Merrill Lynch Continues Choice-of-Law Provisions Despite of Industry Discipline and Admonishment

Attorney Advising Disclaimer

For over two decades, Merrill Lynch has attempted to limit customer rights and/or evade state laws best suited toward consumer protection through using choice-of-law provisions, inserted in customer account agreements, which aims to establish which state's laws apply to a customer's arbitration claim. Even though regulators first punished Merrill Lynch for this violative practice in 1998, the firm has nonetheless persisted to the present day.

Ordinarily, a choice-of-law clause would play out as follows: Customer A resides in State A and invests with Broker B, who resides in State B and whose firm operates in both States A and B. Upon alleging fraudulent misconduct on the part of Broker B, Customer A files a complaint which evolves into arbitration; upon invocation of a choice-of-law provision in the customer agreement, the arbitration is considered under State A's laws, or potentially under State B's laws—the point being that all parties are on the same page as to the applicable state's laws, and that the laws in use are relevant and reasonably related to both parties.

The problem occurs when the brokerage firm's contract calls for a marginally related state or wholly unrelated state's laws to be applied. This usually occurs when a firm believes it can limit the scope of liabilty or damages by having a given state's law applied. In the 1990s, firms frequently inserted New York state choice-of-law provisions in an effort to curtail an arbitration panel's ability to award punitive damages and or attorney's fees. In other words, the brokerage firm caused its customers to waive statutory protections provided under the customer's state's laws.

Merrill Lynch's abusive choice-of-law provisions can be traced back to 1998, when NASD (FINRA's predecessor) disciplined Merrill Lynch for its attempt to limit customers' remedies to seek punitive damages and attorney's fees by invoking the choice-of-law provision in applying New York law to at least 17 arbitration claims. In those 17 cases, Merrill Lynch argued that New York law precluded an award of punitive damages or attorney's fees. NASD punished Merrill Lynch for attempting to limit the arbitration panels' ability to make an award with the same remedies as would be available to the customers if they had been able to seek relief in their states' courts.

In 2005, NASD issued a notice to members concerning pre-dispute arbitration agreements, making it clear that, as of May 2005, the industry would prohibit brokerages from inserting a choice-of-law provision that limits a customer's rights or remedies, or otherwise limits the ability of an arbitrator to make an award, writing that, "there must be an adequate nexus between the law chosen and the transaction or parties at issue."

Despite the punishment and subsequent industry instruction, Merrill Lynch, continues to use choice-of-law provisions to apply the laws of New York state regardless of the location of the customer, broker, and/or branch office. Most recently, Merrill's customer-unfriendly practice was used in a California case.

In a recent unpublished decision, the Court of Appeal of the State of California Second Appellate District, found that choice-of-law provisions can be severed from an otherwise enforceable arbitration agreement after a trial court found that such a choice-of-law provision attempted to deprive a California client of "unwaivable statutory rights" under California's Elder Abuse and Dependent Adult Civil Protection Act by attempting to apply New York laws, which carry no such protections.Los Angeles Thoracic and Cardiovascular Foundation v. Merrill Lynch, Pierce et al., (Dec. 5, 2017) Case No. B271229.

Merrill Lynch is not the only firm caught up in this choice-of-law practice. In 2002, NASD fined and censured Prudential Securities for attempting to enforce a similar New York choice-of-law defense in claiming that "New York law precluded an award of punitive damages or attorney fees." In its decision, NASD ordered Prudential to withdraw any New York choice-of-law defense asserted in any pending arbitration, and to refrain from asserting New York choice-of-law defenses in any future arbitration proceeding.

NASD and FINRA's work makes clear that firms are not allowed to argue choice-of-law provisions in arbitration disputes where the law sought to be applied has no relationship to the parties. Yet, the recent court decision indicates that the choice-of-law issue persists, and violative language appears in modern-day customer agreements.

In light of this, will FINRA take action against one of its largest members for its long history of using the arbitration process to unfairly limit its customer's rights and remedies or will it let Merrill continue to try to trap the unwary customer or attorney?

If you have suffered damages as the result of broker misconduct and have invested with Merrill Lynch, Prudential Securities, or with another firm whose insertion of a choice-of-law provision in its customer agreement may prove problematic in dispute resolution or arbitration, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation.

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