Vol. 12 No. 4

NASD 10106   A Toothless Tiger or Protection from Improper Lawsuits by NASD Members

By Mark A. Tepper

Stock Fraud Lawyer

In a new twist on an old theme, Respondents are arguing that they did not agree to arbitrate claims in irrevocable trust accounts that are sent to their trust affiliates.  After the arbitration is filed, don't be surprised by a Respondent who starts a court action for a preliminary injunction against the arbitration. 

NASD rule 10106 prohibits parties in an NASD arbitration from commencing a lawsuit against the opposing party relating to matters pending in arbitration.  But are there any consequences when an NASD member violates NASD 10106 in a dispute with a public customer?  10106 does not designate a remedy.  Is there a remedy, that an NASD Panel will impose, that has both a remedial and deterrent effect? 

Respondent's court oriented defense to an arbitration claim filed by a public customer against an NASD member are likely to become more commonplace with the greying of America.  In one example, Respondent, the broker-dealer, recommended that an elderly couple, open a Charitable Remainder UniTrust ("CRUT"), knowing that the husband was suffering from a fatal disease.
When they did, Respondent created a CRUT account with its affiliated trust company and affiliated money manager.  Respondent continued to execute the orders for the CRUT account and shared the management fees.  Its affiliate assumed responsibility for investment decisions which it delegated to an affiliated money manager.

When the elderly widow filed a claim in arbitration against the NASD member, Respondent argued that it did not agree to arbitrate the CRUT claims.  It argued that its trust affiliate, an independent company, was responsible for investment decisions. There was no agreement for Respondent to arbitrate the CRUT claims.  Respondent concluded that this was a jurisdictional question that only a court can decide and only a court in the state whose law governs the trust agreement. 

Did Respondent agree to arbitrate the CRUT claims?  Does Respondent have any responsibility for participating in the unsuitable transactions in the CRUT account?

The following attempts to summarize the arguments that challenge an NASD member seeking a preliminary injunction to enjoin an NASD  arbitration.

I.   Summary of the Argument
                   
Respondent agreed to arbitrate the CRUT account claims in its customer agreement and pursuant to NASD rules.  In its customer agreement, Respondent's choice of "any and all controversies" for its arbitration agreement is "inclusive, categorical, unconditional and unlimited," (fn. 1)
regardless of the kind of controversy (fn. 2).

Respondent's "any and all controversies" arbitration clause evidences clear and unmistakable intent that the Panel, not the courts, would decide any and all issues arising from this arbitration. By its plain meaning, Respondent's customer agreement confers complete jurisdiction on the Panel.  Further, Respondent signed its Uniform Submission Agreement ("USA"), which evidences additional clear and unmistakable intent that the Panel shall decide all issues (fn. 3).
                   
Despite these agreements to arbitrate any and all issues, including the CRUT account claims, Respondent asserts that it reserved its right to go to court.  Respondent had no court rights to reserve.  When Respondent elected to arbitrate any and all controversies, it forever waived any right it had to go to court.

Even assuming that Respondent's Answer did reserve its rights, Respondent waived any rights it might have had when it participated in the arbitration by demanding discovery about the CRUT account claims (fn. 4).  Respondent made its discovery demands in this arbitration after submitting its Answer, but before commencing its improper lawsuit in Delaware (fn. 5).

The parties' arbitration agreement is valid, irrevocable and enforceable (fn.6).  Respondent cannot unilaterally change the parties' arbitration agreement in its Answer.  Both parties must agree to effect any change in the arbitration agreement.  Claimant has not agreed to change the arbitration agreement.

The Panel has a duty to enforce agreements to arbitrate and to enforce the NASD rules that prohibit parties from filing lawsuits once the arbitration has begun.  Respondent breached its arbitration agreements and violated the NASD's prohibition against lawsuits by commencing and prosecuting its Delaware lawsuit.  Respondent violated NASD rule 10106 under aggravating circumstances, which prejudiced an 84 year old widow and violated Respondent's duty of fair dealing with its customers.

II.  Respondent's Delaware Lawsuit Violates NASD Rules and Entitles Claimant to Relief

When Respondent signed its submission agreement it agreed that this arbitration is governed by NASD rules.  NASD Rule 10106 strictly prohibits Respondent from commencing or prosecutingits Delaware lawsuit (fn. 7).

Claimant requests the same relief that was granted by another NASD panel confronted with the same violations.  In Yazdani v. Biltmore Securities, Inc., the NASD panel found that Respondent Biltmore's state court lawsuits filed against Claimant Yazdani violated NASD Rule 10106 (fn. 8).  The panel directed the respondents to dismiss their lawsuits within three days and to file proof of the dismissal with the NASD.  The panel further cautioned the respondents that if they
failed to comply, the panel would refer the respondents to the NASD District Committee for disciplinary action.

This Panel has the authority to grant the same relief that was granted in Yazdani.  NASD rules empower arbitrators "to interpret and determine the applicability of all provisions under the Code and to take appropriate action to obtain compliance with any ruling. . . ."  NASD Rule 10324 (fn. 9).

     A.   Respondent has Violated Additional NASD Rules Requiring Respondent to Arbitrate

Besides NASD Rule 10106, Respondent has violated other NASD rules.  NASD IM-10100 provides that Respondent's failure to arbitrate Claimant's claims is conduct inconsistent with just and equitable principles of trade and a violation of NASD Conduct Rule 2110 (fn. 10).
Respondent also violated NASD Rule 10301, which requires Respondent to arbitrate anycustomer claim arising from its business (fn. 11).
    

     B.   Respondent Violated NASD Rules under Aggravating Circumstances

Respondent's attempts to excuse its misconduct clearly illustrate that Respondent violated NASD Rule 10106 under aggravated circumstances.  Aggravating circumstances are facts or situations that relate to a party's misconduct which demand increasing the penalty for the violation. 

Respondent's aggravating circumstances include the following:

          1.  Withholding Claimant's customer agreement(s), while
               denying that there are any agreements to arbitrate the
               CRUT account claims;

          2.  Denying that it agreed to arbitrate the CRUT account claims
               and what will be arbitrated, when Respondent agreed to
               arbitrate "any controversies" between the parties;
                   
          3.  Arguing inconsistent positions before different forums   that
               Respondent's "any controversies" arbitration agreement is
               all encompassing in Alabama to compel arbitration, but
               narrow in Florida and Delaware to avoid arbitration;

          4.  Denying that its Uniform Submission Agreement ("USA")
               referred the CRUT account claims to arbitration after
               signing its USA which specified that Respondent was
               agreeing to arbitrate the CRUT account claims; and

          5.  Falsely stating to the Panel and the Delaware court that
               Respondent did not participate in this arbitration when in
               fact it has been voluntarily participating   including filing
               discovery requests addressed to the CRUT account claims.

Respondent is engaged in improper forum shopping which NASD rules are designed to prevent.  Respondent is using this abusive litigation tactic to intimidate an 84 year old widow by putting financial pressure on her. 
                                
Each day that Respondent's Delaware lawsuit continues, Respondent is needlessly increasing Claimant's costs.  Her Delaware attorney's fees currently exceed $10,000 to defend a lawsuit prohibited by Respondent's arbitration agreements and NASD rules.  Respondent's misconduct, along with the aggravating circumstances, clearly deserve and merit the relief and sanctions that Claimant has requested.

III. Respondent Agreed to Arbitrate Claimant's CRUT Account Claims

     A.   Respondent's Customer Account Agreements

Respondent's arbitration agreement with Claimant states: "I am agreeing in advance to arbitrate any controversies which may arise with you." (fn. 12).   On information and belief, Respondent's customer agreement states further that:

          all controversies which may arise between us,
          including but not limited to those involving any
          transaction or the construction, performance, or
          breach of this or any other agreement between us,
          whether entered into prior [to], on, or subsequent to
          the date hereof, shall be determined by arbitration
          (fn. 13).

This broad arbitration clause is a binding arbitration agreement between the parties which covers the CRUT account claims.

In a similar case, the Alabama Supreme Court specifically concluded that Respondent's arbitration agreement "is sufficiently broad to include any and all controversies between [the parties], regardless of the kind of controversy or the date on which the controversy occurred."
(fn. 14)  In another case, the Alabama Supreme Court agreed with Respondent that "any controversies" in a customer's arbitration agreement for one account required its customer to arbitrate claims arising from a second, separate account   even though there was no arbitration agreement for the second account (fn. 15).

Respondent's argument that the same arbitration clause means something different in Alabama than in Florida and Delaware is self-serving and contradictory (fn. 16). 

     B.   Respondent's Signed Uniform Submission Agreement

As a matter of law, Respondent cannot unilaterally change or revoke its obligation to arbitrate the CRUT account claims.  The USA specifically names Claimant's Charitable Trust.  When Respondent signed its USA,  it knew that it was agreeing to arbitrate the CRUT account claims.

     C.   As an NASD Member, Respondent Agreed to Arbitrate Any Dispute, Claim or Controversy Arising from its Business

Courts have overwhelmingly held that Respondent's "membership in the NASD, in and of itself, is a written agreement to arbitrate according to NASD submission rules." (fn. 17).  Those submission rules require Respondent to arbitrate any disputes, claims or controversies with customers arising out of Respondent's business (fn. 18).

          1.   The CRUT Account Claims Arise out of Respondent's Business

Claimant alleges that Respondent participated or aided in making unsuitable trades in violation of the Florida Investor Protection Act.  As part of its business, Respondent entered unsuitable trades for the CRUT account, executed them on national exchanges and markets, placed them in the CRUT account, made commissions and shared fees from the CRUT account and generated account statements with Respondent's logo and Associated Persons' names on the statements.    

This is precisely the misconduct that the Florida Investor Protection Act is designed to prevent and punish (fn. 19).  Further, Claimant has alleged that Respondent failed to adequately supervise.  Courts have specifically found, and Respondent does not deny, that supervision falls squarely within the scope of Respondent's business (fn. 20).  Clearly, the CRUT account claims arise out of Respondent's business, since Respondent executed every transaction.  

Claimant's theory of liability does not depend on a finding that Respondent made investment decisions   only that Respondent participated or aided in making unsuitable trades (fn. 21).
Significantly, Respondent does not deny that these activities are a part of its business.  Instead, Respondent has alleged that its affiliate was solely responsible for investment decisions or that its affiliate only affected investment decisions 
(fn. 22).

IV.  Respondent Clearly and Unmistakably Expressed its Intent to Give this Panel Jurisdiction to Decide All Issues

Respondent's "any controversies" arbitration clause and its signed USA evidence clear and unmistakable intent that the Panel would decide all issues in this arbitration.  Courts have repeatedly held that either one gives the Panel complete jurisdiction (fn. 23).

Further, Respondent's voluntary participation in this arbitration, including demanding discovery for the CRUT account claims, before commencing its Delaware lawsuit, provides clear and unmistakable evidence that it intended to submit the jurisdiction question to the arbitrators.

    
     A.   The NASD Code Empowers the Arbitrators to Decide All Issues   
           Not the Courts

Respondent's "execution of a USA with the NASD . . . effectively incorporated the NASD Code into the parties' agreement." (fn. 24).  "This means [Respondent] adopted the entire NASD Code, including [NASD Rule 10324]." (fn. 25).  Respondent's "adoption of this provision is a 'clear and unmistakable expression of [its] intent" that the arbitrators   not the courts  would decide what claims should be arbitrated (fn. 26).
 
The United States Supreme Court has held that NASD Rule 10324 exclusively empowers the Panel to interpret and apply all sections of the NASD Code (fn. 27).  The Panel has the authority and the obligation to determine whether the CRUT account claims are covered by the arbitration agreement and/or arise from Respondent's business (fn. 28).  Respondent waived its right to have a court decide these questions by signing its USA and incorporating the NASD Code into the arbitration agreement.

Respondent's reliance on Bensadoun, for the argument that courts decide whether an NASD member must arbitrate, is misplaced (fn. 29).  Unlike petitioner in Bensadoun, Respondent agreed to arbitrate "any all controversies" in its customer agreement, signed a Uniform Submission Agreement and voluntarily participated in this arbitration, which provided clear and unmistakable intent to abide by the entire NASD Code, including NASD Rule 10324 (fn. 30).

V.   Respondent's Answer and Participation Prove that it did not Reserve its Rights to Go to Court

Respondent had no rights to go to court when it agreed to arbitrate "any controversies."
Moreover, on information and belief, Respondent's customer agreement states further: "The parties are waiving their right to seek remedies in court. . . ."
(fn. 31).  However, assuming Respondent had any such rights, it unequivocally waived those rights by filing its Answer and its discovery demands in this arbitration.

     A.   Respondent's Answer did not Reserve any Rights

Respondent expressly acknowledged the NASD's jurisdiction over the CRUT account claims.
Respondent's Answer specifically called for the NASD to decline the use of its arbitration facilities with respect to the CRUT account claims pursuant to Rule 10301(b) (fn. 32).  NASD did not, confirming NASD jurisdiction over the CRUT account claims. 

Respondent's Answer failed to reserve its rights to seek a court order to determine jurisdiction.
Respondent cannot ambivalently "note" that it "may also" file a lawsuit in court (fn. 33) and callit a reservation of its rights months later.

     B.   Respondent Waived its Rights by Filing Discovery Demands with the NASD

Respondent also waived its rights when it filed discovery demands with the NASD.  Respondent failed to object to, or complain in any way about, the inclusion of the CRUT account claims in its request for discovery (fn. 34).

Respondent's request for discovery sought documents and information directly related to the CRUT account claims.  Respondent also requested all documents related to the CRUT account.

Significantly, Respondent defined the relevant time period as commencing in 1993   three years prior to the first transaction in 1996 (fn. 35).  The only reference to the year 1996 in the Statement of Claim concerned Respondent's recommendation that Claimant create her Charitable Trust (fn. 36).                                   

VI.  Claimant did not Waive her Right to Arbitrate her CRUT Account Claims before the NASD                 

Respondent argues that Claimant "has presented her [CRUT] account arguments to the Court" by filing a Motion to Dismiss and Opening Brief.  Respondent's argument is inconsistent with the record before the Panel and the Delaware Court.

Respondent dragged Claimant into Delaware Court.  Claimant has contested the Delaware Court's jurisdiction   not the substantive facts of the CRUT account claims.  Claimant has done nothing inconsistent with the arbitration of her CRUT account claims at all.  As a matter of law, the parties' agreement to arbitrate the CRUT account claims is valid, irrevocable and enforceable. 

VII. Epilogue

The Panel granted no relief to Claimant for Respondent's violation of NASD 10106.  Next, the Delaware Court denied Respondent's motion for a preliminary injunction.  Finally, Respondent's Motion, in arbitration, to Dismiss the CRUT claims was denied by the Panel.  The arbitration is proceeding on the merits.
 
Respondent expected no sanctions for its violation of NASD 10106.  So long as NASD members believe that NASD 10106 has no teeth, it will have  no deterrent effect.  This threatens the purpose of arbitration   a fast, fair and efficient resolution.  This writer suggests that NASD use its arbitrator training program to communicate the importance of enforcing NASD 10106 to its arbitrators to insure that this key provision is not undermined by  failure to enforce it.

____________________________________________________________

1.   PaineWebber v. Bybyk, 81 F.3d 1193, 1199 (2d Cir. 1996).

2.   Merrill Lynch v. Kirton, 719 So.2d 201, 204 (Ala. 1998).

3.   Howsam v. Dean Witter Reynolds, 537 U.S. 79, 86, 123 S.Ct. 588 (2002).

4.   See DeSapio v. Kohlmeyer, 35 N.Y.2d 402 (1974)

5.   See Dean Witter Reynolds v. Fleury, 138 F.3d 1339 (11th Cir. 1998)

6.   Federal Arbitration Act, 9 U.S.C. 2   Validity, Irrevocability, and Enforceability of Agreements to Arbitrate.

7.   NASD Rule 10106   Legal Proceedings: "No party shall, during the arbitration of any matter, prosecute or commence any suit, action, or proceeding against any other party touching upon any of the matters referred to arbitration pursuant to this Code."

8.   Yazdani v. Biltmore Securities, Inc., Order of the Panel dated March 22, 1996, NASD Case No. 95-00929.  NASD re-numbered Section 6 as NASD Rule 10106.

9.   Howsam v. Dean Witter Reynolds, 537 U.S. at 86.

10.  NASD IM-10100(a): "It may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2110 for a member . . . to . . . submit a dispute for arbitration under the NASD Code of Arbitration Procedure as required by that Code."

11.  NASD Rule 10301(a)   Required Submission: "Any dispute, claim or controversy eligible for submission under the Rule 10100 Series between a customer and a member . . .arising in connection with such member . . . shall be arbitrated under this Code, as provided by any duly executed and enforceable written agreement or upon the demand of the customer."

12.  Respondent only produced the signature pages from its customer agreements with Claimant which include the "any controversies" arbitration agreement.  Respondent continues to withhold the text of its customer agreement where, on information and belief, Respondent also agreed to arbitrate "all controversies" between the parties.    

13.  Kirton, 719 So.2d at 202.  As stated above, Respondent continues to withhold its customer agreement. 

14.   Kirton, 719 So.2d at 204.

15.  Jones v. Merrill Lynch, 604 So.2d 332, 339-40 (Ala. 1991)(emphasis added).

16.  The Panel should also note that Respondent's affiliate, Trust Company, is using these same arguments before the Texas Supreme Court to compel arbitration of trust claims where there is no agreement to arbitrate the trust claims.  See In re Merrill Lynch Trust Co., Brief on the Merits in Support of Petition for Writ of Mandamus, 2005 WL 226974, *12, Case No.04-0865 (Tex.).

17.  First Montauk v. Four Mile Ranch, 65 F.Supp.2d 1371, 1377 (S.D. Fla. 1999); John Hancock Life Ins. Co. v. Wilson, 254 F.3d 48, 55-56 (2d Cir. 2001); Kidder, Peabody & Co. v. Zinsmeyer Trusts Partnership, 41 F.3d 861, 863-64 (2d Cir. 1994), cert. denied, 117 S.Ct. 609 (1996); Spear, Leeds & Kellogg v. Central Life Assurance Co., 85 F.3d 21 (2d Cir. 1996); Merrill Lynch v. Hovey, 726 F.2d 1286, 1288-89 (8th Cir. 1984).

18.  NASD Rule 10301.

19.  First Union Discount Brokerage Services, Inc. v. Milos, 744 F.Supp. 1145, 1154-55 (S.D. Fla. 1990), aff'd, 997 F.2d 835 (11th Cir. 1993).

20.  First Montauk, 65 F.Supp.2d at 1379.

21.  Fla. Stat. 517.211(2).  Respondent did not dispute the validity or effect of this
statute in its Answer, which now binds Respondent, pursuant to NASD Rule 10314.

22.  The Panel should note that Respondent has altered its position on this issue.  In its Answer, Respondent alleged that the Trust account claims concerned investment decisions made solely by Respondent's affiliate.  Now, in its Opposition to the present Motion, Respondent has alleged that its affiliate only "effected [sic.] investment decisions," which clearly suggests that Respondent may have either been involved in investment decisions or actually made the investment decisions for the Trust.

23.  Howsam, 537 U.S. at 84; John Hancock Life Ins. Co. v. Wilson et al., 254 F.3d 48, 54 (2d Cir. 2001); Bybyk, 81 F.3d at 1200 ("The parties' broad grant of power to the arbitrators is unqualified by any language carving out substantive eligibility questions . . . for resolution by the courts").

24.  Howsam, 537 U.S. at 86 ("Howsam's execution of a Uniform Submission Agreement with the NASD in 1997 effectively incorporated the NASD Code into the parties' agreement").
 

25.  FSC Securities v. Freel, 14 F.3d 1310, 1312 (8th Cir.1994) (The NASD re-numbered Section 35 of the NASD Code as the current NASD Rule 10324).

26.  Id. (emphasis in original).

27.  Howsam, 537 U.S. at 86. 

28.  Id.; FSC Securities v. Freel, 14 F.3d at 1312 (holding that where the parties sign uniform submission agreements specifying NASD as the arbitral forum, they have incorporated the NASD Code and agreed that the arbitrators would decide questions of arbitrability).

29.  Bensadoun v. Jobe-Riat, 316 F.3d 171, 175 (2d Cir. 2003).

30.    See Howsam, 537 U.S. at 86 (finding clear and unmistakable intent where parties signed Uniform Submission Agreement with NASD); Freel, 14 F.3d at 1312 (same); Bybyk, 81 F.2d at 1200 (finding clear and unmistakable intent where agreement gives a "broad grant of power to arbitrators unqualified by any language carving out substantive eligibility issues . . . for resolution by the courts").

31.  Kirton, 719 So.2d at 202.  As stated above, Respondent continues to withhold its customer agreement.

32.  NASD Rule 10301(b): "Under this Code, the Director of Arbitration, upon approval of the Executive Committee of the National Arbitration and Mediation Committee, or the National Arbitration and Mediation Committee, shall have the right to decline the use of its arbitration facilities in any dispute, claim, or controversy, where, having due regard for the purposes of the Association and the intent of this Code, such dispute, claim, or controversy is not a proper subject matter for arbitration"; Respondent's Answer, p. 5 ("[P]ursuant to NASD
Code of Arbitration Section 10301(b), Respondent respectfully requests that the NASD decline to use its arbitration facilities with respect to the [Trust account] claims and to dismiss the [Trust account] claims").

33.  Id., pp. 2, 5 ("Respondent notes that it may also apply to a court of competent
jurisdiction for an Order staying this arbitration").

34.  Respondent's discovery demands did not distinguish between Trust account claims and non-Trust account claims: "The term 'Claim' refers to the Statement of Claim filed by the Claimants in National Association of Securities Dealers, Inc. ("NASD") arbitration" Respondent's First Request, p. 3, 11.

35.  "Unless otherwise specified, the scope of this Request is for 'all relevant times,' which is defined as any period three years prior to the first transaction at issue in the [Statement of] Claim through present (1993-2005)."  Respondent's First Request for Documents and Information, p. 3, 12.

36.  Statement of Claim, 24: "Respondent opened the Trust Account with an investment objective of Growth & Income in August 1996. . . ."  By contrast, the earliest transaction related to Claimant's non-Trust account claims occurred in 1998, when Respondent drafted its Financial Foundation Report for Claimant.

37.  Fleury, 138 F.3d at 1342 (holding that the parties' uniform submission agreements with the NASD were not abandoned after brokerage firm filed for an injunction); Federal Arbitration Act, 9 U.S.C. 2.