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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Opposition Brief
- **Published:** January 1, 1989
- **Citation:** 489 U.S. 1013

## Text

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
IED 6 cccccaccccccstces coccese i
UT TE reese sb becccccccceseccocecccces ii
I 5 bs cncdcvccsccccscccsceces iii
MED oo cc ccccccccccccccccccece iv
STATUTES INVOLVED .............0.20ceeceseece. 1
Daeeemee Gi BOO CAGE, 20. ccc ccccscccccccece 1
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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BE BU ick b 0 6s binawa cccncseaeussmanueee 15, 17, 18

I MIs ccceecnbisccdeccueveceon Nidates 15

EE MI co vicincnunecectchsaduedateen ue 16

PA IR dik cin 650400s écccbennskeannceuanie 16
California Civil Code

I EE cba cckisedscsccusddassncesenacrene 23
California Civil Procedure Code

I Be 6 6 h.hks bia’ hin dsdckccdieeeese 4

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

—000—
REPORTER’S TRANSCRIPT
AUGUST 25, 1987
—000—

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.

—000—

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385002_0531%3A2. Public record. Not legal advice.