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

• Decision Date: 28 June 1976
• Docket Number: No. 75-2007,75-2007
• Citation: 538 F.2d 532
• Parties: Fed. Sec. L. Rep. P 95,643 Percy D. AYRES, Appellant, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.
• Court: U.S. Court of Appeals — Third Circuit

Page 532

538 F.2d 532

Fed. Sec. L. Rep. P 95,643

Percy D. AYRES, Appellant, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC.

No. 75-2007.

United States Court of Appeals Third Circuit.

Argued March 11, 1976.

Decided June 28, 1976.

David L. Grove, Philadelphia, Pa., for appellant; Frank S. Deming, Montgomery, McCracken, Walker & Rhoads, Philadelphia, Pa., of counsel.

C. Clark Hodgson, Jr., Stradley, Ronon, Stevens & Young, Philadelphia, Pa. and Roger J. Hawke, Brown, Wood, Ivey, Mitchell & Petty, New York City, for appellee.

Harvey L. Pitt, Gen. Counsel, Paul Gonson, Associate Gen. Counsel, Frederic T. Spindel, Asst. Gen. Counsel, Martin S. Berglas, Atty., S. E. C., Washington, D. C., amicus curiae.

Before VAN DUSEN and WEIS, Circuit Judges, and STERN, District Judge.

OPINION OF THE COURT

VAN DUSEN, Circuit Judge.

This is an appeal from a district court judgment entered July 7, 1975, confirming a decision rendered by arbitrators of the New York Stock Exchange ("NYSE"). The principal question involves the applicability and validity of an Exchange arbitration rule in the context of a dispute arising under § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. ¹ For the reasons set forth below, we vacate the judgment of the district court and remand for further proceedings.

During a period from 1945-1970, plaintiff-appellant, Percy D. Ayres, was employed as a registered representative or "account executive" with the firm of Merrill Lynch, Pierce, Fenner & Smith, Inc., a well-known broker-dealer. Through various stock purchases and stock dividends, Ayres became the owner of 8,000 shares of Merrill Lynch common stock. In connection with his original and subsequent purchases, Ayres entered into agreements with Merrill Lynch which, inter alia, gave Merrill Lynch an option, exercisable for any reason on 90 days' notice, to repurchase all or any part of such stock held by Ayres. Merrill Lynch stock was not publicly owned during the period, and Ayres was permitted to own the stock solely because of his status as an employee.

The complaint alleged that, in the spring of 1970, Merrill Lynch began actively to explore the possibility of making a public offering of its stock. By July, the corporation's management had made an initial decision to go public and was taking preliminary steps towards accomplishing that goal. During the late summer, Ayres, who was ignorant of the planned offering which had not been publicly announced and who was under the impression that he would be permitted to retain his 8,000 shares of stock, advised Merrill Lynch of his intention to retire on October 1, 1970. ²

Advised by a fellow employee of the possibility that Merrill Lynch would exercise its 90-day options upon his retirement, Ayres approached a Merrill Lynch vice president to inquire about the firm's plans. The vice president told Ayres that he would take up the matter with the corporation's executives in New York and subsequently reported that Ayres would, in fact, be required to sell his stock if he chose to retire. Neither the vice president with whom Ayres spoke nor any other representative of Merrill Lynch informed Ayres of the prospective public offering. Unaware of the firm's plans, Ayres decided, on the basis of available information, to retire and thus to sell his 8,000 shares. Merrill Lynch subsequently purchased Ayres' stock for $209,064.

Asserting that Merrill Lynch had "wrongfully concealed" material non-public information in connection with the purchase and sale of securities, in violation of 15 U.S.C. § 78j(b) and 17 C.F.R. § 240.10b-5, Ayres commenced this action on December 13, 1971, seeking rescission of the sale and/or damages. The theory of Ayres' complaint, which alleged violation of the anti-fraud provisions of the Securities Exchange Act and of state law, was that (1) in the absence of his voluntary retirement, Merrill Lynch would not have exercised its repurchase option, and (2) if he had known of the information Merrill Lynch "concealed," he would have chosen not to trigger the sale by postponing his retirement. ³

Defendant Merrill Lynch responded to the complaint by moving, pursuant to § 3 of the United States Arbitration Act, 9 U.S.C. § 3, ⁴ for a stay of proceedings pending arbitration. Specifically, Merrill Lynch, a member firm of the NYSE, asserted that the dispute was "(a)ny controversy . . . arising out of (Ayres') employment or termination of employment" and was, therefore, subject to compulsory arbitration under Stock Exchange Rule 347(b) by which both Ayres and Merrill Lynch had agreed to be bound when Ayres became a registered representative in 1945. ⁵ In answer to the argument that agreements to arbitrate future federal securities controversies are "void" under the anti-waiver provision of the Securities Exchange Act, 15 U.S.C. § 78cc(a) and Wilko v. Swan, 346 U.S. 427, 74 S.Ct. 182, 98 L.Ed. 168 (1953), Merrill Lynch contended that Exchange Rule 347(b) fell within the compass of § 28(b), which exempts, inter alia, certain stock exchange "action" from the invalidating effect of the anti-waiver provision. See 15 U.S.C. § 78bb(b).

The district court agreed with Merrill Lynch's contentions that Exchange Rule 347(b) was applicable on its face and was exempt from the anti-waiver provision of the Act. Accordingly, by opinion and order dated January 19, 1973, the court stayed all proceedings pending arbitration. ⁶ The arbitrators, without stating reasons, subsequently rendered a decision adverse to Ayres on all claims, and the district court confirmed this decision in a final judgment entered July 7, 1975. This timely appeal followed.

In our view, the primary question presented by this appeal concerns the district court's conclusion that the arbitration agreement embodied in Exchange Rule 347(b) governs this controversy. That Rule provides:

"Any controversy between a registered representative and any . . . member organization arising out of the employment or termination of employment of such registered representative by and with such . . . member organization shall be settled by arbitration, at the instance of any such party, in accordance with the arbitration procedure described elsewhere in these rules."

Acknowledging that the present controversy "does not clearly and squarely relate to the business functions and commercial transactions normally engaged in by a registered representative of the Exchange in the performance of his prescribed duties," ⁷ the district court nevertheless concluded that the dispute in this case was "any controversy . . . arising out of (Ayres') employment or termination of employment" with Merrill Lynch and hence fell within the purview of Exchange Rule 347(b). The exclusive basis for this determination was the fact that Ayres was initially permitted to purchase Merrill Lynch stock solely because of his status as an employee. Ayres v. Merrill Lynch, Pierce, Fenner & Smith, supra, 353 F.Supp. at 1087, 1091.

Although we find the question not free from doubt, we do not think that Exchange Rule 347(b) was intended to cover a controversy that has a causal connection to the fact of employment as remote as that involved in this dispute. All of the cases that have applied Exchange Rule 347(b) concerned the terms of the consensual relationship between registered representatives and Exchange members and the respective rights and duties of the parties as employer and employee. ⁸ While we have no occasion to mark the bounds of Exchange Rule 347(b), we believe the Rule was primarily designed to cover such disputes and that the present controversy falls outside the perimeter of the rule.

In our view, the dispute here has its primary genesis in an alleged securities fraud and concerns Ayres' rights under federal and state securities laws as a stockholder and as a seller of securities. It does not center on Ayres' rights as a former employee under any consensual arrangement relating to the terms and conditions of his employment or termination. Although, in a purely factual sense, the claims are connected with the termination of employment, the legal rights being asserted have a source wholly independent of the employment relationship. Arbitration is a matter of contract, and we do not think Ayres can reasonably be understood to have waived his right to judicial trial of such claims.

The Supreme Court has characterized Exchange Rule 347(b) as relating to the "exchange's housekeeping affairs" and has suggested it deals primarily with "the area of wage claims." Merrill Lynch, Pierce, Fenner & Smith v. Ware, 414 U.S. 117, 136, 94 S.Ct. 383, 38 L.Ed.2d 348 (1973). To conclude that the Rule applied under the unusual circumstances of this case would be, in our view, to stretch the Rule well beyond those goals. Here the arbitrators would be called upon to apply legal precepts whose importance transcends the Exchange's interests in self-governance and to draw upon far more than the specialized knowledge of industry needs and practices that makes arbitration appropriate when the terms and conditions of the employment relationship are at issue. Cf. Alexander v. Gardner-Denver Co., 415 U.S. 36, 56-57, 94 S.Ct. 1011, 39 L.Ed.2d 147 (1974). Moreover, the Securities and Exchange Commission, which now has jurisdiction to amend, modify or repeal any Exchange rule, opposes any construction which would make Exchange Rule 347(b) applicable under the circumstances of this case. See 15 U.S.C. § 78s(b). Compare Merrill Lynch, Pierce, Fenner & Smith v. Ware, supra, 414 U.S. at 129-131, 94 S.Ct. 383. See page 538 below.

Our conclusion that Exchange Rule 347(b) is inapplicable here is buttressed by the fact that even if Exchange Rule 347(b) was intended to govern controversies such as this, we believe it would, in any event, be unenforceable and invalid as applied to this case. ⁹ In Wilko v. Swan, 346 U.S. 427, 74 S.Ct. 182, 98 L.Ed. 168 (1953), the Supreme Court...