You’ve been swindled by your broker and learn that, not surprisingly, his firm knew nothing about it. Worse yet, you learn that he never actually opened an account for you – “investing” your money in a Ponzi scheme, a phony-baloney high interest promissory note or a cure for Alzheimer’s that the FDA knows nothing about – and sending you made up brokerage firm account statements.
So you inquire whether you can bring a FINRA arbitration claim against the broker (who was fired) and his firm, which, you claim, should have better supervised him. Will you be able to proceed in arbitration or will the firm prevail in a motion to compel the litigation of your dispute? The state of the law in this area has evolved these past few years and this article will bring you up to date.
Because FINRA does not clearly or succinctly define the term “customer” for purposes of bringing arbitration claims, the definition has been left for the courts, resulting in inconsistent interpretations, although one of the most respected and influential federal courts of appeal has set forth a “bright line test” that other courts are sure to follow. The inconsistency in court ruling can confuse potential Claimants and arbitration practitioners alike, leading to wasteful spending on nonarbitrable claims and worse, preventing those who have been harmed from seeking compensation through FINRA.
In 2012, the Southern District of New York held in that a brokerage firm that permitted its agent to service an account thereby agreed to arbitrate a claim regarding its agent’s misconduct in handling the account, even if its broker engaged in a Ponzi scheme that the firm knew nothing about.[1] The federal trial court’s reasoning was:
- “The term ‘customer’ is defined broadly in the Code. ‘FINRA rules do not provide a comprehensive definition of the term customer, stating only that ‘[a] customer shall not include a broker or dealer.””[2]
- “The Second Circuit has suggested that the word ‘customer’ in the [FINRA predecessor] NASD Code refers to one involved in a business relationship with an NASD member that is related directly to investment or brokerage services.”[3]
- “That relationship need not be of a fiduciary character, however.[4] In addition, a person may be considered a ‘customer’ for purposes of a FINRA registrant where that person is involved in a business relationship with the registrant’s agent.”[5]
- “Courts in other districts have compelled brokerage firms to arbitrate a customer claim based on a firm employee’s rogue activities, provided that those activities were regarding trading activity.”[6]
George H. Friedman, who spent 14 years as the head of FINRA’s Dispute Resolution program, addressed this issue in his article, “Defining Who is a Customer in FINRA Arbitration: Time to Clear Things Up!”[7] He wrote, “[c]ourts will balance the federal policy in favor of liberally construing arbitration agreements with whether there actually is an agreement to arbitrate by virtue of Rule 12200.”
After years of uncertainty, the Second Circuit Court of Appeals provided a bright line definition of “customer” in its August 2014 affirmation of the District Court’s decision in Citigroup Global Markets Inc. v. Ghazi Abdullah Abbar.[8] Bottom line – it’s now harder to bring an arbitration.
Mr. Abbar was a Saudi businessman who lost $383 million with a United Kingdom affiliate of Citigroup (a non-FINRA member) through the purchase of complex options in London. He purchased no goods or services from Citigroup’s New York subsidiary (a FINRA member). Despite that fact, he filed a FINRA arbitration and both the Southern District Court of New York and the Second Circuit Court of Appeals in New York held that he was not a customer of the New York entity and could therefore not compel arbitration against Citigroup. The Second Circuit’s reasoning for concluding that a simple, predictable and broad definition of “customer” was necessary is as follows.[9]
Reasonable Expectations – The word “customer” must “be construed in a manner consistent with the reasonable expectations of FINRA members.”[10]
Transaction Based Definition – The purchase of a good or service from a FINRA member creates a customer relationship.[11] When such a purchase is undisputed, “there is no need for further court proceedings” concerning the existence of a customer relationship.[12] Likewise, when it is clear that no goods or services were provided by the FINRA member, “there is no need to grapple with the precise boundaries of the FINRA meaning of ‘customer'” because “no rational factfinder could infer” a customer relationship on such facts.[13]
Test Applied to the Facts – The Court reasoned that since Abbar did not purchase services from Citi NY, his investment agreements were with Citi UK and the fee for all services was paid to Citi UK, Citi UK was the proper counterparty, not Citi NY. While Abbar was certainly a ‘customer’ of Citi UK, that relationship does not allow Abbar to compel arbitration against its corporate affiliate.[14]
Holding – “We hold that a ‘customer’ under FINRA Rule 12200 is one who, while not a broker or dealer, either (1) purchases a good or service from a FINRA member or (2) has an account with a FINRA member.“
Account Holder – “A customer relationship can also come into being by opening an account with the FINRA member.[15] An account holder has a reasonable expectation to be treated as a customer, whether or not goods or services are purchased directly from the FINRA member. So even if the FINRA member executes all securities transactions through an affiliate or provides services without fee, the account-holder can compel arbitration under Rule 12200.”
Conclusion – “The only relevant inquiry in assessing the existence of a customer relationship is whether an account was opened or a purchase made; parties and courts need not wonder whether myriad facts will coalesce into a functional concept of the customer relationship.”
Therefore, from a practitioner’s standpoint, one need not be an account holder to be considered a “customer” in a FINRA arbitration. Nor is a brokerage firm absolved from arbitration for the trading activities of another entity on behalf of its account holder.
Best advice? Speak with an attorney who specializes in securities arbitration law.
[1] Robert Peyser v. Lawrence Kirshbaum and Prestige Financial Center, Inc. 2012 U.S. Dist. LEXIS 176873 (S.D.N.Y. Dec. 2012).
[2] J.P. Morgan Sec. Inc. v. Louisiana Citizens Prop. Ins. Corp., 712 F. Supp. 2d 70, 77 (S.D.N.Y. 2010) (quoting FINRA Arb. Code R. 12100(i)).
[3] Bensadoun v. Jobe-Riat, 316 F.3d 171, 177 (2d Cir. 2003).
[4] See UBS Fin. Servs., Inc. v. W. Virginia Univ. Hosps., Inc., 660 F.3d 643, 652 (2d Cir. 2011).
[5] See, e.g., [*8] Oppenheimer & Co., Inc. v. Neidhardt, 56 F.3d 352, 357 (2d Cir. 1995)(noting that acts of agent were imputed to member); Multi-Fin. Sec. Corp. v. King, 386 F.3d 1364, 1370 (11th Cir. 2004).
[6] E.g., Lincoln Fin. Advisors Corp. v. Healthright Partners, LP, 2010 WL 322141 (D. Utah Dec. 22, 2010).
[7] Securities Arbitration Commentator, Vol. 2012, No. 6, ISSN: 1041-3057, published May 2013.
[8] 2014 U.S. App. LEXIS 14861, 2014, WL 3765867 (2nd Cir. Aug. 2014).
[9] See UBS Fin. Servs., Inc. v. Carilion Clinic, 706 F.3d 319, 325 (4th Cir. 2013) (defining “customer” as “one, not a broker or dealer, who purchases commodities or services from a FINRA member in the course of the member’s business activities . . . .”).
[10] Wachovia Bank, Nat’l Ass’n v. VCG Special Opportunities Master Fund, Ltd., 661 F.3d 164, 171 (2d Cir. 2011).
[11] See UBS Fin. Servs., Inc. v. W. Va. Univ. Hosps., Inc., 660 F.3d 643, 650 (2d Cir. 2011).
[12] Wachovia, 661 F.3d at 173.
[13] Wachovia, 661 F.3d at 173-74 (holding that no customer relationship existed where FINRA member provided no “agency, brokerage, advisory or fiduciary services” for opposing party, and no brokerage services agreement existed).
[14] See Wachovia, 661 F.3d at 171 (holding that a purchaser of a credit default swap from “Wachovia Bank, N.A.” was not a “customer” of affiliate “Wachovia Capital Markets, LLC”).
[15] See Oppenheimer & Co., Inc. v. Neidhardt, 56 F.3d 352, 357 (2d Cir. 1995) (finding that “placing funds with Oppenheimer for investment” created a “customer” relationship under the predecessor rule to FINRA Rule 12200).