Marc J. Goldstein Arbitrator & Mediator NYC
April 26, 2010

Judicial Arbitrability Decisions in FINRA Arbitration: Has Competence-Competence Go Awry?

Former Lehman Brothers CEO Richard Fuld last week failed to convince a federal district judge in New York to enjoin a FINRA arbitration against him arising from a Lehman bond sale in 2006. In this latest of several court decisions concerning arbitrability of pending FINRA arbitrations, Lehman’s erstwhile leader moved to enjoin the arbitration after the panel had denied his motion to dismiss. As to six of the seven claims, the court denied the motion to enjoin the arbitration — but only after accepting that the question was properly one for judicial determination. (Fuld v. Booth Foundation, Inc., 2010 U.S. Dist. LEXIS 38881 (S.D.N.Y. April 20, 2010)).

Do this and other recent mid-stream judicial “interventions” to address arbitrability in FINRA cases indicate that the doctrine of “competence-competence” is in disrepair in the United States? I think not.

U.S. courts of course require, since the First Options case in 1995, “clear and unmistakable evidence” that the parties intended to arbitrate arbitrability, and absent such evidence some questions, including whether a particular individual is bound to arbitrate under a valid arbitration agreement, are for courts to decide, either in the first instance, or without deference to an arbitrator’s prior decision on the same question.

Courts have held frequently that an agreement to arbitrate under rules, such as ICDR or ICC Rules, that invest arbitrators with power to rule upon their own jurisdiction, provides the requisite clear evidence of an agreement to “arb itrate arbitrability.”

But FINRA’s arbitration rules are viewed differently in some situations. FINRA arbitration, when requested by a member firm’s customer, is imposed upon FINRA member firms and certain persons associated with such firms, as a condition of FINRA membership, even if the customer and the firm never expressly agreed with one another directly in a signed bilateral arbitration agreement. In any FINRA arbitration, FINRA Rule 12413 confers authority on FINRA arbitrators “to interpret and determine the applicability of all provisions under the Code” — including those Code provisions that specify the scope of arbitrable disputes.

But when the arbitration arises from a request to arbitrate from a member firm’s customer that the member firm must honor only by reason of its FINRA membership, rather than from a bilateral agreement, the required “clear and unmistakable evidence” has been held not to be present. (John Hancock Life Ins. Co. v. Wilson, 254 F.3d 48 (2d Cir. 2001)).

Does it make sense that the FINRA member’s mere membership, combined with FINRA’s rules imposing arbitration on members (and associated persons) is sufficient “consent” to require arbitration of the merits of a dispute when requested by a customer, but is not sufficient “consent” to require arbitral determinations of arbitrability despite FINRA Rule 12413? Probably not. The sophisticated and well-represented member firms of FINRA understand its rules and, but for the state of the case law, could not fairly say (in the words of the Supreme Court in First Options) that “they reasonably would have thought a judge, not an arbitrator, would decide” arbitrability. The Second Circuit in the John Hancock case justified its holding by saying it was echoing the First Options court’s concern that parties would too often be forced to arbitrate threshold issues they reasonably expected would be decided by a judge.

But that concern dates from another era in the evolution of arbitration theory and practice. The holding in John Hancock appears to be an anomalous rule that in due course will be overtaken by a more contemporary view of the nature of consent in the FINRA arbitration context. In the meantime, the non-arbitrability of arbitrability issues, in FINRA arbitrations, is probably better viewed as a singular exception rather than as a symptom of US judicial disregard for the “competence-competence” principle.

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