Spear, Leeds & Kellogg v. Central Life Assur. Co., 331

• Decision Date: 16 May 1996
• Docket Number: D,No. 331,331
• Citation: 85 F.3d 21
• Parties: , Comm. Fut. L. Rep. P 26,694 SPEAR, LEEDS & KELLOGG, Plaintiff-Appellee, v. CENTRAL LIFE ASSURANCE COMPANY, Alexander Hamilton Life Insurance Company of America, Inc., Canada Life Assurance Co., Defendants-Appellants. ocket 95-7372.
• Court: U.S. Court of Appeals — Second Circuit

Page 21

85 F.3d 21

64 USLW 2761, Comm. Fut. L. Rep. P 26,694

SPEAR, LEEDS & KELLOGG, Plaintiff-Appellee, v. CENTRAL LIFE ASSURANCE COMPANY, Alexander Hamilton Life Insurance Company of America, Inc., Canada Life Assurance Co., Defendants-Appellants.

No. 331, Docket 95-7372.

United States Court of Appeals Second Circuit.

Argued Oct. 16, 1995.

Decided May 16, 1996.

J. Michael Vaughan, Kansas City, Missouri (Heidi R. Youngs, Weisenfels & Vaughan, Kansas City, Missouri; John J. Phelan, III, New York City, of counsel), for Defendants-Appellants.

Howard Schiffman, New York City (Woody N. Peterson, Dickstein, Shapiro & Morin, New York City, and Washington, DC; David Yeres, Rogers & Wells, New York City, of counsel), for Plaintiff-Appellee.

Before CARDAMONE and MAHONEY, Circuit Judges and POLLACK, ^* District Judge.

Judge POLLACK dissents in a separate opinion.

CARDAMONE, Circuit Judge:

On this appeal from the grant of a preliminary injunction enjoining arbitration, issued by the United States District Court for the Southern District of New York (Duffy, J.), we are asked to decide whether plaintiff Spear, Leeds & Kellogg (plaintiff, broker, or Spear, Leeds), a member of the New York Stock Exchange (N.Y.SE or Exchange), is required under the Exchange's Constitution and Arbitration Rules to arbitrate a dispute with the defendants-appellants Central Life Assurance Company, Alexander Hamilton Life Insurance Company of America, Inc., and Canada Life Assurance Company (defendants, appellants, or insurance companies). None of the defendants are Exchange members. The district court granted the injunction barring arbitration because it found there was no contract between the parties to arbitrate.

In so ruling the district judge relied on our decision denying arbitration in Paine, Webber, Jackson & Curtis, Inc. v. Chase Manhattan Bank, N.A., 728 F.2d 577 (2d Cir.1984). There, the dispute--unrelated to exchange business--was between defendants that were not NYSE members and a plaintiff that was a member. We held that because the alleged improper conduct was by the non-member, arbitration should be limited to those disputes

                that come about as a result of the member's exchange-related business.  Id. at 580.   The dispute before us today arises between a member and non-member of the Exchange, but unlike Paine Webber, the non-member is the alleged victim of the member's conduct, and the dispute is related to the member's exchange activities.   In our view the instant dispute is arbitrable.   Accordingly, we reverse
                

BACKGROUND

Spear, Leeds--as a registered futures commission merchant and a member of the NYSE--agreed upon joining the NYSE to act in accordance with its Constitution and Arbitration Rules. The three life insurance companies defendants are not members of the Exchange, but have demanded arbitration pursuant to the Exchange's Constitution and Rules. See Spear, Leeds & Kellogg v. Central Life Assurance Co., 879 F.Supp. 403 (S.D.N.Y.1995). In order to understand the legal issues raised on this appeal, a brief discussion of the underlying facts is necessary.

I Facts

Spear, Leeds opened an account and several sub-accounts on behalf of Marvin Goodman in November 1990. Goodman, previously a customer of Balfour Maclaine Futures, Inc. (another registered futures commission merchant), was reputed to be a successful commodities trader, trading for his own account, for his family, and for a rather sizeable select group of clients. When a background check disclosed no financial or regulatory problems associated with Goodman, Spear, Leeds accepted him as a customer.

Goodman's clients' accounts were listed on Spear, Leeds records as "sub-accounts" of Goodman's account. As such, the accounts were charged a lower commission rate. Professing concern that should he die suddenly, delays in the probate of his estate might create certain risks in his sub-account arrangement, Goodman purchased life insurance and put it in irrevocable trusts so that upon his death his clients would immediately be paid the equity balances in their accounts. At the end of 1990 the trusts held $20 million of life insurance on Goodman's life.

Because of his expanding commodity trading business, Goodman set out in 1991 to augment this life insurance plan. The three insurance companies were persuaded to issue additional life insurance policies totalling $3 million. To obtain this additional insurance Goodman was required to explain his method of trading and why he needed additional insurance. Thus, he provided defendants with detailed financial information regarding his accounts at Spear, Leeds. Defendants were shown the broker's account statements with significant positive account balances--between $17.5 and $20.5 million dollars.

Goodman's plans for the protection of his clients' financial security did protect them on his untimely death, but for the defendant insurance companies, Goodman's plans proved to be fraudulent. See Spear, Leeds, 879 F.Supp. at 404. And, according to the defendants, Spear, Leeds played a vital role in helping Goodman defraud them. The broker generated and mailed monthly account statements to Goodman and his clients. These account statements--subsequently provided to the insurance companies by Goodman--provided a basis for them to extend the additional insurance to Goodman.

According to the defendants, the monthly profits noted in the sub-account statements were illegitimate, a reflection of "arbitrary and concocted directions" from Goodman that bore no relation to his actual trading. The insurance companies further allege that the broker made numerous errors in maintaining its account records. It did not segregate the balances of Goodman's sub-accounts, as shown on the face of the statements, and instead listed the accounts on a "net basis." This resulted in substantial overstatements of actual account balances. Because the accounts were carried on a "net basis" rather than a "gross basis," defendants never learned Goodman's true financial status before issuing the life insurance policies. Hence, Spear, Leeds is charged by defendants with preparing and mailing misleading and false monthly statements that obscured Goodman's trading activities and the reality of his financial condition.

In August 1991 the NYSE, while conducting a routine investigation, discovered Goodman's fraud. Jeffrey Zinn, an Exchange investigator, was alerted by the unusual number of sub-accounts (approximately 86) that Goodman had with Spear, Leeds. The broker stated it knew only of Goodman's interest in the accounts, but it acknowledged mailing statements concerning the many sub-accounts to others. Although Spear, Leeds had the names and addresses for mailing purposes, it maintained no opening account documents establishing these sub-accounts. The broker stated that Goodman was its customer--not the sub-account parties--and conceded that his total account balance was actually closer to $2 million than the $17-$20 million presented to defendants by Goodman.

The Commodity Futures Trading Commission (Commission) also instituted an enforcement action and froze Goodman's assets. On December 17, 1991, before the conclusion of the Commission's proceedings, Goodman died. Accordingly, under the terms of the insurance trusts, Goodman's investment clients received payments from the insurance companies equal to the equity the clients thought they had in the Spear, Leeds sub-accounts. Defendants argue that these insurance monies saved Goodman's clients, the individual victims of the fraud, from any loss, and in fact provided them with a windfall.

II Procedural History

These developments led to three actions between Spear, Leeds and the insurance companies. First, the insurance companies filed an arbitration claim before the NYSE on December 15, 1993, seeking to recover against Spear, Leeds in accordance with the NYSE Constitution and Rules. The essence of that claim is that the broker participated in Goodman's fraudulent scheme by issuing false and misleading account statements to Goodman and his customers. Because the insurance companies would not have issued the life insurance policies without these favorable account statements, they asserted, their losses were directly caused by the broker's actions. The statement of claim seeks relief on the basis of common law theories--principally negligence and fraud--as well as under 18 U.S.C. § 1962(a), (c), (d) (civil RICO), pointing to specific findings made by the NYSE in the course of its investigation. It refers to Spear, Leeds' violations of NYSE rules and its consent to the imposition of a $75,000 fine and a censure by the NYSE. The Commission also reached an agreement with Spear, Leeds under which the broker consented to a $325,000 penalty and its managers were fined and suspended for their activities in connection with Goodman's account. The three insurance companies sought damages totalling just over $1.9 million.

In order to avoid arbitration, plaintiff filed the instant action in the Southern District of New York and moved for a preliminary injunction enjoining the insurance companies from compelling arbitration. A week later, the insurance companies instituted an action in the United States District Court for the District of Nebraska (the situs of the proposed arbitration) seeking to compel arbitration under the Federal Arbitration Act (FAA), 9 U.S.C. § 4 (1994). On March 9, 1994 the parties agreed to stay the Nebraska action and to be bound by the arbitrability determination in the New York action now before us.

The district court decided the case on March 30, 1995. It found no contract to arbitrate, and that in its absence and the absence of any transactional nexus between Spear, Leeds and the insurance companies, compelling arbitration would be inappropriate. See Spear, Leeds, 879 F.Supp. at 406. From the order granting an injunction staying arbitration, the insurance companies appeal.

DISCUSSION...