Schwab Combats Class-Action

As per Reuters, The Charles Schwab Corporation (SCHW - Analyst Report) has received a regulatory approval to disallow its clientele from bringing class-action lawsuits. The approval was given by a Financial Industry Regulatory Authority (FINRA) hearing panel, citing the ban as consistent with the Federal law and the latest Supreme Court analysis of the Federal Arbitration Act.

It all started last year when Schwab announced that it was altering nearly 8.8 million account agreements to rule out class-action lawsuits and enhance its capacity to have more consolidated arbitration cases. Under class-action lawsuit, small investors group together to file court cases against a particular company to recover the losses incurred.

This was in contradiction of the FINRA guidelines. Consequently, the regulatory body dragged Schwab to court for violating its rules.

The decision to alter the agreements was taken by Schwab following a $235 million settlement of a class action lawsuit. Schwab was accused of ambiguous marketing of its high-interest YieldPlus money-market fund between May 2006 and Mar 2008.

The current ruling will have a profound impact on the entire industry and is a blow to the FINRA – a private body that overviews broker-dealer and manages arbitration panels.

However, the hearing panel found that though limiting customer’s class action and arbitration rights is against the FINRA rules, it is also in conflict with Federal Arbitration Act, and hence cannot be enforced.

The hearing is very comforting for the brokerage firm as it maintained that class action lawsuits are disorganized and expensive for both the parties, whereas arbitration process is less expensive and more effective way to arrive at a settlement.

Though one panel cannot single-handedly form a law, the decision will probably influence other brokerage firms – including TD Ameritrade Holding Corporation (AMTD - Analyst Report), E*TRADE Financial Corporation (ETFC - Analyst Report) and Interactive Brokers Group, Inc. (IBKR - Analyst Report) – to follow similar suit. At present, FINRA is reviewing the ruling and has not yet appealed against the verdict to its appellate body – the National Adjudicatory Council.

We believe that the verdict is likely to bring in positive and far-reaching changes for the brokerage firms. However, for the consumers this would be a step backwards as it would strip them of their right to pursue smaller claims.

Schwab currently holds a Zacks Rank #2 (Buy).