1974, September, Pg. 455. Artibration and Other Remedies for Exchange and NASD Rule Violations.

• Author: by Matthew J. Zale

3 Colo.Law. 455

Colorado Lawyer

1974.

1974, September, Pg. 455.

Artibration and Other Remedies for Exchange and NASD Rule Violations

455Vol. 3, No. 11, Pg. 455Artibration and Other Remedies for Exchange and NASD Rule Violationsby Matthew J. ZaleWhether your client is a stockbroker or a customer, there has been enough written on Rule 10b-5 actions to give you plenty of research material to support your position in litigation. This article presents some alternatives to the traditional 10b-5 case, where violations of exchange and National Association of Securities Dealers (NASD) rules are present. Part one deals with arbitration as an alternative, and part two deals with how the courts have dealt with complaints based on violations of exchange and NASD rules.

ARBITRATION

Cases on arbitration are divided into two categories: (a) those in which the customer sues in court and the broker tries to force him into arbitration according to the customer's agreement, and (b) those in which the stockbroker brings suit and the customer attempts to compel arbitration according to the broker's agreement with the exchange or NASD.

Customer Litigation Protected

The landmark case of Wilko v. Swan, 346 U.S. 427 (1953), involved a customer's suit against the partners of Hayden, Stone & Company for misrepresentations in the sale of stock under § 12(2) of the Securities Act of 1933. The customer had signed a compulsory arbitration agreement, and the broker moved to stay the trial and throw the matter into arbitration pursuant to § 3 of the United States Arbitration Act. The customer responded, and the Supreme Court agreed that the Securities Act was drafted to protect investors who are at a disadvantage when they buy securities, and under § 14 of the Securities Act of 1933 Congress has forbidden a waiver of the buyer's right to select the judicial forum in which to seek his remedy. The Court stated (at 346 U.S. 435):

"When the security buyer, prior to any violation of the Securities Act, waives his right to sue in courts, he gives up more than would a participant in other business transactions. The security buyer has a wider choice of courts and venue. He thus surrenders one of the advantages the Act gives him and surrenders it at a time when he is less able to judge the weight of the handicap the Securities Act places upon his adversary. Even though the provisions of the Securities Act, advantageous to the buyer, apply, their effectiveness in application is lessened in arbitration as compared to judicial proceedings."

456The Wilko doctrine has been widely followed in cases attempting to force a customer out of court. A part that has been carved out of Wilko is the holding that an investor's voluntary submission to arbitration after a dispute has arisen, as opposed to prior agreement, is valid and that agreement will be enforced to pull the matter out of court. Moran v. Paine, Webber, Jackson & Curtis, 389 F.2d 242 (3d Cir. 1968). The Supreme Court in Sherk v. Alberto-Culver Co. (June 17, 1974, CCH Securities Law Reporter, 94593) may have carved a little more out of the Wilko doctrine by indicating it might not apply to suits brought under the Securities Exchange Act rather than under the Securities Act. However, Sherk turned largely on the fact that an international arbitration agreement was at issue.

To the great consternation of federal judges, the Wilko doctrine has spawned a game among lawyers---that of attaching a weak federal claim to a complaint and filing a federal lawsuit in order to avoid arbitration. Judge Friendly of the Second Circuit has been an enthusiastic referee of this new game and has sent many of these cases back into arbitration.

In Colonial Realty Corp. v. Bache and Co., 358 F.2d 178 (2d Cir. 1966), a customer of Bache joined breach of contract and negligence claims with claims of violations of the New York Stock Exchange and NASD rules requiring conduct "consistent with just and equitable principles of trade." Judge Friendly ruled that this type of joinder under the Wilko doctrine would saddle the federal courts with garden-variety customer-broker suits and would outlaw the widely adopted practice of resorting to arbitration to settle customer-stockbroker controversies. He sent the case back for arbitration, and in doing so rendered the landmark opinion setting the guidelines for implying civil liability based on violations of exchange and NASD rules. (This and other cases on the subject are analyzed in part two of this article.)

In Kavit v. Stamm & Co., 491 F.2d 1176 (2d Cir. 1974), Judge Friendly heard another novel attempt by a customer to come under the Wilko umbrella. Plaintiff-customer had state claims which would have gone to arbitration under a standard customer agreement if they had stood alone, but joined with the state claims were weak federal claims on the theory of pendent jurisdiction to avoid arbitration under Wilko. Judge Friendly found, however, that the provisions of Wilko did not protect state claims under pendent jurisdiction, and those claims are subject to arbitration.

Judge Friendly took the hapless defendants to task for failure to effectively protect their right to arbitration of the state claims, saying he would have referred these claims back for arbitration if the defendants had timely moved to dismiss or stay the common law claims and separate them from the federal claims. Defendants also should have moved for summary judgment of the federal claims, and then, unhampered by the presence of the federal claims, could have moved for a stay of the state claims. The defendants having failed to do so, the court found that the district court did not abuse its discretion by exercising pendent jurisdiction, but reached this conclusion "without enthusiasm."

United States Arbitration Act

A motion to stay court proceedings pending arbitration is made pursuant to the United States Arbitration Act, 9 U.S.C. § 3, which requires a federal court in which suit has been brought upon any issue referable to arbitration under an agreement in writing to stay the court action. Section 2 of that Act states that a written arbitration agreement will be valid and enforceable if it calls for arbitration of a controversy arising out of a contract involving commerce. The courts have no trouble finding a dispute between a customer and a broker has to do with a contract "involving commerce." In Legg, Mason & Company, Inc. v. Mackall & Coe, Inc., 351 F. Supp. 1367 (D.D.C. 1972) the court even found a business-piracy tort involving the theft of documents for an investment advisory service

457affected commerce under 9 U.S.C. § 2 and granted the motion to stay the court proceedings pending arbitration.An arbitration agreement signed by a customer may be just the handle a broker or other defendant needs to thwart a class action. One state court has held if a customer signed a margin agreement containing an arbitration clause, he could not litigate in a state court as the "leader of a class." Bochner v. Shearson. Los Angeles Superior Court, Civil No. 9890, March...