Merrill Lynch, Pierce, Fenner & Smith Inc. v. Cantone Research Inc., A-2680-10T1; Appellate Division; opinion by St. John, J.S.C., temporarily assigned; decided and approved for publication June 27, 2012. Before Judges Cuff, Waugh and St. John. On appeal from the Law Division, Morris County, L-2646-10 and L-3131-10. [Sat below: Judge Dumont.] DDS No. 03-2-6780 [22 pp.]
Merrill Lynch is a securities broker-dealer registered with the Financial Industry Regulatory Authority Inc. (FINRA). Andrew Katchen is registered with FINRA as an associated person of Merrill. Defendants Cantone Research Inc., PNC Investments Inc., and J.J.B. Hilliard, W.L. Lyons, L.L.C., are securities broker-dealers also registered with FINRA. The individual defendants are registered with FINRA as associated persons of Cantone.
Four groups of investors who were victims of a Ponzi scheme filed suit against the perpetrator and Merrill, where he maintained an investment account to facilitate the fraud. Merrill’s motion for dismissal was granted and plaintiffs’ cross-motion for an order compelling FINRA arbitration was denied on the basis that the investors were not customers of Merrill and it owed them no duty.
In the interim, the investors filed FINRA arbitration actions (the Frederick and Tedeschi arbitrations). Cantone filed third-party arbitration claims against plaintiffs, seeking contribution and indemnification if it were found liable to the investors in those actions. Plaintiffs filed two complaints against Cantone seeking to enjoin them from pursuing their third-party contribution claims. Orders to show cause were issued requiring Cantone to show why they should not be enjoined from proceeding with their third-party claims.
The motion judge held that the court has the authority to decide arbitrability and found that plaintiffs are not required to arbitrate because there is no arbitration agreement or any provision in the FINRA customer code or industry code requiring arbitration of the claim. He preliminarily enjoined Cantone from proceeding with their third-party claims against plaintiffs in the Frederick and Tedeschi arbitrations and denied Hilliard Lyons and PNCI’s cross-motions to compel plaintiffs to FINRA arbitration.
On appeal, defendants argue the motion judge lacked authority to interpret FINRA’s customer and industry codes, and erred in failing to order their claims to FINRA arbitration and in finding their claims derivative of the investors’ and barring them from seeking contribution and indemnification in the arbitration.
Held: The court has the authority to determine whether an arbitration agreement exists between the parties and whether FINRA’s regulations require the parties to arbitrate. Plaintiffs cannot be compelled to arbitrate in the absence of a specific agreement to do so or covered, exchange-related transactions with defendants. Therefore, the orders enjoining defendants from pursuing their third-party arbitration claims for contribution and indemnification are affirmed.
The panel reaffirms that arbitration is favored as a means of resolving disputes but that arbitration is a matter of contract and a party cannot be required to submit to arbitration any dispute that he has not agreed so to submit.
The motion judge’s responsibility to decide the issue of arbitrability depends on whether it is an issue of substantive arbitrability or procedural arbitrability. Substantive arbitrability refers to whether the grievance is within the scope of the clause specifying what the parties have agreed to arbitrate. Procedural arbitrability refers to whether a party has met the procedural conditions for arbitration. Matters of procedural arbitrability should be left to the arbitrator. Whether the parties have submitted a particular dispute to arbitration is a judicial decision, unless the parties clearly and unmistakably provide otherwise.
The panel says the Law Division was the correct venue for plaintiffs to pursue a determination as to whether the parties agreed to arbitrate.
It then says here, there was no written arbitration agreement between the parties concerning the Frederick and Tedeschi arbitrations. Defendants have failed to advance any support for their contention that simply because Merrill and defendants were all FINRA members, they have somehow consented to arbitration for all claims that arise between them. Defendants have failed to show that Merrill was acting in any way as a broker-dealer for any of the parties or that it engaged in a covered, exchange-related transaction with any defendant.
The motion judge accurately determined that the basis for the contribution and indemnification claims was not a dispute between industry members, as it was derivative in nature and contingent on the initial dispute between defendants and the investors. Therefore, the industry code, which compels arbitration between member firms, does not apply. Likewise, the customer code does not apply to plaintiffs because neither defendants nor the investors are customers, as defined by the customer code, of Merrill.
FINRA members are required to submit to arbitration only if an agreement between them exists. Without such an agreement, and without an exchange-related dispute that triggers the mandatory arbitration clause of the industry code, the issue of arbitrability is for the motion judge.
The panel rejects defendants’ claim that the courts are not a proper venue to seek contribution or indemnification because FINRA’s code of arbitration governs these types of disputes. It says when no arbitration agreement exists or if there is a disagreement about whether an arbitration clause applies to a particular type of controversy, the Supreme Court has reserved such issues for the courts.
Finally, the panel says it sees no reason to disturb the grant of injunctive relief.
For appellants: Cantone Research Inc. et al. — George Cieri; PNC Investments — Lubiner & Schmidt (David W. Schmidt of counsel; John E. Jenkins on the briefs); J.J.B. Hilliard and W.L. Lyons — Stark & Stark (Thomas B. Lewis and Michael J. Brittan on the briefs). For respondents — Bressler, Amery & Ross (David J. Libowsky on the brief).