Cohen v. Wedbush, Noble, Cooke, Inc.

• Citation: 841 F.2d 282
• Decision Date: 02 March 1988
• Docket Number: No. 87-6174,87-6174
• Parties: , Fed. Sec. L. Rep. P 93,652 Jack B. COHEN, Betty L. Cohen, Plaintiffs-Appellants, v. WEDBUSH, NOBLE, COOKE, INC., Defendant-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

Page 282

841 F.2d 282

56 USLW 2535, Fed. Sec. L. Rep. P 93,652

Jack B. COHEN, Betty L. Cohen, Plaintiffs-Appellants, v. WEDBUSH, NOBLE, COOKE, INC., Defendant-Appellee.

No. 87-6174.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Feb. 5, 1988.

Decided March 2, 1988.

Neal M. Goldstein, Abrams & Goldstein, Los Angeles, Cal., for plaintiffs-appellants.

Dawn M. Schock, Jeffrey M. Jones, Keesal, Young & Logan, Long Beach, Cal., for defendant-appellee.

Appeal from the United States District Court for the Central District of California.

Before HUG, KOZINSKI and NOONAN, Circuit Judges.

KOZINSKI, Circuit Judge:

We consider the enforceability of an agreement to arbitrate claims arising out of a stock margin purchase agreement.

Background

On October 13, 1986, plaintiffs Jack B. and Betty L. Cohen entered into a Customer's Margin Account Agreement with defendant Wedbush, Noble, Cook, Inc., a stock brokerage firm. The margin agreement provided that Wedbush would loan money to the Cohens to finance the purchase of securities, and required the Cohens to maintain certain securities as collateral for the repayment of those loans. The agreement further provided that "all controversies which may arise ... concerning any transaction or the construction, performance or breach of this ... agreement ... shall be determined by arbitration...." ¹

On February 20, 1987, Wedbush sold securities worth some $3 million held as collateral in the Cohens' account. The Cohens, alleging that this sale violated their agreement with Wedbush, brought suit in federal district court for breach of fiduciary duty, breach of contract and breach of the covenant of good faith and fair dealing. They sought relief in the form of compensatory and punitive damages, imposition of a constructive trust and award of attorney's fees.

Wedbush answered, alleging inter alia that the claims brought by the Cohens were subject to arbitration under the margin agreement, and filed a motion to compel arbitration and stay the proceedings. On June 24, 1987, the district court entered an order compelling arbitration of all claims. The Cohens appeal.

Discussion

The Federal Arbitration Act, 9 U.S.C. Secs. 1-14 (1982), governs our disposition of this case. The Act provides that written agreements to arbitrate disputes arising out of transactions involving interstate commerce "shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." 9 U.S.C. Sec. 2. Federal district courts must issue orders compelling arbitration upon a showing of a failure to comply with a valid arbitration agreement. Id. Sec. 4. The Arbitration Act thus "reverse[s] centuries of judicial hostility to arbitration agreements," Scherk v. Alberto-Culver Co., 417 U.S. 506, 510, 94 S.Ct. 2449, 2453, 41 L.Ed.2d 270 (1974), placing such agreements " 'upon the same footing as other contracts,' " id. at 511, 94 S.Ct. at 2453 (quoting H.R.Rep. No. 96, 68th Cong., 1st Sess. 1, 2 (1924)), and requiring the courts to "rigorously enforce" them. Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213, 221, 105 S.Ct. 1238, 1242, 84 L.Ed.2d 158 (1985).

The Act creates "a body of federal substantive law of arbitrability," enforceable in both state and federal courts and preempting any state laws or policies to the contrary. Moses H. Cone Mem. Hosp. v. Mercury Const. Corp., 460 U.S. 1, 24, 103 S.Ct. 927, 941, 74 L.Ed.2d 765 (1983); see Southland Corp. v. Keating, 465 U.S. 1, 10-12, 16, 104 S.Ct. 852, 858-59, 861, 79 L.Ed.2d 1 (1984). The availability and validity of defenses against arbitration are therefore to be governed by application of federal standards. See Bayma v. Smith Barney, Harris Upham & Co., 784 F.2d 1023, 1024 (9th Cir.1986).

The Cohens raise several objections to the district court's order compelling arbitration. They contend that the arbitration clause is unenforceable as an unconscionable provision of a contract of adhesion, that they were fraudulently induced to sign the agreement, and that arbitration provisions in securities purchase agreements are unenforceable as fraudulent and manipulative devices under regulations promulgated by the Securities and Exchange Commission. We address these contentions in turn, mindful of the Supreme Court's dictate that "questions of arbitrability must be addressed with a healthy regard for the federal policy favoring arbitration." Moses H. Cone Mem. Hosp., 460 U.S. at 24, 103 S.Ct. at 941.

A. The Cohens base their claim of unconscionability on Lewis v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 183 Cal.App.3d 1097, 228 Cal.Rptr. 345 (1986), and Lewis v. Prudential-Bache Sec., Inc., 179 Cal.App.3d 935, 225 Cal.Rptr. 69 (1986), cases arising out of challenges to the methods used by stockbrokers to calculate interest owed them by their clients. The arbitration clause at issue in Prudential provided for arbitration under the auspices of either the American Arbitration Association (AAA) or the New York Stock Exchange (NYSE). The court found that arbitration before the NYSE did not "meet[ ] the level of integrity requisite to withstand a challenge of unconscionability," 179 Cal.App.3d at 944-45, 225 Cal.Rptr. 69, because the challenged practices were virtually universal among securities brokerage firms, and thus any arbitration panel selected by the securities industry itself would be "presumptive[ly] bias[ed]." Id. at 944, 225 Cal.Rptr. 69. The court did, however, order arbitration before the AAA because that body was completely impartial. Id. at 945, 225 Cal.Rptr. 69. The Merrill Lynch court relied on Prudential in holding that an agreement to arbitrate under the procedures established by either the NYSE or the National Association of Securities Dealers (NASD) was unconscionable because both procedures were "institutionally biased." 183 Cal.App.3d at 1102, 1106, 228 Cal.Rptr. 345.

The Cohens contend that their claims, like those in Merrill Lynch and Prudential, attack "long standing practices and customs" of the securities industry, Appellants' Opening Brief at 19, and that the arbitration clause calling for NYSE or NASD arbitration is therefore unconscionable. Their complaint alleges that Wedbush violated the margin agreement in selling their securities. The agreement provided that Wedbush could liquidate the Cohens' margin account whenever "the collateral deposited to protect the [Cohens'] account is determined by [Wedbush] in [its] discretion ... to be inadequate to properly secure the account." ER 4, exh. A. The Cohens argue that Wedbush will defend its exercise of discretion by reference to industry standards; indeed, Wedbush raised as an affirmative defense that "it performed brokerage services in a reasonable and prudent manner, complying with ... the standard of care in the industry...." ER 3 at 10. The Cohens counter that, insofar as industry standards permitted the sale of their securities, they would challenge such standards as unreasonable. We agree with the Cohens that, as in Prudential and Merrill Lynch, this case may call into question industry-wide practices. ²

We respectfully disagree, however, with the conclusion of the California courts that the doctrine of unconscionability is applicable under these circumstances. Cf. Pierson v. Dean, Witter, Reynolds, Inc., 742 F.2d 334, 339 (7th Cir.1984) (rejecting claim that agreement to arbitrate securities claims was unconscionable where plaintiffs made no showing that agreement was commercially unreasonable or that they had no reasonable opportunity to understand it). As the Supreme Court has recognized, the Securities and Exchange Commission has virtually plenary authority over the arbitration procedures adopted by the national securities exchanges and securities associations. See Shearson/American Express, Inc. v. McMahon, --- U.S. ----, 107 S.Ct. 2332, 2341, 96 L.Ed.2d 185 (1987). This authority includes the power to "abrogate, add to, and delete from" the arbitration rules adopted by such bodies if necessary or appropriate to protect the rights created by the Securities Acts. Id.; 15 U.S.C. Sec. 78s(c) (1982). The SEC has explicitly approved the NYSE and NASD arbitration rules and procedures at issue in this case. McMahon, 107 S.Ct. at 2341. Because Congress has committed to the SEC the task of ensuring that the federal rights established by the Securities Acts are not compromised by inadequate arbitration procedures, we are bound by the Commission's determination that the procedures at issue here are satisfactory. Cf. Huber, Safety and the Second Best: The Hazards of Public Risk Management in the Courts, 85 Colum.L.Rev. 277, 333-35 (1985). Any contrary holding would frustrate this carefully crafted federal regulatory scheme.

Our conclusion is not affected by the Cohens' contention that the arbitration agreement is part of a contract of adhesion. ³ We have previously held that state law adhesion contract principles may not be invoked to bar arbitrability of disputes under the Arbitration Act. Bayma, 784 F.2d at 1024-25. We reaffirm that holding today.

The strong federal policy favoring arbitration, coupled with the extensive regulatory oversight performed by the SEC in this area, compel the conclusion that agreements to arbitrate disputes in accordance with SEC-approved procedures are not unconscionable as a matter of law. The Cohens' first objection to the arbitrability of their claims is, therefore, unfounded.

B. The Cohens next contend that they were fraudulently induced to enter into the agreement to arbitrate by Wedbush's failure to disclose the effect of the arbitration clause and by the advice of a Wedbush agent that the margin agreement would "not compromise any of [their] rights." ER 8, 10. They also allege that they were not given a copy of the agreement. The Cohens argue that they are entitled to a jury trial on the issue of arbitrability. They rely on 9 U.S.C. Sec. 4, which provides that...