Tullis v. Kohlmeyer & Co.

• Decision Date: 28 April 1977
• Docket Number: No. 74-4148,74-4148
• Citation: 551 F.2d 632
• Parties: Fed. Sec. L. Rep. P 96,041 Eli W. TULLIS and Edward F. Creekmore, Jr., Plaintiffs-Appellants, v. KOHLMEYER & CO., in Liquidation, through its Liquidators, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 632

551 F.2d 632

Fed. Sec. L. Rep. P 96,041

Eli W. TULLIS and Edward F. Creekmore, Jr., Plaintiffs-Appellants, v. KOHLMEYER & CO., in Liquidation, through its Liquidators, et al., Defendants-Appellees.

No. 74-4148.

United States Court of Appeals Fifth Circuit.

April 28, 1977.

Herschel L. Abbott, Jr., Edward B. Poitevent, II, New Orleans, La., for plaintiffs-appellants.

John L. Toler, New Orleans, La., for Kohlmeyer & Co.

Malcolm W. Monroe, Robert G. Stassi, New Orleans, La., for A. H. Vose.

Thomas B. Lemann, Walter J. Suthon, III, New Orleans, La., for Morris & R. Newmann.

George A. Kimball, Jr., E. Harold Saer, Jr., New Orleans, La., for defendants-appellees.

Appeal from the United States District Court for the Eastern District of Louisiana.

Before TUTTLE, THORNBERRY and TJOFLAT, Circuit Judges.

THORNBERRY, Circuit Judge:

Eli W. Tullis and Edward F. Creekmore, Jr. brought this action under the federal securities laws ¹ and Louisiana law against Kohlmeyer & Co. (Kohlmeyer), a New York Stock Exchange member firm in liquidation, and individual members of the firm. The plaintiffs, partners in the firm prior to its demise, claimed that they were induced by misleading statements and omissions of material fact to issue certain secured notes to Kohlmeyer and to pledge securities as collateral for the notes. Kohlmeyer and others moved that the action in federal district court be stayed pending arbitration of the dispute before the Board of Arbitration of the New York Stock Exchange. The court granted the motion and plaintiffs appeal. ²

I.

During the period of time relevant to this case, Kohlmeyer was a member firm of the New York Stock Exchange (NYSE) engaged in the stock and commodities brokerage business. On January 9, 1967, Tullis, who already was an allied member of the Exchange through a prior association with E. F. Hutton & Co., became a member of the Kohlmeyer firm. Creekmore was admitted as a partner on January 1, 1971. In connection with their admission to the firm, both plaintiffs executed applications for allied membership in the Exchange in which they stated that they had read the Constitution and Rules of the New York Stock Exchange and pledged to abide by them. One such provision, Article VIII of the NYSE Constitution, requires members to arbitrate disputes arising among them. ³

Prior to March, 1973, both Tullis and Creekmore owned marketable securities of substantial value which were held for their account by Kohlmeyer. Although there is a dispute as to whether such securities represented a capital contribution by the partners to the firm, the parties agree that Kohlmeyer was treating the value of the securities as capital for purposes of meeting NYSE requirements concerning the "net capital" of member firms. On June 2, 1972, the Exchange issued a "Member Firm Educational Circular" stating that partners' capital contributions no longer could be directly represented by securities and that after June 1, 1973, all such contributions would have to be in the form of secured demand notes collateralized by a pledge of securities of a specified market value in relation to the notes.

With the objective of meeting this requirement, members of the Kohlmeyer firm approached Tullis and Creekmore in the first months of 1973 and allegedly made misstatements and omissions of material fact concerning the financial status of the firm and its partners, and concerning the capital contributions of other partners. On April 6 Tullis and Creekmore executed Secured Demand Notes to the firm in the amount of $400,000 and $92,000 respectively. To secure the notes, they executed separate Secured Demand Note Collateral Agreements; these agreements pledged each partner's stock and contained an undertaking by Kohlmeyer to pay each of them 4% per annum on the amount of the indebtedness and on the loanable value of the securities which exceeded that amount. Paragraph XII of both of the Secured Demand Note Collateral Agreements contained the following provision:

(e) Arbitration. Any controversy arising out of or relating to this Agreement or the breach thereof shall be submitted to and settled by arbitration pursuant to the Constitution and Rules of the Exchange. The parties hereto and all who may claim under them, shall be conclusively bound by such arbitration.

II.

Plaintiffs' primary argument on appeal is that claimants under the federal securities laws have a right to resolution of their claims by a judicial tribunal, and that the right to such an adjudication cannot be waived by voluntary agreement. ⁴ As authority for their contentions, they point first to the jurisdictional provisions of the 1933 Securities Act and the 1934 Securities Exchange Act, 15 U.S.C. §§ 77v(a), 78aa, which provide that "the district courts of the United States, and the United States courts of any Territory" shall have jurisdiction of securities cases (concurrent with "State and Territorial courts" in 1933 Act cases). Plaintiffs also invoke the "non-waiver" provisions of the 1933 and 1934 Acts, which provide:

Any condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, or of any rule of an exchange required thereby shall be void.

15 U.S.C. § 78cc(a). The effect of the jurisdictional and nonwaiver provisions together is said to be that any person injured in violation of the securities laws has a state or federal court remedy which cannot be waived through an arbitration agreement of any kind.

Substantial support for this theory may be found in the Supreme Court's decision in Wilko v. Swan, 346 U.S. 427, 74 S.Ct. 182, 98 L.Ed. 168 (1953). In that case, a brokerage firm sued under the 1933 Securities Act by a customer sought to stay the action for arbitration pursuant to a clause in the parties' margin agreement. The Court held that the "non-waiver" provision of the 1933 Act rendered the arbitration clause void; it was a "stipulation" waiving the right to select a judicial forum provided by the Act.

Despite the appeal of this argument, the district court found that the cases of Brown v. Gilligan, Will & Co., 287 F.Supp. 766 (S.D.N.Y.1968), and Axelrod & Co. v. Kordich, Victor, & Neufeld, 451 F.2d 838 (2 Cir. 1971), counseled its rejection. Brown was an action by a customer against her broker for failing to inform her that shares which she purchased through it were not properly registered under the 1933 Act. The firm which originally sold the stock was impleaded and sought to have the controversy submitted to arbitration. The court held that the rules of the New York Stock Exchange constituted a contract between all members and that the arbitration provisions therein had contractual validity. This contract, the court held, was one "evidencing a transaction in commerce" under the United States Arbitration Act, 9 U.S.C. § 2, and therefore the arbitration agreement was "valid, irrevocable, and enforceable". To the argument that the nonwaiver provisions of the 1933 and 1934 Acts nullified such an agreement insofar as the federal securities laws were concerned, the court responded by invoking § 28(b) of the 1934 Act, 15 U.S.C. § 78bb(b), which provides:

Nothing in this chapter shall be construed to modify existing law (1) with regard to the binding effect on any member of any exchange of any action taken by the authorities of such exchange to settle disputes among its members, or (2) with regard to the binding effect of such action on any person who has agreed to be bound thereby . . . .

The court held that the stock exchange's rule requiring arbitration of members' disputes was "action" within the meaning of § 28(b). It further held that, because the 1933 and 1934 Acts are in pari materia, the section operated to overcome the nonwaiver provisions of the 1933 Act as well as the 1934 Act.

The Second Circuit expressly adopted the Brown holding in Axelrod & Co. v. Kordich, Victor, & Neufeld, 451 F.2d 838 (2 Cir. 1971). That case involved an agreement by the Kordich firm, not a member of the NYSE, to sell 5,000 shares of stock to Axelrod & Co., a NYSE firm. Axelrod refused tender of the stock and Kordich instituted arbitration proceedings before the Stock Exchange. ⁵ Axelrod then brought an action in the district court alleging that Kordich had misrepresented the stock in violation of the 1933 and 1934 Acts and sought to stay the arbitration proceedings. The Second Circuit upheld the district court's refusal to do so, holding that Axelrod's agreement, through its membership in the NYSE, to arbitrate disputes was binding on it even where arbitration was sought at the instance of a nonmember which had made no other agreement with Axelrod regarding arbitration. The court relied on Brown's holding that § 28(b) of the 1934 Act overcame the nonwaiver provisions of both Acts, and distinguished Wilko v. Swan as a case in which the party seeking to avoid arbitration was "a small investor and not a member firm of an exchange". For that reason, the court noted, the Supreme Court in Wilko had no occasion to consider the effect of § 28(b) on the nonwaiver provisions.

Plaintiffs attempt to distinguish this case from Brown and Axelrod on the ground that they were "outsiders" with respect to the transaction in question. They contend that their securities on account with Kohlmeyer prior to March, 1973, were not contributions of capital, regardless of the treatment given the accounts by the firm, and that their issuance of secured demand notes to Kohlmeyer in April, 1973, evidenced subordinated loans rather than capital contributions to the firm. Accordingly, plaintiffs argue that their position was indistinguishable from that of the general investing public and that the applicable precedent for their case is Wilko v. Swan rather than Brown and Axelrod.

We find that the status of the party seeking to avoid arbitration as an "outsider" or "insider" has no more...