11th Circuit Denies Access to FINRA Arbitration where Dispute did not Arise out of the FINRA Member's Business Activities

Financial Institutions Law Alert

The Eleventh Circuit’s latest arbitration-related decision is a brush-back of the claimants securities bar’s efforts to extend the breadth of who can be subjected to FINRA’s arbitration jurisdiction. The Eleventh Circuit recently found that FINRA’s Code of Arbitration Rule 12200, which requires the arbitration of any dispute brought by a customer against a FINRA member or an “associated person” of a FINRA member, did not stretch so far as to extend jurisdiction to a FINRA member whose only relationship to the underlying dispute was the corporate affiliate’s custody of the funds in dispute. In Pictet Overseas Inc., et al. v. Helvetia Trust, 2018 U.S. App. LEXIS 27241 (11th Cir. Sept. 28, 2018), a three-judge panel ruled that two Trusts could not pursue a $101.8 million action in FINRA’s arbitration forum against brokerage firm and FINRA member, Pictet Overseas Inc. In denying FINRA’s arbitration forum to the Claimants, the Court relied on a “common sense” interpretation of Rule 12200 to state that an associated person is required to arbitrate a dispute before FINRA “only if the dispute has some connection to the associated person’s relationship with the FINRA member.”

The underlying facts supporting the panel’s decision are helpful in defining when a party may be compelled into FINRA arbitration. After the Trusts commenced an arbitration proceeding before FINRA, Pictet filed an action in federal district court seeking to enjoin the arbitration, contending that Rule 12200 did not require it to arbitrate the claims. The Court found that while Pictet is a FINRA member, the Trusts’ claims regarding an independent asset manager’s theft of their investment, which had been held in a custodial account by a corporate affiliate of Pictet, did not arise in connection with Pictet’s business activities. The district court agreed, concluding that the Trusts had failed to establish that the claims were arbitrable against Pictet under Rule 12200, and enjoined the FINRA arbitration.

The Trusts appealed, arguing that the dispute arose “in connection” with Pictet’s business activities, so that arbitration was required under the language of Rule 12200. That Rule requires a FINRA member to arbitrate when the dispute “arises in connection with the business activities of the member or associated person.” The Trusts argued that the dispute was arbitrable because it arose in connection with the business activities of Pictet’s affiliate (a non-member), which the Trusts further argued was an “associated person” of Pictet by virtue of the business affiliation and was therefore covered under a strict reading of the Rule.

The Eleventh Circuit rejected the Trusts’ attempt to get jurisdiction through the back door and found that an affiliation with “any business activity of the associated person” was not enough to compel FINRA jurisdiction. Relying on the Code’s definition of “associated person,” which the Court stated is based solely on the nature of the person’s relationship or role with a FINRA member, the Court found that when Rule 12200 is read “in context” and considered in light of FINRA’s purpose to regulate stock brokerage firms, the Code was intended to bind a FINRA member’s associated persons to arbitrate only when the “dispute arises in connection with the business activities of the associate person undertaken in his or her capacity as an associated person of the FINRA member.” The court further found that even assuming for purposes of the appeal that the corporate affiliate qualified as an associated person of a FINRA member, the dispute was not arbitrable because it did not arise in connection with the FINRA member’s (or associated person’s) business activities, which is the business of giving investment advice.

Justice William Pryor, wrote a concurring opinion to drive home what he called the “fundamental error” of the Trusts’ so called “literal” construction of Rule 12200. Applying a contextual reading of the Rule, Justice Pryor rejected the Trusts’ “hyper-technical” argument that an associated person must arbitrate “any” dispute that arises from any of its business activities. As Pryor explained, a party becomes an associated person only because of his direct or indirect control by a FINRA member. Absent that control, the party could never be compelled to arbitrate. Comparing such language with a hypothetical arbitration clause to arbitrate any “dispute that arises in connection with the activities of an owner of a professional football team,” Pryor wrote that the strict constructionist interpretation that the Trusts urged be adopted would lead to the “foolish” interpretation that a dispute regarding a faulty car sold by the team owner to the coach be arbitrated, where a reasonable reading would lead to the conclusion that football coaches must arbitrate only those disputes that arise in connection with the activities “as owners of football teams.” Pryor echoed the Court’s finding that the context of the words cannot be ignored.

Takeaway: Ultimately, the Eleventh Circuit refused to extend FINRA’s jurisdictional reach beyond FINRA members and their associated persons engaged in the business of FINRA members. Given that arguments similar to those made by the Trusts are often made by counsel attempting to include non-FINRA member firms, affiliated banks or foreign entities under FINRA’s purview, the Eleventh’s Circuit’s latest decision is sure to be increasingly relied on by counsel on both sides of the aisle to define the parameters of FINRA’s reach.