Posts tagged with "FINRA Rule 12100(i)"

Federal Court Narrows the Definition of “Customer” to Limit Compelled Arbitration Under the FINRA Code of Arbitration Procedure for Customer Disputes

Federal Court Narrows the Definition of “Customer” to Limit Compelled Arbitration Under the FINRA Code of Arbitration Procedure for Customer Disputes

Herschel and Mona Zarecor, et al, v. Morgan Keegan & Company, Inc., 2011 WL 5592861 (E.D. Ark. Jul. 29, 2011).

Herschel and Mona Zarecor, et al, v. Morgan Keegan & Company, Inc., 2011 WL 5508860 (E.D. Ark. Nov. 10, 2011)

In a case before the United States District Court for the Eastern District of Arkansas, Herschel and Mona Zarecor (“the Zarecors”) filed a petition to confirm a Financial Industry Regulatory Authority (“FINRA”) arbitration award entered in their favor in October 2010. Morgan Keegan & Company, Inc., (“Morgan Keegan”) filed a counterclaim to vacate the award. The court granted Morgan Keegan’s motion for vacatur. In a later action before the same court, the Zarecors filed a motion for reconsideration. The court denied the motion for reconsideration.

The underlying dispute in this case is based on a Statement of Claims that the Zarecors filed with FINRA to institute an arbitration proceeding against Morgan Keegan. The Zarecors alleged that Morgan Keegan violated state laws by failing to disclose risks associated with the Regions Morgan Keegan funds (“RMK Funds”) that the Zarecors purchased for their individual retirement accounts. The Zarecors alleged that the prospectus and written sales materials for the RMK funds represented these funds as traditional income or bond funds, when these funds were invested instead in risky structured financial products and derivatives. The Zarecors lost over ninety-percent of their original investment in the RMK funds.

In their Statement of Claims, the Zarecors asserted that FINRA had jurisdiction to arbitrate the dispute in absence of a written arbitration agreement because Morgan Keegan was a FINRA member and the Zarecors were public customers. Pursuant to FINRA Rule 12200, a member firm must arbitrate a dispute if: (a) arbitration is required by written agreement or requested by the customer; (b) the dispute is between a FINRA member or associated person of a FINRA member and its customer; and (c) the dispute arises in connection with the business activities of the member or the associated person. Morgan Keegan alleged that the Zarecors did not qualify as their customers because the Zarecors never sought advice from or held accounts with Morgan Keegan; the Zarecors purchased the RMK funds from competitor brokerage firms, held accounts at competitor brokerage firms and had no direct dealings with Morgan Keegan. Morgan Keegan also filed a motion to dismiss under FINRA Rule 12504(a)(6)(B), which the arbitration panel denied after hearing oral arguments from the parties. After three days of arbitration hearings, the FINRA arbitration panel issued an award finding Morgan Keegan liable to the Zarecors for $541,000 in compensatory damages. In November 2010, the Zarecors commenced an action to confirm the award and Morgan Keegan filed a counterclaim to vacate the award.

The Federal Arbitration Act (“FAA”), 9 U.S.C. §§ 9-11, provides statutory grounds for judicial review to confirm, vacate or modify an arbitration award. Where there has been an arbitration agreement between the parties, judicial review is severely limited and the arbitration decision may be vacated on very narrowly defined statutory grounds. See 9 U.S.C. § 10(a). Morgan Keegan asked the court to vacate the arbitration award on two grounds: (1) there was no such arbitration agreement between the parties; and (2) the underlying dispute is not subject to mandatory arbitration under FINRA Rule 12200 because the Zarecors were not customers entitled to request arbitration. The Zarecors countered that, because Morgan Keegan had not sought to enjoin the arbitration proceedings and had participated in the arbitration hearings, the firm had waived its right to contest whether the underlying dispute could be submitted for arbitration.

A party opposed to arbitration has several alternatives to preserve the issue for judicial review: (1) object to the arbitrator’s authority, refuse to argue the arbitrability issue, and proceed to the merits of the agreement; (2) seek declaratory or injunctive relief from a court prior to commencement of arbitration; (3) notify the arbitrators of a refusal to arbitrate altogether; or (4) file a timely motion to vacate in district court. See International Broth. of Elec. Workers, Local Union No. 545 v. Hope Elec. Corp., 380 F.3d 1084, 1101–02 (8th Cir. 2004). The court determined that Morgan Keegan did not waive its right to contest arbitrability by failing to enjoin the arbitration proceedings; its motion to dismiss, its objections to the arbitration panel’s jurisdiction during the hearings and its timely motion to vacate the award supported the court’s finding that Morgan Keegan sufficiently preserved its right to contest that the underlying dispute was not subject to FINRA arbitration.

FINRA Rule 12100(i) provides the following definition of a “customer” to be used throughout the FINRA Code of Arbitration Procedure for Customer Disputes: “A customer shall not include a broker or dealer.” The district court was concerned that the definition of a “customer” under this rule not be construed too narrowly, nor be interpreted in a manner that would ignore the reasonable expectations of FINRA members. For the purposes of compelling a member firm to arbitrate a dispute, precedent within the Eighth Circuit limits the definition of a “customer” to “one involved in a business relationship with [a FINRA] member that is related directly to investment or brokerage related services.” Fleet Boston Robertson Stephens, Inc. v. Innovex, Inc., 264 F.3d 770, 772 (8th Cir. 2001). This narrower definition excludes individuals who receive only financial advice, not investment or brokerage services, from the FINRA member. Id. In the instant case, it is undisputed that the Zarecors purchased the RMK Funds from competitor brokers and did not have a direct transactional relationship with Morgan Keegan; however, the Zarecors asserted that they qualified as customers of Morgan Keegan based on phone conversations with Morgan Keegan representatives regarding the funds, including their liquidity and exposure to the sub-prime market. Courts have found a customer relationship based on interactions between an investor and a FINRA member’s representative only where there is conduct on the part of the representative that indicates the existence of a business or investment relationship, such as soliciting a purchase, taking money from an investor, or facilitating investment transactions. See Oppenheimer & Co., Inc. v. Neidhardt, 56 F.3d 352 (2d Cir. 1995). The Zarecors’ interaction with Morgan Keegan did not satisfy this standard. Therefore, the district court determined that there were no connections or customer relations between the parties that would justify compelling arbitration under FINRA Rule 12200.

Because the district court found that the requirements for compelling arbitration under FINRA Rule 12200 were not satisfied, the court denied the Zarecors’ motion for judgment confirming the arbitration award and granted Morgan Keegan’s counterclaim to vacate the award.

In November 2011, the Zarecors filed a motion for reconsideration pursuant to Rule 59(e) of the Rules of Federal Civil Procedure, which permits a district court to correct its own mistakes in the time period immediately following entry of judgment. Rule 59(e) cannot be used to introduce new evidence, tender new legal theories or raise arguments that could have been offered prior to entry of judgment. In their motion for reconsideration, the Zarecors contended that the court overlooked the material fact that Morgan Keegan signed an agreement to submit to arbitration and that this submission agreement had been part of the record. Although the submission agreement was part of the record, the Zarecors failed to reference it or discuss its relevance in briefs filed prior to judgment. The court’s failure to notice the submission agreement, therefore, did not amount to manifest error of law or fact. The Zarecors additionally contended that Morgan Keegan submitted the issue of arbitrability to the arbitration panel for decision. The court considered this argument to be a new legal theory, contradictory to the Zarecors’ previous argument that Morgan Keegan had waived its right to object to arbitrability by failing to contest the issue before the arbitration panel. Therefore, the district court rejected both contentions as sufficient bases for reconsideration under Rule 59(e).

The district court determined that that the Zarecors were not entitled to relief under Rule 59(e) and, therefore, denied their motion for reconsideration. The court’s previous order and judgment to vacate the FINRA arbitration award were undisturbed.

Should you have any questions relating to FINRA or arbitration issues, please do not hesitate to contact Attorney Joseph C. Maya in the firm’s Westport office in Fairfield County, Connecticut at 203-221-3100 or at JMaya@Mayalaw.com.

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