Ames v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

• Decision Date: 06 December 1977
• Docket Number: No. 92,D,92
• Citation: 567 F.2d 1174
• Parties: Harold AMES, Plaintiff-Appellant, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC. and Christopher V. Streit, Defendants-Appellees. ocket 77-7192.
• Court: U.S. Court of Appeals — Second Circuit

Page 1174

567 F.2d 1174

Harold AMES, Plaintiff-Appellant, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC. and Christopher

V. Streit, Defendants-Appellees.

No. 92, Docket 77-7192.

United States Court of Appeals, Second Circuit.

Argued Oct. 6, 1977.

Decided Dec. 6, 1977.

Barry H. Singer, New York City (Lowenthal, Landau, Fischer & Singer, P.C., New York City, of counsel), for plaintiff-appellant.

James J. Dolan, New York City, for defendants-appellees.

Before KAUFMAN, Chief Judge, and GURFEIN and MESKILL, Circuit Judges.

GURFEIN, Circuit Judge:

Plaintiff, Harold Ames, appeals from an order of the district court, Haight, J., staying the trial of this action against Merrill Lynch, Pierce, Fenner & Smith, Inc. ("Merrill Lynch") and Christopher V. Streit, and compelling arbitration. Plaintiff is seeking money damages for alleged violations of the Commodity Exchange Act, as amended by the Commodity Futures Trading Commission Act of 1974, 7 U.S.C. §§ 6b and 6c, and regulations thereunder, basing jurisdiction on 7 U.S.C. § 2 et seq. ¹

Ames opened his account with Merrill Lynch on November 26, 1975, when he signed a standard form customer's agreement that Merrill Lynch required all of its customers to sign. It provided, inter alia, that any controversy between Ames and Merrill Lynch should be submitted to arbitration under the rules of the New York Stock Exchange. The complaint alleges that some time after January 1976 the defendant deviated from an agreed commodities program primarily for the purpose of generating commissions through excessive trading. Plaintiff further alleges that he received false and misleading reports which the defendants knew were false and that despite their statements, defendants were trading in a manner not allowed by their agreement with the plaintiff. On this appeal, we are not called upon to decide whether the complaint states a claim for relief. It is agreed that there is an implied cause of action under the Act for a private remedy.

This action was commenced on July 13, 1976. The motion to dismiss the complaint for lack of subject matter jurisdiction, F.R.Civ.P. 8(a)(1) and 12(b) (1), or alternatively, to stay the action pending arbitration, 9 U.S.C. § 3, was filed by the defendant on September 3, 1976, and the decision and order of the district court was filed on March 21, 1977.

The plaintiff opposed a stay of arbitration on the ground that the new regulations of the Commodity Futures Trading Commission ("Commission"), 17 C.F.R. Part 180, which became effective on November 29, 1976, after the agreement was executed, were retroactive in their operation and rendered the agreement to arbitrate null and void; and, alternatively, that under the doctrine of Wilko v. Swan, 346 U.S. 427, 74 S.Ct. 182, 98 L.Ed. 168 (1953), the protection of investors under the Act required the nullification of compulsory arbitration of future disputes in a brokerage account agreement.

The district court found that subject matter jurisdiction existed under 28 U.S.C. § 1331(a) or as part of the interstate commerce jurisdiction under 28 U.S.C. § 1337. In reaching its decision to order arbitration, the district court rejected, however, both arguments made by the plaintiff in support of his position that the agreement to arbitrate was void and unenforcible. Judge Haight, in a thoughtful opinion, conceded that 17 C.F.R. § 180.3, in force at the time of his decision, would render the agreement to arbitrate a nullity. ² He agreed with the plaintiff that the Commission intended that § 180.3 be given retroactive effect. ³ He also recognized that a retroactive application of § 180.3 would make it impossible for the defendants to seek arbitration of the instant claims even if the provision to arbitrate might have been entered into voluntarily. He held, however, that the application of § 180.3 "to antedated Customer Agreements could lead to unfairness and inequities not intended by the drafters of the Commodities Exchange Act." He further held, accordingly, "that retrospective application of § 180.3 would serve to prejudice heretofore valid agreements entered into on the basis of existing legal authority." The judge also refused to accept the contention that Wilko v. Swan, supra, required nullification of the arbitration agreement.

A court must apply the law as it exists at the time of its decision, even where the law has changed during the pendency of the action, unless the statute or legislative history reveals an intention of prospective application only, or retroactive application would lead to "manifest injustice." Bradley v. Richmond School Board, 416 U.S. 696, 711, 94 S.Ct. 2006, 40 L.Ed.2d 476 (1974). In applying this principle to the instant case, we are called upon to determine (1) whether the Commission had the authority to apply the provisions of § 180.3 to all arbitration agreements; (2) whether the Commission intended the application of the regulation to arbitration agreements antedating the regulation and (3) whether, given the authority and intention to make the regulation effective as to antedated agreements, the particular circumstance that the dispute arose before the effective date of the regulation nevertheless precludes its application.

The Act, in dealing with the arbitration of customers' disputes, requires only that each contract market provide a "fair and equitable procedure through arbitration or otherwise" for settlement of customers' claims up to $15,000. 7 U.S.C. § 7a(11). The same section provides that "the use of such procedure by a customer shall be voluntary." The Act mentions neither arbitration of claims over $15,000 nor arbitration outside of the contract market.

The Commission determined that to accomplish the purpose of the Act, arbitrations that do not fall within the literal scope of § 7a(11) should also be regulated, even in the absence of a specific statutory source. 40 Fed.Reg. 54,430 (Nov. 24, 1975); 41 Fed.Reg. 42,945-47 (Sept. 29, 1976). The Act gives the Commission authority "to make and promulgate such rules and regulations as, in the judgment of the Commission, are reasonably necessary to effectuate any of the provisions or to accomplish any of the purposes of this Act." 7 U.S.C. § 12a(5). (emphasis added). The Commission acted under this general rulemaking authority when it promulgated § 180.3. 40 Fed.Reg. 54,432-33 (Nov. 24, 1976). There is no challenge to its power to make such a rule under its general rulemaking powers.

The Commission's intention regarding the retroactivity of the regulation can only be ascertained by examining the administrative history of the rule. Shortly after its creation, in 1975, the Commission undertook an examination of the use of arbitration in the futures industry. It learned that arbitration was frequently conducted not under the auspices of the contract markets regulated by the Commission but through arbitration sponsored by the New York Stock Exchange or other securities-oriented organizations. It also became apparent that in many cases arbitration was not undertaken voluntarily by customers, but that customers were compelled to agree to predispute arbitration clauses as a precondition to doing business. Indeed, this practice was found to be so prevalent that a customer might effectively be frozen out of the futures market if he refused to execute a predispute agreement. 41 Fed.Reg. 27,526 (July 2, 1976); 41 Fed.Reg. 42,945 (Sept. 29, 1976).

Initially, the Commission proposed to bar any agreement to arbitrate future disputes. 40 Fed.Reg. 34,152 (Aug. 14, 1975). ⁴ But it provided that the absolute bar should not apply to claims or grievances arising out of transactions occurring prior to the adoption of the regulation and for one year thereafter, if such transactions were subject to agreements actually entered into before the adoption of the regulation. 40 Fed.Reg. 54,430, 54,435 (Nov. 24, 1975).

The Commission received written comments and took oral testimony on March 5, 1976. At this hearing conducted by the Commission, representatives both of Merrill Lynch and Shearson Hayden Stone conceded that a customer could not do futures business with the firm if he refused to sign a predispute arbitration agreement. Commodity Futures Trading Comm'n, Oral Hearing on Arbitration and Other Dispute Settlement Procedures 32-34, 37, 82-98. (March 5, 1976); see generally 41 Fed.Reg. 42,945 (Sept. 29, 1976).

After the hearings and comments, the Commission modified its previous proposal to bar arbitration of future disputes entirely. Instead, the Commission now proposed to permit the continued use of pre-dispute arbitration agreements, but only under conditions designed to insure that arbitration was truly voluntary on the part of the customer. 42 Fed.Reg. 27,526-28 (July 2, 1976).

With the withdrawal of the proposal to bar arbitration entirely, the Commission also withdrew the exemption for disputes arising before or within one year after the adoption of the regulation under arbitration agreements antedating the regulation. Instead, the thrust was to include even preexisting arbitration agreements in the new order of things. Thus, the Commission announced on July 2, 1976, that "on the effective date, all compulsory arbitration agreements which do not comply with the amended proposed rule § 180.3 will be null and void, including those heretofore signed by customers." 41 Fed.Reg. 27,527-28. At the same time, it deleted from the proposed rule the saving clause for agreements and disputes antedating the regulation.

On September 29, 1976, the amended proposed rule was adopted to become effective on November 29, 1976. 41 Fed.Reg. 42,942-47 (Sept. 29, 1976). At that time, the Commission reiterated its position that "on the effective date of proposed § 180.3(b), all pre-dispute arbitration agreements that do not satisfy the conditions set forth in the proposed rule will be null and void, including those heretofore signed by customers." 41...