Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caed-2_04-cv-02564/USCOURTS-caed-2_04-cv-02564-0/pdf.json

Nature of Suit Code: 850
Nature of Suit: Securities, Commodities, Exchange
Cause of Action: 15:78m(a) Securities Exchange Act

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IN THE UNITED STATES DISTRICT COURT

FOR THE EASTERN DISTRICT OF CALIFORNIA

BARBARA RICHARDS, et al., 

Plaintiffs,

v.

MORGAN STANLEY, et al.,

Defendants. 

CIV-S-04-2564 DFL DAD 

MEMORANDUM OF OPINION

AND ORDER

Defendants Morgan Stanley Dean Witter, Michael Jennings, and

John Polhemus move to compel arbitration of plaintiffs’ claims

against them. For the reasons stated below, defendants’ motion

is granted in part and denied in part.

I.

Plaintiff Barbara Richards alleges that she received a “cold

call” in 1992 from Michael Jennings, a securities broker who at

that time worked for Kemper Securities. (Compl. ¶ VIII.) 

Richards alleges that Jennings eventually induced her to let him

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manage her investments. (Id.) In 1993, Jennings transferred his

license and Richards’s account to Dean Witter. (Id. ¶ IX.) John

Polhemus was Jennings’ manager at Dean Witter. (Id.) Richards

subsequently opened several accounts, both in her individual

capacity and as trustee of three different trusts. Richards also

provided funding, as settlor, for a fourth trust account, the

Irrevocable Life Insurance Trust account, with plaintiff Richard

Keene as the account holder and trustee. Plaintiffs allege that

from 1993 to 2003, Jennings engaged in “churning” of these

accounts, making trades solely for the purpose of generating

commissions. (Id. ¶¶ I, XI, XII.) Plaintiffs also allege that

Jennings encouraged Richards to sell her real estate and actively

participated in the sale in order to generate more funds for the

securities accounts. (Id. ¶ XIV.) 

Jennings met with Richards many times over lunch to discuss

her investments and to give her various documents to sign. 

(Richards Decl. ¶ 7.) Among these documents were at least four

agreements containing an arbitration clause: a 1996 Margin Client

Agreement, a 1999 Investment Client Agreement, and two 2001

Investment Client Agreements. (Thomases Decl. Exs. A-D.) The

1996 arbitration provision, which is generally representative,

states:

You agree that all controversies between you or your

principals or agents or Dean Witter or its agents 

(including affiliated corporations) arising out of or

concerning any of your accounts, orders or 

transactions, or the construction, performance or 

breach of this or any other agreement between us, 

whether entered into before or after the date an 

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account is opened, shall be determined by arbitration 

only before the New York Stock Exchange, Inc.; the 

National Association of Securities Dealers, Inc.; or 

the Municipal Securities Rulemaking Board, as you 

may elect.

(Id. Ex. A.) Jennings retired in 2002, but plaintiffs allege

that he continued to manipulate Richards’s accounts by turning

over the accounts to John Polhemus. (Compl. I, XV.)

Plaintiffs assert ten causes of action against defendants

based on this alleged course of conduct: (1) fraudulent

mismanagement of accounts; (2) excessive and authorized trading

of securities account (the alleged “churning”); (3) fraudulent

inducement to open a discretionary account; (4) broker’s breach

of fiduciary duty; (5) financial abuse of an elder; (6) unjust

enrichment/restitution; (7) a “common count” based on defendants’

indebtedness to plaintiff; (8) negligence; (9) violation of 18

U.S.C. § 1962(a); and (10) violation of 18 U.S.C. § 1962(c). 

Defendants move to compel arbitration of all counts based on the

arbitration provisions in the four contracts.

II.

The Federal Arbitration Act (“FAA”) creates a federal policy

favoring arbitration and requires the court, upon motion of a

party, to compel arbitration upon finding that a valid

arbitration agreement exists and that the claims are arbitrable. 

9 U.S.C. §§ 2, 4; Moses H. Cone Mem. Hosp. v. Mercury Const.

Corp., 460 U.S. 1, 24, 103 S.Ct. 927 (1983); Dean Witter

Reynolds, Inc. v. Bryd, 470 U.S. 213, 218, 105 S.Ct. 1238 (1985). 

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A. Existence of Arbitration Agreement for All Trusts

As a threshold matter, the court must determine whether the

arbitration clauses, if valid, apply to all of the trust

accounts. Plaintiffs concede that the claims of the Revocable

Trust and the Charitable Remainder Trust are subject to an

arbitration clause. (Supplemental Wilson Decl. at 2.) However,

plaintiffs contend that the Education Foundation Trust and the

Irrevocable Life Insurance Trust are not subject to any

arbitration agreement. (Id.) 

The arbitration clauses in the contracts are broad and cover

all controversies arising out of or pertaining to “any of your

accounts” with Morgan Stanley. (Thomases Decl. Exs. A-D.) In

light of the broad language, it is most reasonable to interpret

the word “your” in a non-technical way to apply to Morgan Stanley

accounts created and controlled by Richards regardless of her

legal capacity. All of these accounts were “her” accounts.

Because Richards created and controlled the Education Foundation

Trust account at Morgan Stanley any claims by Richards as trustee

of the Education Foundation Trust are covered by the arbitration

provisions contained in the contracts discussed above. (2d

Supplemental Thomases Decl. Exs. A, B.) 

Furthermore, and alternatively, Richards’s claims as trustee

of the Education Foundation Trust are inextricably intertwined

with her other claims. The Education Foundation Trust is alleged

to have been a “scheme” by Jennings to increase his trading

activity. (Compl. ¶ X.) Any claims of the Education Foundation

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necessarily “arise out of” claims by Richards in her individual

capacity, such that the arbitration provisions, if valid, would

also cover these claims. Therefore, any claims by Richards as

trustee of the Education Foundation Trust are subject to

arbitration. See, e.g., In re Prudential Secs., Inc, 2005 WL

726605 at *3 (Tex. App. 2005). 

By contrast, the Irrevocable Life Insurance Trust account

was not controlled by Richards. Although Richards was the

settlor of the Irrevocable Life Insurance Trust, she retained no

legal control over either the trust or the Morgan Stanley trust

account. It was not “hers” and, therefore, does not fall within

the “your account” language of the arbitration clause. The

account opening form and the computerized account information for

the Irrevocable Life Insurance Trust account list Richard Keene

as the trustee and account holder. (Id. Ex. C; McKay Decl. Ex.

A.) Richards retained no authority to alter the beneficiaries of

the trust. (2d Supplemental Thomases Decl. Ex. E.) This account

did not belong to Richards. Any claims by Richard Keene, as

trustee of the Irrevocable Life Trust, against defendants are not

subject to the arbitration agreement between Richards and Morgan

Stanley. 

B. Defenses to Enforcement

Although arbitration agreements exist for Richards’s claims

as to the accounts, those agreements may be deemed unenforceable

for such grounds as exist at law or in equity for the revocation

of any contract. 9 U.S.C. § 2. The validity of the arbitration

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clause is decided by applying state contract law. Circuit City

Stores v. Adams, 279 F.3d 889, 892 (9th Cir. 2002). General

contract defenses such as fraud, duress, or unconscionability may

operate to invalidate an arbitration provision. Id. Because of

the federal policy favoring arbitration, the party seeking to

avoid arbitration has the burden of demonstrating that the

provision is invalid. Moses H. Cone Mem. Hosp., 460 U.S. at 24-

25. Plaintiffs assert that the contract defenses of fraud,

duress, unconscionability and undue influence bar enforcement of

the arbitration clauses. (Opp’n at 2-4.)

1. Fraud

“Fraud in the inducement” may prevent enforcement of an

arbitration agreement. Shearson/Am. Express, Inc. v. McMahon,

482 U.S. 220, 226, 107 S.Ct. 2332 (1987). However, in examining

a claim of fraud in the inducement, the court is limited to the

arbitration clause. Prima Paint Corp. v. Flood & Conklin Mfg.

Co., 388 U.S. 395, 404-03, 87 S.Ct. 1801 (1967). Claims as to

the validity of the underlying contract are for the arbitrator to

decide. Id. The court must look narrowly at whether there was

fraud directed at the arbitration clause itself, such as a

misrepresentation about the arbitration process. Id.; Moseley v.

Elec. & Missile Facilities, Inc., 374 U.S. 167, 170-71, 83 S.Ct.

1815 (1963); Engalla v. Permanente Med. Group, Inc., 15 Cal.4th

951, 973, 64 Cal.Rptr.2d 843 (1997). There is no showing of

fraud in the inducement as to the arbitration clause. Plaintiffs

claim that Jennings misrepresented his expertise to induce

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Richards to give him control of her assets is addressed to the

entire contract and is for the arbitrator to decide. 

“Fraud in the inception” or “fraud in the execution” may bar

arbitration where the party’s apparent assent to the contract is

based upon deception as to the true nature and effect of the

documents signed. Id. Again, plaintiffs’ showing is inadequate. 

Plaintiffs’ allegations that Jennings misrepresented his

abilities and expertise do not show that Richards was duped as to

the nature and effect of the various contracts. 

2. Duress

A contract may be rescinded by a party whose consent was

obtained by duress. Cal. Civ. Code § 1689. Duress includes: (1)

unlawful confinement of a party or an immediate family member;

(2) unlawful detention of the property of any such person; or (3)

confinement of such person, lawful in form, but fraudulently

obtained or made unjustly harassing or oppressive. Id. § 1570. 

Unlawful duress also includes the threat of duress, also known as

menace, and the threat of economic compulsion. Id.; Restatement

(Second) of Contracts § 176 (1981). There are no facts or

allegations here to support a finding of duress in the making of

the contract or in Richards’s agreement to the arbitration

clause. 

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 Defendants cite Cohen v. Wedbush, Noble, Cooke, Inc., 841 1

F.2d 282, 286 (9th Cir. 1988), for the proposition that

arbitration provisions in brokerage agreements, like the one at

issue here, are “not unconscionable as a matter of law.” (Reply

at 2-3.) However, Cohen was based on the premise that state law

principles of unconscionability may not be invoked to bar

arbitration of disputes under the FAA, a premise that was

reconsidered and rejected in Ticknor v. Choice Hotels Int’l, 265

F.3d 931 (9th Cir. 2001). 

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3. Unconscionability1

In California, a contract is unenforceable only if it is

both procedurally and substantively unconscionable. Ting v.

AT&T, 319 F.3d 1126, 1148 (9th Cir. 2003). Courts apply a

“sliding scale” to determine whether a provision may be enforced,

such that a stronger showing on one factor can compensate for a

weaker showing on the other. Id.

A contract is procedurally unconscionable if it involves

either “oppression” or “surprise.” Flores v. Transamerica

Homefirst, Inc., 93 Cal.App.4th 846, 853, 113 Cal.Rptr.2d 376

(2001). These elements are automatically deemed present, making

the contract procedurally unconscionable, if the contract is

adhesive. Ting, 319 F.3d at 1148. For purposes of this

discussion, the court will assume that the contracts were

contracts of adhesion. 

However, to be unenforceable, the contracts must be

substantively unconscionable as well. Substantive

unconscionability focuses on whether the terms of the arbitration

agreement are overly harsh or one-sided. Amendariz v. Found.

Health Psychcare Servs., Inc., 24 Cal.4th 83, 114, 99 Cal.Rptr.2d

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745 (2000). As discussed above, plaintiffs have the burden of

demonstrating that the arbitration provisions are invalid. Moses

H. Cone Mem. Hosp., 460 U.S. at 24-25. Plaintiffs have not

presented evidence showing that the terms of the arbitration

agreement are harsh or one-sided. Therefore, plaintiffs do not

carry their burden of demonstrating unconscionability. 

4. Undue Influence

A court reviewing a claim of undue influence looks at

whether there was voluntary assent to the arbitration provision. 

Ford v. Shearson Lehman/Am. Express, Inc., 180 Cal.3d 1011, 1027-

29, 225 Cal.Rptr. 895 (1986). There are three different types of

undue influence under California law: (1) use of a confidential

or fiduciary relationship to obtain an unfair advantage; (2)

taking unfair advantage of another’s weakness of mind; or (3)

taking a grossly oppressive and unfair advantage of another’s

necessities or distress. Cal. Civ. Code § 1575. A contract

obtained through undue influence is voidable by the party who was

unduly influenced. Id. § 1689. 

The first type of undue influence arises where a fiduciary

relationship exists between the parties. Id. § 1575. Where a

fiduciary or agency relationship exists, any transaction which

allows the fiduciary to obtain an advantage over the client is

presumptively invalid, and the burden is on the fiduciary to

demonstrate that the agreement is fair and that it was made

freely and voluntarily. Webb v. Saunders, 79 Cal.App.2d 863,

870, 181 P.2d 43 (1947). As with the claim of substantive

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unconscionability, plaintiffs have presented no evidence that the

arbitration provisions gave defendants an advantage over

Richards, such that a presumption of undue influence would arise.

The second and third types of undue influence -- taking

advantage of another’s weakness of mind or distress -- apply

where there is no confidential relationship between the parties. 

The definitive California case, Odorizzi v. Bloom Sch. Dist., 246

Cal.App.2d 123, 131, 54 Cal.Rptr. 533 (1966), sets out two

required elements for making a successful claim of undue

influence under these theories: (1) undue susceptibility of the

servient person, and (2) excessive pressure by the dominating

person. In determining whether the person was unduly

susceptible, factors such as age, physical condition, or

emotional anguish may be considered. Id. While the age of the

plaintiff is relevant to a finding of undue influence, old age

alone may be insufficient to find undue influence. Nessen v.

Nessen, 218 Cal. 59, 61, 21 P.2d 415 (1933); Creason v. Creason,

123 Cal.App. 455, 457-58, 11 P.2d 451 (1932); Gosnell v. Lloyd,

215 Cal. 244, 255-56, 10 P.2d 45(1932).

Richards’s advanced age, unremitting back pain, lack of

immediate family, and inexperience in investing support a finding

of undue susceptibility. However, plaintiffs have not presented

evidence of excessive pressure or overpersuasion by Jennings in

inducing Richards to sign the contracts containing the

arbitration provisions. (Daniell Decl. ¶ 4; Compl. VII.) 

Plaintiffs fail to show that Richards’s acquiescence to the

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arbitration clauses was obtained through undue influence.

Plaintiffs have not carried their burden of demonstrating

that the arbitration provisions are unenforceable under any of

the proposed state-law contract defenses. The arbitrations

provisions are valid and enforceable as against all claims by

Richards in her individual and trust capacity.

C. Arbitrability of Particular Claims

Plaintiffs argue that the elder abuse claim is not subject

to arbitration. (Opp’n at 4-5.) The arbitration provisions are

broad and extend to “all controversies” arising out of or

concerning Richards’s accounts with Morgan Stanley. (Thomases

Decl. Exs. A-D.) The duty to enforce arbitration agreements

applies even where statutory claims are present, such that the

nature of the claim is immaterial to its arbitrability. 

Shearson/Am. Express, 482 U.S. at 227; Prima Paint, 388 U.S. at

395. This duty extends even to cases arising under a federal

statute designed to further important social policies, because

these policies can be effectively enforced through arbitration. 

Green Tree Fin. Corp.-Alabama v. Randolph, 531 U.S. 79, 90, 121

S.Ct. 513 (2000). The elder abuse claim is subject to

arbitration. 

D. Conditions of Arbitration

 In the event that the court found their claims to be

arbitrable, plaintiffs request that the arbitration be held in

Redding, CA. (Id.) Section 4 of the FAA generally requires that

arbitration ordered by the court be held within the district in

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which a petition for an order directing such arbitration is

filed. 9 U.S.C. § 4. However, the FAA rules governing

arbitration do not apply where the parties have clearly provided

otherwise. Volt Info. Sci., Inc. v. Bd. of Tr. of Leland

Stanford Jr. Univ., 489 U.S. 468, 469, 109 S.Ct. 1248 (1989). 

Here, the contract provides for the location of the arbitration -

- “the location where the selected forum regularly conducts such

proceedings nearest to the Dean Witter office carrying the

account at the time the claim arose.” (Thomases Decl. Exs. A-D.) 

The location of the arbitration is, therefore, governed by the

arbitration provisions and cannot be ordered by the court. 

Plaintiffs also ask that any deposition of Richards be

expedited and videotaped and that the court require that the

arbitration be completed in four months. (Opp’n at 7.) Although

the court retains authority to grant provisional remedies during

the course of arbitration, that authority is used to maintain the

status quo during the arbitration, rather than set the terms of

arbitration. See, e.g., PMS Distrib. Co. v. Huber & Suhner,

A.G., 854 F.2d 355, 358 (9th Cir. 1988) (holding that the

district court has the authority to grant a writ of possession

while arbitration is pending). Once the court has determined

that the arbitration agreement is valid and enforceable, the

arbitration proceeds according to the terms of the agreement and

the direction of the arbitrator, without interference of the

court. Plaintiffs’ requests are DENIED. Of course, plaintiffs

may make these requests of the arbitrator. 

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Defendants request dismissal of this action in the event

arbitration is compelled. (Mot. at 5.) Because not all claims

are subject to arbitration, dismissal is inappropriate. However,

the court has the inherent power to stay proceedings “pursuant to

its power to control its docket and calendar and to provide for a

just determination of the cases pending before it.” Leyva v.

Certified Grocers of Cal., Ltd., 593 F.2d 857, 864 (9th Cir.

1979). The pendency of independent proceedings, including

arbitration proceedings, which could bear upon the case, may

justify a stay. Id. at 863-64. Because the outcome of the

arbitration proceeding is relevant to, may determine Keene’s

claims, a stay is appropriate here. The remaining claims are,

therefore, stayed until completion of the arbitration proceeding.

III.

Defendants’ motion to compel arbitration is GRANTED as to

claims by Richards in her individual and trustee capacities, but

DENIED as to claims by Keene in his capacity as trustee. 

Defendants’ request to dismiss is DENIED, but the remaining

claims are STAYED pending completion of arbitration. Plaintiffs’

requests for certain conditions of arbitration are DENIED.

IT IS SO ORDERED this 17 day of June, 2005.

DAVID F. LEVI

United States District Judge

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