by Alex Lewis
Within the world of securities arbitration, a recent series of court decisions have threatened to destabilize the ability of investors to arbitrate their claims before the Financial Industry Regulatory Authority (FINRA) instead of bringing their claims in court. Those cases have arisen out of arbitration claims filed against Morgan Keegan due to the collapse of the Regions Morgan Keegan (“RMK”) funds. For more details on the RMK funds, click here.
Arbitration is traditionally a matter of contract and can only be compelled where two parties have agreed to do so. If the parties have not agreed to arbitrate, one party cannot normally force the opposing party to arbitrate. However, under FINRA rule 12200, a “customer” of a FINRA member such as Morgan Keegan may force the member to arbitrate a claim – rather than filing the claim in court – even without a contractual agreement to arbitrate. The disputes in the Morgan Keegan cases arise from the ambiguity in the FINRA definition of “customer”. FINRA rule 12100(i) simply states that, “A ‘customer’ shall not include a broker or dealer.” It has been up to the courts to interpret this vague definition of the term “customer”.
In the line of cases dealing with the RMK funds, investors who did not have accounts with Morgan Keegan have attempted to compel Morgan Keegan to arbitrate their claims relating to the RMK funds. These investors argue that as “customers” of Morgan Keegan, Morgan Keegan did in fact agree to arbitrate the claims as a condition of FINRA membership. They allege that the RMK funds were overleveraged and marketed by Morgan Keegan as safer than they actually were. The investors allege that, in purchasing the RMK funds, they relied on marketing materials provided by Morgan Keegan. They further allege that management of the RMK funds by a Morgan Keegan affiliate supports their position. These investors have sought to compel Morgan Keegan to arbitrate their claims for losses on investments in the RMK funds, despite the fact that they did not hold accounts directly with Morgan Keegan. However, the courts have found that because the investors purchased shares of the RMK funds through third-party broker-dealers with no affiliation with Morgan Keegan, the investors were not “customers” of Morgan Keegan under the FINRA rules, and thus, cannot compel Morgan Keegan to arbitrate. The courts in the Morgan Keegan cases are thus establishing a rule that there a “customer” must have a direct investment relationship with the broker-dealer.
The case primarily relied on by the courts in the Morgan Keegan cases is Fleet Boston Robertson Stephens, Inc. v. Innovex, Inc. In Fleet Boston, a brokerage firm filed a claim against a company for breach of contract, claiming that the company had failed to pay certain fees and expenses. The brokerage firm had provided advice to the company regarding its acquisition of stock in a merger. The company filed a motion to stay litigation and compel arbitration, but the motion was denied on the grounds that the company was not a “customer” under the FINRA rules.
The court in Fleet Boston determined that the company was not a “customer” under the FINRA rules on the grounds that the claim did not arise out of investment or brokerage services. The court found that it was inappropriate to apply the FINRA rule in a strict sense due to the fact that such an application would be overly broad. The court further stated that the claim arose out of services that were too remote for a FINRA member to reasonably expect to arbitrate them solely due to its FINRA membership.
The recent Morgan Keegan decisions thwart investor’s ability to compel arbitration when the investor does not have a direct investment relationship with the FINRA member, even if the FINRA member distributed marketing materials that misrepresented the risk of investing in a fund managed by an affiliate. These rulings promote a line of reasoning that reads additional conditions into the FINRA definition of “customer”. The basis for this reasoning is the precedent established in the Fleet Boston case.
At the same time, other courts that have ruled more favorably for investors in similar cases. In a recent case, Twenty-First Securities Corporation v. Crawford, the Second Circuit Court of Appeals found that an investor was a “customer” of a member due the investor’s reliance on the member firm’s investment advice despite the fact that the customer did not have an account with the firm. Thus, while the Morgan Keegan cases present setbacks for investors seeking to arbitrate their claims, there are still courts willing to find in favor of the investors and compel member firms to arbitrate claims.
The relevant Morgan Keegan Cases are Morgan Keegan & Co., Inc. v. McPoland, 829 F.Supp. 2d 1031 (W.D. Wash. 2011); Morgan Keegan & Co., Inc. v. Johnson, 2011 WL 7789796 (E.D. Vir. 2011); Morgan Keegan & Co., Inc. v. Louise Silverman Trust, et al., 2012 WL 113400 (U.S.D.C. Maryland 2012), aff’d Morgan Keegan & Co., Inc. v. Louise Silverman et al., 2013 U.S. App. LEXIS (Feb. 4, 2013); Zarecor v. Morgan Keegan & Co., Inc., 2011 WL 5592861 (E.D. Ark. Jul. 29, 2011).