FINRA Issues Reg Notice on “Do’s and Don’ts” of PDAA Use in Customer Agreements

This article first appeared on the Securites Arbitration Alert (SAA) Blog here.

FINRA has issued a Regulatory Notice reminding industry parties on the proper use of predispute arbitration agreements (“PDAA”) in customer account agreements.

Regulatory Notice 21-16, FINRA Reminds Members About Requirements When Using Predispute Arbitration Agreements for Customer Accounts, was issued on April 21. Why issue the Notice? “FINRA has become aware that customer agreements used by some member firms contain provisions that do not comply with FINRA rules. Member firms with customer agreements that include provisions that do not comply with FINRA rules should take prompt steps to ensure that their customer agreements fully comply with FINRA rules. Failing to comply with FINRA rules related to customer agreements may subject member firms to disciplinary action. This Notice provides examples of provisions in customer agreements that do not comply with FINRA rules ….” We excerpt below essentially verbatim the key provisions. Footnotes are omitted and links to Rules sections have been added.

Hearing Locations

Some customer agreements attempt to dictate the location of the arbitration hearing…. Any such provision does not comply with FINRA Rule 12213, which provides that the Director of Dispute Resolution Services will decide which of FINRA’s hearing locations will be the hearing location for the arbitration. Generally, the Director will select the hearing location closest to the customer’s residence at the time of the events giving rise to the dispute, unless the hearing location closest to the customer’s residence is in a different state, in which case the customer may request a hearing location in the customer’s state of residence at the time of the events giving rise to the dispute.

Time Limitations

Some customer agreements attempt to shorten or extend applicable statutes of limitations. FINRA Rule 12206 allows arbitration claims to be submitted unless six years have elapsed from the occurrence or event giving rise to the claim. The arbitrator or panel resolves any questions regarding the eligibility of a claim under this rule or under an applicable state statute of limitations. Consequently, customer agreements may not be used to shorten or extend statutes of limitations or require that a question of whether a time limitation applies be judicially determined instead of being submitted to an arbitrator ….

Class Action Claims

Some customer agreements attempt to limit a customer’s right to pursue class actions in court. Examples include customer agreements that state that the customer waives any right to bring a class action; customer agreements that state that any claims between the parties must be brought in an individual capacity; and customer agreements that state broadly that the agreement to arbitrate constitutes a waiver of the right to seek a judicial forum, without sufficiently indicating that class actions are excepted from this waiver….  [L]imiting a customer’s right to pursue class actions in court through a customer agreement, or seeking to enforce such an agreement, does not comply with FINRA rules.

Claims and Awards

Some customer agreements attempt to limit the ability of a customer to file a claim or to limit the authority of the arbitrators to make an award, including, for example, through provisions that purport to limit the member firm’s liability for consequential or punitive damages, or damages that do not arise from the member firm’s gross negligence or intentional misconduct. Other customer agreements attempt to do so indirectly by incorporating a choice of law or governing law clause. However, “if a choice of law provision is used, there must be an adequate nexus between the law chosen and the transaction or parties at issue in accordance with Notices to Members 95-85 and 95-16.”

Indemnity and Hold Harmless Provisions

Some customer agreements contain indemnification or hold harmless provisions, such as broad provisions that require that the customer indemnify and hold harmless the member firm from all claims and losses arising out of the agreement. Indemnification and hold harmless provisions do not comply with FINRA Rule 2268 where the provisions, if given effect, would limit the customer from bringing a claim or receiving an award from the member firm or associated person that they would otherwise be entitled to receive.… In addition, a well-developed line of case law has held that it is contrary to public policy for a person to seek indemnity from a third party for that person’s own violation of the federal securities laws. Accordingly, FINRA believes that it would be unethical and not in compliance with FINRA Rule 2010 for a member firm or associated person to attempt to seek indemnity from customers of costs or penalties resulting from the firm’s or associated person’s own violation of the securities laws or FINRA rules.

(ed: *These are pretty strong admonitions. We expect some well-publicized disciplinary actions will follow. **The Reg Notice adds that: “the provisions in customer agreements that potentially do not comply with FINRA rules are not limited to those discussed in this Notice.” ***The Notice is also available in PDF format.)


George Friedman

George H. Friedman is the publisher and Editor-in-Chief of the Securities Arbitration Alert, a weekly online publication covering the latest developments in financial services arbitration and mediation. He is also the principal of George H. Friedman Consulting, LLC, providing expert advice on arbitration and mediation in general and the FINRA…

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