By Shepherd D. Tate and Ryan R. Baker 

In recent years, there has been an increase in the number of FINRA arbitrations brought by investors against brokerage firms or associated persons with whom the investors were not customers.   Typical examples include: (1) claims brought by secondary market purchasers against underwriters; (2) claims brought by purchasers who claim to have spoken with a representative about a particular security but purchased the security elsewhere; (3) claims brought against a brokerage firm by investors harmed by a Ponzi scheme who had no direct relationship with the brokerage firm; instead, they transferred securities to a third party, appointed that third party their agent and the third party transferred the securities to an account in its name at the brokerage firm; and (4) claims brought by investors against several brokerage firms for failing to detect fraud where the investors entrusted their securities to a third party which then comingled assets and used them to fund unauthorized, speculative trading in accounts at several firms.

Outside of the often sketchy allegations in the Statement of Claim, the firm often has no knowledge of such critical facts as the investor’s background, experience, financial circumstances, the information available or presented to the investor, or the information relied upon by the investor.  Putting aside the obvious proof hurdles that exist for the investor to prevail on the merits, careful consideration should be given to the strategic decisions made when defending against such claims.

The first decision is whether the respondent should defend the claims on the merits, or should challenge the arbitrability of the claims.  Among other things, when weighing this decision, the respondent should consider the differences between arbitration and litigation, including the quality of the trier of fact, the ability to present legal defenses, the applicable discovery procedures, the available motion practice and the nature of post-hearing relief.  If, after weighing these considerations, the respondent decides to consent to arbitrate the claims, the firm simply proceeds as it would with traditional customer arbitration.  On the other hand, if the respondent determines that it would be beneficial to challenge the arbitrability of the claims, the respondent can employ several approaches prior, during and after the arbitration.

Seeking injunctive relief prior to participating in arbitration 

Prior to participating in the arbitration, the respondent can request a court to enjoin the arbitration from proceeding because there is no agreement or rule requiring arbitration.  In the context of FINRA arbitrations, an agreement to arbitrate may be found in a written agreement — typically an arbitration clause in a customer agreement — or in FINRA Rule 12200, which requires member firms and associated persons to arbitrate a claim when “requested by the customer” regardless of whether a written agreement exists.  Although the term “customer” is not directly defined in the FINRA Rules, courts have declined to find a customer relationship where there is no “brokerage or investment relationship between the parties.”  See Fleet Boston Robertson Stephens Inc. v. Innovex Inc., 264 F. 3d 770, 772 (8th Cir. 2001).  For this reason, respondents in non-customer cases who wish to challenge the jurisdiction of the arbitrators can initially seek an injunction to prohibit the proceeding.  See, e.g., UBS Sec. LLC v. Vogeli, 684 F. Supp. 2d 351, 356 (S.D.N.Y. 2010), aff’d 2011 WL 13465 (2d Cir. Jan. 4, 2011).

Objecting and moving to dismiss during arbitration 

Another approach is to object to the arbitrators’ jurisdiction by noting such on any required submission agreement (such as FINRA’s Uniform Submission Agreement), by objecting to jurisdiction in the Answer and other pleadings and by filing a motion to dismiss.  With respect to filing a motion to dismiss, FINRA adopted Rule 12504 in 2009 to provide specific procedures and limitations for motions to dismiss in arbitration.  One of the few grounds remaining for a motion to dismiss is where “the moving party was not associated with the account(s), security(ies), or conduct at issue.”  FINRA Rule 12504(a)(6)(B).  FINRA explained in Regulatory Notice 09-07 that “the panel could grant a motion to dismiss under this exception if a party files a claim against the wrong person or entity, or a claim names an individual who was not employed by the firm during the time of the dispute, or a claim names an individual or entity that was not connected to an account, security or conduct at the firm during the time of the dispute.”  Id. at 5.  A number of FINRA arbitration panels have dismissed non-customer claims under Rule 12504(a)(6).

Challenging the award after arbitration 

In the event the request in court for injunctive relief or a motion in arbitration to dismiss the statement of claim prove unsuccessful, a respondent can also challenge the arbitrability of the dispute after the arbitration through a motion to vacate the arbitrators’ award.  There are several bases for challenging an award obtained without an appropriate jurisdictional basis.  For example, Section 10(a)(4) of the Federal Arbitration Act provides that a court may vacate an arbitration award “where the arbitrators exceeded their powers.”  Under this approach, because there is no agreement to arbitrate (either by contract or through FINRA’s Rules), the arbitrators necessarily exceeded their powers; in fact, they had no powers.  Additionally, a number of state arbitration acts expressly provide for vacatur of an arbitration award where “[t]here was no arbitration agreement and the issue was not adversely determined in proceedings [to compel arbitration] and the party did not participate in the arbitration hearing without raising the objection.”  See, e.g., Tenn. Code Ann. § 29-5-313.  Other courts have held that arbitration awards rendered without an agreement to arbitrate are invalid ab initio.  See MCI Telecomm. Corp. v. Exalon Indus. Inc., 138 F.3d 426 (1st Cir. 1998) (explaining that “a party that contends it is not bound by an agreement to arbitrate can therefore simply abstain from participating in the proceedings, and raise the inexistence of a written contractual agreement to arbitrate as a defense to a proceeding seeking confirmation of the arbitration award, without the limitations contained in section 12, which are only applicable to those bound by a written agreement to arbitrate.”).

Conclusion 

In any given situation, the outcome of challenges to the arbitrability of claims will turn on the factual circumstances and the law of the jurisdiction; however, careful consideration of potential challenges throughout the arbitration process may reduce the costs of defending against non-customer claims and increase the chances of desirable outcomes.

(Shepherd D. Tate is a Member of Bass, Berry & Sims PLC, focusing his practice on securities litigation, arbitration, compliance and regulatory matters.  Ryan R. Baker is an attorney at Bass, Berry & Sims PLC, focusing his practice on civil litigation and arbitration.  Ryan has represented a wide range of clients, concentrating his practice on representing clients in the financial services industry).