Opinion
CIVIL ACTION NO. H-01-0511
October 2, 2001
MEMORANDUM AND ORDER
Pending is Defendant GMS Group, L.L.C.'s Motion to Compel Arbitration and to Stay Proceedings Pending Arbitration (Document No. 7). After having reviewed the motion, response, reply, and applicable law, the Court concludes that the motion should be denied.
I. Background
Plaintiffs seek damages from Defendant The GMS Group, LLC ("GMS"), which rendered brokerage and investment services to Plaintiffs, based on GMS's alleged fraud, negligent misrepresentation, breach of fiduciary duty, DTPA violations, and breach of contract. GMS has moved to compel arbitration of the dispute based on an arbitration clause contained in certain client agreements between Plaintiffs and Gruntal Co. The background of the dispute is as follows:
Plaintiffs and Defendant GMS began doing business together in 1991 and, between 1991 and 1993, Plaintiffs opened several brokerage accounts with GMS. Plaintiff Wayne H. Christensen, Jr. ("Christensen") first opened an account for himself. Christensen served also as an informal advisor/manager for the investment accounts of his sister and mother, and accounts were opened for them and for a family estate account. GMS, Plaintiffs allege, was in the business of selling investments and investment services and, as pertains to this case, dealt with Plaintiffs through its agent, Charles Pluff ("Pluff").
GMS was what is known as an "introducing broker," and evidently it was not a member of the major stock exchanges. It therefore entered into a clearing agreement with Regional Clearing Corporation, which was a member of the exchanges and was able to execute the trades that GMS's clients ordered. Regional Clearing Corporation later assigned its rights and obligations under the clearing agreement to Gruntal Co. ("Gruntal"). Gruntal, a member of the New York Stock Exchange and all other exchanges, then performed the clearing services for GMS. On its letterhead and in other of the documents that it generated, GMS regularly reflected that GMS was "an affiliate of Gruntal Co., established 1880, member of all exchanges." Throughout the period in question, GMS used Gruntal as its clearing broker.
In 1991, when Christensen began doing business with GMS, it procured from him a new account form bearing the name of Gruntal Co., shown on the agreement to be a member of the New York Stock Exchange. In 1992 and 1993, similar new account forms were signed by Plaintiffs for their additional accounts. None of these new account forms contained an arbitration clause. In 1994, Plaintiffs were asked to sign "Client Agreements" with Gruntal for their accounts, and they did so. These client agreements with Gruntal (collectively referred to as the "Agreement") refer to Gruntal as the clearing broker for Plaintiffs' accounts. No separate written agreement was executed by Plaintiffs and GMS, the introducing broker that furnished to Plaintiffs investment advice and counsel.
The arbitration clause sought to be enforced by GMS is contained in the 1994 Gruntal Agreement executed by Plaintiffs at the request of GMS. This Agreement, evidently required by Gruntal of parties for whom it executes trades on the exchanges, makes no mention of GMS and GMS is not a signatory to the Agreement. GMS and Gruntal have a separate clearing agreement, as mentioned above, which presumably governs their relationship, and Plaintiffs are not parties to that agreement.
Plaintiffs have made no allegations against Gruntal in this case, and make no complaint about its execution on the stock exchanges of any of the transactions that it handled for Plaintiffs' accounts. Plaintiffs' complaints are against GMS alone, the introducing broker that provided investment advisory services to Plaintiffs through its agent Pluff. In particular, Plaintiffs allege that in 1996, GMS through its agent Pluff urged Plaintiffs to purchase sizeable positions in securities issued by Flagstar and United States Leather, which Plaintiffs agreed to do as a result of GMS's investment advice and importunities, and that Plaintiffs thereafter suffered severe losses when these securities suffered precipitous declines in value. Plaintiffs allege that unbeknownst to them at the time, GMS itself owned many millions of dollars of these securities which GMS, knowing of the unacceptable risks that the securities then had, wanted to unload from its own portfolio, and that this prompted GMS to urge its own customers, Plaintiffs in this case, to purchase these ill-fated securities without disclosing to Plaintiffs the significant changes in circumstances that made these investments extremely poor risks. It appears uncontroverted, moreover, that it was GMS, not Gruntal, that provided all of the direct investment advice to Plaintiffs through its employee/agent Pluff. The question raised by the instant motion is whether Plaintiffs' dispute with GMS is required to be referred to arbitration under the arbitration clause found in the Agreement between Plaintiffs and Gruntal.
II. Discussion
The adjudication of a motion to compel arbitration under the Federal Arbitration Act involves a two-step inquiry. Webb v. Investacorp., Inc., 89 F.3d 252, 257-58 (5th Cir. 1996). The first step is to determine whether the parties agreed to arbitrate the dispute in question. First Options of Chi., Inc. v. Kaplan, 115 S. Ct. 1920, 1924 (1995); Webb, 89 F.3d at 258. This requires consideration of (a) whether there is a valid agreement to arbitrate between the parties, and (b) whether the dispute in question falls within the scope of that arbitration agreement. Webb, 89 F.3d at 258. The second step is to determine ""whether legal constraints external to the parties' agreement foreclose us] the arbitration of those claims.'" Id. (quoting Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth. Inc., 105 S.Ct. 3346, 3355 (1985)).
The arbitration clause that GMS invokes in this case is contained in the Agreement that Plaintiffs executed with Gruntal in 1994. GMS was not a party to the Agreement and is not mentioned in the Agreement. The introductory paragraph states that the Agreement is between Plaintiffs and Gruntal. It begins: "[i]n consideration of Gruntal Co., Incorporated . . . I agree with Gruntal as follows. . . ." (emphasis added). The next paragraph sets outs the scope of the Agreement, and provides that it "shall inure to the benefit of and be binding upon you and me and our respective estates, executors, administrators, successors and assigns." (emphasis added). "You" is defined as Gruntal, and the terms "I, me, or we" are defined as the undersigned client. The language contained in the arbitration clause is also unambiguous:
Any dispute I now or hereafter may have with Gruntal or any of their respective current or former officers, directors, agents and/or employees, arising out of or relating to any of my accounts with Gruntal or to transactions heretofore or hereafter made herein or to any agreement between myself and Gruntal, shall be settled by arbitration.
(emphasis added).
As evidenced from its plain language, GMS is not a party to the Agreement. GMS is not mentioned in the arbitration clause nor in any other clause, and GMS did not sign the Agreement. Although GMS, the introducing broker, acknowledges that it is not a party to the Agreement between Plaintiff and Gruntal, which was a clearing broker, it nevertheless claims that the arbitration clause applies to GMS.
It is generally held that an introducing broker, who is not a party to a separate agreement between the client and a clearing broker, may not invoke the arbitration clause contained in the clearing broker's agreement. See, e.g., Arrants v. Buck, 130 F.3d 636 (4th Cir. 1997);Taylor v. Investors Assoc., Inc., 29 F.3d 211 (5th Cir. 1994); McPheeters v. McGinn, Smith Co., Inc., 953 F.2d 771 (2d Cir. 1992); Mowbray v. Moseley, Hallgarten, Estabrook Weeden, Inc., 795 F.2d 1111 (1st Cir. 1986); Conway v. Icahn Co., Inc., 787 F. Supp. 340 (S.D.N.Y. 1990). Arbitration is a matter of contract. Air Line Pilots Ass'n v. Miller, 118 S.Ct. 1761, 1763 (1998). Thus, if an investor does not directly contract with an introducing broker to arbitrate, the introducing broker cannot compel arbitration based on a collateral agreement between the client and a clearing broker to which the introducing broker is not a party. See Conway, 787 F. Supp. at 344.
There are certain exceptions to this rule, however, such as when the introducing broker is an agent of the clearing broker or is a third-party beneficiary to the client-clearing broker agreement. Arrants, 130 F.3d at 641; Taylor, 29 F.3d at 213; Conway, 787 F. Supp. at 344; Ahn v. Rooney, Pace Inc., 624 F. Supp. 368, 370 (S.D.N.Y. 1985). These exceptions are rare. Arrants, 130 F.3d at 641 (explaining that although some courts have recognized an agency relationship between an introducing broker and a clearing broker or third party beneficiary status, they have done so only in very limited circumstances).
A. Agency Theory
"[T]he standard arrangement between an introducing and clearing broker . . . does not support a claim that the introducing broker is the agent of the clearing broker." Arrants, 130 F.3d at 641; see also Taylor, 29 F.3d at 214; Conway, 787 F. Supp. at 345. This has been the case even when the client-clearing broker agreement expressly states that the relationship between the introducing broker and the clearing broker is that of agent/principal. See McPheeters, 953 F.2d at 773 (rejecting an introducing broker's attempt to invoke an arbitration clause found in a client-clearing broker agreement and holding that although the agreement specified an agent/principal relationship between the clearing broker and the introducing broker, the agency was limited to actions in carrying out the account transactions and was not applicable to the agreement as a whole). It is therefore only in rare situations that introducing brokers have been recognized as agents of clearing brokers, Arrants, 130 F.3d at 641, and in those cases there must be some evidence of subservience on part of the introducing broker. Ahn, 624 F. Supp. at 370. "[T]here can be no agency relationship where the alleged principal holds no rights of control over the alleged agent." Id.
GMS claims that this is such a rare situation for the following reasons: (1) GMS is a wholly owned subsidiary of Gruntal; (2) GMS disclosed its affiliation with Gruntal in its letterhead; (3) GMS's employees signed the Gruntal account opening paperwork; (4) GMS accepted requests for preferred margin loans on behalf of Gruntal; and (5) GMS introduced Plaintiffs to Gruntal. Based on the applicable case law, those facts, even if taken together, are not enough to establish an agency relationship. Each of these points will be considered.
(1) GMS did not become a wholly owned subsidiary of Gruntal until September, 1997, after Plaintiffs' cause of action accrued. See Exhibit A of Defendant's Motion to Compel Arbitration. The facts giving rise to this action occurred in 1996.
(2) GMS did display on its letterhead that it was affiliated with Gruntal. The mere "affiliation" of two companies, without more, does not give rise to an agent/principal relationship. See Dayhoff Inc. v. H.J. Heinz Co., 86 F.3d 1278, 1297 (3d Cir. 1996) (holding that a parent company could not invoke an arbitration clause in an agreement signed by its wholly owned subsidiary simply by reason of its corporate relationship with the subsidiary). As mentioned above, in order to establish an agency relationship, GMS must establish that Gruntal exercised some control over GMS regardless of affiliation. Ahn, 624 F. Supp. at 370 (holding that there can be no agency relationship without some form of control by the principal over the agent).
(3) GMS's employees, Pluff and Paul Steets ("Steets"), did sign the new account forms bearing Gruntal's name that Plaintiffs completed when they originally opened their accounts in 1991, 1992, and 1993. Because those forms on their face appear to be Gruntal's new account forms, GMS argues that Pluff's and Steet's signatures on those forms establish an agency relationship between GMS and Gruntal. Even if there is a suggestion of GMS acting as Gruntal's agent to facilitate Gruntal's receipt of its new account forms, there is no evidence of GMS acting as Gruntal's agent for any other purpose. This limited agency cannot be used to invoke the arbitration clause in the Gruntal Agreement. See, e.g., McPheeters, 953 F.2d at 773 (explaining that while the client-clearing broker agreement established an agent/principal relationship between the introducing broker and the clearing broker for purposes of certain transactions, the agency did not apply to the client-clearing broker agreement as a whole). More to the point, there is no showing on this motion that GMS acted as Gruntal's agent when GMS provided investment advice to Plaintiffs and urged them to buy or sell certain securities. Moreover, although GMS was a party to a clearing agreement with Gruntal that governed their relationship, GMS has not exhibited the agreement, which presumably would spell out the full breadth of GMS's agency role if it were indeed an agent of Gruntal. On this record, agency has not been shown.
(4) GMS did accept requests for preferred margin loans on behalf of Gruntal, but this too does not make GMS an agent of Gruntal when GMS provides investment advice to its own customers. A clearing broker does not usually have direct contact with clients. Macaulay v. Norlander, 12 Cal.App.4th 1, 4 (Cal.Ct.App. 1992). Rather, a clearing broker "executes orders with the exchange at the direction of the introducing broker." Id. On the other hand, an introducing broker deals directly with the investor. Id. Thus, it seems commonplace that Plaintiffs would submit their requests for preferred margin loans to GMS which, in turn, would communicate those requests to Gruntal. Again, there is no showing that when GMS advised Plaintiffs on the purchases of securities that it was in any manner acting as agent of Gruntal, which is shown to have been only a clearing broker.
(5) GMS did introduce Plaintiffs to Gruntal in the sense of nominating Gruntal as the clearing broker. This does not establish an agency relationship with regard to GMS's investment advice to Plaintiffs. An "element of subservience is essential" to an agent/principal relationship. Ahn, 624 F. Supp. 370. There is no showing that Gruntal had any authority over GMS's investment advice to GMS's customers or in any manner exercised control over GMS with regard to the subject matter of this case.
GMS relies on Nesslage v. York Sec., Inc., 823 F.2d 231 (8th Cir. 1987) and Okcuoglu v. Hess, Grant Co., Inc., 580 F. Supp. 749 (E.D. Pa. 1984). In both of those cases the court held that although not a party to the client agreement, the introducing broker could invoke the arbitration clause in the client-clearing broker agreement based on agency principles. The facts of those cases, however, are distinguishable from the facts of this case.
In Okcuoglu, the basis of plaintiff's complaint involved the execution of unauthorized option transactions. Okcuoglu, 580 F. Supp. at 750. This controversy necessarily implicated the clearing broker. The court held that so long as it was possible to bring in the clearing broker into the litigation as a necessary party, the introducing broker could invoke the arbitration clause in the client-clearing broker agreement. Id. at 751. Unlike Okcuoglu, Plaintiffs' complaint in this case relates exclusively to misrepresentations allegedly made by GMS and Plaintiffs' allegations in no way implicate Gruntal. There is no basis in this case for GMS to invoke the arbitration clause in Gruntal's Agreement.
Nesslage held that the introducing broker could invoke the arbitration clause found in the margin agreement between the plaintiffs and the clearing broker based on agency principles. Nesslage, 823 F.2d at 233. Unlike this case, in Nesslage the introducing broker was a disclosed agent of the clearing broker. Based on this disclosed agency, the court held that plaintiffs intended the client agreement to extend to the introducing broker. Id. There is not a disclosed agency in this case, but only an attempt by GMS after the dispute arose — to imply an agency based on the arguments discussed and rejected above.
B. Third Party Beneficiary Theory
In a third-party beneficiary analysis the most important factor to consider is the intent of the parties. Mowbray, 795 F.2d at 1117. The intent "to benefit a third party must be apparent from the construction of the contract in light of all surrounding circumstances. . . ."Taylor, 29 F.3d at 215. In the context of introducing brokers and investors, "courts usually find that the requisite intent to benefit [the introducing broker] is lacking and do not permit introducing brokers to compel arbitration as third-party beneficiaries." Arrants, 130 F.3d at 641.
In this case, GMS claims that it can invoke the arbitration clause in the Agreement as a third party beneficiary. GMS asserts that it presented the Agreement to Plaintiffs and that at the time it was presented, the Agreement was intended to define the operation of Plaintiffs' brokerage accounts which were then supervised by GMS. Because GMS supervised and conducted the day-to-day activity on the accounts, GMS claims that the Agreement was logically intended to extend to GMS. In support of its position, GMS cites Cauble v. Mabon Nugent Co., 594 F. Supp. 985 (S.D.N Y 1984).
In Cauble, the plaintiff alleged that the introducing broker had liquidated his account without authorization. Cauble, 594 F. Supp. at 990. The introducing broker claimed that it had liquidated the plaintiff's account pursuant to a liquidation clause in the client-clearing broker agreement. Id. at 991. The agreement contained a liquidation provision that authorized the clearing broker to liquidate the plaintiff's account without authorization if the plaintiff failed to maintain an adequate margin. Id. The introducing broker claimed that because he was a third party beneficiary to the client agreement, he was likewise authorized to liquidate the plaintiff's account without prior authorization. Id. Although the introducing broker was not mentioned in the agreement, the court held that the course of dealing between the parties established that the introducing broker would monitor and control the plaintiff's obligations under the client agreement. Id. at 991-92. Because the plaintiff knew of the introducing broker's supervisory powers over the plaintiff's account, it was reasonable to conclude that the introducing broker was a third party beneficiary to the client agreement. Id.
Cauble, of course, dealt with a liquidation clause and not with the application of an arbitration clause. The parties' intent is critical to the analysis. It is not "obvious," as the First Circuit wrote, "that a customer intended or agreed to have all disputes with an introducing broker arbitrated merely because the introducing broker exercises certain supervisory powers over an account or its margin requirements." Mowbray, 795 F.2d at 1117 (distinguishing and declining to follow Cauble). In fact, in Mobray, the introducing broker was mentioned in certain parts of the agreement, but not in the arbitration clause. The fact that the introducing broker was not named in the arbitration clause provided further reason to infer that the parties did not intend the introducing broker to be a beneficiary of the arbitration clause. Id.
In this case the Agreement states that its benefit "shall inure to the benefit of and be binding upon you and me and our respective estates, executors, administrators, successors and assigns." (emphasis added). "You" as defined in the Agreement relates solely to Gruntal. The scope of the arbitration clause is likewise unambiguous. It states that "any dispute [Plaintiffs] may have with Gruntal officers, directors, agents and/or employees shall be settled by arbitration." (emphasis added). If the parties intended GMS to benefit from the Agreement, or from its arbitration clause, the Agreement would have stated so. See Taylor, 29 F.3d at 215 ("[N]o consent to arbitration with [the introducing broker] may be implied based solely on the relationship between the introducing broker and the clearing house.").
In this case, Plaintiff 5 had a broker-investor relationship with GMS long before Plaintiffs executed the Gruntal Agreement. The first of Plaintiffs' accounts was opened in 1991 and the last in 1993. The Agreement with Gruntal, however, was not signed until April, 1994, three years after the first account with GMS was opened. It is most unlikely, to say the least, that Plaintiffs understood or intended the arbitration clause of the Gruntal Agreement to apply to GMS, an entity never mentioned in the Agreement and with which Plaintiffs had been conducting business for over three years.
Because Plaintiffs and GMS have no agreement to arbitrate this dispute, Defendant's Motion to Compel Arbitration and to Stay Proceedings Pending Arbitration will be denied.
III. Order
Based on the foregoing, it is
ORDERED that Defendant's Motion to Compel Arbitration and to Stay Proceedings Pending Arbitration (Document No. 7) is DENIED.
The Clerk shall notify all parties and provide them with a true copy of this Order.