Ruling in Charles Schwab Self-Dealing Suit Suggests Limits of Arbitration Agreements

For one thing, a federal court judge found the defendants provide no authority supporting their contention that a plan document executed after the participant has ceased participation in the plan can bind the participant to arbitration.

A district court judge has denied a motion by Charles Schwab that sought to mandate an employee’s lawsuit alleging self-dealing under the Employee Retirement Income Security Act (ERISA) to instead proceed via individual arbitration, rather than as a class action in federal court.

By way of background, the initial lawsuit was filed in the United States District Court for the Northern District of California almost exactly one year ago today, labeled as Severson vs. Charles Schwab. This new ruling, rejecting arbitration as an acceptable outcome in the self-dealing affair, is technically labeled separately as Dorman vs. Charles Schwab—but Dorman is a plaintiff in that original case, and so the matters are interrelated in important ways.

After the filing of the initial Severson lawsuit and these related claims, Charles Schwab moved to compel individual arbitration and, on that basis, dismiss the lawsuits, or stay the litigation pending the outcome of individual arbitration. In their motion, the attorneys noted that the arbitration provisions in Schwab’s retirement plan document and severance agreement clearly fall within the scope of the Federal Arbitration Act (FAA). The plan document’s arbitration provision broadly encompasses “any claim, dispute, or breach arising out of or in any way related to the Plan,” and extends to the ERISA claims asserted, they said. The Schwab attorneys further contended the arbitration provision of the plaintiff’s severance of employment agreement likewise embraces the ERISA claims, insofar as it requires arbitration of “any dispute or breach arising out of or in any way related to employment.”

The new ruling in Dorman vs. Charles Schwab forcefully denies the financial services company’s motion to force arbitration and/or dismiss the lawsuit.

Stepping through the logic of the decision, the judge points out that the Federal Arbitration Act provides that any agreement within its scope “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” The judge notes the FAA represents “a liberal federal policy favoring arbitration agreement, notwithstanding any state substantive or procedural policies to the contrary.” But even with such a liberal standard in place, the judge found Charles Schwab’s motion to mandate arbitration to be unconvincing. Important to this decision is that, in considering a motion to compel arbitration, a court considers two distinct items—whether a valid arbitration agreement exists and whether the agreement encompasses the dispute at issue.

On the first matter, the court finds Schwab has fallen short: “Defendants argue that the Plan Document binds Dorman. But the Plan Document provided by Defendants was dated January 1, 2016, and executed on June 13, 2016, over a year after Dorman terminated his participation in the Plan on December 18, 2015. … The Plan Document issued a year after Dorman ceased participation in the Plan cannot apply to his claims. To hold otherwise would be inequitable because it would allow a plan defendant to amend the plan documents unilaterally at any time, even after a participant has brought suit against the defendant, and put the participant at a disadvantage. Defendants provide no authority supporting their contention that a plan document executed after the participant has ceased participation in the plan can bind the participant to arbitration.”

The decision continues, rejecting the second of Schwab’s approaches: “Defendants argue that Form U-4’s arbitration provision encompasses Dorman’s claims because the provision covers ‘any dispute, claim or controversy’ between Dorman and Schwab. Defendants read this provision out of context. The provision actually states, ‘I agree to arbitrate any dispute, claim or controversy that may arise between me and my firm, or a customer, or any other person, that is required to be arbitrated under the rules, constitutions, or by-laws of the SROs indicated in Section 4.’ The arbitration provision does not apply to any dispute between Dorman and Schwab, but only those that are required to be arbitrated under the rules, constitutions, or by-laws of the SROS indicated in Section 4. This section lists a number of SROs, or self-regulatory organizations such as FINRA, but mentions nothing whatsoever about the Plan. Defendants fail to explain adequately why the language of this provision encompasses Dorman’s claims.”

The judge goes on to note that, while Schwab contends that Dorman’s breach of fiduciary duty claims are ones “arising out of or relating to his employment or termination of employment,” it is not clear that defendants are correct.

“Defendants themselves contend elsewhere that ERISA claims are not ordinarily viewed as work-related legal claims,” the decision states. “Moreover, the arbitration provision contains an exception for ‘claims for benefits under any ERISA-governed employee benefit plan(s),’ which are to be resolved according to the ‘claims procedures under such benefit plans.’ Dorman’s claims, which arise not under the Compensation Plan but under the Schwab Plan, are therefore governed by the claims procedures of the Schwab Plan. Because the arbitration provisions cited by Defendants do not encompass Dorman’s claims, they do not require him to submit his claims to arbitration.”

Among some additional matters discussed in the decision, the judge points out that, even if the arbitration provisions cited by Schwab encompassed Dorman’s claims, the provisions could not be enforced. This is because Dorman brings his claims pursuant to ERISA Sections 502(a)(2) and 502(a)(3) “on behalf of the plan.” He cannot waive rights that belong to the plan, such as the right to file this action in court.

“The Court recently resolved this question in a similar case, Cryer v. Franklin Templeton,” the decision observes. “There, a release and class action waiver signed by the plaintiff could not be enforced against the plaintiff’s § 502(a)(2) claims brought on behalf of the plan. Relying on Bowles v. Reade (9th Circuit 1999), the Court explained that a plan participant cannot settle, without the plan’s consent, a § 502(a)(2) breach of fiduciary duty claim seeking ‘a return to [the plan] and all participants of all losses incurred and any profits gained from the alleged breach of fiduciary duty.’ … The vast majority of courts have concluded that an individual release has no effect on an individual’s ability to bring a claim on behalf of an ERISA plan under § 502(a)(2). By the same token, a participant bringing a § 502(a)(2) claim also cannot release the right to file in court or the right to file a class action on behalf of a plan, which also belong to the plan. The Court therefore concluded that the release and class action waiver could not be enforced against the plaintiff’s claims brought in a representative capacity on behalf of the plan. … Here, too, enforcement of the arbitration and class action provisions would violate the principles set forth in Bowles v. Reade.

The full decision in Dorman vs. Charles Schwab is available here. Important to note, defendants sought to seal redacted portions of the Compensation Plan Acknowledgment filed in support of their motion to compel arbitration or stay the case. This motion was approved.

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