Scher v. Bear Stearns & Co., Inc.

• Decision Date: 19 October 1989
• Docket Number: No. 88 Civ. 7620 (PKL).,88 Civ. 7620 (PKL).
• Citation: 723 F. Supp. 211
• Parties: Gerald J. SCHER, Plaintiff, v. BEAR STEARNS & CO., INC. and Lawrence J. Friedlander, Defendants.
• Court: U.S. District Court — Southern District of New York

723 F. Supp. 211

Gerald J. SCHER, Plaintiff, v. BEAR STEARNS & CO., INC. and Lawrence J. Friedlander, Defendants.

No. 88 Civ. 7620 (PKL).

United States District Court, S.D. New York.

October 19, 1989.

Schwartzfeld, Ganfer & Shore, New York City (Neal Schwartzfeld, Marc D. Powers, of counsel), for plaintiff.

Stroock & Stroock & Lavan, New York City (Melvin A. Brosterman, Pat S. Conti, of counsel), for defendants.

ORDER & OPINION

LEISURE, District Judge.

This action arises from defendants' alleged mishandling of plaintiff's bond trading account. Plaintiff alleges that defendant, through excessive trading, misrepresentation, and poor trading decisions, caused plaintiff to suffer severe losses in his account.

The first issue before the Court is whether plaintiff's claims must be arbitrated pursuant to a customer agreement that plaintiff signed upon opening his account with defendants ("Customer Agreement"). The law involving the arbitration of claims arising under the federal securities laws has been in a state of metamorphosis in recent years and appears to be still in evolution. This evolutionary process has resulted in numerous disputes testing the reach and breadth of arbitration clauses in securities matters, not dissimilar to the one presented herein. Litigants and the courts have sought to fashion the appropriate jurisdictional limits of arbitration in these matters in light of the changes in the legal standards.

The parties also raise a second, and legally clearer, issue. Plaintiff claims that regardless of the arbitrability of any of its claims against defendant Bear Stearns & Co., Inc. ("Bear Stearns"), none of his claims against defendant Lawrence J. Friedlander ("Friedlander"), whether common law or statutory, are subject to arbitration. Defendants assert, however, that the arbitration clause at issue covers not only claims against Bear Stearns, but also claims against employees of Bear Stearns arising out of transactions for which the arbitration agreement was signed.

BACKGROUND

In 1985, plaintiff Gerald Scher ("Scher") was looking for a sound investment under the then prevailing market conditions, and decided to invest in municipal bonds. In or about May of that year, Scher opened a municipal bond trading account with Bear Stearns, and initially purchased a bond with a face value of $250,000. Complaint ¶¶ 6, 7. At or about the time Scher opened the account with Bear Stearns, he executed the Customer Agreement which contained, among numerous other clauses, an arbitration agreement, which will be examined in detail below.

At the time the account was opened, or soon thereafter, Friedlander became the representative on Scher's account and contacted Scher about other investment opportunities. Def. Memorandum p. 4; Complaint ¶¶ 8, 9, 10. Scher agreed to participate in at least one of the investments offered by Friedlander, and, accordingly, Scher began to keep large amounts of cash in his account at Bear Stearns, ranging from between $1,000,000 and $4,000,000, during the period of his dealings with Bear Stearns. Complaint ¶¶ 14, 15. Scher alleges that Friedlander, in handling Scher's account, made numerous misrepresentations regarding the risk involved and the status of the account, made excessive trades in the account in order to increase defendants' transactional profits, selected unwise and unduly risky investments, and consistently failed to consult Scher about actions taken on the account. Complaint ¶¶ 17, 18, 19, 20. Scher claims that as a result of this misconduct he suffered losses in excess of $1,500,000.

Scher commenced this action on October 27, 1988. The first and fifth claims for relief alleged violations of the federal securities laws. The second, third, fourth, and sixth claims for relief allege common law causes of action for breach of fiduciary duty, breach of contract, negligence, and fraud. On February 1, 1989, pursuant to the arbitration clause contained in the Customer Agreement, Scher agreed to withdraw the second, third, fourth, and sixth claims for relief against Bear Stearns — all of which constitute state common law causes of action — and submit those common law claims to arbitration. Scher refused, however, to submit to arbitration the first and fifth claims for relief which arise under the federal securities laws. Plaintiff has also refused to submit any of his claims against Friedlander — arising under common or federal law — to arbitration. Defendants have moved to compel arbitration of the federal securities law claims against Bear Stearns and of all claims against Friedlander.

DISCUSSION

1. Arbitration of Securities Law Claims

The question of whether the Bear Stearns Customer Agreement signed by Scher mandates the submission to arbitration of claims arising under the federal securities law turns upon a parsing of the language of the contractual arbitration clause in that Customer Agreement. The arbitration clause that the Court is asked to consider reads in relevant part:

Any controversy arising out of or relating to your account in connection with transactions between us or pursuant 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., the Board of Governors of the New York Stock Exchange, Inc. or the Board of Governors of the American Stock Exchange, Inc. as you may elect.... Judgment upon any award rendered by the arbitrators may be entered in any court having jurisdiction thereof. You understand that this Agreement to arbitrate does not constitute a waiver of your right to a judicial forum where such a waiver would be void under the securities laws and specifically does not prohibit you from pursuing any claim or claims arising under the federal securities law in any court of competent jurisdiction.

Exhibit A, attached to Hubbert Aff. (emphasis added).

This contractual arbitration clause in whole is similar to clauses previously included in many investment and account agreements throughout the securities industry. These contractual clauses and questions regarding their reach have frequently been before this and other courts in recent years. The issue of the scope of this clause essentially reduces itself to whether the emphasized language above is part of a mere notice provision, or whether it gives a substantive contractual right to litigate federal securities claims regardless of the arbitrability of other related claims.

While the Second Circuit has not yet reached the issue of the scope of this or other similar arbitration clauses, the Court is not without substantial, though not always consistent, guidance from other courts. Before examining the case law, however, it is essential to review briefly the history and context of this semantic dispute.

It was the original teaching of the courts that a party could not contract away its right to a federal judicial forum for claims arising under the securities laws. See Wilko v. Swan, 346 U.S. 427, 74 S.Ct. 182, 98 L.Ed. 168 (1953) (claims under the Exchange Act of 1933) and its progeny. The Securities and Exchange Commission ("SEC") included that position in its own framework in Rule 15c2-2, explicitly excepting claims under the federal securities laws from pre-dispute arbitration agreements. The Rule stated in part:

It shall be a fraudulent, manipulative or deceptive act or practice for a broker or dealer to enter into an agreement with any public customer which purports to bind the customer to the arbitration of future disputes between them arising under the federal securities laws, or to have in effect such an agreement, pursuant to which it effects transactions with or for a customer.

Former 17 C.F.R. § 240.15c2-2(a) (1987). In compliance with this rule, brokers whose customer agreements provided for arbitration included in their arbitration clauses language specifically noting that federal securities law claims were exempt from the arbitration provisions. The SEC itself provided a form disclosure statement, which could be adopted to comply with the rule. See, former 17 C.F.R. § 240.15c2-2(b).

In recent years, there have been significant changes in the relationship of the policies underlying arbitration and the federal securities law. The most important of these changes came in Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 107 S.Ct. 2332, 96 L.Ed.2d 185 (1987), where the Supreme Court held that an arbitration agreement between a broker and a customer is enforceable as to claims arising under the Securities Exchange Act of 1934.¹ In light of McMahon the SEC rescinded Rule 15c2-2. See, SEC Exchange Act Release No. 25034 1987 Transfer Binder Fed Sec.L.Rep. (CCH) ¶ 84,163 (October 15, 1987).

Under McMahon and Rodriguez, and with the withdrawal of Rule 15c2-2, there is no legal reason a plaintiff's federal securities laws claims should not be arbitrable. Under current law, the question thus becomes whether there was a contract between these parties to arbitrate federal securities claims. More specifically, the Court must address whether the parties agreed to arbitrate all claims to the full extent allowed under the law — and merely include a notice provision then required that certain claims were non-arbitrable — or whether all federal securities claims were explicitly excluded from the arbitration agreement regardless of the state of the law.

Accordingly, it is apparent that this is an issue of contract interpretation. It is fundamental that arbitration agreements are creatures of contract law. Pompano-Windy City Partners v. Bear, Stearns, Inc., 698 F.Supp. 504 (S.D.N.Y.1988). Arbitration contract clauses cannot be interpreted in a policy vacuum, however. Both Congress and the courts have expressed a leaning toward arbitration. Congress first put forward its support of arbitration as a means of dispute resolution in the Federal Arbitration Act, 9 U.S.C. § 1, et...