I have reported on three recent occasions concerning judicial decisions on arbitrability in the context of FINRA arbitrations. FINRA is the Financial Institutions Regulatory Authority, successor to the National Association of Securities Dealers, the principal self-regulatory organization of the financial services industry.
In yet another such case, a New York federal judge last week denied a motion by J.P. Morgan Securities, Inc. (“Morgan”) (on its own behalf and as successor to Bear Stearns & Co. (“Bear”)) to enjoin a FINRA arbitration pending in Louisiana. However, the Court declined to enter an order compelling arbitration, interpreting Section 4 of the Federal Arbitration Act to prohibit such an order where a choice of forum clause in the arbitration agreement provides for, or is applied to direct that, the arbitration to proceed elsewhere. (J.P. Morgan Securities, Inc. v. Louisiana Citizens Property Insurance Corp., 2010 U.S. Dist. LEXIS 42953 (S.D.N.Y. April 30, 2010).
Morgan and Bear had acted as co-underwriters on a $1 billion bond issue for the Louisiana company that commenced the arbitration. The company also entered into interest rate swaps with affiliates of Morgan and Bear to hedge its exposure on the bonds. When the market for auction rate securities (ARS) based on the bonds collapsed in 2008, interest on the bonds soared, causing losses well beyond the protection offered by the swaps. The company alleged fraud by Morgan and Bear in failing to disclosure their activities as market-makers in the ARS market.
As noted in my prior commentary, FINRA arbitrability decisions are often for the court not the arbitrators in the first instance, if a party seeks judicial intervention on that issue, becasue customer arbitration often arises not from a bilateral agreement to arbitrate with the customer, but from the FINRA member’s agreement with FINRA to submit disputes with customers to arbitration under FINRA’s Arbitration Rules at the customer’s request – provided the dispute arises out of the business activities of the firm with the customer. (As explained in this most recent decision, the customer is considered a third-party beneficiary of the FINRA-member firm agreement.) The reason for this, the Second Circuit and New York federal courts have held, is that the FINRA-member firm arbitration agreement does not provide the needed “clear and unmistakable evidence” that the member firm and its adversary in a particular case intend to submit arbitrability issues to the arbitrators.
The district court in J.P. Morgan Securities, after finding that its powers to enjoin arbitration are derived from Section 4 of the FAA even though that provision does not explicitly confer such power, declined to issue the injunction. The court held that the relationship of issuer and underwriter was indeed a member-customer relationship. It based this decision on a Third Circuit Court of Appeals case that had similarly held, and the Third Circuit’s reference to an NASD committee statement that the compulsory arbitration provision in the NASD Code was intended to cover disputes over a proposed underwriting. The court then proceeded to find that the case involved Morgan and Bear’s business activity with the member, as the alleged fraudulent nondisclosure of the role as market-maker “relate[d] directly to plaintiffs’ role as underwriters of the ARS bonds….”
The court declined, however, to compel arbitration, finding that FINRA’s designation of New Orleans as the venue of the arbitration, based on the venue-selection powers conferred in the FINRA Rules, had the effect of divesting any district court other than a district court at the arbitration venue from entering an order compelling arbitration.The key language of FAA Section 4, in the court’s view, is that “The hearings and proceedings, under such agreement, shall be within the district in which the petition for an order directing such arbitration is filed.”
While noting that some courts had interpreted Section 4 to allow a district court to compel arbitration in its own district notwithstanding the choice of another venue in the arbitration agreement, the court held that to do so would in its view ignore the statutory directive to compel arbitration “in accordance with the agreement.” The court noted that, of course, the arbitration claimant could seek an order compelling arbitration in the federal district court at the place of the arbitration.