On Monday, January 8, 2018, the Sixth Circuit affirmed a District Court finding that a brokerage firm was obligated to arbitrate pursuant to FINRA Rule 12200, rejecting the member firm’s argument that the outside investments at issue did not “arise in connection with the business activities” of the member firm as required for arbitration to be mandatory under the Rule. Wilson-Davis & Co, Inc. v. James Mirgliotta, No. 17-3496 (6th Cir. Jan. 8, 2018). This unpublished decision has potential ramifications for all member firms by expanding the scope of the Rule to include lack of supervision claims. Even where the firm had no involvement with the trades and further did not even know the trades occurred, firms could potentially be required to arbitrate under circumstances where a court would be the preferred forum. While FINRA arbitration is generally preferable for customer disputes, here, member firms would be deprived of the opportunity to obtain a pre-hearing dismissal where favorable facts exist to prevail on either a pre-answer motion to dismiss or a summary judgment motion.
In Mirgliotta, the Claimant investor held an investment account with Wilson-Davis, when a non-Wilson-Davis financial advisor recommended an investment in penny stocks at “New Market Enterprises.” Wilson-Davis’ involvement in the purchase was via its employee, Christopher Cervino, who was the customer’s account representative. Cervino wired funds from the Mirgliotta’s Wilson-Davis IRAs for the purchase. Thereafter, Cervino moved to a different firm, and the Mirgliottas followed him, transferring their IRAs, continuing to invest in penny stocks with money wired from the IRAs. The Mirgliotta’s investments are now worthless, and Cervino and the non-Wilson Davis financial advisor have been convicted of, among other things, fraud and money laundering. The SEC has also filed a parallel civil suit against them.
Mirgliotta filed a FINRA arbitration against Wilson-Davis, Cervino, and others, alleging lack of oversight over the customer accounts and the brokers, including negligent supervision, training, and liability for misconduct of its employee. Wilson-Davis filed a Complaint for declaratory and injunctive relief in the Northern District of Ohio, asserting that it was not obligated to arbitrate the Mirgliotta claims. The District Court denied the injunction, which Wilson-Davis subsequently appealed.
In reaching its decision, the Sixth Circuit focused on one of Wilson-Davis’s claims of error – that the New Market Enterprise purchases did not “arise in connection with the business activities of” Wilson-Davis per FINRA Rule 12200(2), because Wilson-Davis had no involvement or knowledge of the trades, and the losses occurred after the funds were transferred away from Wilson-Davis. The Sixth Circuit disagreed and, following Vestax Sec. Corp. v McWood, 280 F.3d 1078 (6th Cir. 2002), held that “a dispute arising ‘from a firm’s lack of supervision over its brokers’ constitutes a dispute that ‘arises in connection with the business activities’ of the FINRA member, even when the FINRA member is not aware of the transactions facilitated by the broker.” The customer’s assertion that Wilson-Davis negligently supervised Cervino, including moving the money from their Wilson-Davis account, “falls comfortably within Vestax’s broad holding.”