Who Is A Customer

worried womanFINRA Rule 12200 provides that:

Parties must arbitrate a dispute under the Code if:

Arbitration under the Code is either:

(1) Required by a written agreement, or

(2) Requested by the customer; and

The dispute is between a customer and a member or associated person of a member; and The dispute arises in connection with the business activities of the member or the associated person, except disputes involving the insurance business activities of a member that is also an insurance company.

Many Courts have found the term “customer” to be ambiguous. John Hancock Life Ins.v.Wilson, 254 F.3d 48,58 (2d Cir. 2001).

The FINRA Code states only that “[a] customer shall not include a broker or dealer.” FINRA Rule 12100(i). FINRA’s glossary states that a “customer” is “[a] person or entity (not acting in the capacity of an associated person or member) that transacts business with any member firm and/or associated person” but provides little additional guidance.

scales of justiceUnder this definition, as one Court has observed, the meaning is plain. “[It] provide[s] that [the party] is a customer as long as [he, she it] is not a broker or dealer; nothing in the Code directs otherwise or requires more. Enforcing the limitation [the securities firm] seeks would be tantamount to reading language into the Code that is conspicuously absent.” Multi-Financial Securities Corp v. King, 386 F.3d 1364, 1368 (11th Cir. 2004)(“when Rule 12200 was proposed, the addition of the words ‘of a member’ after the word ‘customer’ w[as] explicitly rejected because it would ‘narrow the scope of claims that are required to be arbitrated under the Customer Code.” (quoting Waveland Capital Partners, LLC v. Tommerup, 2012 WL 70572, 6 (D.Mont., Jan.6, 2012) (citing Order Approving Proposed Rule Change to Amend NASD Arbitration Rules for Customer Disputes, 72 Fed. Reg. 4574, 4579 (2007)).

The Second Circuit suggests that the term “customer” is intentionally broad because FINRA intended to require its members to arbitrate disputes with the full array of parties as part of its “investor-protection mandate.” See UBS Fin. Servs. v. W. Va. Univ. Hosps., 660 F.3d 643, 651 (2d Cir. 2011) (“We also reject UBS’s contention that FINRA has a narrow ‘investor-protection mandate,’ such that ‘customers’ should include only those receiving ‘investment or brokerage services.”’).

Indeed, many commentators suggest that the term “customer” has been construed broadly to include all members of the “investing public.” as part of FINRA and the NASD’s express purpose “[t]o investigate and adjust grievances between the public and members and between members.” Restated Certificate of Incorporation of Financial Industry Regulatory Authority, Inc. § 3 (July 2, 2010)(emphasis added); See also, David E. Robbins, Securities Arbitration Procedure Manual § 5-6(i) (5th ed. 2009); Norman S. Poser & James A. Fanto, Broker-Dealer Law and Regulation § 28.07(A) (4th ed. 2009).

Customers Need Not Be Traditional Customers

A “customer” is not required to have an “account” with the member firm to compel arbitration pursuant to FINRA Rule 12200. First Montauk Securities Corp. v. Four Mile Ranch Development Company, Inc., 65 F. Supp. 2d 1371, 1381 (S. D. Fla 1999)(“[t]he NASD chose not to limit customers to investors with accounts with the member-firm); WMA Sec. v. Wynn, 191 F.R.D. 128, 130 (S.D. Ohio 1999) (“A Customer is defined as anyone who is not a broker or dealer. ‘Customer’ is not defined as WMA would have it, as a person who opened an account with a brokerage firm.”)(emphasis added).

picture of New York Stock ExchangeUnder the FINRA Rules, there is no exemption from the obligation to arbitrate claims based upon an assertion that the activities of the associated person were unknown to the firm or were outside the normal scope of the relationship. White Pacific Securities, Inc. v. Mattinen, Case No. 12 cv 151 YGR (N.D. Cal. March 19, 2012); O.N. Equity Sales Co. v. Maria Cui, 2008 WL 170584, *3 (N.D.Cal., January 17, 2008)(district courts in this circuit that have examined situations nearly identical to the one presented here have concluded that, even if the FINRA-member broker-dealer was not involved directly as the account issuer or as a participant).

Numerous other courts have interpreted the Code similarly. Vestax Sec. Corp. v. McWood, 280 F.3d 1078, 1082 (6th Cir. 2002)(rejecting the argument that the Code requires the defendant-investors be direct customers of the NASD member firm in order to compel arbitration against the member); Oppenheimer & Co., Inc. v. Neidhardt, 56 F.3d 352 (2d Cir. 1995)( investors who had been defrauded by a representative of an NASD securities brokerage firm were “customers” of that firm under the NASD Code despite their never opening formal accounts with the firm); BMA Fin. Servs., Inc. v. Guin, 164 F. Supp. 2d 813, 820 (W.D. La. 2001) (“[NASD] Rule 10301(a) does not require the Defendant-Investors to be direct customers of [the member].”); SEC. v. Ruppert, 80 F. Supp. 2d 786, 789 (S.D. Ohio 1999) (“The facts that [the customers] never had an account with [the member] and that the . . . promissory notes in which both [customers] invested were not approved products of [the member] are irrelevant.”).

In cases where, persons associated with the member firm, hold themselves out “on their business cards, stationary, promotional materials, and [their] internet site” as offering securities through the member, courts will find that those persons are “customer” of the member. See, e.g. Multifinancial Securities v. Brown, 2002 U.S. Dist. LEXIS 26527 (E.D. Pa. December 20, 2002)(“For example, the record includes a letter written by Kevin Brown to Defendant, regarding the trust account in question, written on his company’s stationary stating “Securities offered through Multi-Financial Corp. – Member SIPC and NASD.” )(citing, Vestax Securities Corp. v. McWood, 280 F.3d 1078 (6th Cir. 2002); John Hancock Life Insurance Co. v. Wilson, 254 F.3d 48 (2d Cir.2001); see also BMA Fin. Servs., Inc. v. Guin, 164 F. Supp. 2d 813 (W.D. La. 2001).

Customers of the Broker Are Customers of the Firm

As stated above, FINRA Rule 12200, in pertinent part, provides that “ Parties must arbitrate a dispute under the Code if the dispute is between a customer and a member or associated person of a member. (Emphasis added).

Rule 12100(r) of the FINRA Code defines an “associated person” as: (1) A natural person who is registered or has applied for registration under the Rules of FINRA; or (2) A sole proprietor, partner, officer, director, or branch manager of a member, or other natural person occupying a similar status or performing similar functions, or a natural person engaged in the investment banking or securities business who is directly or indirectly controlling or controlled by a member, whether or not such person is registered or exempt from registration with FINRA under the By-Laws or the Rules of FINRA. For purposes of the Code, a person formerly associated with a member is a person associated with a member. See also, NYSE Rule Interpretation 345(a) (“Independent Contractors” The establishment of “independent contractor” status between a natural person registered with and qualified by the Exchange and a member organization is permitted only if it does not in any way compromise such person’s characterization and treatment as an “employee” of their associated member organization for purposes of the Rules of the Exchange.

man with money in pocketWhile in “selling away” cases, investors seeking to arbitrate their claims with the member firm, may not have a traditional account with the member firm, or engaged in the purchase or sale of securities at issue through the member firm, invariably, by definition, these investors are “customers” of the member’s “associated persons.”

“ When an investor deals with a member’s agent or representative, the investor deals with the member.” Vestax Securities Corp. v. McWood, 280 F.3d 1081 (6th Cir. 2002); See also, Multi-Financial Securities Corp v. King, 386 F.3d 1364, 1368 (11th Cir. 2004)(several circuit courts have held that customers of an “associated person” are “customers” of the member as well for purposes of compelling arbitration under Code); Washington Square Secs. Inc. v. Sowers, 218 F. Supp. 2d 1108, 1116 (D. Minn. 2002)(“Federal case law plainly states that when the investor deals with an agent or representative [of a member], the investor deals with the member, and on that basis the investor is entitled to have resolved in arbitration any dispute that arises out of that relationship” (quotation marks and citation omitted)); In BMA Financial Services, Inc. v. Guin, 164 F. Supp. 2d 813, 820 (W.D. La. 2001)( Rule 10301(a) does not require the Defendant-Investors to be direct customers of BMA. Instead, they fit within the confines of the Rule — and therefore may require BMA to arbitrate — even if they are only customers of BMA’s “associated person” and not BMA; Vestax Securities Corporation v. Skillman, 117 F. Supp. 2d 654, 657 (N.D. Ohio 2000)(By conducting business with plaintiff’s registered representative, defendants conducted business with plaintiff and became its customers.”); Wash. Square Sec., Inc. v. Aune, 253 F. Supp. 2d 839, 841 n.1 (W.D.N.C. 2003) (“The majority view is stated in the John Hancock opinion . . . holding that customers of the NASD member firm’s representative/associated person can require the NASD member to submit to arbitration.”); Multi-Financial Securities Corp., v. Brown, 2002 U.S. Dist. LEXIS 26527 (E.D. Pa. December 20, 2002)(“this relationship between the Browns and Multi-Financial is alone sufficient to compel the legal conclusion that Defendant, who undisputably had a relationship with the Browns, was a ‘customer’ of Multi-Financial for purposes of Rule 10301(a)”); Daugherty v. Wash. Square Sec., Inc., 271 F. Supp. 2d 681, 690 (W.D. Pa. 2003)(“The majority of federal courts faced with interpreting NASD Rule 10301(a) concluded that NASD members must arbitrate disputes raised by customers of their associated persons.”).

Indeed, “no federal appellate court has prohibited the customer of an associated person, asserting a claim arising out of the associated person’s business, from compelling a member to arbitrate under [NASD] Rule 10301.” John Hancock Life Ins. Co. v. Wilson, 254 F.3d 48, 59 (2d Cir. 2001)(citing, Miller v. Flume, 139 F.3d 1130 (7th Cir. 1998).

In John Hancock Life Ins. Co. v. Wilson, 254 F.3d 48 (2d Cir. 2001), the defendant Investors filed arbitration claims against John Hancock arising out of their purchase of fraudulent promissory notes from Hancock’s agents (Fucilo and Palladino). The Investors were customers of Fucilo, but not John Hancock, and sought to hold John Hancock liable under a number of theories, including the failure to supervise.

John Hancock filed eleven separate actions against the Investors.

In each, John Hancock sought a declaration that the parties had not entered into a valid arbitration agreement and a preliminary and permanent injunction staying the arbitration proceedings because the sale of the notes in no way related to John Hancock’s business and the investors were not “customers” of John Hancock at the time they purchased the promissory notes. 254 F.3d at 52.

The district court held that the plain language of Rule 10301 encompasses disputes between customers and members arising out of the business of associated persons, and found that “what is important is that the [Investors] were customers of a person associated with [John Hancock]. Because [the Investors] were Fucilo’s customers and Fucilo was associated with [John Hancock], this dispute is arbitrable.” 254 F.3d at 57.

Similarly, in WMA Securities, Inc. v. Ruppert, 80 F. Supp. 2d 786 (W.D. Ohio 1999), defendants sought to arbitrate claimed losses from their investment in promissory notes issued by First Lenders Indemnity Corporation. In the underlying arbitration claim, defendants alleged that WMA securities violated NASD rules governing the supervision of registered representatives by broker-dealers. WMA argued, however, that defendants were not its customers and that the disputes embodied in defendants’ arbitration claims did not arise from WMA’s business, and based upon it own narrow definition of “customer,” sought to enjoin the arbitration.

The Court however found that the defendant was a customer of WMA’s registered representative, and accordingly, found WMA’s argument that the defendant was not a “customer” for purposes of NASD Rule 10301(a) to be “unavailing.” 80 F. Supp. 2d at 791 (emphasis added).

In Oppenheimer & Co. v. Neidhardt, 56 F.3d 352 (2d Cir. 1995), the court concluded that investors who had been defrauded by a representative of an NASD member firm, but who never opened accounts with that firm, were, nonetheless, “customers” because the defendant investors dealt with registered representatives of Plaintiff while those representatives were associated with Plaintiff.

In dismissing Oppenheimer’s injunction action, the court found Plaintiff’s argument “fatally flawed” because Oppenheimer ignored the second part of the Code that requires that the claim arise either in connection with Plaintiff’s business or in connection with the activities of persons associated with Plaintiff.

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The litigation of individual and group investor claims against securities broker-dealers and investment professionals adjuducated in arbitration before the Financial Industry Regulatory Authority.

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Alternative Investments, Promissory Notes, Structured Products, High Yield Bond Funds, Non-Marketable Real Estate Investment Trusts, Inverse and Leveraged ETFs,  the Failure to Conduct Due Diligence.

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