did not waive Reading Health’s rights under FINRA Rule 12200, the Third Circuit held that the district court properly concluded the securities broker was required to arbitrate Reading Health’s claims. The Third Circuit ultimately affirmed the district court’s order “declining to transfer Reading’s declaratory judgment action” and compelling the broker-dealer “to submit to FINRA arbitration.”

Carilion Clinic

In UBS Financial Services, Inc. v. Carilion Clinic, No. 12-2066 (4th Cir. Jan. 23, 2013), the Court of Appeals for the Fourth Circuit held that broker-dealers must engage in arbitral proceedings under FINRA Rule 12200. In that case, Carilion, a Virginia-based not-for-profit health care system, issued a series of auction-rate bonds. As part of the bond issuance, Carilion entered into both broker-dealer and underwriting agreements with UBS and Citi. In response to significant financial losses related to the bonds, Carilion initiated FINRA arbitration proceedings against the two broker-dealers.

UBS and Citi sought a declaratory judgment against Carilion. According to the broker-dealers, “Carilion was not a ‘customer’ entitled to arbitration under the FINRA Rules,” and Carilion previously agreed “in the forum selection clause of the broker-dealer agreements, to litigate, rather than arbitrate, all disputes in a federal court in New York County.” The district court held that Carilion was a customer under the FINRA arbitration rules and stated the forum selection clause at issue had no effect on the broker-dealers’ arbitration obligations due to the “federal policy favoring arbitration.”

On appeal, the Fourth Circuit also rejected the broker-dealers’ claim that Carilion was not a customer under the FINRA rules. In addition, the court stated that it would expect a forum selection clause that was intended to supersede a party’s right to arbitration to mention arbitration. The court added that it was a “more natural reading of the forum selection clause to require that any litigation arising out of the agreement would have to be brought in the U.S. district court in New York County and that as to any such action or proceeding, a jury trial would be waived.” Finally, the court rejected the notion that the forum selection clause waived Carilion’s right to arbitration provided by FINRA Rule 12200 and affirmed the district court.

Golden Empire School Financing Authority and
North Carolina Eastern Municipal Power Agency

In the consolidated cases of Goldman, Sachs & Co. v. Golden Empire School Financing Authority and Citigroup Global Markets Inc. v. North Carolina Eastern Municipal Power Agency, Nos. 13‐797‐CV, 13‐2247‐CV (2d Cir. Aug. 21, 2014), the Court of Appeals for the Second Circuit held that a later-executed contract that includes a forum selection clause requiring “all actions and proceedings” to be litigated superseded FINRA Rule 12200.

In Golden Empire School Financing Authority, a school district issued capital campaign debt using ARS that were distributed by Goldman Sachs. As part of the transaction, the school district and Goldman Sachs executed a series of broker-dealer agreements in 2004, 2006, and 2007. The agreements, however, were silent on the issue of alternative dispute resolution. In addition, the 2007 agreement included a forum selection clause requiring “all actions and proceedings” to be litigated in New York. Each contract included a merger clause stating all agreements executed in connection with the issuance of ARS constituted the parties’ entire agreement.

Later, the school district commenced FINRA arbitration proceedings, and Goldman Sachs filed a motion for declaratory and injunctive relief. A district court ruled that the forum selection clause included in the 2007 broker-dealer agreement superseded the FINRA rule providing for arbitration, and the school district filed an interlocutory appeal. The procedural history in North Carolina Eastern Municipal Power Agency was sufficiently similar to be consolidated with the Goldman Sachs case.

The Second Circuit distinguished the Fourth Circuit’s recent precedent in Carilion Clinic and concluded that the forum selection clause contained in the broker-dealer contracts must be interpreted broadly to include arbitration proceedings. The court also cited its own decision in Applied Energetics v. NewOak Capital Markets holding that a FINRA arbitration must be enjoined because the mandatory adjudication provision of the parties’ later agreement superseded an earlier contract requiring arbitration of their disputes. Ultimately, the court held that “the forum selection clause at issue in these cases is plainly sufficient to supersede FINRA Rule 12200.”

City of Reno

In Goldman, Sachs & Co. v. City of Reno, No. 13-15445 (9th Cir. Mar. 31, 2014), the City of Reno, Nevada, issued more than $200 million in securities with Goldman Sachs acting as both broker-dealer and underwriter in 2005 and 2006. Later, the city brought a FINRA arbitration against Goldman Sachs. Goldman Sachs sought to enjoin the arbitration proceedings. According to the broker-dealer, the City of Reno was not a customer under the FINRA arbitration rules and the city relinquished its right to arbitrate when it signed a contract that contained a forum selection clause. The City of Reno replied by asserting that questions of arbitrability are for an arbitrator to decide.

A district court agreed with the City of Reno and ordered the parties to arbitration. On appeal, the Ninth Circuit Court of Appeals held that the city was clearly a customer under FINRA Rule 12200. Despite this, however, a divided appellate court panel “held that although Reno qualified as Goldman’s customer under FINRA Rule 12200, Reno disclaimed its right to FINRA arbitration by agreeing to the forum selection clauses in the parties’ agreements.” After that, the case was remanded to the district court.


Because the circuit courts of appeals are currently divided on whether the language “all actions and proceedings” encompasses arbitration as well as litigation, it will be interesting to see if the question of whether a party may waive the right to arbitration under FINRA Rule 12200 via a forum selection clause will be addressed by the U.S. Supreme Court.

Beth Graham is an attorney and legal content writer at Karl Bayer, mediator, arbitrator, and court master in Austin, Texas.

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