McMahon v. Shearson/American Exp., Inc.

• Citation: 788 F.2d 94
• Decision Date: 16 April 1986
• Docket Number: Nos. 806,894,D,s. 806
• Parties: , Fed. Sec. L. Rep. P 92,550, RICO Bus.Disp.Guide 6245 Eugene McMAHON, Julia McMahon, individually and as Trustees of the David J. Hodder & Son, Inc. Employee Pension Plan; the David J. Hodder & Son Inc. Profit Sharing Plan; the Laurie Funeral Home, Inc. Employee Pension Plan; the Laurie Funeral Home Profit Sharing Plan, Plaintiffs-Appellants-Cross-Appellees, v. SHEARSON/AMERICAN EXPRESS, INC., and Mary Ann McNulty, Defendants-Appellees- Cross-Appellants. ockets 85-7844, 85-7846.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Page 94

788 F.2d 94

54 USLW 2567, Fed. Sec. L. Rep. P 92,550,

RICO Bus.Disp.Guide 6245

Eugene McMAHON, Julia McMahon, individually and as Trustees

of the David J. Hodder & Son, Inc. Employee Pension Plan;

the David J. Hodder & Son Inc. Profit Sharing Plan; the

Laurie Funeral Home, Inc. Employee Pension Plan; the Laurie

Funeral Home Profit Sharing Plan, Plaintiffs-Appellants-Cross-Appellees, v. SHEARSON/AMERICAN EXPRESS, INC., and Mary Ann McNulty,

Defendants-Appellees- Cross-Appellants.

Nos. 806, 894, Dockets 85-7844, 85-7846.

United States Court of Appeals, Second Circuit.

Argued March 3, 1986.

Decided April 16, 1986.

Theodore G. Eppenstein, New York City (Madelaine Eppenstein, and Eppenstein & Eppenstein, New York City, on the brief), for plaintiffs-appellants-cross-appellees.

Theodore A. Krebsbach, New York City (Harry D. Frisch and Shearson Lehman Brothers Inc., New York City, on the brief), for defendants-appellees-cross-appellants.

William J. Fitzpatrick and Gerard J. Quinn, New York City, submitted a brief for the Securities Industry Ass'n, Inc., amicus curiae.

Before FEINBERG, Chief Judge, and TIMBERS and NEWMAN, Circuit Judges.

TIMBERS, Circuit Judge:

Eugene McMahon and Julia A. McMahon ("appellants"), individually and as trustees for various pension and profit-sharing plans, appeal from that part of an order entered September 25, 1985 in the Southern District of New York, Lloyd F. MacMahon, District Judge, 618 F.Supp. 384, which required appellants to arbitrate their claims against Shearson/American Express, Inc. and its registered representative, Mary Ann McNulty, ("Shearson") for alleged violations of the Securities Exchange Act of 1934 ("1934 Act") and state law claims of fraud and breach of fiduciary duties. Shearson appeals from that part of the order holding not arbitrable appellants' claim under the Racketeer Influenced Corrupt Organizations Act, 18 U.S.C. Sec. 1962(c) (1982) ("RICO"). The district court stayed litigation of the RICO claim pending arbitration of the securities law and state law claims.

For the reasons set forth more fully below, under the settled law of this Circuit we hold that the district court erred in holding arbitrable appellants' claims under Sec. 10(b) of the Securities Exchange Act, 15 U.S.C. Sec. 78j(b) (1982), and Rule 10b-5, 17 C.F.R. Sec. 240.10b-5 (1985). The district court, however, was correct in holding the RICO claim to be non-arbitrable. Applying the decision of the Supreme Court in Dean Witter Reynolds, Inc. v. Byrd, 105 S.Ct. 1238 (1985), we hold that arbitration of the pendent state law claims is required, even though bifurcated proceedings may result.

In short, we affirm in part, and reverse and remand in part.

I.

The facts and prior proceedings are simple and straightforward.

Appellants, individually and as trustees for various pension and profit-sharing plans, commenced this action against Shearson, a brokerage firm, and its registered representative who handled appellants' accounts. Appellants alleged that the registered representative of Shearson, with its knowledge, had violated Sec. 10(b) of the 1934 Act and Rule 10b-5 by churning appellants' accounts, making false statements and omitting material facts from the advice given appellants. Appellants also alleged a RICO claim and state law claims for fraud and breach of fiduciary duties.

On June 15, 1982 Julia McMahon entered into a customer agreement with Shearson which contained an arbitration clause providing in relevant part as follows:

"Unless unenforceable due to federal or state law, any controversy arising out of or relating to my accounts, to transactions with you for me or to this agreement or the breach thereof, shall be settled by arbitration in accordance with the rules, then in effect, of the National Association of Securities Dealers, Inc. or the Boards of Directors of the New York Stock Exchange, Inc. and/or the American Stock Exchange, Inc. as I may elect."

Relying on this clause, Shearson moved, pursuant to Sec. 3 of the United States Arbitration Act, 9 U.S.C. Sec. 3 (1982), to compel arbitration of all of appellants' claims. In the alternative, Shearson moved to dismiss the complaint for failure to state a claim upon which relief could be granted and on other grounds, none of which is relevant in view of the district court's disposition of the motion to compel arbitration.

The district court rejected appellants' assertions that the customer agreement containing the arbitration clause is a contract of adhesion, that fraud is not an arbitrable issue, and that Shearson had waived its right to arbitrate. The court ordered arbitration of the Sec. 10(b) and Rule 10b-5 claims, reasoning that recent Supreme Court decisions cast doubt on holding claims under the 1934 Act to be not arbitrable. In view of the important federal policies inherent in the enforcement of RICO by the federal courts, however, the court stayed litigation of that claim pending arbitration. The court ordered arbitration of the state law claims.

We shall examine first the district court's decision that the claims under Sec. 10(b) and Rule 10b-5 are arbitrable. We shall then address the arbitrability of the RICO claim and state law claims.

II.

We turn first to the district court's disposition of appellants' 1934 Act claims.

We hold that the district court's decision that appellants' claims under Sec. 10(b) and Rule 10b-5 are arbitrable is an unwarranted departure from the settled law of this Circuit and must be reversed.

In Wilko v. Swan, 346 U.S. 427 (1953), the Supreme Court held that, despite the United States Arbitration Act, 9 U.S.C. Sec. 1 et seq., claims arising under Sec. 12(2) of the Securities Act of 1933 ("1933 Act") are not arbitrable. In reaching this result, the Court pointed out that an agreement to arbitrate claims is void under Sec. 14 of the 1933 Act as a stipulation binding the securities customer to waive compliance with a provision of the Act. ¹ The provision referred to is the aggrieved party's right to select the judicial forum under Sec. 22(a) of the 1933 Act.

As our late colleague, Judge Friendly, noted in Colonial Realty v. Bache & Co., 358 F.2d 178, 183 n. 5 (2 Cir.), cert. denied, 385 U.S. 817 (1966), the non-waiver provision of Sec. 14 of the 1933 Act has an almost identical counterpart in Sec. 29(a) of the 1934 Act. ² In view of Wilko and the similarity of the non-waiver provisions of the 1933 and 1934 Acts, we consistently have held that Sec. 10(b) and Rule 10b-5 claims are not arbitrable. ³ In Greater Continental Corp. v. Schechter, 422 F.2d 1100, 1103 (2 Cir.1970), we observed that alleged violations of Rule 10b-5 were "properly litigated in the courts where a complete record is kept of the proceedings and findings and conclusions are made." We also pointed out the similarity between Sec. 14 of the 1933 Act and Sec. 29(a) of the 1934 Act. Id. In Allegaert v. Perot, 548 F.2d 432, 436-38 (2 Cir.), cert. denied, 432 U.S. 910 (1977), we reiterated the view that claims under Sec. 10(b) of the 1934 Act are not arbitrable, noting that the broad policy questions involved in securities law claims require a judicial forum for resolution of disputes. Again in AFP Imaging Corp. v. Ross, 780 F.2d 202, 205 (2 Cir.1985), we held that, in an action which alleged violations of Sec. 10(b) and Rule 10b-5, an arbitration clause in the contract was "unenforceable under the law of this Circuit".

Despite the settled law of this Circuit that claims under Sec. 10(b) and Rule 10b-5 of the 1934 Act are not arbitrable, Shearson, speculating as to what the Supreme Court may do with our settled law, invites us to overrule our own precedents. We decline the invitation.

The district court, in addition to emphasizing the strong national policy favoring arbitration, focused on the Supreme Court's decisions in Dean Witter Reynolds, Inc. v. Byrd, 105 S.Ct. 1238 (1985), and Scherk v. Alberto-Culver Co., 417 U.S. 506 (1974). In Byrd, since the securities broker had sought to compel arbitration of only pendent state claims--not claims arising under the 1934 Act--the Court declined to reach the issue of whether Sec. 10(b) and Rule 10b-5 claims are arbitrable. 105 S.Ct. at 1240 n. 1. Nevertheless, various courts, in holding that Sec. 10(b) and Rule 10b-5 claims are arbitrable, have sought refuge in Justice White's concurring opinion in Byrd, 105 S.Ct. at 1244. Justice White stated that Wilko's reasoning cannot be "mechanically transplanted" to the 1934 Act. Id. While acknowledging the similarity between Sec. 14 of the 1933 Act and Sec. 29(a) of the 1934 Act, Justice White reasoned that the narrower jurisdiction under the 1934 Act and the implied, rather than express, causes of action under Sec. 10(b) and Rule 10b-5 distinguished claims under the 1934 Act from those arising under the 1933 Act. Id. Both the Byrd majority and Justice White's concurring opinion acknowledged that Scherk v. Alberto-Culver Co., supra, 417 U.S. at 513-15, cast some doubt on the applicability of Wilko to claims under Sec. 10(b) or Rule 10b-5. 105 S.Ct. at 1240 n. 1; 105 S.Ct. at 1244. ⁴ The Supreme Court in Byrd, however, referred to the Scherk decision as follows:

"The [Scherk] Court did not, however, hold that Wilko would not apply in the context of a Sec. 10(b) or Rule 10b-5 claim, and Wilko has retained considerable vitality in the lower federal courts. Indeed numerous District Courts and Courts of Appeals have held that the Wilko analysis applies to claims arising under Sec. 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b), and that agreements to arbitrate such claims are therefore unenforceable."

105 S.Ct. at 1240 n. 1. (Citations omitted, being among those included in note 3, supra).

In the instant case, the district court focused on the allegations of churning and misrepresentation centered on particular securities accounts and held inapplicable the broad policy concerns which this Circuit has...