Last week, a Financial Industry Regulatory Authority hearing panel gave Charles Schwab permission to modify its customer agreements to prohibit consumers from bringing class action lawsuits against the company. That’s not surprising; a narrow majority of the Supreme Court believes the enforcement of arbitration clauses deserve preferential treatment over all other legal principles, and companies have been falling over themselves to stick these sorts of waivers into every document they ever send their customers.


The surprising part is the degree to which the company feels comfortable making absurd statements like this:


“The company believes customers are better served through the existing FINRA arbitration process and that class-action lawsuits are a cumbersome and less effective means of resolving disputes – for both parties. …”

Schwab amended its customer agreements to include the class action waiver because class action litigation is unduly expensive and time-consuming, and too often results in resolutions benefiting the class action lawyers rather than their clients. … [I]t is highly questionable as to whether consumers receive any material benefit from many class action settlements. In the litigation leading to the AT&T Mobility v. Concepcion decision, the lower court commented that members of class actions “rarely receive more than pennies on the dollar for their claims, and that few class members (approximately 1 percent to 3 percent) even bother to file a claim when the amount they would receive is small.” * When Congress modified the laws concerning class actions, it commented that “Class members often receive little or no benefit from class actions, and are sometimes harmed . . .” **


Not coincidentally, Charles Schwab first stuck the class action waiver into its contracts in September 2011 — just five months after a federal court approved a $235 million settlement in a class action brought by investors against the company. Of that $235 million, more than 90% went to investors, and less than 10% was allocated as attorney’s fees.


The details of that case show exactly why Charles Schwab wants the class action waiver, so bear with me as we review In re Charles Schwab Corporation Securities Litigation, No. C 08-01510 WHA (N.D.Ca.).   For years, the company had the “YieldPlus Fund,” an “ultra-short” mutual fund that was advertised as a safe-but-more-profitable alternative to typical mutual funds, that would invest in a mixture of safe fixed-income securities over very short time frames. Like most of Wall Street, though, the company got caught up in the roaring mortgage-backed securities market of the early 2000s, didn’t bother to follow any of its own agreements or requirements, and dumped nearly half of the fund into securities backed by dubious mortgages. 


The YieldPlus Fund tanked, and a securities class action was filed on behalf of 252,729 investors. After a couple years, the case settled for $235 million (order approving settlement here), broken down as $200 million for federal law claims and $35 million for California law claims. (Notice how there’s no other state other than California listed? That’s because no other state has meaningful consumer protection laws. But I digress.) To achieve that settlement, the plaintiff’s lawyers invested $7,083,599 worth of attorney time and spent $2,710,112 out of pocket on litigation expenses, like electronic discovery and experts’ fees.


To sum up: Charles Schwab mismanaged one of its funds, making decisions contrary to their investment prospectus and in violation of fund management law, and it took nearly $10 million in attorney’s fees and expenses to get the the point that they were willing to offer a reasonable settlement. Proving securities violations by a major investment firm or national bank is difficult, time-consuming and expensive.


The details of the settlement matter. Recall that there were 252,729 class members. As the Court noted, “the average estimated settlement payment is expected to be approximately $881, and the highest estimated settlement payment is expected to exceed $2,177,000.”


Thus, in the absence of a class action, none of the cases would have justified the cost of litigating them, even if you knew in advance that you would win. Indeed, the only way the case would make any sense is if the lawyers could somehow find hundreds or thousands of the customers with the most losses — even though that information is all confidential, and all held by the company — and then somehow convince them to all sign up with you individually to bring the lawsuit at once, and to group the arbitrations together. (Charles Schwab tried to prevent consolidation of arbitrations, too, but the panel ruled against them on that.)


Indeed, if it wasn’t for the availability of the class action, many of those claims couldn’t have been brought at all. Even simple, plain-vanilla securities arbitrations in front of FINRA aren’t cheap — as one securities lawyer noted in Forbes, even if an investor wins, “[t]he average forum fees for investors—the filing fee plus 50% of the hearing session fees—are thus $4,000 to $5,000.” And that’s just for the arbitration fees, not including attorney’s fees, or litigation expenses like expert fees and discovery costs and court reporters.


Remember how the average estimated settlement payment in the YieldPlus litigation was $881? That means that the vast majority of claims — anything not worth the $4,000–$5,000 filing fees, plus attorney time, plus other expenses like experts — are worthless, even if grouped together with larger claims, because they won’t recover enough to pay even the cost of bringing them. Add to those costs the risk of bringing the claims and losing, and you start to see that all but the very largest claims aren’t worth pursuing at all.


So when Charles Schwab says “customers are better served through the existing FINRA arbitration process,” what they actually mean is that most customers can be safely cheated tens of thousands of dollars and ignored if forced into FINRA arbitration. After all, if this was such a boon for customers, why wouldn’t Charles Schwab just make it an option?