SWEET, District Judge.
Defendants Oppenheimer & Co., Inc. ("Oppenheimer") and Scott Seskis ("Seskis") (together, "Oppenheimer") have moved for an order pursuant to Fed.R.Civ.P. 50(b) setting aside the jury verdict received January 21, 1988 and compelling arbitration of all of plaintiff R. Stockton Rush's ("Rush")
Rush commenced this action on March 4, 1984 against Oppenheimer and Seskis, formerly a broker at Oppenheimer, asserting federal securities, RICO and pendant common law claims. Since the dismissal of Rush's RICO claim, the arbitrability of Rush's remaining claims
By the opinion of December 23, 1986, Oppenheimer's motion for summary judgment on the preliminary issue of fraudulent inducement was denied on the grounds that a material issue of fact existed as to whether defendants had wrongly induced Rush to agree to arbitrate all claims arising out of his account with Oppenheimer and that under the Supreme Court's decision in Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 87 S.Ct. 1801, 18 L.Ed.2d 1270 (1967), Rush was entitled to a jury trial to resolve that issue. For the same reason, the opinion of September 18, 1987 denied Oppenheimer's motion, following the Supreme Court's recent decision in Shearson/American Express, Inc. v. McMahon, ___ U.S. ___, 107 S.Ct. 2332, 96 L.Ed.2d 185 (1987), for an order compelling the arbitration of Rush's federal securities and pendant state law claims. The September 18 Opinion observed that the Court's decision in McMahon had not obviated the requirement under Prima Paint and § 4 of the Federal Arbitration Act (the "Act"), 9 U.S.C. § 1 et seq., that a federal court resolve claims as to illegality in the making of an agreement to arbitrate.
The issue of whether Rush was induced to enter into the arbitration agreement by defendants' material or fraudulent misstatements was tried before a jury in January 1988.
Following the submission of briefs from both parties, oral argument was held on the instant motion on February 4, 1988.
Standards for Judgment NOV
Fed.R.Civ.P. 50(b) provides that "[w]henever a motion for a directed verdict made at the close of all the evidence is denied or for any reason is not granted, the court is deemed to have submitted the action to the jury subject to a later determination of the legal questions raised by the motion." As to the trial court's review of the jury's findings, the standards governing a motion for the entry of judgment notwithstanding the verdict in this Circuit are well-settled:
Mattivi v. South African Marine Corp, "Huguenot", 618 F.2d 163, 167-68 (2d Cir. 1980); accord Aaron Ferer & Sons Ltd. v. Chase Manhattan Bank, N.A., 731 F.2d 112, 121-22 (2d Cir.1984). Defendants' motion both raises legal questions and challenges the sufficiency of the evidence supporting the verdict.
In addition, Oppenheimer contends that there was no evidence to support the jury's findings as to the elements of fraudulent or material misrepresentation. In particular, Oppenheimer argues that Rush failed to establish (1) that the statements made by Seskis were false, (2) that they were material, (3) that Rush justifiably relied on them, (4) and that Seskis's statements were actionable statements of opinion.
The Prima Paint Issue
Prima Paint involved an action for rescission of a consulting agreement between a paint manufacturer and a company seeking to acquire its assets. The consulting agreement contained a broad arbitration clause providing that "[a]ny controversy ... arising out of this agreement, or the breach thereof, shall be settled by arbitration in the City of New York in accordance with the rules ... of the American Arbitration Association." Over Prima's objection that the consulting agreement had been induced by fraud,
Prima Paint, 388 U.S. at 406, 87 S.Ct. at 1807.
By expressly referring to Prima's failure to show that it had not intended "legal" issues relating to the making of the principal contract to be subject to arbitration, the Court implicitly adopted the Second Circuit's rationale that "arbitration clauses as a matter of federal law are `separable' from the contracts in which they are embedded, and that where no claim is made that fraud was directed to the arbitration clause itself, a broad arbitration clause will be held to encompass arbitration of the claim that the contract itself was induced by fraud." Prima Paint, 388 U.S. at 402, 87 S.Ct. at 1805. This rationale is consistent with the federal policy expressed in the Act in favor of the enforceability of arbitration agreements: "A written [arbitration] provision in ... a contract evidencing a transaction involving commerce ... shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." 9 U.S.C. § 2.
It follows logically from Prima Paint and § 4 of the Act that a court may order arbitration only when the party opposed to arbitration has not claimed that the arbitration agreement itself was fraudulently procured. Only when the arbitration agreement itself is valid does the Act instruct a federal court to order arbitration. To permit an arbitration panel to resolve a challenge to the validity of an arbitration agreement, whether or not accompanied by challenges to the underlying contract, would require a federal court to relinquish its jurisdiction, and its obligation, under § 4 of the Act to determine that "the making of the agreement for arbitration ... is not in issue."
Neither the Act nor the Court's analysis in Prima Paint support the conclusion that the allegation of fraud must be directed exclusively at the arbitration clause and not at the overall contract. Indeed, the Court in Prima Paint explicitly noted that its decision was consistent with its holding in Moseley v. Electronic & Missile Facilities, Inc., 374 U.S. 167, 83 S.Ct. 1815, 10 L.Ed.2d 818 (1963). Prima Paint, 388 U.S. at 404 n. 12, 87 S.Ct. at 1806 n. 12. In Moseley, the Court held that where allegations of fraud were directed at both the contract generally and the arbitration clause in particular, the district court must first resolve the issue of fraud with respect to the arbitration agreement. Only if that issue were determined favorably to the party seeking arbitration could the district court order arbitration of the remaining claims, including fraud with respect to the contract generally.
Scherk v. Alberto-Culver involved a dispute that arose out of an agreement between an American company and a German citizen for the purchase of three companies organized under the laws of Germany and Liechtenstein, together with the trademark rights of those companies. In response to the American company's action in federal court alleging that the petitioner had made fraudulent representations concerning the trademark rights, the petitioner moved to stay the action pending arbitration pursuant to a clause in the sales contract which provided that any claims arising out of the agreement or the breach thereof would be referred to arbitration before the International Chamber of Commerce in Paris. Finding that the arbitration clause was, in effect, a specialized kind of forum selection clause, see The Bremen v. Zapata Off-Shore Co., 407 U.S. 1, 92 S.Ct. 1907, 32 L.Ed.2d 513 (1972), the Court held that under the Act, federal courts were required to enforce it. Scherk, 417 U.S. at 519-20, 94 S.Ct. at 2457. Because the respondent in Scherk did not allege fraud with respect to the arbitration clause itself, the Court's discussion of the Prima Paint issue was limited to a footnote observation that "an arbitration or forum-selection clause in a contract is not enforceable if the inclusion of that clause in the contract was the product of fraud or coercion." Scherk, 417 U.S. at 519 n. 14, 94 S.Ct. at 2457 n. 14. The Court's observation supports the rationale, discussed above, that any claim of fraud directed at the arbitration clause itself is not an appropriate issue for arbitration, regardless of whether it is accompanied by allegations of fraud aimed at the overall contract.
In Moses H. Cone Hospital v. Mercury Constr. Corp., the party that had drafted the principal agreement, which contained an arbitration provision, sought to avoid its terms by filing a declaratory judgment action in state court. No claim having been made that the principal contract, let alone the arbitration clause, was procured through fraud, the Supreme Court affirmed the Fourth Circuit's order compelling arbitration of the parties' underlying dispute, notwithstanding the fact that state court proceedings on the underlying dispute were already pending. Moses H. Cone Hospital, 460 U.S. at 29, 103 S.Ct. at 943. The Court cited Prima Paint merely as support for the strong federal policy in favor of arbitration agreements. Id. at 24-25, 103 S.Ct. at 941; see also Southland Corp. v. Keating, 465 U.S. at 11, 104
The federal policy in favor of arbitration agreements has provided the foundation for the Court's recent expansion of the types of claims that they may encompass. See, e.g., Mitsubishi Motors, 473 U.S. at 629, 105 S.Ct. at 3355 (antitrust claim against foreign company); Shearson/American Express, 107 S.Ct. at 2343 (§ 10(b) claims under the '34 Act), 2346 (RICO claims). However, this broadening of the scope of arbitrable claims only underscores the necessity for federal courts to determine that the making of the arbitration agreement is not in issue before sending the parties to arbitration. A federal court's obligation to resolve issues as to the making of an agreement to arbitrate is a particularly important safeguard in cases involving the kind of customer account agreements used in the securities industry. In such cases the agreement to arbitrate is commonly no more than one of many fine-printed clauses in the broker's form contract. Normally, customer agreements for trading in securities do not contain a separate signature line that requires the customer's explicit assent to arbitration, as is required by law for customer agreements under the Commodity Exchange Act.
Unlike arbitration provisions in such other commercial contracts as asset purchase agreements, distribution agreements, licensing agreements, and joint venture agreements, the agreement to arbitrate contained in a securities account agreement
In support of its reading of Prima Paint in general and its application to the facts of this case in particular, Oppenheimer has cited to decisions from other circuits in which courts have ordered arbitration where the plaintiff's claim of fraudulent inducement pertained to the principal agreement and not solely to the arbitration clause contained therein. Each of these cases rests on an interpretation of the Supreme Court's decision in Prima Paint that, as set forth at length above, reaches beyond its holding. For example, in Schacht v. Beacon Ins. Co., 742 F.2d 386 (7th Cir.1984), the appellant claimed that the appellee had fraudulently induced it to enter into a reinsurance agreement by orally promising to pay an advance premium. The appellant alleged that the fraudulent representation went to the arbitration agreement as well as to the entire agreement. In rejecting the appellant's attempt to avoid arbitration, the Seventh Circuit stated,
Schacht v. Beacon Ins. Co., 742 F.2d at 389-90. In its opinion, the Court did not consider the distinction between fraud claims that can reasonably be found to relate to both the principal agreement and the arbitration agreement itself and fraud claims that pertain only to the principal contract. Thus, the Court's overbroad application of Prima Paint prevented it from addressing the merits of appellant's claim of fraud with respect to the arbitration agreement itself. The Courts of Appeals for the Fifth, Sixth and Eleventh Circuits have similarly adopted a broad reading of Prima Paint in sending to the arbitrator claims of fraud that arguably went to both the principal agreement in general and the arbitration clause in particular. See, e.g., Bitkowski v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 833 F.2d 1011 (6th Cir.1987); Bhatia v. Johnston, 818 F.2d 418 (5th Cir.1987); Driscoll v. Smith Barney, Harris, Upham & Co., 815 F.2d 655 (11th Cir.1987); Coleman v. Prudential Bache Securities, Inc., 802 F.2d 1350 (11th Cir.1986).
Because the decisions to order arbitration in these cases are not based on an analysis of the Act or Prima Paint and its progeny, however, they provide little guidance as to what this Circuit might hold were it confronted with the issue of whether a federal court should resolve allegations of fraud based on statements that obviously relate to the principal agreement but that are alleged, as here, to be fraudulent with respect to the arbitration agreement. Although there are no decisions from this Circuit that are directly in point, in the cases in which the Circuit has followed Prima Paint and ordered arbitration, the Circuit has been careful to point out that the party objecting to arbitration had not alleged that the arbitration agreement itself was induced by illegality or fraud. See Hamilton Life Ins. Co. v. Republic National Life Ins. Co., 408 F.2d 606, 610 (2d Cir.1969); Trafalgar Shipping Co. v. International Milling Co., 401 F.2d 568, 572 (2d Cir.1968). Thus, these Second Circuit cases are consistent with Prima Paint, which did not involve allegations of fraud with respect to the arbitration agreement.
The lack of federal regulations concerning the making of agreements to arbitrate, such as those promulgated under the Commodity Exchange Act, leaves the courts solely responsible for reviewing the validity of the making of such agreements under general principles of contract law. Under these circumstances, the relief that Prima Paint and the Act provide investors from the fraudulent procurement of their assent to arbitration would be illusory if the federal court did not retain jurisdiction over claims that statements pertaining to the underlying agreement were fraudulent with respect to the arbitration agreement. Thus, Prima Paint requires a federal court to resolve allegations of fraud that pertain to both the principal agreement as a whole and the arbitration agreement in particular.
Rush Failed to Establish a Prima Facie Claim of Fraud as to the Making of the Agreement to Arbitrate
Whether a given allegation can give rise to a prima facie claim of fraud with respect to the making of an arbitration agreement is a matter for the court to decide.
In the instant case, Rush contends that he was fraudulently induced to agree to arbitration when his broker told him to sign without reading a margin agreement that contained an arbitration clause. Rush testified on both direct and cross-examination that at a meeting at Oppenheimer's offices with Seskis, Seskis handed him some documents that he was required to sign before opening an account at Oppenheimer. Rush testified that Seskis told him "there was no need to read [the documents], that they were just a formality and they were just like the documents at Drexel." Trial Transcript ("TT") at 59.
The evidence adduced at trial indicated that both the customer account agreement Rush had signed at Drexel and the margin agreement he signed at Oppenheimer contained arbitration clauses. That the Oppenheimer agreement provided for arbitration before the New York Stock Exchange ("NYSE") or the National Association of securities Dealers whereas the Drexel arbitration clause provided a choice of either the American Arbitration Association or the NYSE did not create a material difference between the two clauses.
The jury's finding that Seskis had told Rush that he did not need to read the margin agreement creates a closer issue with respect to the arbitration clause. Under a different set of facts, it would not be wholly unreasonable for a jury to find falsity where a broker has told a customer that the latter need not read a contract that contained a waiver of a constitutional right. Here, however, Rush testified that he had signed two Drexel customer account agreements when Seskis was at Drexel, and both contained arbitration clauses. Although Rush claimed that he had not read the Drexel arbitration clauses when he signed the Drexel agreements, he testified that he had never posed an objection to the Drexel agreements or the arbitration clauses contained therein. The facts established that both Seskis and Rush viewed the actual execution of the documents required to transfer Rush's account to Oppenheimer, as previously agreed, as a formality in an otherwise uninterrupted relationship that had arisen at Drexel. In addition, the evidence showed that the arbitration clauses in the Drexel and Oppenheimer agreements were substantially the same. Under this set of facts, therefore, there was no reasonable basis for the jury's conclusion that Seskis's "no-need-to-read" statement was false or misleading as to the arbitration clause itself.
The lack of evidence to support the jury's decision as to the falsity of Seskis's statements is a sufficient basis for overturning the verdict. However, even if one were to assume arguendo that there was a sufficient factual basis for the jury's finding on falsity, the insufficiency of the evidence as to both materiality and justifiable reliance provides adequate alternate grounds for setting aside the verdict. As for materiality, Rush was required to show that Seskis's statements would have been reasonably likely to induce a reasonable person to manifest his assent to the margin agreement. Further, Rush had to establish that Seskis's statements, which allegedly kept him from reading the margin agreement and discovering the arbitration clause, were a substantial factor in causing him to sign the margin agreement.
The evidence showed, however, that less than one year prior to the time he executed the Oppenheimer agreements, Rush had freely executed, without objection, customer account agreements at Drexel that contained similar arbitration provisions. Thus, the proof showed that the inclusion of an arbitration clause in a customer account
Rush also testified that he would not have entered into the Oppenheimer margin agreement if he had known that the arbitration clause might require him to pursue his claims before a tribunal of which Oppenheimer was a member, namely the NYSE. There was, however, no evidentiary support for this claim. On the contrary, Rush testified that he had not been aware of arbitration as an alternate form of dispute resolution prior to its appearance as an issue in this litigation. Thus, only through "sheer surmise and conjecture" could the jury conclude that if he had read the arbitration clause Rush would have decided not to sign the margin agreement.
Finally, Rush failed to establish that he justifiably relied on Seskis's statements in signing the margin agreement without reading it and without objecting to the arbitration clause contained therein. The lack of proof of materiality underscores the absence of proof as to Rush's reliance; that is, there was no evidence that if he had read the arbitration clause, he would not have signed the margin agreement and thereby committed himself to arbitration. Moreover, Rush did not offer into evidence any facts from which the jury could have inferred that Rush was justified in relying on Seskis's statements. As the jury was instructed, Rush's reliance on Seskis's statements would not have been justified if he could have discovered the falsity of the statement by a cursory examination. Rush testified that only he and Seskis were present in the conference room when he signed the margin agreement. Rush also testified that, although Seskis told him he did not need to read the document, he was not physically prevented from reading the two page document that he held in his hands.
Rush explained his failure to read the document on the grounds that he did not want to appear to be questioning "Seskis's trust, trustworthiness or truthfulness." TT at 67. However, Rush did not produce evidence to establish that a confidential, fiduciary or trusting relationship existed between him and Seskis. On the contrary, Rush testified that he had signed a similar agreement containing a similar arbitration clause the very first time he met Seskis. As the Seventh Circuit stated in Fey v. Walston & Co., Inc., 493 F.2d 1036, 1049 (7th Cir.1974), the "mere existence of a broker-customer relationship is not proof of its fiduciary character...." The fiduciary obligation that arises between a broker and a customer as a matter of New York common law is limited to matters relevant to affairs entrusted to the broker. Schenck v. Bear, Stearns & Co., 484 F.Supp. 937, 946-48 (S.D.N.Y.1979). There was no evidence from which the jury could infer that Rush had placed his trust in Seskis with respect to any matters beyond the individual transactions in his account.
In sum, there was no evidence to support the jury's verdict on the issues of falsity, materiality and justifiable reliance. Rush failed to establish a prima facie case of fraudulent inducement with respect to the making of the agreement to arbitrate. For the reasons set forth above, Oppenheimer's motion for judgment n.o.v. is granted, and judgment will be entered dismissing the complaint and directing the parties to arbitrate.
The parties are directed to submit judgment on notice within ten (10) days.
IT IS SO ORDERED.
Thus, the jury was instructed on the elements that Rush was required to prove under New York law to void the arbitration agreement on the grounds of either material misstatement or fraudulent misstatement.
1. Did Seskis tell Rush that the margin agreement was a formality which Rush was not required to read and was the same as the agreement he had previously signed at Drexel Burnham?
2. If you answered YES to Question 1, did the statement pertain to the arbitration clause?
3. Was the statement made by Seskis false as to the arbitration clause?
4. Was the statement material?
5. Was the statement an opinion?
6. If you answered YES to Question 5, did Seskis stand in a position of trust with respect to Rush?
7. Did Seskis have special knowledge and know that Rush did not and was relying on his skill as an expert?
8. Did Rush justifiably rely on the statement?
9. Did Seskis have the confidence that he stated or implied in the truth of the statement he made to Rush?
10. Did Seskis know that he did not have the basis that he stated or implied for the assertion?
11. Did Rush justifiably rely on the statement made by Seskis?
In addition, to establish that Seskis had made fraudulent misstatements concerning the margin agreement, Rush was required to show that Seskis did not have the confidence that he stated or implied in the truth of his statements or that Seskis knew that he did not have the basis that he states or implies for the assertion. See Restatement (2d) Contracts, § 162.
Moseley, 374 U.S. at 171, 83 S.Ct. at 1817. The Court found that the petitioner had sufficiently alleged fraud as to the arbitration agreement itself to require the federal court to address that issue, even though the petitioner had also alleged fraud as to the overall agreement.
Question: You were told not to read [the document]?
Q: When were you told not to read it?
Rush: I started to look at it.
Q: And what were the words that were spoken?
Rush: "There is no need to read it. It's just a formality. It's the same as at Drexel."
Q: "No need to read it." He didn't say stop reading, did he?
Rush: No, he didn't.
TT at 125. Seskis testified that he had told Rush to read the forms. TT at 175.