Lewis v. Lynch, Pierce, Fenner, & Smith, Inc.

• Decision Date: 18 July 1986
• Court: California Court of Appeals Court of Appeals
• Parties: Bernard L. LEWIS etc., Plaintiff and Respondent, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Defendant and Appellant. D002997.

Page 345

228 Cal.Rptr. 345

183 Cal.App.3d 1097

Bernard L. LEWIS etc., Plaintiff and Respondent, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., Defendant and Appellant.

D002997.

Court of Appeal, Fourth District, Division 1, California.

July 18, 1986.

As Modified on Denial of Rehearing Aug. 8, 1986.

Rogers & Wells, Charles R. Hartman, Los Angeles, Terrence L. Bingman, San Diego, and Charles E. Wheeler, Los Angeles, for defendant and appellant.

Bernard L. Lewis, in pro. per.

BUTLER, Associate Justice.

Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch) appeals a denial of its petition to compel arbitration of Bernard L. Lewis's complaint alleging Merrill Lynch fraudulently calculated interest charges on the basis of a 360-day year on his margin and cash management account. We affirm, holding the arbitration forums in which the claim is required to be arbitrated are fundamentally unfair and the agreement to arbitrate before one of those forums is unenforceable, without prejudice to a renewal of a motion to arbitrate before an impartial arbitrator.

I

Lewis's complaint alleges it is filed on behalf of all customers of Merrill Lynch who purchase securities of any type on margin or are paying debts to Merrill Lynch or are paying interest to Merrill Lynch. The first cause of action alleges Merrill Lynch charges interest in excess of the stated amount agreed to be charged customers by means of false and deceptive calculations. Lewis claims Merrill Lynch tells its customers interest will be charged at an annual rate. Customers receive a monthly statement showing the stated annual rate of interest for each day of the month computed on an average daily balance. The amount of interest charged is then shown on the statement. Merrill Lynch in fact charges the customer the stated rate of interest for 360 days but the actual amount is increased by 1/72 of the interest rate shown, as the customer is charged 365 days times 1/360 for each day's interest. The customer is not aware of the practice which Lewis claims is an unfair trade practice under Business and Professions Code section 17500 entitling customers to restitution. Lewis claims this practice results in an overcharge of more than $500,000 per year as to some 10,000 members of the class.

The second cause of action alleges like interest computations and overcharges as to a class consisting of Lewis and other customers who purchase U.S. Treasury bonds, notes, participation certificates, and corporate and municipal bonds.

II

Merrill Lynch petitioned the court for an order to compel arbitration of the issues in the complaint and to stay proceedings. The petition ignored the class action aspects of the complaint and sought arbitration and the stay solely with respect to Lewis. In his answer to the petition, Lewis simply asked the court to deny the petition. His opposition points and authorities asserted the interest of the class could only be protected in the lawsuit, as individual arbitration as to each member of the 10,000-member class would be absurd. The court denied the petition, referring solely to Lewis and making no mention of the class. This appeal is from that order denying arbitration as to Lewis. While the complaint is couched in class action terms, Lewis and Merrill Lynch did not request class arbitration and neither sought class certification. Accordingly, we do not address arbitrability of the controversy as a class action, a matter to be considered, if at all, by the trial court.

III

Lewis and other class members signed a Merrill Lynch customer agreement form. Paragraph 11 provides in relevant part:

"It is agreed that any controversy between us arising out of your business or this agreement shall be submitted to arbitration conducted under the provisions of the Constitution and Rules of the Board of Governors of the New York Stock Exchange, Inc. or pursuant to the Code of Arbitration Procedure of the National Association of Securities Dealers, Inc., as the undersigned may elect.... Arbitration must be commenced by service upon the other of a written demand for arbitration or a written notice of intention to arbitrate, therein electing the arbitration tribunal. In the event the undersigned does not make such designation within five (5) days of such demand or notice, then the undersigned authorizes you to do so on behalf of the undersigned."

Merrill Lynch made a letter demand upon Lewis to submit his individual claim to arbitration and stated in the event Lewis did not select the New York Stock Exchange (NYSE) then Merrill Lynch elected arbitration under the National Association of Securities Dealers (NASD). Lewis did not respond to the letter and Merrill Lynch petitioned the court to order Lewis's individual claim to arbitration. We conclude Merrill Lynch has selected NASD as the arbitrator. Answering the petition for arbitration, Lewis asserted:

"Plaintiff requests the Court to take Judicial Notice of Lewis et al v. Prudential Bache Securities Inc., San Diego Superior Court # 510797, in which Department 35 of this Court on June 21, 1984, by Minute Order, the Honorable Sheridan Reed, Judge presiding, denied a virtually identical Motion to Compel Arbitration under facts and circumstances virtually identical to the instant case. Defendant therein relied upon both the State and Federal arbitration acts."

IV

Prudential Bache Securities, Inc. appealed that denial to this court. On April 8, 1986, we filed our opinion in that case (Lewis v. Prudential Bache Securities, Inc. (1986) 179 Cal.App.3d 935, 225 Cal.Rptr. 69) reversing the order denying arbitration, directing the court to appoint the American Arbitration Association to arbitrate the matter and to determine whether the class may be certified and to retain jurisdiction to safeguard interests of absent class members. Issues in Prudential track some of those presented here.

A.

Merrill Lynch contends the state law issues framed in Lewis's complaint are subject to arbitration under the Federal Arbitration Act (9 U.S.C. §§ 1-14) and California limitations on enforceability of arbitrable contracts deemed adhesive are inapplicable. We agree, referring and adhering to Prudential in which we discussed and disposed of those issues.

B.

In Prudential, 179 Cal.App.3d 935 at p. 942, fn. 1, 225 Cal.Rptr. 69, we noted claims arising under the Securities Act of 1933 and the Securities Exchange Act of 1934 are not arbitrable (Wilko v. Swan (1953) 346 U.S. 427, 74 S.Ct. 182, 98 L.Ed. 168) and the federal district courts have exclusive jurisdiction over violations of those acts and the rules and regulations promulgated by the Securities and Exchange Commission (SEC) (Tit. 15, U.S.C. § 78aa). Lewis's claims here, as in Prudential, do not arise under the federal securities acts and are not exclusively within the federal jurisdiction.

Effective December 28, 1983, prior to the date Lewis filed his complaint, the SEC promulgated rule 15c2-2 (17 C.F.R. § 240.15c2-2; 48 Fed.Reg., pp. 53404-53407 (1983)), declaring it a fraudulent, manipulative act or practice for a broker-dealer to enter into an agreement with a public customer purporting to bind the customer to the arbitration of future disputes between them arising under the federal securities laws. While this rule became effective after the filing date of the complaint in Prudential, it is consistent as far as public customers are concerned with the holding in Wilko and we conclude it has no application here as Lewis's causes of action do not arise under the federal securities laws.

C.

The trial court denied arbitration on the grounds the arbitration of Lewis's claimed violations by Merrill Lynch of an industry-wide practice of using a 360-day year for interest calculations before a panel including securities dealers selected under NASD rules would be unconscionable.

The customer agreement in Prudential gave the customer a choice of arbitration forums, NYSE or the American Arbitration Association. As Lewis in Prudential failed to elect, Prudential Bache selected the NYSE. We reviewed recent California cases dealing with arbitration forum questions and voidability of arbitration provisions where the selected forum is claimed to be institutionally biased. We held the record in Prudential established such bias in the NYSE and we designated the American Arbitration Association as the arbitration forum. Here, the customer agreements offer a choice between the NYSE and the NASD. As Lewis declined to elect either forum, Merrill Lynch chose NASD. Nothing in the record on this appeal suggests the analysis made and conclusion reached in Prudential is inapplicable as to NYSE's institutional bias. As a conceded impartial forum such as the American Arbitration Association is not available here, we are required to examine Lewis's contention the arbitration provision is unenforceable because NASD is likewise institutionally biased.

V

NASD adopted a Code of Arbitration Procedure (the code) applicable to NASD arbitrations at times relevant here. The code provided for appointment by NASD's board of governors of a national arbitration committee with authority to establish rules, regulations and procedures for the conduct of arbitration matters. The board appoints a director of arbitration responsible for administration functions involved in arbitration. The director composes and appoints panels of arbitrators from an existing pool ¹ to conduct arbitrations. All arbitrations of disputes between NASD members or persons associated with members consist of not less than three nor more than five arbitrators, all of whom are from the securities industry.

Controversies between a customer and a member are arbitrated under the code. The director, with appropriate committee approval, has the right to decline arbitration where the controversy, with due regard to the purposes of NASD and the code's intent, is not a proper subject matter for arbitration. Controversies involving...