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

• Decision Date: 09 July 1986
• Docket Number: No. 85-5156,85-5156
• Citation: 795 F.2d 1393
• Parties: , Fed. Sec. L. Rep. P 92,815 Louis L. PHILLIPS and L.L. Phillips Charities, Inc., Appellees, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., and Ben M. Sirianni, Appellants.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 1393

795 F.2d 1393

55 USLW 2075, Fed. Sec. L. Rep. P 92,815

Louis L. PHILLIPS and L.L. Phillips Charities, Inc., Appellees, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., and Ben M Sirianni, Appellants.

No. 85-5156.

United States Court of Appeals Eighth Circuit.

Submitted Dec. 11, 1985.

Decided July 9, 1986.

James Vessey, Minneapolis, Minn., for appellant.

Terence M. Fruth, Minneapolis, Minn., for appellee.

Before ROSS, Circuit Judge, BRIGHT, Senior Circuit Judge, and BOWMAN, Circuit Judge.

BRIGHT, Senior Circuit Judge.

Merrill Lynch, Pierce, Fenner & Smith, Inc. and Ben M. Sirianni appeal from a district court order denying their motion to compel arbitration of claims arising under section 10(b) of the Securities Exchange Act of 1934 (1934 Act), 15 U.S.C. Sec. 78j(b) (1982), and Rule 10b-5 of the Securities Exchange Commission, 17 C.F.R. Sec. 240.10b-5 (1985). For the reasons discussed below, we reverse the order of the district court and remand for further proceedings.

I. BACKGROUND.

Louis L. Phillips opened securities accounts for himself and for L.L. Phillips Charities, Inc. with Merrill Lynch, Pierce, Fenner & Smith, Inc. in October 1978. The accounts were managed by Ben M. Sirianni, a vice president and registered representative of Merrill Lynch. ¹ Upon opening the accounts, Phillips signed a standard "Customer Agreement" and a standard "Option Agreement", both of which provided that any controversies relating to the accounts "shall be submitted to arbitration". ²

In July 1981, Phillips sued Merrill Lynch, charging that its registered representative, Sirianni, executed unauthorized option trades in Phillips' accounts and made various misrepresentations and omissions regarding those trades. Phillips' complaint alleged violations of section 10(b) of the 1934 Act and Rule 10b-5, section 12(2) of the Securities Act of 1933 (1933 Act), 15 U.S.C. Sec. 77l(2) (1982), the Minnesota Securities Act, Minn.Stat.Ann. Secs. 80A.01 et seq., 80A.03 (West Supp.1986), and state common law.

On March 27, 1985, Merrill Lynch moved, pursuant to the parties' arbitration agreement, to compel arbitration of Phillips' claims arising under section 10(b) of the 1934 Act and Rule 10b-5. The district court denied this motion ³ and on May 9, 1985, Merrill Lynch appealed. ⁴ On appeal, Merrill Lynch contends that the Federal Arbitration Act (Arbitration Act), 9 U.S.C. Secs. 1-14 (1982), requires enforcement of the parties' arbitration agreement, and that the 1934 Act does not create an exception to this requirement.

II. DISCUSSION

The centerpiece provision of the Federal Arbitration Act provides that arbitration agreements "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. In recent years, the Supreme Court has stressed that this provision, and the Arbitration Act as a whole, reflects a strong federal policy favoring the enforcement of arbitration agreements. ⁵ The Court has indicated that arbitration agreements should be liberally construed, and that any doubt as to the arbitrability of an issue should be resolved in favor of arbitration. Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., --- U.S. ----, 105 S.Ct. 3346, 3353-54, 87 L.Ed.2d 444 (1985); Dean Witter Reynolds Inc. v. Byrd, 470 U.S. 213, 105 S.Ct. 1238, 1242-43, 84 L.Ed.2d 158 (1985); Southland Corp. v. Keating, 465 U.S. 1, 10-16, 104 S.Ct. 852, 858-61, 79 L.Ed.2d 1 (1984); Moses H. Cone Memorial Hospital v. Mercury Construction Corp., 460 U.S. 1, 24-25, 103 S.Ct. 927, 941-42, 74 L.Ed.2d 765 (1983).

In Wilko v. Swan, 346 U.S. 427, 74 S.Ct. 182, 98 L.Ed. 168 (1953), however, the Supreme Court held a predispute arbitration agreement unenforceable with regard to claims arising under section 12(2) of the 1933 Act. The Court reasoned that a predispute arbitration agreement is void under section 14 of the 1933 Act because it constitutes a stipulation binding the securities customer to waive compliance with a provision of the Act. ⁶ The provision referred to is the aggrieved party's right to select the judicial forum under section 22(a) of the 1933 Act. ⁷

The Court deemed section 22(a) "the kind of 'provision' that cannot be waived" under section 14 by viewing it in conjunction with the substantive right afforded a securities customer in section 12(2). The Court observed that section 12(2) "create[s] a special right to recover for misrepresentation which differs substantially from the common-law action in that the seller is made to assume the burden of proving lack of scienter." Wilko v. Swan, supra, 346 U.S. at 431, 74 S.Ct. at 184. It expressed concern that the "effectiveness" of this special right would be "lessened in arbitration as compared to judicial proceedings." Id. at 435, 74 S.Ct. at 187. The Court, therefore, concluded that Congress must have intended section 14 to preclude the waiver of a section 22(a) judicial remedy for the section 12(2) right. Id. at 437, 74 S.Ct. at 188. In short, the Wilko Court decided that Congress, in enacting the 1933 Act, created an exception to the mandate of the Arbitration Act.

A number of courts of appeals have held that Wilko extends to claims arising under section 10(b) of the 1934 Act and Rule 10b-5. E.g., Miller v. Drexel Burnham, Inc., 791 F.2d 850, 854 (11th Cir.1986) (per curiam) McMahon v. Shearson/American Express, Inc., 788 F.2d 94, 98 (2d Cir.1986); De Lancie v. Birr, Wilson & Co., 648 F.2d 1255, 1258-59 (9th Cir.1981); Mansbach v. Prescott, Ball & Turben, 598 F.2d 1017, 1030 (6th Cir.1979); Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Moore, 590 F.2d 823, 827-29 (10th Cir.1978); Weissbuch v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 558 F.2d 831, 833-35 (7th Cir.1977); Sibley v. Tandy Corp., 543 F.2d 540, 543 n. 3 (5th Cir.1976), cert. denied, 434 U.S. 824, 98 S.Ct. 71, 54 L.Ed.2d 82 (1977); Ayres v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 538 F.2d 532, 536 (3d Cir.), cert. denied, 429 U.S. 1010, 97 S.Ct. 542, 50 L.Ed.2d 619 (1976). Recent Supreme Court pronouncements indicate, however, that this remains an open question. Dean Witter Reynolds Inc. v. Byrd, supra, 105 S.Ct. at 1240 n. 1; Id. at 1244 (White, J., concurring); Scherk v. Alberto-Culver Co., 417 U.S. 506, 513-14, 94 S.Ct. 2449, 2454-55, 41 L.Ed.2d 270 (1974). ⁸

In the present case, the district court concluded, relying on its interpretation of this court's opinion in Surman v. Merrill Lynch, Pierce, Fenner & Smith, 733 F.2d 59 (8th Cir.1984), that Wilko is to be read broadly. Therefore, the district court denied Merrill Lynch's motion to compel arbitration of Phillips' section 10(b) and Rule 10b-5 claims. ⁹

On appeal, Merrill Lynch contends, relying on language in Byrd and Scherk, and on the strong federal policy favoring arbitrability, that Wilko does not apply to claims arising under section 10(b) and Rule 10b-5. Merrill Lynch argues that the Arbitration Act requires enforcement of its predispute arbitration agreement with Phillips, and that the 1934 Act does not create an exception to this requirement. We agree. ¹⁰

In Scherk v. Alberto-Culver Co., supra, 417 U.S. at 513-14, 94 S.Ct. at 2454-55, the Supreme Court, without deciding the issue, questioned the applicability of Wilko to section 10(b) and Rule 10b-5 claims. ¹¹ Last term, in Dean Witter Reynolds Inc. v. Byrd, supra, 105 S.Ct. at 1240 n. 1, the Court briefly reviewed the arguments raised in Scherk, yet concluded that the issue was not properly before it. In a separate concurrence, however, Justice White compared the 1933 and 1934 Acts and concluded that the extension of Wilko's reasoning to 1934 Act claims "is a matter of substantial doubt." Dean Witter Reynolds Inc. v. Byrd, supra, 105 S.Ct. at 1244 (White, J., concurring). ¹²

We observe that although the 1934 Act contains a non-waiver provision, section 29(a), ¹³ virtually identical to section 14 of the 1933 Act, counterparts of the other two provisions relied on by the Wilko Court "are imperfect or absent altogether." Dean Witter Reynolds Inc. v. Byrd, supra, 105 S.Ct. at 1244 (White, J., concurring). The jurisdictional provision of the 1934 Act, section 27, 15 U.S.C. Sec. 78aa (1982), is narrower than section 22(a) of the 1933 Act. Section 27 requires a plaintiff to bring his or her action exclusively in federal court, while section 22(a) allows suit in federal or state court and prevents removal from a state court. See supra note 7, at 5. As the Supreme Court noted, compared to section 22(a) of the 1933 Act, section 27 of the 1934 Act "significantly restrict[s] the plaintiff's choice of forum." Scherk v. Alberto-Culver Co., supra, 417 U.S. at 514, 94 S.Ct. at 2455 (footnote omitted).

Moreover, a plaintiff's cause of action under section 10(b) and Rule 10b-5 differs in important respects from his or her cause of action under section 12(2). Berger v. Bishop Investment Corp., 695 F.2d 302, 308 (8th Cir.1982). First, the section 10(b) and Rule 10b-5 private cause of action is implied rather than express. Herman & MacLean v. Huddleston, 459 U.S. 375, 380 & nn. 9-10, 103 S.Ct. 683, 686 & nn. 9-10, 74 L.Ed.2d 548 (1983). Second, unlike in a section 12(2) action, the plaintiff in an action under section 10(b) and Rule 10b-5 bears the burden of proving scienter. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 190, 193, 96 S.Ct. 1375, 1379-80, 1381, 47 L.Ed.2d 668 (1976); Harris v. Union Electric Co., 787 F.2d 355, 362 (8th Cir.1986). ¹⁴

The Supreme Court's decision in Wilko rested, at least in part, on the "special" nature of the section 12(2) right, so described because it is expressly created by Congress and "differs substantially from the common-law action in that" a securities customer is not required to prove scienter to recover. Wilko v. Swan, supra, 346 U.S. at 431, 74 S.Ct. at 184-85. As we have observed, the section 10(b) and Rule 10b-5 cause of action lacks both of these attributes.

Based on these...