Federal Appellate Court Upholds FINRA Rules

In Interactive Brokers LLC v. Saroop, No. 19-1077, 2020 WL 4668551 (4th Cir. 2020), the Fourth Circuit Court of Appeals recently confirmed that a violation of FINRA rules can be a breach of an agreement between an investor and a broker-dealer.

Three investors opened accounts with Interactive Brokers, an online broker-dealer. The investors’ agreements with Interactive Brokers had an arbitration clause. Trading on margin, a third-party investment manager invested the accounts in an exchange-traded note that moved based on the stability of the market and also sold naked call options. FINRA rules prohibit trades of some high risk securities on margin, including the exchange traded note. A large, one-day drop in the markets in August 2015 led to Interactive Brokers liquidating the accounts and a margin call.

The investors brought claims in FINRA arbitration against Interactive Brokers. The arbitration panel found for the investors. In dismissing a counterclaim brought by Interactive Brokers, the arbitrators referred to FINRA Rule 4210, which includes the prohibition against trading certain high risk securities on margin. Interactive Brokers challenged the award in federal district court.

The district court sent the case back to the arbitrators, seeking an explanation of the award. The arbitrators referred to FINRA rules in explaining the award and wrote, “To ignore a FINRA rule by the Panel would defeat the purpose of FINRA.” Interactive Brokers again moved to vacate the panel’s award. The district court did so, finding that by basing liability on FINRA Rule 4210, the arbitrators disregarded the law because there is no private right of action to enforce FINRA rules.

The investors appealed to the Fourth Circuit. The Fourth Circuit vacated the judgment of the district court and instructed the district court to confirm the arbitration award. In its opinion, Interactive Brokers LLC v. Saroop, No. 19-1077, 2020 WL 4668551 (4th Cir. 2020), the Fourth Circuit explained that the agreement between the investors and Interactive Brokers provided that all transactions were subject to rules and polices of relevant markets and clearinghouses, and applicable laws and regulation. The Court held, “[t]his, of course, includes the publicly available FINRA rules (citation omitted). As such, the clause could well be read as incorporation the FINRA rules, making a violation of the rules a breach of the parties’ contract.”

This blog is intended to provide information to the general public and to practitioners about developments that may impact Oregon Investments.

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Cody Berne

Cody Berne is an attorney at Stoll Berne in Portland. Cody’s practice focuses on representing investors who lost money because of fraud and other misconduct, class actions, and business litigation. He is an active member of the Oregon Trial Lawyers Association.


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