Matthew W. Woodruff ()
Three recent decisions1 from the Southern District of New York have now enjoined a customer from proceeding with arbitration against a member of FINRA on the ground that the combination of a merger clause and a forum-selection clause in a contract between the parties “overrides” or “supplants” the customer’s right to arbitrate under FINRA Rule 12200.2 Passing the question of whether a federal court may ever issue an injunction in a case where a federal statute provides complete relief,3 the decisions in the three cases—Goldman, Sachs & Co. v. Golden Empire Schools Financing Authority (Golden Empire), Citigroup Global Markets v. North Carolina Eastern Municipal Power Agency (Citigroup) and Goldman, Sachs & Co. v. North Carolina Municipal Power Agency No. One (NCMPAI)—raise a fundamental question about how an “agreement in writing for arbitration” is made for purposes of Section 4 of the Federal Arbitration Act when a customer initiates arbitration by “request” under the FINRA Code.
The facts of Golden Empire serve as a paradigm for all three cases: In Golden Empire, the customer engaged a member of FINRA to raise capital through the issuance of so-called “auction rate securities.” The member acted as an underwriter pursuant to an “underwriting agreement” and also as a broker-dealer pursuant to a “broker-dealer agreement.” Neither agreement contained an arbitration clause, but the broker-dealer agreement did contain a merger clause and a forum-selection clause.
The collapse of the market for auction rate securities gave rise to a dispute between the parties, which the customer sought to arbitrate by “request” under FINRA Rule 12200. Although FINRA accepted the dispute for arbitration, the Golden Empire court issued an injunction on the ground that by agreeing to the merger and forum-selection clauses, the customer had waived or revoked its right to arbitrate. The district courts in Citigroup and NCMPAI followed the analysis in Golden Empire and reached the same result.4
Two Sets of Decisions
All three district court cases relied upon the U.S. Court of Appeals for the Second Circuit’s opinions in Bank Julius Baer5 and Applied Energetics6 even though the facts underlying the two sets of decisions are significantly different. In Bank Julius Baer and Applied Energetics, the parties first executed an agreement containing an arbitration clause and then executed an agreement that contained merger and forum-selection clauses. The question was whether the second agreement superseded the first. In Bank Julius Baer the court reviewed the agreements and concluded that “neither the Merger Clause nor the Forum Selection Clause contained in the Pledge Agreements vitiates the Arbitration Agreement.”
In Applied Energetics, the Second Circuit reviewed a similar set of agreements that contained different terms and reached a different conclusion, viz.: that “contracting parties are free to revoke an earlier agreement to arbitrate by executing a subsequent agreement the terms of which plainly preclude arbitration.”
While parties in future cases may dispute whether the terms of their own agreements are more like those of Bank Julius Baer or of Applied Energetics, the overarching rule in the Second Circuit seems clear: Sufficiently precise wording in a subsequently executed agreement will be held to revoke an existing arbitration clause. Parties, of course, have always been able to do that by express agreement: Bank Julius Baer and Applied Energetics merely describe the circumstances under which such intent will (or will not) be inferred from merger and forum-selection clauses.
In Golden Empire, Citigroup and NCMPAI, on the other hand, the parties did not enter into any agreement containing an arbitration clause. Instead, they only entered into an agreement containing merger and forum-selection clauses. There was no “conflict” because an arbitration clause did not exist. A conflict arose—if it arose at all—only when the customer subsequently made a “request” to arbitrate under FINRA Rule 12200. Under the reasoning of Bank Julius Baer and Applied Energetics, however, the agreement to arbitrate formed upon the customer’s request should be the “superseding” agreement. Nonetheless, the Golden Empire court (followed by the courts in Citigroup and NCMPAI) drew the opposite conclusion, holding that the forum-selection clause had revoked the “arbitration agreement in FINRA Rule §12200.”7 As discussed below, this latter conclusion appears to be in error.
Rule and Agreement
Although the Second Circuit has held that the rules of a self-regulatory organization like FINRA are “contractual in nature” and may serve as the “agreement in writing for arbitration” required by Section 4 of the Federal Arbitration Act,8 the court has done so only in the context of a customer’s request for arbitration—not in lieu of one. FINRA Rule 12200 does not contain an arbitration agreement and does not create a “right” to arbitrate (which would continue to exist under the common law even if FINRA Rule 12200 were abrogated).
As a self-regulatory organization under the federal securities laws, however, FINRA does provide a forum for the arbitration of disputes arising out of the business activities of its members, as well as a set of rules by which such arbitrations are to be conducted. Under FINRA Rule 12200, there must be either a “written agreement” between the parties or a “request” by the customer before the parties can be required to arbitrate. If neither exists (as was initially the case in Golden Empire, Citigroup and NCMPAI), the parties must resolve their dispute by litigation instead.
Under those circumstances—as with other common-law contracts—there is nothing that prevents parties from selecting a forum in which to conduct any litigation that may occur. Because litigation is the default method of dispute resolution, the “exclusivity” of litigation in cases like Golden Empire,Citigroup and NCMPAI derives from the fact that the parties did not make an agreement to arbitrate. Whether the parties agreed further on a specific forum in which to litigate (and also included a merger clause in their agreement) does not fundamentally change the analysis. For the same reason, the use of terms like “all claims” or “any claims,” the verb “adjudicate” or a mandatory “shall” does not make a forum-selection clause any “more” exclusive.9 Even without such terms, litigation would still be the exclusive method of dispute resolution in the absence of an arbitration agreement.
Thus, the inference drawn by the district courts in Golden Empire, Citigroup and NCMPAI from the existence of a forum-selection clause—with or without a merger clause—does not appear to be justified. In such a case, a forum-selection clause only means that the parties have not (yet) agreed to change the default rule of the legal system that requires all disputes to be resolved by litigation; it does not mean that the parties cannot agree to arbitrate in the future. The Second Circuit reached just such a conclusion in Kidder, Peabody & Co. v. Zinsmeyer Trusts Partnership.
In that case, the parties had agreed to strike a pre-dispute arbitration clause (“Paragraph 16″) from their customer agreement—thereby indicating in the clearest possible way their joint intent not to arbitrate claims arising out of their relationship. When the customer subsequently made a “demand” for arbitration under former NASD Code §12(a), the member argued that “the deletion of paragraph 16 must be construed to eliminate any duty to arbitrate, and that the act of striking the paragraph otherwise would carry no meaning.”
The Second Circuit rejected this argument, holding that the “elimination of such a superseding clause…does not signify an intention to erase a pre-existing obligation.” The main difference between Zinsmeyer and Golden Empire is that in Zinsmeyer the parties made—or at least considered making—a superseding arbitration clause before striking it, whereas in Golden Empire they didn’t even get that far. The “waiver” that the district court inferred from a party’s silence or inaction in Golden Empire, in other words, is a “waiver” that the Second Circuit specifically declined to infer from the parties’ actual conduct.
Finally, although a party that accepts the benefit of litigation to the prejudice of its adversary may be estopped from proceeding with arbitration,10 the mere selection of a forum for potential litigation does not rise to the level of an estoppel. When a party sues in court, it “selects” a forum with even greater specificity than under a contractual forum-selection clause. Nonetheless, in the Second Circuit the mere filing of a lawsuit does not constitute “prejudice” and will not support a finding of waiver.11
The “pre-existing obligation” that the Second Circuit referred to in Zinsmeyer is a member’s obligation to submit a dispute to arbitration at the request of a customer. Although the Second Circuit has held that a customer is an intended third-party beneficiary of a firm’s membership agreement with its self-regulatory organization and may therefore “invoke” arbitration with a member pursuant to that agreement,12 it is only when the customer actually invokes those rights that an arbitration agreement comes into existence. Before then, arbitration on “request” is optional with the customer and litigation remains the default method of dispute resolution.
After the customer elects arbitration, on the other hand, FINRA’s written Submission Agreement—which the customer must execute as a necessary part of any “invocation”13—becomes the final expression of the parties’ agreement to arbitrate and supersedes any prior inconsistent or conflicting promise. In either case, arbitration is not precluded by even the most “exclusive” of forum selection clauses.
Matthew W. Woodruff practices in New York City and represents individual and institutional investors in securities arbitration and litigation.
1. See Goldman, Sachs & Co. v. Golden Empire Schools Financing Authority, slip op., No. 12 Civ. 4558 (RJS) (S.D.N.Y. Feb. 8, 2013), 2013 WL 500888; Citigroup Global Markets v. North Carolina Eastern Mun. Power Agency, slip op., No. 13 CV 1703 (JMF) (S.D.N.Y. May 5, 2013); and Goldman, Sachs & Co. v. North Carolina Mun. Power Agency No. One, slip op., No. 13 Civ. 1319 (PAC) (S.D.N.Y. Dec. 9, 2013) (NCMPAI), 2013 WL 6409348. In Citigroup, Judge Furman ruled from the bench; the transcript is available on PACER.
2. FINRA Rule 12200 provides in relevant part: “Parties must arbitrate a dispute under the Code if: Arbitration under the Code is either: (1) Required by a written agreement, or (2) Requested by the customer;….”
3. See Pennsylvania Bureau of Correction v. United States Marshals Service, 474 U.S. 34, 43 (1985). Whether a district court may issue an injunction against arbitration to protect an existing judgment, see, e.g., In re American Express Fin. Advisors Sec. Litig., 672 F.3d 113 (2d Cir. 2011), is a separate issue that was not presented in any of the cases considered here.
4. Similar issues were addressed in Patten Securities Corp. v. Diamond Greyhound & Genetics, 819 F.2d 400 (3d Cir. 1987), and UBS Financial Services v. Carilion Clinic, 706 F.3d 319 (4th Cir. 2013), as well as by district courts in Biremis, Corp. v. Merrill Lynch, Pierce, Fenner & Smith, slip op., No. 11 Civ. 4934 (LDW) (E.D.N.Y. March 8, 2012), and Goldman, Sachs & Co. v. City of Reno, slip op., No. 3:12-cv-00327-RJC-WGC (Nov. 26, 2012 D. Nev.). See also UBS Financial Services, Inc. v. West Virginia University Hospitals, 660 F.3d 643 (2d Cir. 2011).
5. Bank Julius Baer & Co. v. Waxfield, 424 F.3d 278 (2d Cir. 2005).
6. Applied Energetics v. NewOak Capital Markets, 645 F.3d 522 (2d Cir. 2011).
7. Golden Empire, 2013 WL 500888 at *3. See also Citigroup Tr. at 62; NCMPAI, 2013 WL 6409348 at *5.
8. Kidder, Peabody & Co. v. Zinsmeyer Trusts P’ship, 41 F.3d 861, 864 (2d Cir. 1994).
9. See Applied Energetics, 645 F.3d at 525-26.
10. Cotton v. Slone, 4 F.3d 176, 179 (2nd Cir. 1993); In re American Express Fin. Advisors Sec. Litig., supra.
11. Leadertex v. Morganton Dyeing & Finishing, 67 F.3d 20 (2d Cir. 1995).
12. See also Spear, Leeds & Kellogg v. Central Life Ins., 85 F.3d 21, 27 (2d Cir. 1996); UBS Financial Services, supra.
13. FINRA Rule 12307. The same result follows even more directly under the Second Circuit’s “standing offer” theory. See Republic of Ecuador v. Chevron, 638 F.3d 384, 392 (2d Cir. 2011).