Second Circuit Holds Mandatory Broker Dealer Arbitration Not Available to Non-Customer

by Katten Muchin Rosenman LLP

On May 15, the US Court of Appeals for the Second Circuit issued a summary order in a closely watched case regarding the circumstances in which a broker dealer may be compelled to arbitrate with an institutional counter-party which is not a traditional “customer” of the broker-dealer. SunTrust Banks, Inc. et al. v. Turnberry Capital Management LP, 13-CV-2075 (2d Cir., May 15, 2014). The Second Circuit’s decision in Turnberry provides important additional guidance for broker dealers and institutional market participants regarding their respective rights to avoid (or compel) arbitration. 


Over the past few years, broker dealers and institutional market participants have been engaged in an increasing number of procedural litigations to determine the governing forum for disputes arising in the course of their relationships. Traditionally, the choice between the courtroom and the arbitration forum had often been viewed as a close call, with each forum offering well-known advantages and countervailing disadvantages. Advocates for arbitration frequently cited perceived cost advantages, freedom from onerous discovery demands, more sophisticated fact finders and an absence of public scrutiny as factors favoring the arbitral forum. Litigation proponents, meanwhile, noted greater opportunities for appellate review, broader injunctive and judgment-enforcement rights, and greater adherence to precedent, evidentiary rules and substantive law as reasons to prefer judicial forums. Historically, these offsetting factors occasionally tilted demonstrably one way or another, but litigants often viewed the increased costs of litigating the governing forum as not worth the fight. In recent years, however, pro-claimant rule changes and perceived pro-claimant sentiment within the arbitration wings of many major self-regulatory organizations have arguably tilted the playing field, rendering arbitration a less-hospitable forum for the defense, relative to the courtroom, than it was traditionally understood to be prior to the Great Recession (2008–2010). 

Factual Summary and Decision

Turnberry arose in the context of this broader evolution in the perceived benefits of arbitration for institutional plaintiffs. Turnberry is a hedge fund that commenced a Financial Industry Regulatory Authority, Inc. arbitration against its point-of-sale broker dealer (Raymond James) over the purchase of trust certificates collateralized by cash flows from a pool of residential mortgage loans. Rule 12200 of the FINRA Code of Arbitration Procedure generally obligates broker dealers such as Raymond James to arbitrate disputes with their “customers,” and that aspect of the FINRA arbitration was not controversial. However, in addition to naming Raymond James, Turnberry also named SunTrust Robinson Humphrey (STRH), the broker dealer affiliate of SunTrust Banks, which had, through other affiliates, sponsored and/or issued the subject trust certificates. STRH moved to enjoin the arbitration of claims against it, arguing that Turnberry was not its “customer” under Rule 12200 (after all, Turnberry was already Raymond James’ customer), and that STRH had no contractual obligation to arbitrate a dispute with Turnberry. In response, Turnberry argued that the “economic reality” of the relationship was such that Turnberry was effectively the “customer” of both Raymond James and STRH, and thus entitled to arbitrate against both of these broker dealers. In support of this argument, Turnberry cited documents allegedly prepared by STRH for provision to Turnberry, a non-disclosure agreement between the parties, Raymond James’ alleged role as a mere conduit in a transaction that was effectively between Turnberry and STRH, and post-transaction dealings between the parties. US District Judge Naomi Reice Buchwald roundly rejected Turnberry’s contentions, holding that Turnberry was not STRH’s customer and enjoining the arbitration of Turnberry’s claims. Importantly, the lower court reached this decision after first holding that “doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration.” Despite this presumption (which arguably misapplied Second Circuit precedent holding that “the presumption does not apply to disputes concerning whether an agreement to arbitrate has been made,” (see Applied Energetics, Inc. v. NewOak Capital Markets, LLC, 645 F.3d 522, 525 (2d Cir. 2011)), the lower court found that a “customer relationship requires some substantial relationship between the parties, and such a relationship is not present here.”   

The Second Circuit affirmed under a de novo standard (for the issue of arbitrability) and clear error standard (for factual findings made below), sustaining the lower court’s finding that there was no indicia of a customer relationship based on a review of a variety of factors. The Second Circuit noted that it was not persuaded by Turnberry’s argument that the lower court had defined the term “customer” under FINRA Rule 12200 too narrowly. Rather, the Second Circuit found that the District Court had relied not only on whether Turnberry acquired goods or services from STRH, but also on whether it received financial advice, whether there was a brokerage agreement, whether a fee was paid and whether STRH made statements evincing a customer relationship.   

The Turnberry case is only one of several cases before the Second Circuit and other courts concerning the scope of mandatory arbitration. Cases concerning the scope of forum selection clauses and whether bright-line definitional requirements that “customers” maintain accounts and/or transact with the defendant broker dealers will further clarify the scope of mandatory arbitration under FINRA Rule 12200 in months to come.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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