GT Alert

Court Holds Predispute Arbitration Agreement Between Broker and Client Precludes State Securities Regulator From Pursuing Victim-Specific Relief in a Subsequent Enforcement Action

February 2004
By J. Richard Tucker and Dennis A. Meloro, Greenberg Traurig, Wilmington Office

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The United States District Court for the District of Delaware has held that where a broker and a client enter into a predispute arbitration agreement, a state securities regulator may not, in a subsequent enforcement action, pursue victim-specific relief against the broker on behalf of the client. Ropp v. 1717 Capital Management Co., Civ. A. No. 02-1701-KAJ, 2004 WL 93945 (D.Del. Jan. 14, 2004). The Court based its decision on Olde Discount Corp. v. Tupman, 1 F.3d 202 (3d Cir. 1993), cert. denied, Hubbard v. Olde Discount Corp., 510 U.S. 1065 (1994).

The 1991 amendments to § 7325 of the Delaware Securities Act, 6 Del. C. §§ 7301-7330, added restitution to investors to the list of remedies the Securities Commissioner is empowered to seek on behalf of Delaware citizens. Notwithstanding this state legislation, both Olde and Ropp stand for the proposition that the Commissioner should not be seeking victim specific relief on behalf of Delaware citizens where the parties have entered into a predispute arbitration agreement.

The Court’s decision invalidates the Securities Commission’s practice of acting as an advocate, on behalf of Delaware citizens, by seeking victim-specific relief in the Securities Commission’s Administrative Forum, (for clients of financial institutions who are involved in disputes with those financial institutions) when the parties have a contractual predispute agreement specifying Arbitration as the exclusive forum for remediation of any disputes arising between the financial institution and its clients.

Summary of the Case

In April 1997, Lisle and Patricia Shaffer (the “Shaffers”) opened a brokerage account with 1717 Capital Management Company (“1717”). The Shaffers completed an application form and account agreement, each of which contained a predispute arbitration agreement. In August 2001, Lisle Shaffer filed a complaint with the Division of Securities of the State of Delaware (the “Securities Division”) regarding the manner in which 1717 and one of its representatives, Raymond N. Ianni (“Ianni”) were handling the brokerage account. After an investigation, the Securities Division filed an administrative complaint with the Securities Commissioner for the Division of Securities of the State of Delaware Department of Justice, James B. Ropp (the “Commissioner”). The Securities Division’s complaint alleged that 1717 and Ianni had engaged in “dishonest and unethical conduct” and that 1717 had “failed to reasonably supervise Mr. Ianni,” in violation of 6 Del. C. §§ 7316 and 7325. After a pre-hearing conference, 1717 filed a Motion to Preclude Restitution and Other Relief Available Through Arbitration. The Commissioner then filed the instant complaint seeking a declaratory judgment that he may pursue restitution and other victim-specific relief in a state administrative proceeding against 1717.

Both parties filed motions for summary judgment.

The Commissioner’s Argument

The Commissioner advanced three primary arguments in support of his motion: (1) Olde had been effectively overruled by the United States Supreme Court in Equal Employment Opportunity Commission v. Waffle House, 534 U.S. 279 (2002); (2) the predispute arbitration agreement was limited in scope to disputes between the Shaffers and 1717; and (3) the Federal Arbitration Act (“FAA”) did not preempt the Commissioner’s statutory authority to pursue or order victim-specific relief for violations of the Delaware Securities Act.

1717’s Argument

1717 advanced three primary arguments in support of its motion: (1) the Supreme Court did not overrule Olde in Waffle House; (2) the statutory framework and public policy concerns in employer-employee disputes involving the EEOC under federal law and state law securities disputes between brokers and investors are fundamentally different; and (3) the Securities Division was preempted from pursuing restitution on behalf of the Shaffers by the FAA.

The District Court’s Decision

Both parties and the Court agreed that the Third Circuit’s decision in Olde was controlling. Olde involved a nearly identical set of facts. In Olde, a couple had opened a brokerage account and signed an account agreement containing a predispute arbitration clause. The Third Circuit held that by seeking rescission on behalf of investors who had entered into a predispute arbitration agreement, the Delaware Division of Securities interfered with Olde Discount’s right under the FAA to resolution of the issues through arbitration. Olde, 1 F.3d at 204, 209.

Delaware’s pursuit of rescission was preempted by the FAA for two reasons. First, the rescission remedy presented an obstacle to the accomplishment of the congressional purpose of enforcing arbitration agreements. Second, it was impossible to give effect to both the administrative rescission remedy and the federal right to arbitration. Id. at 210. The Court reasoned that the potential for actual conflict between simultaneous proceedings, one before an arbitration panel, and another before the Delaware securities commissioner necessitated the conclusion that the two proceedings would be irreconcilable. Id. at 209-10.

While the Court in Olde recognized that its analysis might have been different if a finding of preemption were to work a “substantial interference” with traditional state objectives of securities law enforcement, it found that other remedies remain available to the state concerning a company’s registration as a broker-dealer, including pursuing individualized remedies, such as rescission, as to securities transactions not subject to arbitration agreements. Id. at 210-11.

The District Court rejected the Commissioner’s argument that Waffle House had effectively overruled Olde. Nothing in the language of Waffle House indicated that its holding applied beyond the employment dispute arena or implicitly overruled Olde. The Court held that the law of the Third Circuit set forth in Olde was clear. Because the Shaffers and 1717 had entered into predispute arbitration agreements, the Commissioner could not pursue such victim-specific relief, and therefore granted 1717’s motion for summary judgment.

© 2004 Greenberg Traurig

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