NO. 92-539 

IN THE SUPREME COURT OF THE STATE OF MONTANA 

1993 

LEROY E. MUESKE, 

Plaintiff and Respondent, 

PIPER, JAFFRAY & HOPWOOD, INCORPORATED, 

JOHN LAWRENCE SCHTJLTZ, TERRAN FINANCIAL 

GROUP, INC., TERRAN SECURITIES, INC., 

TERRAN PARTNERS 1. DANIEL E. HALLIGAN, 

RONALD G. HEPPNER. AND MAURICE F. BOLGEN, 

Defendants and Appellants. 

APPEAL FROM: District Court of the Second Judicial District, 

In and for the County of Silver Bow, 

The Honorable James E. Purcell, Judge presiding. 

COUNSEL OF RECORD: 

For Appellant: 

John G. Crist and James L. Jones, Dorsey & Whitney, 

Billings, Montana 

For Respondent: 

Daniel R. Sweeney, Butte, Montana; A. Clifford 

Edwards and Kevin M. Funyak, Edwards Law Firm, 

Billings, Montana 

Filed: 

Submitted on Briefs: March 18, 1993 

Decided: AuquSt 27, 1993 
Justice Fred J. Weber delivered the Opinion of the Court. 

Defendant, Piper, Jaffray & Hopwood, Incorporated (Piper, 

Jaffray & Hopwood), appeals the Order of the District Court of the 

Second Judicial District, Silver Bow County, which denied its 

Motion to Compel Arbitration in an action brought by plaintiff 

alleging negligence and violations of the Montana Securities Act in 

relation to investments purchased through Piper, Jaffray & Hopwood. 

We affirm. 

Piper, Jaffray & Hopwood has raised several questions on 

appeal including the correctness of the District Court's findings 

of constructive fraud. admissions against interest of Piper, 

Jaffray & Hopwood's employees and the plaintiff's intent to be 

bound by a Margin Agreement. However, the District Court stated 

that these factual findings made by the court are not the law of 

the case. The sole issue before the District Court in the 

evidentiary hearing was the validity of the arbitration clause 

Piper, Jaf fray & Hopwood sought to enforce. The sole issue for our 

review is: 

Does Piper, Jaffray & Hopwood's failure to comply with the 

rules of the New York Stock Exchange and the National Association 

of Securities Dealers render the predispute arbitration clause 

within Piper, Jaffray & Hopwood's Margin Agreement invalid? 

The following findings of fact of the District Court and 

testimony presented provide the foundation for our review: Leroy 

E. Mueske (Mueske) operated a dental practice in Butte, Montana. 

He contacted defendant John Lawrence Schultz (Schultz) who was a 

2 
broker employed by Piper, Jaffray & Hopwood. On September 13, 

1989, Mueske purchased one unit of Terran Partners I limited 

partnership through Schultz. 

On November 8, 1989, Schultz obtained Mueske's signature on a 

"Margin AgreementN with Piper, Jaffray & Hopwood. The Margin 

Agreement contained the following extensive provision with regard 

to arbitration on the last page of the Margin Agreement just above 

the signature line on which Mueske signed: 

11. Customer Agrees to Arbitrate. * Arbitration is final and binding on the 

parties. * The parties are waiving their right to seek 

remedies in court, including the right to jury 

trial. * Pre-arbitration discovery is generally more 

limited than and different from court 

proceedings. * The arbitrators* award is not required to 

include factual findings or legal reasoning 

and any partyls right to appeal or to seek 

modification of rulings by the arbitrators is 

strictly 1FmFted- * The panel of arbitrators will typically 

include a minority of arbitrators who were or 

are affiliated with the securities industry. 

I agree to arbitrate any disputes between PJH and 

me. I specifically agree and recognize that all 

controversies which may arise between PJH its 

agents, representatives or employees and me 

concerning any transaction, account or the 

construction, performance or breach of this or any 

other agreement between us, whether entered into 

prior, on, or subsequent to the date hereof, shall 

be determined by arbitration to the full extent 

provided by law. Such arbitration shall be in 

accordance with the rules then in effect, of the 

Arbitration Committee of the New York Stock 

Exchanae. Inc. or the National Association of 

Securities Dealers, Inc. as I may elect. I 

authorize PJH, if I do not make such election by 

registered mail addressed to PJH at its main office 

within 15 days after receipt of notification form 

PJH requesting such election, to make such election 

on my behalf. (Emphasis supplied.) 
On December 26, 1989, again through Schultz, Mueske purchased 

additional units of the Terran investments for $50,000, On August 

23, 1990, the Securities Department of the State Auditor's office 

sought a cease and desist order of all the named defendants in this 

action, except Piper, Jaffray & Hopwood, based on fraud and 

misrepresentation to the Terran investors. 

Mueske contends that he lost his entire $75,000 investment in 

the Terran investments. Mueske brought this action against Piper, 

Jaffray & Hopwood concerning the Terran transactions. Piper, 

Jaffray & Hopwood filed a Motion to Compel Arbitration based on the 

above-outlined arbitration clause in the Margin Agreement. 

After a hearing on Piper, Jaffray & Xopwood's motion, the 

District Court concluded that the arbitration clause was severable 

from the Margin Agreement as a whole based on incorporated choice 

of law provisions relating solely to arbitration requiremehts and 

procedures. In adjudicating the validity of the arbitration 

clause, the court relied on the "doctrine of incorporation of 

extrinsic documents" where reference is made within the contract to 

such documents. The arbitration clause contains specific language, 

which provides that arbitration shall be in accordance with the 

rules then in effect of the New York Stock Exchange, Inc. (NYSE) 

and the National Association of Securities Dealers, Inc. (NASD). 

The rules of the NYSE and NASD were thus incorporated into the 

contract. 

The stipulation by Piper, Jaffray & Hopwood that it did not 

fully comply with NASD Rules of Fair Practice, Art. 111, Sec. 21, 
and NYSE Rule 537 is crucial to the District Court's conclusion 

that the arbitration clause was invalid. The specific section of 

NASD Section 21 with which Piper, Jaffray & Hopwood did not comply 

provides : 

Requirements When Using Predispute Arbitration Agreements 

With Customers 

(f) . . . (3) A copy of the aqreement containinq any 

such clause shall be aiven to the customer who shall 

acknowledqe receipt thereof on the aqreement or on a 

separate document. (Emphasis supplied.) 

NASD Manual--Rules of Fair Practice (CCH) a 2171, Art. 111, Sec. 

21 (f) (3) (1991) . The District Court concluded that compliance with 

the above rule was a condition precedent to a valid arbitration 

clause, stating: 

. . . [Piper, Jaffray & Hopwood] . . . has G&?,ZC, 

mandated obligations of disclosure regarding the use of 

pre-dispute arbitration clauses. Failure to comply with 

such rules is a failure to abide by the explicitly 

incorporated terms of the agreement. 

This Court finds that the May 10, 1989 changes in 

the rules incorporated within the arbitration clause were 

deliberate and purposeful actions of the Securities 

Exchange Commission which require proper recognition from 

the Court. . . . ... [Piper, Jaffray & Hopwood's] failure to adequately 

correct its procedures and amend its account forms to 

reflect the new disclosure requirements is a failure to 

provide the Plaintiff with due and proper 

notice/disclosure as determined by the Securities and 

Exchange Commission as evidenced by the May 10, 1989 

adoption of rule changes. 

The District Court further noted that the burden of showing 

satisfaction of the notice/disclosure requirements was on Piper, 

Jaffray & Hopwood and that Piper, Jaffray & Hopwood had failed to 

show that Mueske had received a copy of the agreement or that he 
had acknowledged receipt of a copy of the agreement. The court 

then stated that the requirements are not unduly burdensome, but 

that even if they were, Piper, Jaffray & Hopwood nevertheless 

designated the applicable rules and was bound by them. 

Piper, Jaffray & Hopwood contends that the District Court 

incorrectly concluded that the terms of the arbitration clause 

clearly establish a choice of law election to be bound by the rules 

of the NYSE or the NASD. They contend this was wrong for three 

reasons: (1) Piper, Jaffray & Hopwood's minor variance from the 

industry self-regulating rule did not prejudice Mueske, (2) the 

arbitration clause is not a choice of law provision for the 

purposes of determining what law governs the provision's 

enforceability, and (3) nothing in the NASD rules mandates that the 

clause is void if the rules are not followed. 

First, we agree with the District Court that Piper, Jaffray & 

Hopwood's noncompliance with the rules relating to disclosure and 

notice is not a "minorw triviality. The District Court noted that 

the changes in the NYSE and NASD rules, which were incorporated in 

the Piper, Jaffray & Hopwood arbitration clause, resulted from 

deliberate and purposeful actions of the Securities and Exchange 

Commission (SEC) which require proper recognition from the court. 

The key question is whether the arbitration clause is a choice of 

law provision for the purposes of determining what law governs the 

validity of the arbitration clause. We will uphold the District 

Court's conclusions of law if they are correct. Steer, Inc. v. 

Department of Revenue (l990), 245 Mont. 470, 474, 803 P.2d 601, 
503. 

Piper, Jaffray & Hopwood claims that the NASD rules control 

only the arbitration process, not the validity of the clause 

itself, As noted by Piper, Jaffray & Hopwood, the last paragraph 

of the arbitration clause as reprinted above provides in the first 

two sentences that the parties are to arbitrate all disputes to the 

"full extent provided by law." As further noted by Piper, Jaffray 

& Hopwood, no reference is made in the first two sentences to NYSE 

or NASD rules--it is only further along in the clause (in the third 

sentence) that it provides that any arbitration shall be in 

accordance with the rules of the NASD or NYSE. Piper, Jaf fray & 

Hopwood admits that it did not strictly comply with all the 

requirements of NASD Section 21. Mueske contends that it is 

inconsistent for Piper, Jaffray & Kopwood to argue that the 

arbitration clause should be found valid and strictly enforced 

while at the same time argue that substantial compliance--not 

strict compliance--with the requirements of NASD Section 21 is 

sufficient. 

The parties agree that the Federal Arbitration Act (FAA) 

controls here. The FAA provides that an agreement to arbitrate is 

valid except where grounds exist at law or in equity to revoke the 

contract. 9 U.S.C. 2 (1988). A district court properly 

adjudicates the validity of an arbitration agreement when a party 

contests the validity of an arbitration clause within a contract, 

but does not contest the validity of the contract as a whole. 

Larsen v. Opie (19891, 237 Mont. 108, 111-12, 771 P.2d 977, 979-80 
(citing Prima Paint Corp. v. Flood & Conklin Mfg. Co, (1967), 388 

U.S. 395, 87 S.Ct. 1801, 18 L.Ed.2d 1270). Federal policy behind 

the FAA is designed to ensure enforceability of private agreements 

to arbitrate. Volt Information Sciences, Inc. v. Board of Trustees 

(19895, 489 U.S. 468, 109 S.Ct. 1248, 103 L.Ed.2d 488. Allowing 

enforcement of private agreements to arbitrate gives effect to the 

contractual rights and expectations of the parties, without 

ravaging the policies behind the FAA. Volt, 489 U.S. at 479, 109 

S.Ct. at 1255-56, 103 L.Ed.2d at 500. 

In Audit Services v. Frontier-West, Inc. (1992)' 252 Mont. 

142, 148, 827 P.2d 1242, 1246, we said that "[a] state court may 

rely on state contract law as long as it effectuates the policy 

underlying federal labor legislationm and applies federal 

substantive law. The same holds true for determining the validity 

of an arbitration clause coming under the guidelines and 

requirements of federal arbitration legislation. 

Based on the language in volt, a district court's goal, 

therefore, should be to give effect to the contractual rights and 

expectations of the parties without running contrary to the 

policies behind the FAA. Although the policy behind the FAA is to 

encourage and enforce arbitration agreements, that extends only to 

valid arbitration agreements. The court could find the agreement 

invalid according to the law the parties have chosen to apply, so 

long as the chosen law is not contrary to the FAA and the 

legitimate rights and expectations of the parties. Here the 

District Court determined that Piper, Jaffray & Hopwood's 
arbitration clause was invalid by enforcing the provision of the 

arbitration clause that provided for application of NASD and NYSE 

rules as a choice of law provision. 

The self-regulating securities industry, through the 

Securities Industry Conference on Arbitration (SICA), developed 

rules relating to arbitration and arbitrability for its own use, 

pursuant to g 19(b) (1) of the Securities Exchange Act of 1934. 

Order Aparovincr Proposed Rule Chancres bv NYSE, NASD and AMEX 

Relatinq to the Arbitration Process and the Use of PredisBute 

Arbitration Clauses, Exchange Act Release No. 34-26805 (19891, 54 

Fed. Reg. 21144. SICA was formed in 1977 by the securities 

industry in response to the SEC's request for a review of thenexisting arbitration procedures as an alternative to the 

implementation of the SEC's own proposals to establish a system for 

dispute resolution between broker/dealers and their customrs. Id., 

54 Fed. Reg. at 21145. This resulted in a Uniform Code of 

Arbitration. In September of 1987, after reviewing industrysponsored arbitration, the SEC advised SICA of its views regarding 

the need for changes to the Uniform Code of Arbitration. Id., 54 

Fed. Reg. at 21145. After that time, SICA and the SEC met 

regularly to work out proposals in response to SEC concerns. Id., 

54 Fed. Reg. at 21145. NYSE Rule 637 and NASD Section 21 were 

developed by the self-regulating organizations in response to SEC 

concerns. 

NYSE Rule 637 and NASD Section 21 are included in the rules 

adopted by the SEC. They were specifically designed to improve 
disclosure to customers in account opening agreements and to 

restrict the content of the arbitration clauses. Id., 54 Fed. Reg. 

at 21153. Notice of the proposed changes was given in Securities 

Exchange Act releases and by publication in the Federal Register. 

see, e.q., ProDosed Rule Chanqes bv NYSE, Exchange Act Release No. 

34-26474 (1989j, 54 Fed. Reg. 3883. After reviewing the filings 

and the comments received in response to notice, the SEC determined 

that the proposed rule changes were consistent with the 

requirements of the Securities Exchange Act. Exchange Act Release 

No. 34-26805, 54 Fed. Reg. at 21155. One industry member commented 

that the new rules should enhance investor confidence in the 

system. Id., 54 Fed. Reg. at 21155. The SEC approved the NYSE and 

NASD rules discussed above on May lo, 1989, and NYSE Rule 637 and 

NASD Section 21 became effective September 13, 1989. Id., 54 Fed. 

Reg. at 21155, n.61. 

One of the most significant changes in the rules is the level 

of disclosure and the emphasis on disclosure of arbitration clauses 

in agreements such as Piper, Jaffray & Hopwood's Margin Agreement. 

In its order approving the changes, the SEC stated: 

The Commission welcomes the changes in SRO arbitration 

heralded by these proposals, and the cooperative effort that 

produced them. These rules represent several years of effort 

by SICA. They represent the promise of the SROs to maintain 

fair and efficient forums for the arbitration of disputes 

between members and investors. The Commission believes that 

the proposed rules appropriately balance the need to 

strengthen investor confidence in the arbitration systems at 

the SROs, both by improving the procedures for administering 

the arbitrations and by creatinq clear obliqations reqardinq 

the use by SRO members of predispute arbitration clauses, with 

the need to maintain arbitration as a form of dispute 

resolution that provides for equitable and efficient 

administration of justice. (Emphasis supplied.) 
Exchange Act Release No. 34-26805, 54 Fed, Reg, at 21155. 

Congress established a self-regulatory scheme for the 

securities industry. This scheme of self-regulation involves SEC 

approval of rules developed by industry members. In approving the 

new rules, the SEC stated that the rule changes of the NYSE and 

NASD "dynamically advance the public interest in SRO arbitration 

. . . [and] we conclude that these rules are designed to prevent 

fraudulent and manipulative practices, promote just and equitable 

principles of trade and in general, protect investors and the 

public interest consistent with sections 6(b) (5) and 15A(b) (6) [of 

the SEA]." Id., 54 Fed. Reg. at 21155. 

The District Court's decision to include the NASD and NYSE 

rules in the contract as a choice of law provision applicable to 

the entire arbitration clause is reasonable. The SEC would not 

approve the NYSE and NASD rules without the disclosure provision 

requiring a signature for the arbitration agreement and requiring 

that a copy be given to the investor. Exchange Act Release No. 34- 

26805, 54 Fed. Reg. at 21144. The disclosure requirements of the 

rules were intended to further the purpose of the FAA in enforcing 

arbitration agreements, but only when the agreements are fully 

disclosed to the investor. 

As the drafter of the arbitration clause, Piper, Jaffray & 

Hopwood should have specified therein if it had intended to submit 

disputes to arbitration under the terms of the NASD and NYSE rules 

but did not intend to have the determination of validity of the 

arbitration agreement made by using the same rules. This is 
particularly important where the NASD and NYSE rules include 

sections which specify procedures for disclosure of arbitration 

clauses to investors and where the SEC has stressed the importance 

of the disclosure procedures and specifically required the industry 

to include them. 

"Arbitration clauses are creatures of contract and, therefore, 

principles of contract interpretation are applicable." Frates v. 

Edward D. Jones & Co. (1988), 233 Mont. 377, 382, 760 P.2d 748, 

752. By not specifically stating in the arbitration clause the law 

which will govern a determination of validity of the clause, Piper, 

Jaffray & Hopwood has created an ambiguity. When ambiguities 

exist, general rules of contract interpretation apply to determine 

the intent of the parties. 

Uncertain terms in a contract are to be construed against the 

party causing the uncertainty. Section 28-3-206, MCA. see also 

Rumph v. Dale Edwards, Inc. (1979), 183 Mont. 359, 600 P.2d 163, 

169. Any ambiguity in the arbitration clause is thus to be 

construed strictly against Piper, Jaffray & Hopwood as the drafter 

of the contract. Frates, 760 P.2d at 752. 

Further, the intention of the parties must be determined by 

reading the instrument in full and not by isolating words and 

phrases as Piper, Jaffray & Hopwood urges the Court to do here. 

It is a well-established principle of contractual 

construction that in interpreting a written instrument, 

the court will not isolate certain phrases of the 

instrument to garner the intent of the parties, but will 

grasp the instrument by its four corners and in the light 

of the entire instrument, ascertain the paramount and 
guiding intent of the parties. Mere isolated tracts, 

clauses and words will not be allowed to prevail over the 

general language utilized in the instrument. ... Particular clauses of the agreement are subordinate to 

the general intent of the contract. . . . 

Rumph, 600 P.2d at 168 (citing 5 28-3-307, MCA). 

Piper, Jaffray & Hopwood's arbitration clause incorporates the 

rules of the NYSE and NASD as controlling law. The arbitration 

clause does not include an exception for allowing other law to 

govern determinations of validity. Applying the general rules of 

contract interpretation set forth above, we conclude that those 

rules, along with the public policy considerations expressed by the 

SEC, direct that the validity of the arbitration clause be 

determined according to the incorporated controlling law--the NYSE 

and NASD rules--unless such rules contravene the substantive law of 

the FAA. 

We hold Piper, Jaf fray & Hopwood's failure to comply with NYSE 

and NASD rules renders the predispute arbitration clause within 

Piper, Jaffray & Hopwood's Margin Agreement invalid. 

Affirmed and remanded for further proceedings consistent with 

this opinion. 

We Concur: _ -4- 
Justice Karla M. Gray 
Justice James C. Nelson respectfully dissents. 

The opinion of the Court states that when Piper, Jaffray & 

Hopwood, Inc. (Piper) drafted the Margin Agreement at issue, which 

included an arbitration clause, Piper included a choice of law 

provision. ' This tqchoice of lawm provision was the National 

Association of Security Dealers (NASD) rules. The opinion of the 

Court calls the NASD rules in this case "controlling law". 

Although the Securities and Exchange Commission (SEC) has some 

power over the NASD, the NASD is a private, independent, selfregulating organization. The SEC did direct the NASD to implement 

rules regarding arbitration. Essentially, the SEC allowed the NASD 

to promulgate rules, rather than force rules on the group. 

The new promulgated rules provided specific directions (Rule 

21) for incorporating arbitration provisions into securities 

agreements. A violation of Rule 21 could result in sanctions by 

the NASD against the violating dealer. 

Here, the Court held that a failure to comply with controlling 

law incorporated into an arbitration agreement, such as an NASD 

rule, renders a pre-dispute arbitration clause invalid. However, 

if the NASD rule is "'controlling law", as held by the Court here, 

then all of the NASD rules should control. The NASD rules provide 

that a violation of Rule 21 can result in sanctions being issued 

against the violating dealer. There is no provision for 

'I do not believe that the reference by the District Court or 

by this Court to the provision at issue as being one of "choice of 

law" is accurate in the context in which that concept is usually 

understood. 
invalidating the arbitration agreement in its entirety. 

If there is some legal basis for the Court to determine that 

a violation of a llchoice of laww provision can result in a remedy 

not provided for by that law, this legal basis should be clearly 

articulated. If there is no legal basis for allowing this remedy, 

one should not be artificially created. 

For the foregoing reasons, I dissen 
August 27, 1993 

CERTIFICATE OF SERVICE 

I hereby certify that the following order was sent by United States mail, prepaid, to the following 

named: 

John G. Crist and James L. Jones 

Dorsey & Whitney 

P.O. Box 7188 

Billings, MT 59103 

Daniel R. Sweeney 

Attorney at Law 

P.O. Box 3725 

Butte, MT 59702 

A. Clifford Edwards and Kevin M. Funyak 

Edwards & Paoli 

P.O. Box 20039 

Billings, MT 59104 

John L. McKeon 

Attorney at Law 

P.O. Box 879 

Anaconda, MT 59711 

Ronald G. Heppner 

431 Grantsdale Rd. 

Hamilton, MT 59840 

William K. Van Canagan 

Datsopoulos, MacDonald & Lind 

201 W. Main, Ste. 201 

Missoula. MT 59802 
ED SMITH 

CLERK . OF THE SUPREME COURT 

STATE-OF MONTANA