Source: https://www.mzclaw.com/new-guidance-on-when-finra-members-may-be-compelled-to-arbitrate/
Timestamp: 2019-04-25 04:05:42+00:00

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The federal Second Circuit Court of Appeals has recently issued a decision, Citigroup Global Markets, Inc. v. Abbar, — F.3d —, 2014 WL 3765867 (Aug. 1, 2014) clarifying who may demand arbitration with FINRA members despite the absence of an arbitration agreement. The Abbar decision concerns the scope of FINRA Rule 12200 (formerly NASD Rule 10101, which is substantively identical), which sets forth when a member or associated person must arbitrate under the Code.
The dispute arises in connection with the business activities of the member of the associated person, except disputes involving the insurance business activities of a member that is also an insurance company.
In Abbar, the investor-claimant pursued a leveraged investment strategy by purchasing options from a UK-based Citigroup entity (“Citi UK”). The option agreements were with Citi UK, the transactions were recorded on the books of Citi UK, and the investment assets were all owned by Citi UK. However, the investments were overseen by a New York-based Citigroup affiliate (“Citi NY”), which served as the investment advisor and selected the investments, and some of the investment bankers who developed the client’s trading strategy were based at Citi NY.
The district court conducted a partial trial on the issue of whether the investor was properly considered a “customer” of Citi NY which it could force to arbitrate pursuant to FINRA Rule 12200. In his opinion, district court Judge Stanton found that the investor was not a client of Citi NY because of the primacy of the connection with Citi UK. However, the judge did not rest his opinion on a fact-intensive inquiry definition of “customer” that would “make a mockery” of the efficiencies arbitration is designed to achieve. He held that a customer is one who both has an account with the FINRA member and purchases a product from that member. 943 F. Supp. 2d 404, 408 (S.D.N.Y. 2013).
The Second Circuit began by discounting the argument that the presumption in favor of arbitration applied in determining when a party was a “customer,” because the presumption only applied to the scope of an arbitration clause, not the existence of an obligation to arbitrate. 2014 WL 3765867, at *5. It affirmed the district judge’s opinion, but with a slightly broader definition of “customer”: one (other than a broker or dealer) who either (1) purchases a good or service from a FINRA member, or (2) has an account with a FINRA member. 2014 WL 3765867, at *6. In the Abbar case, even though Citi NY had certainly provided services to the investor by structuring and managing the options transactions, the investor did not purchase those services from Citi NY, but rather Citi UK; the investment agreements were with Citi UK, the fees for services rendered by all Citigroup personnel were paid to Citi UK, and the counterparty to the options agreements was Citi UK. Id. at *6. There was no doubt that the investor was a “customer” of Citi UK, but it did not follow that Rule 12200 allowed it to compel arbitration against a corporate affiliate. Id. Had there been an account agreement with Citi NY, however, the investor would have been deemed a “customer” of that entity even if it had not received a fee. Under Abbar’s disjunctive test (either services or an account), a FINRA member could be compelled to arbitration even if all securities transactions were made through an affiliate or all services were provided without a fee, so long as there was an account with that member. Id.
Other circuits, however, have taken a different view of the definition of a “customer” under Rule 12200. For example, opinions from the Fourth and Ninth Circuits finding that a party was a “customer” emphasized not only that a commodity or service had been purchased from the member, but also that the member had received fees for its services. Goldman Sachs & Co. v. City of Reno, 747 F.3d 733, 740 (9th Cir. 2014); UBS Financial Serv., Inc. v. Carilion Clinic, 706 F.3d 319, 327-28 (4th Cir. 2013). Those opinions also continue to emphasize numerous facts concerning the relationship between the customer and the firm, suggesting that the fact-intensive inquiry which Abbar intended to do away with may have continued staying power, at least in other circuits.
One of the decisions in most significant tension with Abbar is the Fourth Circuit’s opinion in Waterford Investment Serv., Inc. v. Bosco, 682 F.3d 348 (4th Cir. 2012), which suggests that, in certain circumstances, a corporate affiliate may be compelled to arbitrate with a customer. In Waterford, the FINRA member attempting to avoid arbitration was a separate corporate entity from the broker-dealer whose representative recommended the investment and through which the investment was sold. However, the firms had the same majority shareholder and a significant number of directors and officers in common; their Chief Compliance Officers were different, but there were six common employees in compliance, operations, sales, and accounting. The firms also shared an office suite and utilized the same trading desk and administrative platforms. Unlike the Second Circuit in Abbar, the Fourth Circuit did apply a presumption in favor of arbitrability in interpreting Rule 12200. It then went on to hold that, because of the commonality of directors and shared resources, the related corporation had indirect control over the registered representative. 682 F.3d at 355-56. Because of the corporation’s indirect control over its corporate affiliate, the court found that the registered representative on the transaction was an “associated person” of both firms. Although the Waterford court utilized a different rule term, its holding addressed a similar issue as Abbar: it considered whether a corporate affiliate with significant connections with the actual broker-dealer on a transaction could be compelled to arbitration, and held that it could.
The Abbar opinion should help to further the efficiencies intended by arbitration by emphasizing the need for clear-cut rules on when Rule 12200 applies. The rule is also a recognition of the realities of modern securities practice, where finance involves increasingly interconnected national and international networks of information, talent, and technology. 2014 WL 3765867, at *7. However, continued differences between Circuits about the presumption in favor of arbitrability, and the potentially long reach of the term “associated person” could complicate the Second Circuit’s efforts to bring clarity to this area of the law.
This article does not address situations where arbitration is demanded pursuant to an agreement requiring arbitration of disputes arising out of the business relationship between a customer and a registered representative of a broker-dealer. Recent Supreme Court opinions have continued to counteract states’ traditional hostility toward arbitration agreements as part of a longstanding pro-arbitration trend in federal law. In 2011, AT&T Mobility LLC v. Concepcion held that consumer arbitration agreements, including those that prohibited class actions for state law claims, were enforceable despite objections that they are one-sided contracts of adhesion. In 2013, class action waiver provisions in arbitration agreements were also upheld in American Express v. Italian Colors Restaurant for claims arising out of federal antitrust laws. Whether all affiliated entities, in addition to the direct signatories to arbitration agreements, may also be brought into arbitration through such agreements, remains to be seen. The trend has been toward widening the net of arbitration, but the Abbar opinion may be an indication that the corporate form and the legal principle of privity to contract could serve as potential limits to that trend.

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