Opposition Brief — Heily v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

No. 88-922 CLERK

WOR os a a

In The

Supreme Court of the United States

October Term, 1988

+

KATHRYN A. HEILY,

Petitioner,

v.

MERRILL LYNCH, PIERCE, FENNER &

SMITH INC. et al.,

Respondents.

+

On Petition For A Writ Of Certiorari

To The California Court Of Appeal,

First Appellate District

--

BRIEF IN OPPOSITION

TO PETITION FOR CERTIORARI

Orrick, HERRINGTON & SUTCLIFFE

600 Montgomery Street

San Francisco, CA 94111

Telephone: (415) 392-1122

Attorneys for Respondents

Merrill Lynch, Pierce, Fenner &

Smith Inc., Paul F. Hayes

and Peter F. Sansevero

*Attorney of Record

COCKLE LAW BRIEF PRINTING CO. (00) 225-6964

OR CALL COLLECT (402) 342-2831

or

QUESTION PRESENTED

Whether a stockbroker, who is a registered represen-

tative with the New York Stock Exchange (“NYSE”) and

who has repeatedly agreed in writing to resolve any

disputes with her employer pursuant to arbitration, may

defeat a petition to compel NYSE arbitration on the

ground that the as-yet-unknown NYSE arbitrators are

presumptively biased against her personally or against

stockbrokers generally in employment disputes.

ii

PARTIES _

The parties to the proceeding below were as follows:

Petitioner Kathryn A. Heily was the petitioner before the

California Court of Appeal. Respondents Merrill Lynch,

Pierce, Fenner & Smith Inc.,* Paul F. Hayes and Peter F.

Sansevero were “real parties in interest” before the Cali-

fornia Court of Appeal. The Superior Court of the City

and County of San Francisco was the respondent before

the California Court of Appeal.

* Pursuant to Supreme Court Rule 28.1, respondent Mer-

rill Lynch, Pierce, Fenner & Smith Inc. reports that its parent

company is Merrill Lynch & Co. Inc. and that its subsidiaries

and affiliates are: Broadcourt Capital Corp.; Merrill Lynch &

Co., Canada Ltd.; Merrill Lynch Life Agency, Inc.; Merrill

Lynch Princeton Incorporated; Securities Option Corp.; and

Wagner Stott Clearing Corp.

iii

TABLE OF CONTENTS

Page

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STATUTES INVOLVED .............0.20ceeceseece. 1

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REASONS FOR DENYING THE PETITION ........ 9

I. HEILY CANNOT PRESENT HER “UNCLEAN

HANDS” AND “FRAUDULENT INDUCE-

MENT” CLAIMS TO THIS COURT, BECAUSE

THEY WERE DISPOSED OF BELOW ON THE

FACTS, UNDER STATE LAW ................. 10

Il. HEILY CANNOT PRESENT HER BROAD DUE

PROCESS CLAIMS TO THIS COURT, BECAUSE

THEY ARE NOT RAISED BY THE RECORD

Ti etnbnedeebesdssehsGnaessnkeecees 13

Ill. BOTH THE 1934 ACT AND THE FAA INSU-

LATE THE NYSE FROM HEILY’S ATTACK... 15

A. The 1934 Act Preempts State-Law Chal-

lenges To The Adequacy Of The NYSE As

An Arbitration Forum.................... 15

B. The FAA Also Preempts State-Law Chal-

lenges To The Adequacy Of The NYSE As

An Arbitration Forum .................... 20

SS fo na babs dcdcdes ctcceceéeveducwsas 24

iv

TABLE OF AUTHORITIES

Page

Cases

California Retail Liquor Dealers Association v. Midcal

Aluminum, Inc., 445 U.S. 97 (1980) ............546. 12

Cohen v. Wedbush, Noble, Cooke, Inc., 841 F.2d 282

tte Cle, 1GGE). 0. ccccccciccsccscccccccesces 9, 19, 20

Downs v. Prudential-Bache Securities, Inc., 202 Cal.

App. 3d 616, 248 Cal. Rptr. 734 (1988) ............ 23

Fidelity Federal Savings & Loan Assoc. v. De La

Cuesta, 458 U.S. 141 (1982)........ 22. e cece eee eeee 16

Graham v. Scissor-Tail, Inc., 28 Cal. 3d 807, 171 Cal.

Rptr. 604, 623 P.2d 165 (1981)...... 4, 7, 8, 21, 22, 23

Heily v. Superior Court, 202 Cal. App. 3d 255, 248

Cal. Rptr. 673 (1988)...........-..-eeeee 8, 12, 13, 23

Herman & MacLean v. Huddleston, 459 U.S. 375

GRID 5 kcnckncc0decsatescasancbocseencddedesecaces 17

Liddington v. The Energy Group, Inc., 192 Cal. App.

3d 1520, 238 Cal. Rptr. 202 (1987)................. 21

Merrill Lynch, Pierce, Fenner & Smith Inc. v. Ware,

GAG CEB. BEF GRIP Oe ccc cewccsssccscncccsscccsen 17, 18

Moses H. Cone Memorial Hospital v. Mercury Con-

struction Corp., 460 U.S. 1 (1983) .............-.05. 21

Perry v. Thomas, 482 U.S. 483, 107 S.Ct. 2520 (1987)

peceubasedagebnscenetseeseas 7, 8, 12, 17, 18, 21, 22, 23

Shearson/American Express, Inc. v. McMahon, 482

U.S. 220, 107 S.Ct. 2332 (1987) .......... 6, 18, 19, 20

Skelly Oil Co. v. Phillips Petroleum Co., 339 U.S. 667

GU Nok vtccncccdccnucoscesvansckadetdtneeecccece 12

Sola Electric Co. v. Jefferson Electric Co., 317 U.S. 173

CREED 006 becccncsccunbaneesecenscacssascessacsoese 16

Vv

TABLE OF AUTHORITIES-Coniinued

Page

Southland Corp. v. Keating, 465 U.S. 1 (1984) ......... 21

Thomas v. Perry, 200 Cal. App. 3d 510, 246 Cal.

ee ee A meee 24

Tibbs v. Florida, 457 U.S. 31 (1982)..............0005. 23

Western Hospitals Federal Credit Union v. E. F. Hut-

ton & Co., [Current Binder] Fed. Sec. L. Rep.

(OCH) FJ 95,990 GED. Cal. 1966).......cccccccsces 19

STATUTES AND REGULATIONS

Federal Arbitration Act, 9 U.S.C. §§ 1 et seq.

PO Bike 6 4 odin a50 seus beans d005n0de¥asdkseaseaee 21

IY ln nos kbdcevsendainkatasasicueae 14

Securities Exchange Act of 1934, 15 U.S.C. §§ 78a

et seq.

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I MIs ccceecnbisccdeccueveceon Nidates 15

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PA IR dik cin 650400s écccbennskeannceuanie 16

California Civil Code

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California Civil Procedure Code

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vi

TABLE OF AUTHORITIES-Continued

Page

MISCELLANEOUS

Implementation of an Investor Dispute Resolution

ystem, Exchange Act Release No. 13470,

[1977-78 Transfer Binder] Fed. Sec. L. Rep.

(CCH) 4 81,136 (April 26, 1977) .....-.0-0eeeeeees 18

In the Matter of New York Stock Exchange, Inc.,

Exchange Act Release No. 16390, 18 S.E.C.

Docket 1197 (November 30, 1979)... ......+++00055 18

Securities Act Amendments of 1975: Hearings on

S. 249 before the Subcommittee on Securities of

the Senate Committee on Banking, Housing and

Urban Affairs, 94th Cong., Ist « 1 (1975)...... 17

STATUTES INVOLVED

9 U.S.C. § 2

A written provision in any maritime transaction

or a contract evidencing a transaction involving com-

merce to settle by arbitration a controversy thereafter

arising out of such contract or transaction, or the

refusal to perform the whole or any part thereof, or

an agreement in writing to submit to arbitration an

existing controversy arising out of such a contract,

transaction, or refusal, shall be valid, irrevocable,

and enforceable, save upon such grounds as exist at

law or in equity for the revocation of any contract.

New York Stock Exchange Rule 347

Any controversy between a registered represen-

tative and any member or member organization aris-

ing out of the employment or termination of

employment of such registered representative by and

with such member or member organization shall be

settled by arbitration, at the instance of such party, in

accordance with the arbitration procedure prescribed

elsewhere in these rules.

o*-

STATEMENT OF THE CASE

In 1968, petitioner Kathryn A. Heily (“Heily”) was

hired by respondent Merrill Lynch, Pierce, Fenner &

Smith Inc. (“Merrill Lynch”) to be a stockbroker. She first

applied for registration with the New York Stock

Exchange (“NYSE”) that same year, and has been contin-

uously registered with the NYSE, as well as other securi-

ties exchanges, ever since. As such, she is subject to the

NYSE’s rules, including Rule 347, which requires her

(upon demand) to settle any employment disputes with

Merrill Lynch by arbitration in accordance with the

NYSE’s arbitration procedures. Moreover, between 1968

and 1982, Heily signed five separate documents requiring

her to arbitrate disputes arising between her and Merrill

Lynch.! |

1 In 1968, in connection with her initial application for

NYSE registration, Heily signed a form stating, inter alia:

I agree that any controversy between me and any mem-

ber or member organization or affiliate or subsidiary

thereof arising out of my employment or the termination

of my employment shall be settled by arbitration at the

instance of any such party in accordance with the arbi-

tration procedure prescribed in the Constitution and

rules then obtaining of the New York Stock Exchange.

In 1974 and 1976, when opening her own option

accounts at Merrill Lynch, Heily signed forms stating, inter

alia:

Any controversy between us arising out of such option

transactions or this agreement shall be settled by arbitra-

tion before the National Association of Securities

Dealers, Incorporated, or the New York Stock Exchange,

or the American Stock Exchange, only.

The arbitration clause went on to give Heily five days to elect

the forum of her choice among the three available, after which

Merrill Lynch would have the right of election.

In 1978, in connection with her application for registra-

tion with various exchanges in various states, Heily signed a

form stating, inter alia:

I agree to abide by the statute(s), constitution(s),

rule(s) and bylaw(s) as any of the foregoing are

amended from time to time of the agency, jurisdiction or

organization with or to which I am filing or submitting

this application.

(Continued on following page)

In 1987, just such a dispute arose. Heily, alleging that

she had been wrongfully discharged by Merrili Lynch as

a result of her actions in connection with index option

trading by customers serviced by her and others, filed

suit in the Superior Court for the City and County of San

Francisco against Merrill Lynch and two of its employees.

Defendants promptly petitioned the Superior Court to

compel arbitration of all of Heily’s claims before the

NYSE.

Heily opposed the arbitration petition vigorously,

with the benefit of thorough discovery.2 Her principal

argument to the Superior Court was that the agreements

she had signed were “unconscionable,” and therefore

unenforceable, because the as-yet-unknown arbitrators

that would be selected to hear her claims before the

NYSE were likely to be biased against an employee in a

dispute between an employee and a brokerage firm.

(Continued from previous page)

And 1982, in connection with yet another application for

registration, Heily signed a form stating, inter alia:

I agree to arbitrate any dispute, claim or controversy

that may arise between me and my firm. . . that is

required to be arbitrated under the rules, constitutions

or bylaws of the organizations with which I register.

While the 1978 and 1982 applications do not themselves

specify NYSE arbitration, they both require Heily to comply

with NYSE Rule 347, which expressly provides for NYSE arbi-

tration of disputes between registered representatives and bro-

kerage firms. :

2 A total of 147 pages of briefs were filed in connection

with the petition to compel arbitration, accompanied by 27

declarations and excerpts from four pre-hearing depositions.

Heily relied upon Graham v. Scissor-Tail, Inc., 28 Cal. 3d

807, 171 Cal. Rptr. 604, 623 P.2d 165 (1981), which had

held, as a matter of state law under the California Arbi-

tration Act,3 that an arbitration clause in an adhesion

contract may be unconscionable and therefore unenforce-

able where “it designates an arbitrator who, by reason of

its status and identity, is presumptively biased in favor of

one party.” 28 Cal. 3rd at 821.

Factually, Heily based her bias argument on a New

York Times article and five declarations from persons who

had served as NYSE or National Association of Securities

Dealers, Inc. (“NASD”) arbitrators, including Heily her-

self. Each of the declarants expressed his or her opinion

that NYSE (and NASD) arbitrators were likely to favor

brokerage firms in disputes with employees.*

In addition to her bias theory, Heily argued to the

Superior Court that Merrill Lynch had “unclean hands”

and that the arbitration agreements she had signed were

3 Cal. Civ. Proc. Code §§ 1280-1294.2 (West 1982 & Supp.

1988).

4 Of the five declarants, only two had actually served as

NYSE arbitrators in disputes between brokerage firms and

their employees. And even those two failed to identify any

specific instances of actual bias in an employment dispute.

Instead, the declarations contained generalized, conclusory

charges, amounting to no more than the declarants’ opinions

that panelists tend to be biased against individual employees

in disputes with big brokerage firms. None of the declarants

admitted to having rendered biased decisions him- or herself,

and, needless to say, none of them was able to state that the

panelists selected to hear Heily’s claims would be biased in

any way.

“fraudulently induced.” The unclean hands argument

was a curious mix of unsubstantiated factual allegations

and twisted logic.5 As for the fraudulent inducement

theory, it boiled down to Heily’s contention that she had

never read the five arbitration agreements she had

signed, and therefore should be excused from complying

with them.

In reply, Merrill Lynch noted that Heily’s presump-

tive bias argument was faulty in that (among other

things) it relied exclusively on California arbitration law.

Merrill Lynch pointed out that under controlling federal

precedent, derived from both the Federal Arbitration Act,

9 U.S.C. §§ 1 et seq. (“FAA”), and the Securities Exchange

Act of 1934, 15 U.S.C. §§ 78a et seq. (“1934 Act”), the

NYSE is an adequate arbitration forum as a matter of law.

Merrill Lynch also took on Heily’s “evidence” of bias,

pointing out the deficiencies in the five declarations on

which she relied, and submitting persuasive evidence -

both testimonial and statistical - of the procedural and

5 Heily’s allegation that Merrill Lynch had pressured one

of her co-workers not to help her prosecute her lawsuit was

not only false but completely unrelated to the arbitration

agreements and hence to the petition to compel arbitration.

The fact that the NYSE’s arbitration director submitted a decla-

ration in defense of the system he oversaw tended to prove

nothing more sinister than the NYSE believes its arbitration

process to be fair and just. And the independent decision of

the NASD arbitration director to suspend Heily’s five declar-

ants from NASD arbitration panels until she could investigate

their sudden charges of bias (never brought to the NASD’s

attention before) was not only justified but totally irrelevant to

Heily’s claim that Merrill Lynch’s unclean hands barred it from

seeking NYSE arbitration.

substantive fairness of NYSE arbitration. As for Heily’s

other two theories, Merrill Lynch demonstrated that the

facts established by the record did not amount to either

an unclean hands or a fraudulent inducement defense

under California law.

On June 10, 1987, two days after this Court decided

Shearson/American Express, Inc. v. McMahon, 482 U.S. 220,

107 S.Ct. 2332 (1987), the Superior Court heard oral argu-

ment on the petition to compel arbitration. (The tran-

script of that hearing is reprinted herein as Appendix F

[“App. F”].) The judge commented that she had “never

seen so much paper,” but stressed that she “did read all

these things,” including “every word” of the five declara-

tions from the securities arbitrators. App. F at 3-5.

Addressing herself at greatest length to Heily’s bias argu-

ment, the judge held that federal law governs the issue of

the presumptive fairness of the NYSE as an arbitration

forum, and that “under [flederal law, it’s an appropriate

forum.” Id. at 4. She also discussed and rejected Heily’s

fraudulent inducement claim on the facts, under Califor-

nia law. Id. at 3. Ultimately, the court granted the arbitra-

tion petition without specifically discussing Heily’s

unclean hands contention, and ordered Heily to arbitrate

her dispute before the NYSE.

A month later, Heily moved for reconsideration of

that order. This time she argued that an ongoing investi-

gation by the enforcement division of the NYSE of her

performance while at Merrill Lynch was further “evid-

ence” of presumptive bias against her by the not-yet-

selected arbitrators who would hear her claim against

Merrill Lynch. And she suggested that, if she were

forced to arbitrate, she be permitted to do so before the

American Arbitration Association (“AAA”), even though

none of the arbitration agreements she signed even men-

tioned the AAA as a possible forum. She also contended

that a footnote in this Court’s just-announced opinion in

Perry v. Thomas, 482 U.S. 483, 107 S.Ct. 2520 (1987), sug-

gested a radical change in judicial interpretation of the

FAA and required the trial court to apply California

arbitration law — specifically, the Graham case - to her

claim that the NYSE is a presumptively biased arbitration

forum. Heily did not ask the court to reconsider its rul-

ings on her unclean hands or fraudulent inducement

claims. Once again, the issues were thoroughly briefed

and each party submitted evidence.”

The reconsideration motion was heard on August 25,

1987. (The transcript of the August 25 hearing is

6 Heily had known about the investigation since before

she brought her lawsuit. She has never explained why she

failed to raise it as an issue until she moved for reconsidera-

tion of the Superior Court’s original order.

7 A total of 44 pages of briefs were filed in connection

with the reconsideration motion, accompanied by three decla-

rations and excerpts from two depositions. Despite her charge

that Merrill Lynch had acted improperly in submitting the

declaration of an NYSE official during the earlier proceeding,

Heily supported her reconsideration motion with a solicited

declaration from the AAA’s Regional Director. Of course,

according to her own logic, the AAA's willingness to “side”

with Heily was conclusive evidence that any AAA arbitration

panel would be biased in her favor and therefore could not be

entrusted with the arbitration of her claims against Merrill

Lynch.

reprinted herein as Appendix G [“App. G”].) The judge

explained at the outset that she still believed Heily’s bias

claim was governed by federal law, and therefore that she

would not change her original ruling. App. G at 2-3. The

judge also pointed out that, despite Heily’s insistence on

using the term “actual bias,” her arguments — at best -

went to the issue of presumptive or institutional bias:

I agree with counsel for Merrill Lynch that your

remedy under federal law is to attack the arbitration

award, when and if that occurs, as being biased or

that she was incapable of receiving a fair hearing.

But I think that is a record that has got to be

made in front of the arbitrators, not in front of the

law and motion judge. I don’t think I can decide in

futuro that the New York Stock Exchange is incapable

of giving Ms. Heily a fair hearing.

Id. at 8. The petition for rehearing was denied.

Heily next argued her claims before the California

Court of Appeal. The appellate panel, in a published

opinion issued June 20, 1988, declined to disturb the trial

court’s factual rulings on Heily’s fraudulent inducement

or unclean hands claims, but carefully examined her pre-

sumptive bias argument. The court began with the propo-

sition that, under the FAA as interpreted by this Court in

Perry, the enforceability of an arbitration agreement is a

matter of federal law, except that general state law con-

tract principles may be applied to determine the enfor-

ceability of the contract containing the arbitration clause.

The court then determined that the arbitral-bias principle

enumerated in Graham was not a general state law con-

tract principle and hence could not be applied to the five

agreements Heily had signed. Heily v. Superior Court, 202

Cal. App. 3d 255, 260, 248 Cal. Rptr. 673, App. A at 5

(1988). Turning to federal cases instead to judge the ade-

quacy of the NYSE as an arbitration forum, the court

agreed with a recent Ninth Circuit case, Cohen v. Wedbush,

Noble, Cooke, Inc., 841 F.2d 282 (9th Cir. 1988), holding

that the NYSE is an adequate arbitration forum as a

matter of federal law. 202 Cal. App. 3d at 262-263, App. A

at 8.

Heily’s petition for a review of the Court of Appeal

decision in the California Supreme Court was denied,

and she thereupon petitioned this Court for a Writ of

Certiorari.

REASONS FOR DENYING THE PETITION

Kathryn Heily’s Petition to this Court is but the latest

chapter in her relentless attempt to utilize every conceiv-

able legal mechanism to avoid or delay arbitration of her

claims against Merrill Lynch. Relying on advocacy more

notable for its vigor than its clarity, Heily has never

hestitated to misrepresent the record in her effort to put

off the day of reckoning when she must expose the merits

of her case to a factfinder’s scrutiny. Her Petition to this

Court pursues the same strategy. In her attempt to

engage this Court’s attention, she argues for Supreme

Court review of questions that are simply not presented

by the decision of the Court of Appeal or the record

below.

Section I of this brief reveals that Heily’s fraudulent

inducement and unclean hands arguments were disposed

of below under California law as applied to the facts of

this case, and are therefore not suitable for Supreme

10

Court review. As for her contention that this case pre-

sents broad issues of Due Process as applied to arbitra-

tion proceedings, Section II of this brief demonstrates

that neither the trial court rulings nor the Court of

Appeal opinion purports to impose the wholesale ban

that Heily fears on judicial consideration of bias in arbi-

tration proceedings.

Stripped of its hyperbole and read against the record

made in the California courts, Heily’s Petition presents

only one narrow question potentially cognizable by this

Court on a Writ of Certiorari. That question is whether

her presumptive bias challenge to the adequacy of the

NYSE as an arbitration forum was properly rejected

under federal law. As Section III of this brief demon-

strates, two separate lines of well-settled Supreme Court

precedent compel the conclusion that it was.

I. HEILY CANNOT PRESENT HER “UNCLEAN

HANDS” AND “FRAUDULENT INDUCEMENT”

CLAIMS TO THIS COURT, BECAUSE THEY WERE

DISPOSED OF BELOW ON THE FACTS, UNDER

STATE LAW.

Heily raised three objections below to Merrill Lynch’s

arbitration petition: presumptive bias, unclean hands,

and fraudulent inducement. As to all three claims, Heily

submitted evidence and asked the trial court to apply

California law to that evidence. As to all but the bias

claim, that is exactly what the court did.

Contrary to Heily’s charge that “[t]he trial court

refused to consider Heily’s evidence,” Petition at 4, the

transcript of the June 10, 1987 hearing reveals that the

judge not only read all of the parties’ submissions but

11

commented on their length, saying, “I remember as if I

had been reading this for the last month of my life.” App.

F at 3. And contrary to Heily’s representation that the

trial court held that the FAA “preempts all state-law

challenges,” Petition at 4, the record establishes some-

thing very different. The trial judge forthrightly

addressed the choice-of-law issue at the outset of the

hearing, and announced,

Under the state of the law as it exists now and as |

see it, whether an arbitration clause is enforceable is

determined by Federal law except to the extent that the

contract itself is unenforceable under State law.

App. F at 3 (emphasis added).

The court obviously recognized Heily’s unclean

hands and fraudulent inducement arguments as going to

the enforceability of “the contract itself,” and therefore

applied state law to the evidence presented on both sides

of those claims. As to the fraudulent inducement issue,

the court explicitly stated during the hearing that the

substance of it, “Ms. Heily’s claim that she never read

any of these five agreements . . . is not a ground under the

facts of this case or under California law to set aside the

contract ....” The court then distinctly ruled that “there

was no fraud in the inducement” of the arbitration agree-

ments Heily signed. App. F at 3 (emphasis added). While

the unclean hands argument was not specifically

addressed at the hearing, both parties had briefed the

issue under California law as applied to the evidence

adduced in this case. There is no reason to assume that

the Superior Court’s rejection of Heily’s unclean hands

defense was based on anything else.

a

12

Significantly, when Heily moved for reconsideration

of the original arbitration order, she argued that the Perry

v. Thomas footnote required the court to apply state law to

her bias claim. She did not ask the court to reconsider its

fraudulent inducement and unclean hands rulings — thus

implicitly acknowledging that those rulings had already

been made based on the evidence adduced and California

law.

The Court of Appeal, recognizing that the Superior

Court had considered and rejected Heily’s fraudulent

inducement and unclean hands arguments on the evi-

dence, refused to reconsider those issues. In fact, it chas-

tised Heily for attacking the trial court’s factual rulings

without even advising the appellate court of “the consid-

erable evidence contrary to her positions.” Heily v. Super-

ior Court, 202 Cal. App. 3d at 263, App. A at 8. Heily has

repeated that mistake in her Petition to this Court, and

has compounded it by misrepresenting the record below

so as to make it appear that the trial court rejected her

fraudulent inducement and unclean hands claims on fed-

eral preemption grounds.

This Court does not sit to review factual determina-

tions made by a state court applying state law. California

Retail Liquor Dealers Association v. Midcal Aluminum, Inc.,

445 U.S. 97, 111 (1980) (“we customarily accept the fac-

tual findings of state courts”); Skelly Oil Co. v. Phillips

Petroleum Co., 339 U.S. 667, 674 (1950) (“we do not reex-

amine the local law as applied by the lower courts”). No

matter how unhappy Heily is with the failure of her

fraudulent inducement and unclean hands defenses

below, she has no right to present them to this Court for

review.

13

Il. HEILY CANNOT PRESENT HER BROAD DUE

PROCESS CLAIMS TO THIS COURT, BECAUSE

THEY ARE NOT RAISED BY THE RECORD

BELOW.

Heily would like this Court to believe that the deci-

sion below, if permitted to stand, would “mandate[] that

evidence of bias in an arbitration system was inadmis-

sible and beyond judicial consideration in deciding

whether to compel arbitration.” Petition at 12. In fact,

Heily has grossly distorted the rulings of both the Super-

ior Court and the Court of Appeal.

Merrill Lynch never argued - and the lower courts

never ruled — that the fairness of an arbitration forum is

immune from any and all judicial scrutiny on a petition to

compel arbitration. Instead, Merrill Lynch argued —- and

the lower courts agreed — that the question of the pre-

sumptive bias of an arbitration forum must be addressed

under federal law. Thus, the trial court held that the ade-

quacy of the NYSE as an arbitration forum “is a matter of

[flederal law.” App. F at 3 (emphasis supplied). Similarly,

the Court of Appeal engaged in a searching analysis of

the question of NYSE bias, but was careful to do so under

federal law. Heily v. Superior Court, 202 Cal. App. 3d at

260-63, App. A at 5-8.

Nor did Merrill Lynch argue - or the lower courts

rule — that federal law protects every arbitration forum

from presumptive bias challenges. Instead, Merrill Lynch

contended — and the lower courts so held — that the NYSE

in particular is a presumptively fair arbitration forum as a

matter of federal law. Merrill Lynch’s argument, as

accepted by the Superior Court and the Court of Appeal,

smite cain

ee

14

was premised on the fact that the NYSE’s arbitration

procedures are subject to oversight and approval by the

Securities and Exchange Commission (“SEC”) under the

1934 Act. See Section III of this brief, infra.

And finally, Merrill Lynch was always careful to

point out - as were the lower courts - that a claim of

actual rather than presumptive bias in the operation of an

NYSE arbitration panel may be raised on appeal from an

arbitration decision. See 9 U.S.C. § 10(b) and (c) (court

may vacate an arbitration award where “there was evi-

dent partiality or corruption in the arbitrators” or

“I(w)here the arbitrators were guilty of ... any

.. . misbehavior by which the rights of any party have

been prejudiced”). If indeed the arbitrators to be appoin-

ted by the NYSE to hear Heily’s claim are biased against

her, she will have every opportunity to place evidence of

that bias before a court. What the courts below have not

permitted her to do is to avoid arbitration before a forum

that is presumptively adequate under federal law by

making a premature, speculative claim that a decision not

yet rendered, by arbitrators not yet appointed, will be

infected by bias against her.

The decision below simply cannot be manipulated to

stand for any proposition broader than that those few

arbitration forums overseen and approved by the SEC

under the 1934 Act are not subject to pre-arbitration

challenges based on state law principles of presumptive

arbitral bias. Properly understood, the decision below is

not only consistent with, but mandated by, clear Supreme

Court precedent.

15

Ill. BOTH THE 1934 ACT AND THE FAA INSULATE

THE NYSE FROM HEILY’S ATTACK.

Heily’s obligation to arbitrate her claims against Mer-

rill Lynch stems from two interrelated sources. The first is

NYSE Rule 347, promulgated pursuant to the Securities

Exchange Act of 1934, which requires her, as a former

employee of Merrill Lynch, to arbitrate her claims against

the brokerage firm. The second is the Federal Arbitration

Act, which requires courts to enforce the five arbitration

agreements that she signed. The Court of Appeal’s

refusal to permit Heily to raise a state law challenge to

the adequacy of NYSE arbitration was not only consistent

with, but compelled by, both the 1934 Act and the FAA.

A. The 1934 Act Preempts State-Law Challenges

To The Adequacy Of The NYSE As An Arbitra-

tion Forum.

Section 19 of the 1934 Act, 15 U.S.C. § 78s, gives the

SEC broad regulatory authority over the securities

exchanges, including the NYSE. Since 1975, when Con-

gress amended Section 19 to enhance that authority, the

SEC has been charged with, and has exercised, the

responsibility to review the NYSE’s rules and regulations

for fairness and consistency with the objectives of the

1934 Act itself.

Thus, under Section 19(b)(1), the NYSE must submit

any proposed rule changes to the SEC. 15 U.S.C.

§ 78s(b)(1). Upon the filing of any proposed rule change,

the SEC must publish notice of the proposed change and

provide interested parties an opportunity to comment. Id.

Subject to certain exceptions, no proposed rule change

may take effect unless approved by the SEC. Id. Under

16

Section 19(b)(2), the SEC must grant such approval, but

only if it finds after notice and comment that the pro-

posed rule is consistent with the requirements of the 1934

Act and with the rules and regulations thereunder. 15

U.S.C. § 78s(b)(2). Moreover, under Section 19(c), the SEC

may on its own initiative “abrogate, add to, and delete

from” any rule if it finds such changes necessary or

appropriate to further the purposes of the 1934 Act. 15

U.S.C. § 78s(c).

In sum, Congress has by statute delegated to the SEC

the responsibility and duty of ensuring the fairness of the

NYSE’s rules and regulations. The SEC, in turn, has exer-

cised that responsibility and duty and approved the

SEC’s rules, including Rule 347, which requires a stock-

broker to arbitrate any disputes “arising out of [her]

employment or termination of employment,” and Rules

600-634, which set out the actual arbitration procedures

to be used by the NYSE in such a case. Thus, the NYSE

rules requiring Heily to arbitrate her dispute with Merrill

Lynch and prescribing the procedures to be used at the

arbitration all operate pursuant to delegated Congres-

sional authority under the 1934 Act. Where a contrary

state principle conflicts with this Congressionally-autho-

rized regulatory scheme, the state law must yield as a

matter of federal preemption. See Fidelity Federal Savings

& Loan Assoc. v. De La Cuesta, 458 U.S. 141, 153 (1982)

(“Federal regulations have no less preemptive effect than

federal statutes”); Sola Electric Co. v. Jefferson Electric Co.,

317 U.S. 173, 176 (1942) (state common-law rules, like

state statutes, are subject to federal preemption).

Merrill Lynch is well aware of the fact that, in 1973,

this Court held that Rule 347 and the NYSE’s arbitration

rules did not preempt a California statute guaranteeing

17

employees the right to maintain a court action for back

wages. In Merrill Lynch, Pierce, Fenner & Smith Inc. v.

Ware, 414 U.S. 117 (1973), this Court declined to hold that

the NYSE’s rules preempted state law. However, the deci-

sion in Ware was explicitly based, in part, on the fact that,

in 1973, Rule 347 and the arbitration procedures pre-

scribed for use in employee-employer disputes were not

subject to SEC oversight. 414 U.S. at 134-35. Fourteen

years later, this Court again acknowledged that the lack

of SEC oversight over Rule 347 at the time of the Ware

decision was a major factor in the decision not to hold

state law preempted. Perry v. Thomas, 482 U.S. at __, 107

S.Ct. at 2525-26.

In 1975, as mentioned above, Section 19 of the 1934

Act was amended to give the SEC increased authority

over the securities exchanges. The 1975 amendments con-

stituted the “most substantial and significant revision of

this country’s Federal securities laws since the passage of

the Securities Exchange Act in 1934.” Herman & MacLean

v. Huddleston, 459 U.S. 375, 384-85 (1983) (quoting Securi-

ties Act Amendments of 1975: Hearings on S. 249 before

the Subcommittee on Securities of the Senate Committee

on Banking, Housing and Urban Affairs, 94th Cong., 1st

Sess., 1 (1975)). They explicitly granted the SEC the

authority to amend any NYSE rule, including Rule 347

and the rules prescribing arbitration procedures, if neces-

sary to ensure the adequacy and fairness of the arbitra-

tion system or otherwise further the purposes of the 1934

Act.

In point of fact, the SEC has heavily involved itself

since 1975 in promoting the effective and fair resolution

of disputes through NYSE arbitration. For example, in

18

1977 the SEC played a key role in the formation of the

Conference on Arbitration, which was created to develop

a uniform arbitration code. See Implementation of an

Investor Dispute Resolution System, Exchange Act

Release No. 13470, [1977-78 Transfer Binder] Fed. Sec. L.

Rep. (CCH) 81,136 (April 26, 1977). That Conference

drafted the Uniform Code of Arbitration which has since

been expressly approved by all of the Conference’s mem-

bers, including the NYSE. See In the Matter of New York

Stock Exchange, Inc., Exchange Act Release No. 16390, 18

S.E.C. Docket 1197 (November 30, 1979).

Two recent opinions of this Court hint broadly that

the 1975 amendments to Section 19 would be sufficient to

tip the Ware balance the other way, were the question

directly presented, and require a holding that, under the

current 1934 Act, the NYSE’s arbitration rules preempt

contrary state law. Thus, in Shearson/American Express,

Inc. v. McMahon, this Court held that agreements to settle

claims arising under Section 10(b) of the 1934 Act, 15

U.S.C. 78j(b), by arbitration before the NYSE, are enforce-

able. In reaching that conclusion, this Court depended

heavily upon the assurance, provided by SEC oversight,

that NYSE arbitration procedures are fair and adequately

protect the parties’ rights. 482 U.S. at __, 107 S.Ct. at

2341. And in Perry v. Thomas, this Court explained that

Ware had been premised on “[t]he fact that NYSE Rule

347 was outside the scope of the SEC’s authority” in 1975.

482 U.S. at __, 107 S.Ct. at 2526. The Perry opinion then

went on to sidestep the question of pure 1934 Act pre-

emption and to base its holding — that the same California

statute at issue in Ware must give way - on “the pre-

emptive effect of the Federal Arbitration Act... .” Id. See

Section III(B) of this brief, infra.

_ en ae

19

In Cohen v. Wedbush, Noble, Cooke, Inc., the Ninth

Circuit faced claims almost identical to Heily’s. The

appellants in that case had attempted to sue a brokerage

firm in court and to avoid arbitration by claiming, inter

alia, that the NYSE and the NASD would be presump-

tively biased against them. Like Heily, the Cohens relied

on California law to support their position that a claim of

presumptive arbitral bias could exempt them from their

obligation to arbitrate. The Ninth Circuit looked to this

Court’s opinion in Shearson/American Express for guid-

ance, and found it:

As the Supreme Court has recognized, the Securities

and Exchange Commission has virtually plenary

authority over the arbitration procedures adopted by

the national securities exchanges and securities asso-

ciations. This authority includes the power to “abrog-

ate, add to and delete from” the arbitration rules

adopted by such bodies if necessary or appropriate to

protect the rights created by the Securities Acts. The

SEC has explicitly approved the NYSE and NASD

arbitration rules and procedures at issue in this case.

Because Congress has committed to the SEC the task

of ensuring that the federal rights established by the

Securities Acts are not compromised by inadequate

arbitration procedures, we are bound by the Com-

mission’s determination that the procedures at issue

here are satisfactory.

Cohen, 841 F.2d at 286 (citations omitted). The Ninth

Circuit went on to conclude that, “[A]greements to arbi-

trate disputes in accordance with SEC-approved pro-

cedures are not unconscionable as a matter of law.” Id.8

8 Cohen has also been followed by the Northern District of

California in Western Hospitals Federal Credit Union v. E. F.

Hutton & Co., [Current Binder] Fed. Sec. L. Rep. (CCH) 4

93,990 (N.D. Cal. 1988).

a

20

Cohen’s conclusion, which was followed by the Court

of Appeal in the case at bar, is virtually compelled by this

Court’s recognition, in Shearson/American Express, that the

NYSE’s arbitration rules, as they stand today, are the

product of delegated Congressional authority under the

1934 Act. If principles of federal preemption do not safe-

guard those procedures from state-law attacks on their

fairness, then the uniform, nationwide dispute resolution

system carefully crafted by the SEC would fall into a

shambles. The enforceability of an agreement to arbitrate

before the NYSE (or any other exchange subject to SEC

oversight) would vary from state to state. In fact, the

enforceability of such an agreement could well vary from

case to case, depending on the persuasiveness and cred-

ibility of the witnesses enlisted to testify or submit decla-

rations in each action.

A rule permitting such piece-mail evaluation would

be illogical as well as unworkable. An NYSE arbitration

panel is either presumptively fair or it is not. Congress

has delegated the task of ensuring its fairness to the SEC,

and this Court has recognized that the SEC has done its

job. Therefore, the Cohen court — and the Court of Appeal

in the case at bar — were absolutely correct to rule that

state law principles-cannot be used to challenge the pre-

sumptive fairness of NYSE arbitration on a case-by-case

basis.

B. The FAA Also Preempts State-Law Challenges

To The Adequacy Of The NYSE As An Arbitra-

tion Forum.

Heily’s obligation to arbitrate her dispute with Mer-

rill Lynch stems not only from NYSE Rule 347 but also

21

from the Federal Arbitration Act,-which provides that

written arbitration agreements — such as the five agree-

ments Heily signed - “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

is by now well-settled that, “The effect of this section is to

create a body of federal substantive law of arbitrability,

applicable to any arbitration agreement within the cover-

age of the Act.” Moses H. Cone Memorial Hospital v. Mer-

cury Construction Corp., 460 U.S. 1, 24 (1983). Thus, the

Supreme Court has consistently held that an arbitration

agreement enforceable under the FAA cannot be avoided

by the application of conflicting state law. E.g., Southland

Corp. v. Keating, 465 U.S. 1, 12 (1984) (FAA preempts

provision of California law guaranteeing judicial deter-

mination of claims under the state’s Franchise Investment

Law); Perry v. Thomas, 482 U.S. at __, 107 S.Ct. at 2526

(FAA preempts provision of California law guaranteeing

judicial determination of wage disputes). See also Lid-

dington v. The Energy Group, Inc., 192 Cal. App. 3d 1520,

238 Cal. Rptr. 202 (1987) (FAA preempts provision of

California law permitting a stay of arbitration proceed-

ings pending judicial resolution of related litigation).

Heily claims that her state-law challenge to NYSE

arbitration is not preempted by the FAA because the FAA

does “noi preempt general principles of state law which

might affect the enforcement of an agreement to arbi-

trate,” Petition at 7, and because the principles enumer-

ated in Graham v. Scissor-Tail, on which she bases her

challenge, “applly] generally to any kind of contract.” Id.

at 10.

22

Merrill Lynch does not dispute Heily’s contention

that general state-law contract principles may be applied

to contracts governed by the FAA. Nor did the Court of

Appeal. But the lower court did recognize that the same

paragraph of Perry v. Thomas acknowledging the appli-

cability of general state contract law also sharply defined

what “general” means:

[S]tate law, whether of legislative or judicial origin, is

applicable if that law arose to govern issues concern-

ing the validity, revocability, and enforceability of

contracts generally. A state law principle that takes

its meaning precisely from the fact that a contract to

arbitrate is at issue does not comport with this

requirement of § 2. A court may not, then, in assess-

ing the rights of litigants to enforce an arbitration

agreement, construe that agreement in a manner dif-

ferent from that in which it otherwise construes non-

arbitration agreements under state law. Nor may a

court rely on the uniqueness of an agreement to

arbitrate as a basis for a state-law holding that enfor-

cement would be unconscionable, for this would

enable the court to effect what we hold today the

state legislature cannot.

482 U.S. at __, 107 S.Ct. at 2527 n.9 (citations omitted).

The arbitral-bias principle enunciated in Graham v.

Scissor-Tail, as the Court of Appeal recognized, did not

arise “to govern issues concerning the validity,

revocability and enforceability of contracts generally.” It

was developed especially for, and applied exclusively to,

arbitration contracts. Nor is the Graham case simply a

specific application of general California uncon-

scionability doctrine, as Heily would have this Court

believe. Indeed, under ordinary California contract law, a

23

contract is not rendered unenforceable due to uncon-

scionability unless it was unconscionable “at the time it

was made.” Cal. Civ. Code § 1670.5 (West 1985). In

Graham, the California Supreme Court created a special

unconscionability rule, applicable only to arbitration con-

tracts, which apparently permits courts to consider the

presumptive bias of an arbitration forum as of the time

the contract is sought to be enforced. Moreover, as the

Court of Appeal pointed out, Graham “weav[es] together

principles of adhesion contracts and state statutes gov-

erning the neutrality of arbitrators.” Heily v. Superior

Court, 202 Cal. App. 3d at 260, App. A at 5. In short, the

Graham arbitral-bias principle that Heily seeks to rely on

“takes its meaning precisely from the fact that a contract

to arbitrate is at issue,” Perry v. Thomas, 482 U.S. at __,

107 S.Ct. at 2527 n.9, and therefore cannot be applied to

an arbitration contract under the FAA.® See also Downs v.

Prudential-Bache Securities, Inc., 202 Cal. App. 3d 616, 248

Cal. Rptr. 734 (1988) (adequacy of NYSE as an arbitration

forum must be judged under federal law rather than

Graham and its progeny).

Heily does nut contend that federal law renders the

arbitration agreements she signed unconscionable due to

any presumptive bias of the NYSE arbitrators. Nor could

she, given the approval of the NYSE’s arbitration pro-

cedures by the SEC under the 1934 Act, as discussed in

® To the extent that Heily’s Petition may be read to con-

tend that the Court of Appeal wrongly interpreted Graham, she

is without recourse in this Court. See Tibbs v. Florida, 457 U.S.

31, 46-47 (1982) (state court’s construction of prior state court

decision ordinarily “binds this Court”).

24

Section III(A) of this brief, supra. See also Thomas v. Perry,

200 Cal. App. 3d 510, 515, 246 Cal. Rptr. 156 (1988) (on

remand from this Court, the Court of Appeal held, “exist-

ing federal precedent finds the [NYSE’s] arbitration rules

not to be unconscionable or presumptively biased”).

Thus, under the FAA as well as the 1934 Act, the Court of

Appeal was absolutely correct to rule that Heily’s state-

law challenge to the adequacy of the NYSE as an arbitra-

tion forum was out of order, and that the NYSE is a

presumptively fair forum as a matter of federal law.

sa

a

CONCLUSION

As the foregoing sections demonstrate, the instant

case presents a very narrow question to this Court. That

question was decided correctly below, based upon clear

federal precedent from two separate sources. There is no

need for any correction or clarification by this Court.

Accordingly, respondents respectfully submit that Heily’s

Petition for Writ of Certiorari should be denied.

W. Reece BADER

BARBARA MOsEs

Orrick, HERRINGTON & SUTCLIFFE

600 Montgomery Street

San Francisco, CA 94111

Telephone: (415) 392-1122

By: W. Reece BADER

Attorneys for Respondents

Merrill Lynch, Pierce, Fenner &

Smith Inc., Paul F. Hayes

and Peter F. Sansevero

F-1

APPENDIX F

IN THE SUPERIOR COURT OF THE STATE OF CALI-

FORNIA IN AND FOR THE CITY AND COUNTY OF

SAN FRANCISCO BEFORE THE HONORABLE LUCY

KELLY-McCABE, JUDGE

DEPARTMENT NO. 26

PAUL HAYES, PETER

SANSEVERO, and DOES

ONE through FIFTY,

Defendants.

—000—

KATHRYN A. HEILY, )

: Plaintiff, :

ve. ) No. 868892

MERRILL LYNCH PIERCE )

MOTION TO COMPEL

)

)

)

REPORTERS TRANSCRIPT OF PROCEEDINGS

June 10, 1987

APPEARANCES:

For the Plaintiff: BRONSON, BRONSON &

McKINNON

Bank of America Center

San Francisco, CA 94104

BY: SHAND STEVENS, ESQ.

F-2

For the Defendant: ORRICK, HERRINGTON &

SUTCLIFFE

600 Montgomery Street

San Francisco, CA 94111

BY: W. REECE BADER, ESQ.

and

JAY M. CUTLER, ESQ.

Reported by: Janice L. Davis

CSR No. 3899

WEDNESDAY, JUNE 10, 1987 10:30 a.m.

THE COURT: Line 27, Heily versus Merrill Lynch.

MR. BADER: Good morning, your Honor. W. Reece

Bader and Jay Cutler, Orrick, Herrington & Sutcliffe, on

behalf of the defendant and moving party.

MR. STEVENS: Shand Stevens appearing for the

plaintiff, Kathryn Heily, who is on my right.

MR. BADER: Your Honor, in view of the tentative

ruling, I will reserve my time to respond to counsel's

argument.

I do have one inquiry, your Honor. There was also a

Motion for Stay of Proceedings on file. I assume the

tentative ruling with respect to granting the Petition to

Compel would also include granting the stay of

proceedings.

THE COURT: Correct.

MR. BADER: Thank you.

MR. STEVENS: Your Honor, this is, from the plain-

tiff’s point of view, an extremely significant part of her

lawsuit.

F-3

THE COURT: I know. You told me everything at

least three times. I have never seen so much paper.

MR. STEVENS: I think only half of it was mine.

THE COURT: Here is my analysis in an attempt to

focus this. This clearly is a matter of Federal law. Under

the state of the law as it exists now and as I see it,

whether an arbitration clause is enforceable is deter-

mined by Federal law except to the extent that the con-

tract itself is unenforceable under State law.

Since that is the law in my view, it is irrelevant for

purposes of this motion what procedures are used by

NASD or the New York Stock Exchange because under

Federal law, those have been determined to be appropri-

ate remedies.

So what I looked at —- and I don’t have my notes here,

but I remember as if I had been reading this for the last

month of my life. The contract of adhesion - well, first

Ms. Heily’s claim that she never read any of these five

agreements, which is not a ground under the facts of this

case or under California law to set aside the contract, the

Court found that there was no fraud in the inducement of

both the employment contract, the application of the

securities for registration or the option trading

agreements.

That’s all I can think of right now. You claim there is

no consideration. I didn’t agree with that.

What am I forgetting?

MR. STEVENS: Your Honor, we have submitted the

declarations from five arbitrators from the New York

F-4

Stock Exchange, the American Stock Exchange and

NASD. |

THE COURT: I read every word of those and it was

real interesting and I got out of the market immediately.

But under Federal law, it’s an appropriate forum.

If I find that the contract itself is enforceable, I don’t

think, as a State court, I can even look at that. Do you all

disagree with that?

MR. BADER: No, your Honor.

MR. STEVENS: Well, of course that is their position.

THE COURT: No. I just want to make sure I wasn’t

misstating -

MR. STEVENS: Your Honor, that simply is not true,

and if the - The question is whether or not the Court is

entitled to look at whether or not the forum is, in fact,

unconscionable, whether it is unconscionable to enforce

the arbitration provision by sending this plaintiff back.

The authority directly on point, which is 1986 Lewis vs.

Prudential-Bache, says that.

Under the Federal Arbitration Act, an arbitration

clause can be revoked on any legal or equitable ground

that allows revocation of the contract, including uncon-

scionability. In other words, under Federal law, uncon-

scionability of the arbitration clause is a ground for

revocation. So that there is no question that you can

consider that. That is the thrust of our argument, that it

is.

_

F-5

THE COURT: Unconscionability of what?

MR. STEVENS: The arbitration clause is uncon-

scionable because it will force the plaintiff to adjudicate

an employment dispute in an arbitration forum where the

arbitrators themselves are biased against low-level

employees such as the plaintiff in wrongful termination

disputes.

THE COURT: I understand that that’s your

position.

MR. STEVENS: Well, I must admit that the entire

case in this context is extremely troublesome to this par-

ticular lawyer who works in a large law firm and repre-

sents many large corporate clients and this is an unusual

experience for me to deal with an individual plaintiff.

The facts as I see them, your Honor, are that we had

five arbitrators who had tremendous experience in the

system. They have had over 340 arbitrations between

them. All swear to this Court that arbitrators in these

securities forums are biased against employees such as

the plaintiff and they cited separate reasons, each of them

for several conclusions that they drew, not the least of

which was that the panelists are mostly management and,

therefore, they are biased against non-management plain-

tiffs in arbitrations.

The arbitrators tend to give more credibility to man-

agement witnesses than they do to employees. For that

same reason it is common in a securities industry for

these managers to change jobs and to -

THE COURT: I read all this. I mean I did read all

these things.

F-6

MR. STEVENS: Well, your Honor, I understand

that, and these people who swore that these things were

true, who had participated in the arbitration system

somewhere between thirty and eight years, were all fired

within four days after that evidence was submitted to the

Court.

THE COURT: See, what you didn’t argue and what

you didn’t ask for and what I considered doing was the

Prudential-Bache Court says, “Well, the arbitration clause

is enforceable, but since the forum is biased, then go to

Triple A arbitration,” but don’t want that either; correct?

MR. STEVENS: Your Honor, quite frankly, I would

prefer to be sent to Triple A arbitration than I would to a

forum — I mean I am not here spending my time and the

Court’s time with this simply because I’m trying to do an

abstract exercise.

THE COURT: Nobody addressed that aspect of that

case and I’m well aware of the case and the Court did not

really enter into the analysis of whether the problem with

the forum - The Court ordered that, it seems to me, more

as an equitable remedy and this is sort of the Court’s

discretion. If you’re going to do this, it may be an inap-

propriate arbitrator, but there is nothing wrong with the

clause.

I did not view that case as not giving me jurisdiction

to send it off to a forum that’s specified in the agreement

and the reason - since you didn’t argue for it, I didn’t

spend very much mental activity on it; and secondly, I

think that as a matter of Federal law, I probably cannot

do it anyway.

ie end

— a «

F-7

MR. STEVENS: Well, your Honor, may I address the

last first.

The question of the ability of the Court do do that,

and if —- Lewis vs. Prudential-Bache, once again, which is

cited on Page 12 of our brief.and it’s 179 C.A.3d 935, and

Lewis vs. Merrill Lynch stand for the proposition that you

can do that.

First of all, they address the question of whether

unconscionability is a defense under the Federal Arbitra-

tion Act and they clearly conclude that it is.

THE COURT: Unconscionability of the original con-

tract is, agreed. I agree with that, but I don’t agree with

your argument that because there’s a problem with the

forum, that that relates back to the inception of the con-

tract and makes the contractual provision unenforceable.

MR. STEVENS: The question is whether it’s uncon-

scionable to enforce agreentent, and I am actually moving

in the direction of your Honor’s suggestion, and that is

that if your Honor is inclined or believes that it would be

appropriate to send it to Triple A arbitration rather than

securities arbitration, I would like to have that done.

THE COURT: Well, nobody argued it, so I’m not

prepared to-do it right now.

MR. STEVENS: Would it be possible, then, your

Honor, to delay this for 15 or 20 days in order to raise

that point, because Lewis clearly - The Court of Appeal

did that on its own in Lewis.

THE COURT: Let me ask counsel what he thinks

about Lewis, which wasn’t really in this monumental

sacrifice to this case since it wasn’t really addressed by

F-8

you or by them except as to other propositions set forth

in Lewis.

MR. BADER: Your Honor, my response would be

with respect to this question of unconscionability, that

even - what Ms. Heily is really saying here in connection

with the declarations that they submitted is that she has a

premature claim of institutional bias on the part of arbi-

trators not yet selected in an arbitration not yet held that

will be conducted in the future.

In our response, we confronted head-on the declara-

tions that were submitted, and as your Honor is also

aware, we filed a motion to strike certain aspects of those

declarations.

The point is those declararions offer no specific

examples of actual bias, and under Federal law, partic-

ularly the Drayer case or the Tonetti case in the Court of

Appeal, the question is resolved only on a showing of

actual bias.

In addition, I think from the declarations we submit-

ted, we provided specific factual examples refuting that

bias and specific results directed at that aspect of the

uncons¢ionability argument that Ms. Heily, according to

her, would not have a fair and reasonable opportunity to

prevail, and I think, given the record that exists - and I

don’t know of anything more, quite frankly, that could be

added to the record at this point in time - there is no

showing.

F-9

THE COURT: No reply to the reply to the reply?

MR. BADER: There is no showing of actual bias,

and again, your Honor, I come back. What counsel is

saying is that somehow there’s going to be a presumed

bias. That, in fact, is not the case. As your Honor has

recognized as a matter of law, that won’t be the case, and

if, in fact, there is actual bias in conjunction with the

subsequent arbitration of this proceeding before the New

York Stock Exchange, an arbitrator selected by them,

there are going to be numerous procedural devices by

which the plaintiff can raise those issues.

We referred to the ruse [sic] in our reply brief and |

won't get into them now. Suffice it to say, given the

involvement of both the Exchange and the NASD in this

particular case, it strikes me that an extraordinary effort

of care and consideration is going to go into the selection

of those arbitrators and the plaintiff is going to have

ample opportunity to question whether they, in fact, are

appropriate arbitrators for this case.

The contract deals with arbitration under the aus-

pices of the New York Stock Exchange or the NASD, and

we believe that the contract, as your Honor believes, is

enforceable and that we are entitiled to proceed to arbi-

tration before, as we have selected in Ms. Heily’s absence

in selecting a forum, the New York Stock Exchange and

we do not believe that the matter should be referred to

the Triple A for arbitration and we further see no reason

really to delay this proceeding any further.

MR. STEVENS: Well, your Honor, it is untrue that

the particular forum is specified and it is also clearly the

fact that your Honor can send it to Triple A arbitration if

= ;

—_

F-10

you choose, because that’s exactly what Lewis did. The

Court of Appeal has already adopted that particular mid-

dle road for dealing with this kind of a problem.

The plain fact of the matter is that your Honor knows

that the remedies with respect to arbitration, and once it’s

happened, are extremely limited. The grounds for appeal-

ing are extremely limited, and, in fact, your Honor, I must

admit that my concern about this case being adjudicated

in those forums is immensely heightened by what we

have now done, which-is the head_of the direction of the

New York Stock Exchange has seen all these declarations,

including one from my own client, and has submitted a

declaration to this Court in which he indicates how

offended he is at the notion that his system is biased and

now we're supposed to go to that very system and adju-

dicate our claim where it’s come to the attention of its

highest levels.

Not only that. Within a couple of hours of the NASD

discovering that declarations had been submitted to this

Court, every arbitrator who su itted declarations for

the plaintiff was summarily dismissec I can’t see how,

in light of the fact that these compenant a reputable

people are willing to say that in an employment ute

of this kind with a low-level employee, the securities

arbitration is unfair; that it is fair, in fact, to send it to that

forum.

The only agreement that there is at all, if there is one,

is to arbitrate, and it can be arbitrated under the Triple A

rules if your Honor so chooses, and that would be much

preferable to doing it in front of this forum and it would

solve on of Merrill Lynch’s problems. They say it’s

Bet

i. |

F-11

cheaper to arbitrate and it probably is and that’s the

advantage, but the advantage should not be, your Honor,

where we're adjudicating in front of a forum where we

won't get a fair and impartial hearing or a fair result.

MR. BADER: I’m not sure, your Honor, that I can

really add anything more to what I've said.

THE COURT: I want to hear what objections you

would have to Triple A arbitration.

MR. BADER: Two. First of all, in Lewis vs. Pruden-

tial-Bache, which is a customer case, the customer agree-

ment had several alternative forums, or had at least a

Triple A alternative in addition to the New York Stock

Exchange and the NASD forum. That's not present in this

case with respect to the options account agreements

signed by Ms. Heily and it is not an alternative forum

with respect to the application form RE-1 and the two

U-4’s.

Secondly, your Honor, one of the significant purposes

of securities industry arbitrations in this context, which

was just reiterated two day ago by Justice O’Connor in

American Expriss vs. McMahon in which the Court upheld

in the customer context arbitration arising under section

10 of the ‘34 act an arbitration of RICO claims, was the

fact that — two facts: the involvement of the FCC [sic]

with respect io all of the rules and regulations of the

regulatory organizations as well as its specific approval

of bitraton procedures, which would be applicable

here, and sec basic purpose behind the securities

industry arbitration in <3 ayn ela case like this

involving disputes between employe tian cel

firms and those brokerage firms is the expertise that i ee |

F-12

brought to bear by having experienced arbitrators deal

with it. I’m not sure that’s the case with AAA in conjunc-

tion with the panels of arbitrators that they have.

And lastly, again, we believe the contract is enforce-

able according to its terms and ought to be submitted to

the New York Exchange for arbitration.

THE COURT: Submitted by both of you?

MR. STEVENS: Yes, your Honor.

THE COURT: The tentative is adopted. The Petition

to Compel Arbitration is granted. This action is stayed

pending arbitration.

With regard to the - Since you’re going to have to

prepare the order with regard to the Labor Code claim, I

was totally convinced by Judge Lynch’s opinion.

MR. STEVENS: Your Honor, is it to be sent to AAA

arbitration?

THE COURT: It’s to be sent to their election.

MR. BADER: New York Stock Exchange.

Your Honor, there’s one other matter. Mr. Stevens just

before we came in here -

MR. STEVENS: I have not filed that and I don’t

intend to.

MR. BADER: All right. I’ll withdraw that.

THE COURT: All right.

(Whereupon, the proceedings were concluded.

G-1

APPENDIX G

IN THE SUPERIOR COURT OF THE STATE OF CALI-

FORNIA IN AND FOR THE CITY AND COUNTY OF

SAN FRANCISCO BEFORE THE HONORABLE LUCY

KELLY MC CABE, JUDGE

—o00—

KATHRYN A. HEILY,

PLAINTIFF,

VS.

MERRILL LYNCH, ET AL.,

DEFENDANTS.

CASE NO. 868892

se ee ee ee

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REPORTER’S TRANSCRIPT

AUGUST 25, 1987

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APPEARANCES:

FOR THE PLAINTIFF: BRONSON, BRONSON &

MC KINNON

SHAND S. STEPHENS, ESQ.

555 CALIFORNIA STREET

SUITE 3400

SAN FRANCISCO, CA 94104

(415) 986-4200

G-2

FOR THE DEFENDANTS: ORRICK, HERRINGTON &

SUTCLIFFE

W. REECE BADER, ESQ.

600 MONTGOMERY STREET

SAN FRANCISCO, CA 94111

(415) 392-1122

OFFICIAL COURT

REPORTER: NOREEN T. IKEUYE, C.S.R.

CERTIFICATE NO. 3538

OG

AUGUST 25, 1987 9:30 CALENDAR

PROCEEDINGS

—000—

THE COURT: Line 11, Heily v. Merrill Lynch.

I should make it clear before you begin, I did recon-

sider it. But I decided not to change my mind. I mean, I

didn’t decide this on procedural grounds. I looked at the

reasons. I denied the reconsideration based on Perry, and

the new First District - what is the name of that real

recent case somebody talked about?

MR. STEPHENS: Lewis v. Merrill Lynch?

THE COURT: No.

MR. BADER: Liddington.

THE COURT: Yes, the Energy Power case.

It seems to me that federal law is now really clear

that once there’s coverage by the Federal Arbitration Act,

the only state law defenses to arbitration that are avail-

able are what would be defenses to any contract.

G-3

What you have asked me to do is to decide that only

the forum selection clause is unconscionable. At this

point, given what I have decided in the first place — that

this contract was not unenforceable because of uncons-

cionablility, and that under federal law this clause is

enforceable. And for that reason, I am declining to

change the ruling on the motion to compel arbitration.

MR. STEPHENS: May I discuss it with you for a

moment?

THE COURT: Sure.

MR. STEPHENS: The let me take it in two steps.

Perry v. Thomas, which was decided 5 days after your

honor ruled on the motion, specifically says that state law

principles of general applicability to contract apply to

these arbitration agreements. Are you and I agreed as to

that?

THE COURT: Yes. Also section 2 of the Federal

Arbitration Act says that, too.

MR. STEPHENS: Right. Now, I don’t agree that

what that means in this particular case is that we are

attacking something that specifically relates only to arbi-

tration. Unconscionability relates in the larger context to

all contracts.

THE COURT: Agreed.

MR. STEPHENS: All right. There are two issues

then before the court.

First of all, is this actually a forum selection clause?

And the answer is no, there is not. And that is partic-

ularly evident from the fact that we quoted the language

out of them. And Merrill Lynch chooses not to rely on

G-4

them, saying there is a forum selection clause in the

arbitration provision we have quoted for your Honor on

page 2. }

THE COURT: Yes.

MR. STEPHENS: And if you look at the 1982 appli-

cation, which is the last one signed, it says — and I will

leave — try to leave some of the words out so you can get

to the thrust of it - “I agree to arbitrate any dispute that

is required to be arbitrated under the rules, constitutions

or bylaws of the organizations with which I register.”

Now what that means is if those rules require some-

thing to be arbitrated, I agree to do that. It doesn’t say

that it must be before the New York Stock Exchange or

any other particular place.

And so I believe that, your Honor, in this situation,

under both the Federal Arbitration Act, Section 5, and

general state law, the court has the power to choose

where to send it.

THE COURT: Except the effect of that is to incorpo-

rate the rules of whatever exchange she is required to —

register with.

MR. STEPHENS: But I mean - I agree that I under-

stand perhaps that that is what you are saying. But if you

focus on the language, it doesn’t mandate that result at

all. And if it’s not mandated, then the choice rests with

the court to do that, even —

THE COURT: Let me hear from counsel for Merrill

Lynch on that point.

MR. BADER: On that specific issue, your Honor?

THE COURT: Yes.

MR. BADER: Well, I don’t have the exact agree-

ments in front of me. They are part of the record from our

earlier hearing.

THE COURT: Part of our problem - Well, I didn’t

go through -

MR. BADER: Yes. I didn’t -

THE COURT: I have trusted my memory about

what he had the last time, as I recall.

MR. BADER: The agreements.

THE COURT: There are 5 agreements.

MR. BADER: Yes, there are 5.

THE COURT: And this — excuse me a second. Is this

particular language from -

MR. BADER: The 1982 agreement.

THE COURT: Okay.

MR. STEPHENS: It is the last agreement that was

signed that relates to the entire complaint.

MR. BADER: The first agreement which was the

original RE-1 application in 1968 where it first refers

specifically to Rule 374 of the New York Stock Exchange -

Rule 347 requires arbitration of employment disputes.

That rule has not changed. That rule therefore, as your

Honor indicated, becomes incorporated in the subsequent

agreements.

The reference to “organizations with which I regis-

ter” — they are all securities industry organizations — the

G-6

exchanges, the NASD. That is also true with respect to

the options, the two options agreements as well, whether

it's NASD or New York Stock Exchange. So it’s clearly a

securities industry forum.

We petitioned to compel; plaintiff made no response,

no elections, with respect to a forum. Rather, plaintiff

challenged the process wholesale. We asked that the

agreements be enforced as mandated by the Arbitration

Act, and that the New York Stock Exchange be the proper

forum.

I don’t think there is anything new or different or

any valid reason which presently exists to change that

ruling.

THE COURT: I understand that’s your position.

MR. STEPHENS: Your Honor, you have the power

to choose the forum for this particular plaintiff. The only

right under that contract that exists, if one does at all, is

to force arbitration, not to choose the forum where it is to

occur.

The language, doesn’t dictate that. And it is untrue

that any of these agreements which I have quoted for

your Honor, on page 2, mention Rule 347 of the New

York Stock Exchange. They do not.

You have the power then under the United States

Supreme Court decisions, the Federal Act, Lewis v. Merrill

Lynch and Liddington which parrots Perry — it says that

state law principles apply. You have the power to choose

the forum. There is no necessity for sending it to a place

—

G-7

where there is any doubt about whether or not the plain-

tiff will receive a fair hearing. There is every reason to

send it somewhere where she will.

Whether there is no such doubt in the particular case

here, since the choice exists, and since a particular place

for doing this is not required by the agreement, there is

every reason to do it, and no reason not to. Because the

issue is one at the heart of American jurisprudence - will

she receive an unbiased, impartial hearing of what she

has to say? Regardless of whether she wins or loses, she

is entitled to that at least.

The importance of this issue to the defendant is

indicative of the fact that that forum is an advantage to

Merrill. They have obviously seen it that way, or they

wouldn’t be here fighting so hard not just for arbitration,

but now they are fighting real hard to send it where they

want it sent.

Why? Is there any difference between there and here

with respect to the discovery or the rules or procedure?

They don’t cite you any of that. They say we have a right

to send it there, your Honor, and that is where we want

it. But they don’t have that right. They don’t even have

an election to do that. It’s not their choice. It is your

Honor’s choice. The contract doesn’t mandate that

choice.

THE COURT: I don’t agree with you. I don’t think I

have got that choice. After Perry, I don’t think I have got

that choice. Federal law, which nobody got into in these

papers because it’s 3 steps removed from where we are

now, but the federal law as to the enforceability of forum

selection clauses is pretty clear.

G-8

I view the language you quoted as incorporating the

rules of the exchanges that she registers with. I agree

with counsel for Merrill Lynch that your remedy under

federal law is to attack the arbitration award, when and if

that occurs, as being biased or that she was incapable of

receiving a fair hearing.

But I think that is a record that has got to be made

and in front of arbitrators, not in front of the law and

motion judge. I don’t think that I can decide in futuro that

the New York Stock Exchange is incapable of giving Ms.

Heily a fair hearing. That is my view of where we are in

the law as of 3 weeks ago.

MR. STEPHENS: In going through the Federal Act

and then reading that law, in accord with Perry v. Thomas

as well as our own appellate court decisions, it’s clear -

THE COURT: The only appellate court decision you

have got is Lewis.

MR. STEPHENS: Okay.

THE COURT: Right? Agreed? That really has to do

with what we are doing here?

MR. STEPHENS: It’s directly on point, yes. And it

holds that the forum selection clause in one of Merrill

Lynch’s customer agreements is unconscionable because

that forum is presumptively biased — not even by biased,

presumptively biased in industry-wide dispute.

THE COURT: Lewis involves a case where it was

undisputed that every single brokerage firm used a 360

day year for computing interest.

MR. STEPHENS: Correct.

G-9

THE COURT: That was undisputed, right?

MR. STEPHENS: Yes, there was an allegation.

THE COURT: So there is really no dispute of fact at

all about whether the arbitrators could put that out of

their minds or, you know, not be ever presumptively

biased but actually biased.

We have nothing like that here. We have something

tending - you have submitted evidence that may tend to

show that there may be bias, but it’s not like Lewis.

MR. STEPHENS: Well, but the specific facts of

Lewis, I don’t believe, are actually what is important with

respect to this proceeding.

What is important is the fact that the court in Lewis

recognizes, and that is a 1986 decision, that the Superior

Courts of this state have the power to hold that, number

one, even though an arbitration clause is enforceable, the

forum selection may not be. And that is severable.

And that severing out the forum choice, the court

then has the power to order arbitration in a neutral

forum. And in that case, Lewis v. Merrill Lynch, I mean

this situation was some other neutral forum, that is, the

American Arbitration Association. There is simply no

doubt that the court has the power to do this. It exists

both under federal and state law, your Honor.

The federal law, the Federal Arbitration Act in sec-

tion 2 talks about the agreements, and about the fact that

state law defenses are applicable. And then in section 5 it

says, if there is a forum selection clause, that should be

G-10

enforced. Obviously, reading the 2 sections together, the

forum selection is subject to an attack under state law.

And the bottom line, your Honor, is that addressing

the equity of a situation — to the court’s equitable powers,

there is no reason to require the plaintiff to arbitrate in a

forum where there is even a reasonable doubt of any kind

that she will receive a fair hearing.

In the end, as your Honor knows, attempting to

attack an arbitration award after an arbitration is very

very difficult. The standards for doing that are extremely

limited - bad faith and dishonesty on the part of the

arbitrator is extremely difficult to prove.

What we have presented your Honor with is the up

front evidence from 5 different arbitrators, to the effect

that their experiences in all of these systems put together,

tell them that in this kind of a dispute, a wrongful termi-

nation case, there is unfortunately a bias that exists

against the plaintiff. And why incur that risk? Someone

with an 18 year career is entitled to the limited benefit of

an impartial hearing. And that is all that is being

requested here, the particular forum, which your Honor

has the power to do.

THE COURT: I don’t agree that I do. But I guess we

will find out whether I do or not.

MR. STEPHENS: I suppose so, your Honor.

MR. BADER: Your Honor, I did prepare a proposed

form of order. I have not shown it to Mr. Stephens. It’s

very straightforward.

THE COURT: Show it to Mr. Stephens.

i eae

G-11

MR. STEPHENS: If it’s represented to be straight-

forward, I’d better read it carefully.

THE COURT: Oh, gentlemen.

MR. STEPHENS: That is fine.

MR. BADER: May I approach the bench?

THE COURT: Yes.

MR. STEPHENS: Thank you for your time.

THE COURT: Thank you for your papers. It was an

interesting question.

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