Petition for Writ of Certiorari — Connolly v. Securities Industry Ass'n

Suprema Court. US$. }

'

89.-894 8 8&8 O

1 NOW, 29° 190s

No. 89- ie Mii a

¢, oct ean ax iS . — ae

Inthe i

Supreme Court of the United States.

OCTOBER TERM, 1989.

MICHAEL J. CONNOLLY,

MASSACHUSETTS SECRETARY OF STATE,

AND

BARRY C. GUTHARY, DiREcTOor,

MASSACHUSETTS SECURITIES DivISION,

PETITIONERS,

¥.

SECURITIES INDUSTRY ASSOCIATION, ET AL.,

RESPONDENTS.

Petition for a Writ of Certiorari

to the United States Court of Appeals

for the First Circuit.

JAMES M. SHANNON,

ATTORNEY GENERAL

COMMONWEALTH OF MASSACHUSETTS,

THomas A. BarNIco,* :

RICHARD M. BRUNELL,

ASSISTANT ATTORNEYS GENERAL,

One Ashburton Place,

Boston, Massachusetts 02108-1698.

(617) 727-2200, ext. 2086

Counsel for Petitioners

*Counsel of Record

BATEMAN & SLADE. INC.

BOSTON, MASSACHUSETTS

QUESTION PRESENTED

Does the Federal Arbitration Act, 9

U.S.C. § 1 et seg., preempt a State from

protecting investors by (1) requiring

securities brokers to disclose the legal

effects of mandatory, pre-dispute

arbitration agreements, and (2)

prohibiting brokers from requiring an

arbitration agreement as a

non-negotiable condition of opening a

brokerage account?

PARTIES TO T PROCEEDING

The petitioners are identified in

the caption. In addition to the

respondent listed in the caption, the

following are respondents:

Dean Witter Reynolds, Inc.;

Donaldson, Lufkin & Jenrette

Securities Corp.;

Drexel Burnham Lambert, Inc.;

Fidelity Brokerage Services, Inc.;

Kidder Peabody & Co.;

Merrill, Lynch, Pierce,

Fenner & Smith, Inc.;

Paine Webber Inc.;

Prudential-Bache Securities, Inc.;

Shearson Lehman Hutton, Inc.;

Smith Barney, Harris Upham & Co.

ii

TABLE OF CONTENTS

QUESTION PRESENTED

PARTIES TO THE PROCEEDING

OPINIONS BELOW

JURISDICTION

CONSTITUTIONAL AND STATUTORY

PROVISIONS INVOLVED

STATEMENT OF FACTS

STATEMENT OF PRIOR PROCEEDINGS

REASONS FOR GRANTING THE WRIT

I. THE DECISION BELOW

PRESENTS AN IMPORTANT

QUESTION CONCERNING

THE AUTHORITY OF THE

STATES TO PROTECT

INVESTORS IN THE

FORMATION OF

ARBITRATION AGREEMENTS.

II. THE DECISION HAS NATIONAL

IMPLICATIONS FOR STATE

REGULATION OF MANDATORY

ARBITRATION AGREEMENTS IN

BANKING, HEALTH CARE,

AUTOMOBILE, AND MANY

OTHER INDUSTRIES.

234

PAGE

11

13

13

23

III. THE DECISION BELOW

MISCONSTRUES THE

PURPOSES AND OBJECTIVES

OF THE FAA. 32

CONCLUSION 50

APPENDIX

iv

TABLE OF AUTHORITIES

PAGE

Cases

Ames v. Merrill Lynch, Pierce,

Fenner & Smith, 567 F.2d 1174

(2d Cir. 1977) 45n

Coit Independence Joint Venture

v. Federal Savings and Loan

Ins. Corp., 109 S.Ct. 1361 (1989) 34n

Dean Witter Reynolds, Inc.

v. Byrd, 470 U.S. 213 (1985) 41, 46

Dinong v. Superior Court,

102 Cal. App. 3d 845,

162 Cal. Rptr. 606 (1980) 27

Hines v. Davidowitz,

312 U.S. 52 (1941) 33

Madden v. Kaiser Foundation

Hospitals, 17 Cal.3d 699,

131 Cal. Rptr. 882,

552 P.2d 1178 (1976) 26, 27

Mitsubishi Motors v. Soler

Chrysler-Plymouth, Inc.,

473 U.S. 614 (1985) 36

Moses H. Cone Memorial Hospital v.

Mercury Constr. Corp.,

460 U.S. 1 (1983) 38

New State Ice Co. v. Liebmann,

285 U.S. 262 (1932) 22

Perry v. Thomas,

482 U.S. 483 (1987) 35, 45

Prima Paint Corp. v. Flood

& Conklin Mfg. Co.,

388 U.S. 395 (1967) 43, 49

Rice v. Santa Fe Elevator

Corp., 331 U.S. 218 (1947) 34n

Sanchez v. Sirmons,

121 Misc. 2d 249,

467 N.Y.S. 2d 757 (1983) 26

Saturn Distribution Corp.

v. Williams, Commissioner of

the Department of Motor

Vehicles of Virginia,

717 F. Supp. 1147

(E.D. Va. 1987) 30, 31, 46n

Shearson/American Express Co.

v. McMahon,

482 U.S. 220 (1987) Qn, 14, 44

Smoky Greenhaw Cotton

v. Merrill Lynch Pierce

Fenner & Smith, Inc.,

720 F.2d 1446 (5th Cir. 1983) 37

vi

Southland Corp. v. Keating,

465 U.S. 1 (1984) a

Volt Information Sciences, Inc.

v. Board of Trustees of Leland

Stanford Junior University,

109 S.Ct. 1248 (1989) Ja, S23, Ba

Federal Constitution and Statutes

U.S. Const. Art. vI, ea. 2 3

5 U.S.C. § 8902 (1988 ed.) 27

Federal Arbitration Act

9 U.S.C. § 1 et seg. (1982 ed.)

W

9 U.S.C. § 2 (1982 ed.) 5

9 U.S.C. § 3 (1982 ed.) 5

9 U.S.C. § 4 (1982 ed.) 6

The Securities and Exchange Act

of 1934

15 U.S.C. § 78bb(a) (1982) 4, 7

28 U.S.C. § 1254(1) a

Federal Regulations

17 C.F.R. 180.3(b) 17, 18-19n, 37

vil

PAGE

41 Fed. Reg. 42,943

(Sept. 29, 1976) 18n, 38

54 Fed. Reg. 21,144

(May 16, 1989) 20, 39, 44n

Federal Legislative Materials

H.R. 4960, 100th Cong., 2d Sess.

(June 30, 1988) 15n

H.R. Rep. 96, 68th Ccng.,

lst Sess. 1 (1924) 42, 46

Senate Rep. No. 536, 68th

Cong., lst Sess. (1924) 43

134 Cong. Rec. E2233

(daily ed. June 30, 1988) 15n

134 Cong. Rec. E2239

(daily ed. June 30, 1988) 15n

134 Cong. Rec. E2245

(daily ed. June 30, 1988) 15n

Hearing on S. 4213 and S. 4214

before the Subcommittee of the

Senate Committee on the Judiciary,

67th Cong., 4th Sess. (1923) 43

Statement of James C. Myer Before _

the Subcomm. on Telecommunications

and Finance of the House Comn.

on Energy and Commerce,

December 16, 1987 14

viii

PAGE

Massachusetts Statutes

Mass. Gen. Laws c. 9, § 1 7

Mass. Gen. Laws c. 110A, §101 et seq. 8

Mass. Gen. Laws c. 11OA, § 204 11

Mass. Gen. Laws c. IL1OA, § 412 7

Mass. St. 1921, c. 499 8

Massachusetts Requlations

950 CMR 12.204(a)(2)(G) 1l.a-c passim

Mass. Register No. 593

(October 14, 1988) 8, 44

Other State Statutes

Alaska Stat. § 0.955.535(b)

(Michie 1988 ed.) 29

Cal. Civ. Proc. Code § 1295(a)

and (b) (West 1982 ed.) 28

Ill. Rev. Stat. c. 10, § 209

(West 1987 ed.) 29

Mich. Comp. Laws § 600.5041

(West 1987 ed.) 29

Mich. Comp. Laws § 600.5041(2)

and (5) (West 1987 ed.) 30

ix

PAGE

Ohio Rev. Code Ann. § 2711.23

(Banks-Baldwin 1989 Supp.) 28

South Dakota Cod. Laws

Tit. 21-25B-3 (Michie 1987 ed.) 28

Miscellaneous

J. Butler, Arbitration in Banking -

State of the Art

(Robert Morris Associates, 1988) 25

California Banks are Using

Arbitration to Cut Court Costs,

Avoid Jury Verdicts, 2 ADR Rep.

(BNA) 181 (May 12, 1988) 25

Fed. R. Civ. P. 56(f) 40n

Note, Medical Malpractice

Arbitration: A Patient’s

Perspective, 61 Wash. Univ. L.

Rev. 1235 (1983) 26

Posner, Strict Liability:

A Comment, 2 J. Leg. Stud. 205

(1973) 21n

Rakoff, Contracts of Adhesion:

An Essay in Reconstruction,

96 Harv. L. Rev. 1174 (1983) 21n

South Dakota Atty. Gen.

Op. No. 76-98 30

x

No. 8&9-

IN THE SUPREME COURT OF THE UNITED STATES

October Term, 1989

MICHAEL J. CONNOLLY, et al.,

Petitioners,

Vv.

SECURITIES INDUSTRY ASSOCIATION, et al.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

Michael J. Connolly, Massachusetts

Secretary of State, and Barry C. Guthary,

Director, Massachusetts Securities

Division, respectfully petition for a

writ of certiorari to review the

judgment of the United States Court of

Appeals for the First Circuit in this

case.

OPINIONS BELOW

The opinion of the court of appeals

(App. la-52a) is reported at 883 F.2d

1114 (lst Cir. 1989). The opinion of

the district court (App. 55a-130a) is

reported at 703 F. Supp. 146 (D. Mass.

1988).

JURISDICTION

The judgment of the court of appeals

was entered August 31, 1989. App. 53a.

The court of appeals held that certain

Massachusetts regulations were invalid

as repugnant to the Federal Arbitration

Act, 9 U.S.C. § 1 et seq. Petitioners

invoke the jurisdiction of this Court

under 28 U.S.C. § 1254(1).

CONSTITUTIONAL AND STATUTORY

PROVISIONS INVOLVED

Art. VI, cl. 2, of the United States

Constitution provides:

This Constitution, and the Laws of

the United States which shall be

made in Pursuance thereof...

shall be the supreme Law of the

Land[. ]

The Massachusetts regulations at

issue are Title 950 Code of

Massachusetts Regulations (CMR)

12.204(a)(2)(G) 1.a-c. The text of the

regulations appears in the addendum to

the opinion of the court of appeals,

App. 49a-52a, and in the text of the

opinion of the district court. App.

62a-63a n.5.

Section 28 of the Securities and

Exchange Act of 1934, 15 U.S.C.

§ 78bb(a) (1982 ed.), provides in

pertinent part:

Nothing in this chapter shail

affect the jurisdiction of the

securities commission (or any agency

or officer performing like func-

tions) of any State over any

security or any person insofar as it

does not conflict with the

provisions of this chapter or the

rules and regulations thereunder.

Section 2 of the Federal Arbitration

Act, 9 U.S.C. § 2 (1982 ed.) (the Act),

provides in pertinent part:

A written provision in any...

contract evidencing a transaction

involving commerce to settle by

arbitration a controversy thereafter

arising out of such contract or

transaction .. . shall be valid,

irrevocable, and enforceable, save

upon such grounds as exist at law or

in equity for the revocation of any

contract.

Section 3 of the Act, 9 U.S.C. § 3

(1982 ed.), provides:

If any suit or proceeding be brought

in any of the courts of the United

States upon any issue referable to

arbitration under an agreement in

writing for such arbitration, the

court in which such suit is pending,

upon being satisfied that the issue

involved in such suit or proceeding

is referable to arbitration under

such an agreement, shall on

application of one of the parties

stay the trial of the action until

such arbitration has been had in

accordance with the terms of the

agreement([. ]

Section 4 of the Act, 9 U.S.C. § 4

(1982 ed.), provides:

A party aggrieved by the alleged

failure, neglect, or refusal of

another to arbitrate under a written

agreement for arbitration may

petition any United States District

Court which, save for such agree-

ment, would have jurisdiction...

of the subject matter of a suit

arising out of the controversy

between the parties, for an order

directing that such arbitration

proceed in the manner provided for

in such agreement.

xk *& &

The court shall hear the parties,

and upon being satisfied that the

making of the agreement for

arbitration or the failure to comply

therewith is not in issue, the court

shall make an order directing the

parties to proceed to arbitration in

accordance with the terms of the

agreement.

x k&

If the making of the arbitration

agreement or the failure, neglect,

or refusal to perform the same be in

issue, the court shall proceed

summarily to the trial thereof.

OF S

In September, 1988, the

Massachusetts Secretary of State issued

regulations (1) requiring securities

brokers to disclose to customers the

legal effects of a mandatory "pre-

dispute" arbitration clause in a

brokerage agreement, and (2) prohibiting

brokers from requiring such an arbitra-

tion clause as a non-negotiable condi-

tion of opening a brokerage account.

The Secretary promulgated the

regulations pursuant to his authority

under federal and state securities laws

to regulate the conduct of semuesties

brokers. See 15 U.S.C. § 78bb(a) (1982

ed.); Mass. Gen. Laws c. 9, § 1;

c. l1OA, § 412. Massachusetts has

broadly regulated the sale of securities

Since 1921. See Mass. St. 1921, c.

499. Massachusetts’ regulation of

securities brokers - like that of all

other state "blue-sky" authorities -

protects investors from unfair and

dishonest broker conduct. See Mass.

Gen. Laws c. 110A, § 101 et seq.

(Uniform Securities Act).

The stated purpose of the regula-

tions is to "provide the customer with a

meaningful choice prior to making a

decision to sign the [arbitration]

agreement." Mass. Register No. 593

(October 14, 1988). As the district

court found, the prevailing practice in

the brokerage industry is not to advise

prospective customers of the legal

effects of the arbitration clause, and

is to require retail customers to agree

to arbitrate disputes as a condition to

opening a brokerage account. App.

66a-69a./

The Massachusetts regulations

address there practices by requiring

disclosure and bargaining in the

formation of arbitration agreements.

1/ A 1987 study by the Securities and

Exchange Commission (SEC), credited by

the district court, confirms the growing

trend by brokers to require arbitration

for all securities accounts in the wake

of Shearson/American Express v. McMahon,

482 U.S. 220 (1987). The study "found

that arbitration agreements were all but

universal for margin accounts (89

percent of the firms used such

agreements) and for option accounts (83

percent of the firms used such agree-

ments)," that 40 percent of the firms

use arbitration agreements in cash

accounts, and that 30 percent of the

firms surveyed "had under active

consideration plans to expand the number

of accounts for which an arbitration

agreement would be required." App. 69A

n. 7.

The regulations do not prohibit brokers

from entering into pre-dispute arbitra-

tion agreements with customers. A

broker may enter an arbitration clause

if he discloses its legal effect and

does not insist on the clause without

offering anything in return. 2/ A

broker may, for example, negotiate a

commission discount for customers who

agree to arbitrate future disputes, or

charge a higher commission to those who

do not agree to the clause. See App.

116a. Nor do the regulations deem

unenforce-

able those arbitration agreements which

are entered into without compliance

2/ Under the rules of the self-

regulatory organizations, brokers are

required to arbitrate upon the request

of the customer, even in the absence of

a predispute arbitration agreement. See

Appendix to Brief of Appellant, First

Circuit Docket No. 89-1022 at 469.

- 10 -

with the regulations. Rather, the

regulations make the prohibited

practices subject to sanction in broker

disciplinary proceedings. See Mass.

Gen. Laws c. lL1OA, § 204.

STATEMENT OF PRIOR PROCEEDINGS

On September 22, 1988, the

Securities Industry Association and nine

brokerage firms (the “industry") filed

their complaint in the United States

District Court for the District of

Massachusetts. App. 56a. On abbrev-

iated cross-motions for summary

judgment, the district court declared

the regulations preempted by the Act.

App. 57a-58a, 99a-106a, 131la-132a. The

- l1l-

court of appeals affirmed. Although

conceding that "(t]he Commonwealth may

well be correct that [arbitration

Clauses] ought to be arrived at with

greater negotiation and disclosure

between broker-dealers and customers

than currently takes place," App. 46a,

the court ruled that "[e]ven if regu-

lators find industry-wide practices that

would be grounds for voiding arbitration

agreements at common law, e.g., fraud or

coercion, any separate regulatory action

{such as the Massachusetts disclosure

requirement] or sanction singling out

arbitration agreements from contracts

generally would be preempted" by the

Federal Arbitration Act. App. 24a-25a

(emphasis original). As petitioners

- 12 -

demonstrate in Part III, infra, this

reasoning seriously misconstrues the

purposes and objectives of the Act.

I. THE DECISION BELOW PRESENTS AN

IMPORTANT QUESTION CONCERNING THE

AUTHORITY OF THE STATES TO PROTECT

INVESTORS IN THE FORMATION OF

0) G NTS.

This case presents a question of

national significance for the regulation

of securities brokers by the States.

Review by this Court is necessary to

determine the extent of state authority

to protect investors in the formation of

arbitration agreements.

The growing use of mandatory

arbitration agreements in the securities

- 13-

and commodities industries in the wake

of Shearson v. McMahon, 482 U.S. 220

(1987), has drawn increasing attention

from federal and state regulators and

legislators. The intense interest of

state regulators is shown by the actions

of the North American Securities

Administrators Association (NASAA). In

December, 1987, NASAA urged Congress to

require brokers to negotiate arbitration

agreements and to provide potential

customers with a separate document

explaining the terms and implications of

mandatory arbitration clauses. See

Statement of James C. Myer Before the

Subcomm. on Telecommunications and

Finance of the House Comm. on Energy and

Commerce, December 16, 1987. NASAA

supported its Congressional testimony

- 14 -

with its "Investor Hotline Study," a

report which found that many of the

investors who complained to NASAA aft r

the October, 1987, market "crash," did

not know that they had signed an

arbitration clause and did not under-

stand its implications. See App.

59a-60a n.2.2/

In October, 1988, NASAA adopted a

"Resolution Concerning the Execution of

Compulsory Pre-Dispute Arbitration

3/ NASAA submitted further testimony to

Congress in 1988 in support of the

proposed "Securities Arbitration Reform

Act of 1988," H.R. 4960, 100th Cong., 2d

Sess. (June 30, 1988), which would have

required disclosure and prohibited

brokers from making pre-dispute arbitra-

tion clauses a condition of doing

business. See 134 Cong. Rec. E 2233

(remarks of Cong. Boucher); E 2239-41

(remarks of Cong. Dingell); E 2245-46

(remarks of Cong. Markey) (daily ed. June

30, 1988) 2 Cong. Index (CCH) at 35,106

(100th Cong.); App. 6lan. 4.

- 15 -

Agreements as a Condition Precedent to

Obtaining Brokerage Services," in which

NASAA expressed "support [for] the goals

and policies of the Massachusetts rules

as being consistent with NASAA’s purpose

of advancing the principle of investor

protection and affording choice to

investors in their decisions to

participate in the securities markets."

App. 59a-60a n.2. NASAA also filed a

brief amicus curiae in the court of

appeals in this case which stated that

"at least 15 other members [of NASAA]}

would consider adopting some form of

regulation covering mandatory arbitra-

tion clauses and disclosure of investor

rights." Brief at 4.4/

4/ NASAA also is expected to file a

brief amicus curiae in this Court

supporting this petition.

- 16-

The national importance of this

issue is similarly shown by the actions

of federal agencies which have addressed

mandatory arbitration clauses. The

Commodities Futures Trading Commission

(CFTC), for example, has enforced regu-

lations similar to the Massachusetts

regulations since 1976. Title 17 C.F.R.

180.3(b) precludes a commodities broker

from entering into a mandatory predispute

arbitration agreement with a customer

unless, inter alia, the agreement is not

a condition for the customer to utilize

the Siecle of the broker, and the

agreement contains cautionary language

in large bold-face type, separately

endorsed by the customer, that

enumerates the customer’s rights and the

legal effect of the agreement. The

existence of § 180.3(b) prompted the

CFTC to file a letter in the court of

appeals in this case which stated that

"Commission regulation 180.3 does not

conflict with the Federal Arbitration

Act because both provisions reflect a

policy favoring the arbitration of

commodities disputes, and because

regulation 180.3 enhances, not

diminishes, the likelihood that

pre-dispute arbitration agreements that

comply with its terms will be

enforced. "2/

5/ In promulgating its original regu-

lations in 1976, the CFTC considered

arguments that the cautionary language

"would be in the nature of a warning

against use of an arbitration procedure

and would thus discourage persons from

Signing pre-dispute arbitration agree-

ments[(,]" and that "{s]Juch warnings are

not usual in commercial contracts,’ and

‘can only result in frightening away

some customers.’" 41 Fed. Reg. 42,943

(footnote continued)

- 18 -

The Securities and Exchange

Commission (SEC) has also recently (but

partially) addressed voluntariness in

the entry of arbitration agreements. On

May 10, 1989, the SEC issued an "Order

Approving Proposed Rules Changes by the

New York Stock Exchange, Inc., National

Association of Securities Dealers, Inc.,

and the American Stock Exchange, Inc.,

Relating to the Arbitration Process and

the Use of Predispute Arbitration

(footnote continued)

(Sept. 29, 1976). In response, the CFTC

reiterated "its positive attitude toward

the settlement of disputes by arbitra-

tion. It does not follow from this,

however, that the Commission can or

should leave a customer unaware of the

purpose of the agreement he is requested

to sign." Id. The CFTC noted that it

believed that "cautionary language is

necessary to assure an informed consent

on the part of the customer at the time

he enters into the arbitration agree-

ment." Id.; see 41 Fed. Reg. at 42,945.

- 19 -

clauses." 54 Fed Reg. 21,144 (May 16,

1989). See App. 32a-33a. As the court

of appeals noted below, the SEC approved

exchange rules "requiring brokers to

discuss customers’ rights under manda-

tory arbitration agreements and to

include language in arbitration clauses

informing customers that they are

waiving judicial fora." Id. at

32a-33a. The SEC declined, however, to

adopt rules that would prohibit brokers

from requiring arbitration clauses as a

condition of opening an account, on the

hope that "competitive forces" in the

market would provide more choice. 54

Fed. Reg. at 21,154.2/

6/ That brokerage firms uniformly

require arbitration agreements and do

not offer arbitration-less accounts even

at higher prices suggests a classic

market failure. Investors do not shop

(footnote continued)

- 20 -

The court of appeals dismissed the

CFTC and SEC actions as irrelevant

because they are "products of federal,

not state, authority." App. 33a. But

the actions of these federal regulators

strongly support certiorari in this case

because they demonstrate that there is

national interest in the issues

(footnote continued)

for brokerage firms on the basis of

arbitration clauses because they do not

focus on the eventuality of a dispute

arising with their broker. See Rakoff,

Con S esion: ssay in

Reconstruction, 96 Harv. L. Rev. 1174,

1226-1227 (1983). And brokerage firms

do not compete on arbitration clauses

precisely because they do not want

customers to focus on such an

eventuality, for fear of souring their

customer relationships. See, e.g.,

Affidavit of Theodore Kresbach, @ 6,

lst. Cir. App. 688-89. In this way,

agreements without arbitration clauses

are similar to consumer product safety

features or warranties which are offered

at inefficient levels in the absence of

regulation. See, e.g., Posner, Strict

Liability: A Comment, 2 J. Leg. Stud.

205, 211 (1973).

- 21-

presented and important public interests

protected by the Massachusetts regula-

tions. Further, the belated and limited

SEC action shows that there is a

pressing need for a decision by this

Court defining the extent of state

authority to supplement federal regula-

tion of the disclosure and negotiability

of arbitration agreements.

In sum, the Massachusetts regula-

tions address a new problem in an

established area of state concern - the

conduct of securities brokers. In

taking limited steps to assure volun-

tariness in arbitration agreements,

Massachusetts has served as a "labora-

tory" for the development of new

protections for investors. See New

State Ice Co. v. Liebmann, 285 U.S. 262,

- 22 -

ts cil

311 (1932) (Brandeis, J., dissenting).

The court of appeals struck down these

protections as repugnant to the Federal

Arbitration Act. Plenary review is

necessary in order to rectify the error

below and define the extent of state

power in this important area.

II. THE DECISION HAS NATIONAL

IMPLICATIONS FOR STATE

REGULATION OF MANDATORY

ARBITRATION AGREEMENTS IN

BANKING, HEALTH CARE,

AUTOMOBILE, AND MANY OTHER

INDUSTRIES.

Review by this Court is also

necessary in order to define the scope

of state power to regulate, in any

fashion, the formation of arbitration

- 23-

clauses in consumer agreements in

banking, health care, car sales, and

other areas of historic state concern.

Under the preemption theory applied by

the court of appeals, a state is power-

less to require disclosure in connection

with arbitration clauses in consumer

contracts unless the State requires the

same disclosure in all contracts,

whether or not involving consumers.

Prompt and plenary review by this Court

will define the authority of the States

to apply traditional consumer protection

regulation to arbitration agreements and

avoid harm to consumers and the States

that will flow from inconsistent

decisions in the lower courts.

Mandatory arbitration clauses in the

banking industry are becoming common-

place. See J. Butler, Arbitration in

Banking - State of the Art (Robert

Morris Associates, 1988); California

Banks e Using Arbitration to Cut Court

Costs, Avoid Jury Verdicts, 2 ADR Rep.

(BNA) 181-82 (May 12, 1988). Bank of

America, for example, currently includes

mandatory arbitration clauses in com-

mercial loans and consumer safety

deposit agreements. J. Butler, supra,

at 24. Similarly, Marathon National

Bank, a commercial bank based in Los

Angeles, “has decided to initiate

arbitration for virtually all its

disputes with customers, vendors,

employees, and others." Id. at 26-27.

- 25 -

The use of mandatory arbitration

clauses has also spread to agreements

between patients and their doctors and

health insurers. Under common agree-

ments between doctors and patients,

patients agree to mandatory arbitration

of future claims of medical malpractice.

See generally Note, Medical Malpractice

Arbi ion: ient’s spective,

61 Wash. Univ. L. Rev. 123 and App. A

and C (1983); see also Sanchez v.

Sirmons, 121 Misc.2d 249, 467 N.Y.S.2d

757 (1983) (arbitration clause in

"consent to abortion" form).

Health insurers have similarly

included mandatory arbitration clauses

in group health benefit contracts. See,

e.gq., Madden v. Kaiser Foundation

- 26 -

Hospitals, 17 Cal.3d 699, 131 Cal. Rptr.

882, 552 P.2d 1178 (1976) (contract

between Kaiser Foundation Health Plan,

Inc., and the State of California,

governing group medical plan for state

employees). Mandatory arbitration

clauses thus cover thousands of private

and state and federal employees. See

id., 552 P.2d at 1180; Dinong v.

Superior Court, 102 Cal. App.3d 845, 162

Cal. Rptr. 606 (1980) (contract between

Kaiser Foundation Health Plan, Inc., and

the United States Civil Service

Commission); see also 5 U.S.C. § 8902

(1988 ed.) (Office of Personnel

Management authorized to contract for

group health benefit plans for federal

employees).

- 27 -

While many States endorse the

arbitration of medical service claims,

many of the same States require

disclosure and bargaining of agreements

to arbitrate such claims. For example,

California specifies the precise

language that must be used in arbitra-

tion clauses in all "contracts for

medical services," and requires notice,

in "10 point bold red type," that the

arbitration agreement waives the "right

to a jury or court trial." Cal. Civ.

Proc. Code § 1295(a) and (b) (West 1982

ed.). Other States require similar

disclosures. See Ohio Rev. Code Ann.

§ 2711.23 (Banks-Baldwin 1989

Supp.) (requiring, inter alia, a separate

document for the arbitration agreement) ;

South Dakota Cod. Laws Tit. 21-25B-3

- 28 -

(Michie 1987 ed.) Michigan requires

that the agreement "shall be accompanied

by an information brochure. .-. ."

Mich. Comp. Laws § 600.5041 (West 1987

ed.)

In addition to requiring disclosure

of the waiver of a patient’s right to a

trial, Illinois requires language, in

specified form and size, informing

persons that they "cannot be required to

sign (the arbitration] agreement in

order to receive treatment." Ill. Rev.

Stat. c. 10, § 209 (West 1987 ed.).

Alaska and Michigan have similar

requirements. See Alaska Stat.

§ 0.9.55.535(b) (Michie 1988 ed.)

(requiring "in bold print on face of

agreement" statement that "execution of

the agreement is not a prerequisite to

- 29 -

receiving treatment or care; form used

"shall be approved in advance by the

attorney general of the state to assure

that it fairly informs both parties to

the agreement and properly protects

their interests"); Mich. Comp. Laws

§ 600.5041(2) and (5) (West 1987 ed.);

see also South Dakota Atty. Gen. Op. No.

76-98 (health maintenance organization’s

enrollee contracts cannot make arbitra-

tion agreement a prerequisite to medical

care or treatment).

Yet another industry affected by the

issue presented in this case is the

automobile industry. In Saturn Distri-

bution Corp. v. Williams, Commissioner

of the Department of Motor Vehicles of

Virginia, 717 F. Supp. 1147 (E.D. Va.

1989), the district court held that

the Federal Arbitration Act does not

preempt a Virginia statute which

prohibits automobile manufacturers from

requiring franchise dealers to sign

arbitration clauses as a condition of

dealership agreements. The district

court expressly rejected the reasoning

of the courts below in this case. The

Fourth Circuit will hear oral argument

on the manufacturers’ appeal in Saturn

on December 6, 1989. (Docket No.

89-2773). Whatever the outcome of that

appeal, the Saturn case shows that the

implications of the decision below in

this case extend far beyond the

securities industry.

The issue presented by these state

statutes governing disclosure and

bargaining is not whether arbitration

- 31-

agreements in consumer contracts may be

enforced, (see Southland Corp. v.

Keating, 465 U.S. (1984)), but whether

the States have any authority to ensure

that arbitration agreements are entered

into knowingly and voluntarily, in lieu

of case by case adjudications under

traditional contract law doctrines.

This issue is squarely presented by this

petition and warrants plenary review at

this time.

III. THE DECISION BELOW

MISCONSTRUED THE PURPOSES

AND OBJECTIVES OF THE FAA.

The "FAA contains no express

pre-emptive provision, nor does it

reflect a congressional intent to occupy

- 32 -

the entire field of arbitration." Volt

Information Sciences, Inc. v. Board of

Trustees of Leland Stanford Junior

University, 109 S.Ct. 1248, 1254

(1989). Whether a state law is

preempted by the FAA thus depends on

whether it "stands as an obstacle to the

accomplishment and execution of the full

proposes and objectives of Congress."

Id. at 1255 (quoting Hines v.

Davidowitz, 312 U.S. 52, 67 (1941)).

The decision below purported to apply

this preemption test, but the court

misconstrued the purposes and objectives

of the FAA.—/

7/ The court below also appears to have

placed on Massachusetts the burden of

proving that Congress did not intend to

preempt the state regulations. See App.

19a (noting duty of courts to "defend

(the Act’s]) mechanisms vigilantly and

with some fervor," and to "be on guard

(footnote continued)

- 3-

"Congress’ principal purpose" in

enacting the FAA, which the court below

ignored, was to “ensur[e] that private

arbitration agreements are enforced

according to their terms." Volt, 109

S.Ct. at 1255. Thus, this Court has

held that state "anti-waiver" laws,

which "require a judicial forum for the

resolution of claims which the

contracting parties agreed to resolve by

(footnote continued)

for artifices in which the ancient

suspicion of arbitration might

reappear"); App. 3la (noting that the

state had failed to carry its burden "to

show that Congress intended to preclude

a waiver of judicial remedies"). This

was error since "federal law pre-empts

state law in traditional fields of state

regulation only when ‘that was the clear

and manifest purpose of Congress.’"

E.G., Venture v.

d vings n _ [ore., 109

$.Ct. 1361, 1377 (1989) (Scalia, J.,

concurring) (quoting Rice v. Sante Fe

Elevator Corp., 331 U.S. 218, 230

(1947)).

- 34 -

arbitration," are preempted by the Act.

Southland Corp. v. Keating, 465 U.S. 1,

10 (1984) (state law that made agree-

ments to arbitrate certain franchise

claims unenforceable held preempted

because it "directly conflicts" with

section 2 of the Act); Perry v. Thomas,

482 U.S. 483, 491 (1987) (similar state

law barring enforcement of agreement to

arbitrate wage-collection claims held

preempted because it was in "unmistake-

able conflict” with federal policy).

However, this Court has never suggested

that state laws, such as the

Massachusetts regulations, that simply

require disclosure and bargaining in the

formation of arbitration agreements in a

regulated industry are preempted.

Such disclosure and bargaining

requirements do not conflict with the

Act’s primary purpose of "enforcing

arbitration agreements according to

their terms," because they do not limit

the ability of parties to enter into

arbitration agreements, nor limit the

enforcement of arbitration agreements

once entered. On the contrary, by

serving as a prophylactic against

"claims that the agreement to arbitrate

resulted from ... fraud or overwhelming

economic power," Mitsubishi Motors v.

Soler C sler- ou a. See Boba

614, 627 (1985), such state laws advance

the primary propose of the Act by making

it more likely that arbitration agree-

ments that conform to the laws will be

enforced. ee Brief Amicus Curiae of

a |

the CFTC in the First Circuit

("Commission regulation 180.3 does not

conflict with the FAA because both pro-

visions reflect a policy favoring the

arbitration of commodities disputes, and

because regulation 180.3 enhances, not

diminishes, the likelihood that pre-

dispute arbitration agreements that

comply with its terms will be

enforced."); see also Smokey Greenhaw

Cotton v. Merrill Lynch Pierce Fenner &

Smith, Inc., 720 F.2d 1446, 1450 (5th

Cir. 1983) (broker’s compliance with

CFTC Rule 180.3 militates against claim

of fraud).

The court below nonetheless held the

Massachusetts regulations preempted

because it found that the regulations

conflicted with the Act’s "liberal

federal policy favoring arbitration

- 37 -

agreements." App. 18a-39a (quoting

Moses H. Cone Memorial Hospital v.

Mercury Constr. Corp., 460 U.S. 1, 24

(1983)). The court viewed the

regulations as a "gyve" or "shackle"

that would "inhibit a party’s

willingness to create an arbitration

agreement" or would "frustrate"

arbitration. App. 27a. But this view

is contrary to the views of both the

CFTC and the SEC. See Amendments to

CFTC Rules Governing Arbitration or

Other Dispute Settlement Procedures, 41

Fed. Reg. 42,943 (Sept. 29, 1976) (CFTC

has "positive attitude toward the

settlement of disputes by arbitration.

It does not follow from this, however,

that the Commission can or should leave

a customer unaware of

the purpose of the agreement he is

requested to sign."); Order Approving

Proposed Rule Changes by the New York

_ Stock Exchange, Inc., et al., 54 Fed.

Reg. 21,144, 21,154 (May 16, 1989)

(hereinafter cited as SEC Order)

(disclosures alerting investors to the

meaning of arbitration contracts they

are signing "should promote more

knowledgable acquiesence or rejection by

customers of arbitration provisions").

Moreover, the record is devoid of any

basis on which the court below could

reasonably predict the likely effect of

the regulations on arbitration

agreements, since the regulations permit

brokers to induce investors to enter

into arbitration agreements, e.g., by

offering a reduced commission. 2/

In any event, the court below

misconstrued the "liberal federal policy

favoring arbitration" to suggest that

arbitration per se is a goal of the

FAA. E.g., App. 3a ("The hope has long

been that the Act could serve as a

therapy for the ailment of the crowded

docket.") This approach conflicts with

the recent ruling of this Court that

"(wjhile Congress was no doubt aware

8/ In opposing summary judgment in the

district court, Massachusetts moved for

relier under Fed. R. Civ. P. 56(f).

App. 99a-106a, 48a n.10. As grounds for

its motion Massachusetts cited its

pending discovery, which sought

additional facts concerning the alleged

effects of the regulations on the entry

of arbitration agreements by brokers and

customers. The district court denied

the motion, and the court of appeals

essentially affirmed. App. 106a, 48a

n.10.

- 40 -

that the Act would encourage the

expeditious resolution of disputes, its

passage ‘was motivated, first and

foremost, by a congressional desire to

enforce agreements into which parties

had entered.’" Volt, 109 S.Ct. at 1254

(quoting Dean Witter Reynolds, Inc. v.

Byrd, 470 U.S. 213, 220 (1985)). Thus,

in Volt this Court upheld the appli-

cation of a state arbitration rule,

which had been incorporated into an

arbitration agreement via a choice-

of-law provision, "even if the result is

that arbitration is stayed where the Act

would otherwise permit it to go

forward." Volt, 109 S.Ct. at 1255.

Moreover, this Court has "recognized

that the FAA does not require parties to

arbitrate when they have not agreed

- 41 -

to do so." Id. At bottom, therefore,

the liberal federal policy favoring

arbitration is not, as the court below

suggested, a policy designed to promote

a particular kind of conduct, but rather

a policy to "give effect to the

contractual rights and expectations of

the parties. ..." Yelt, 109 $.ct. at

1256; see H.R. Rep. 96, 68th Cong., 1st

Sess. 1 (1924) ("effect of the bill is

Simply to make the contracting party

live up to his agreement").

To the extent the Act was designed,

in part, to promote arbitration, it was

plainly intended to facilitate

consensual arbitration. See Volt, 109

S.Ct. at 1256 ("Arbitration under the

Act is a matter of consent, not

- 42 -

coercion"); S. Rep. No. 536, 68th Cong.,

lst Sess. 1, 3 (1924) ("The record ...

shows not only the great value of

voluntary arbitrations but the practical

justice in the enforced arbitration of

disputes where written agreements for

that purpose have been voluntarily and

solemnly entered into.") (emphasis

added); see also Prima Paint Corp. v.

nklin ~ fe. 396 0.8. 395,

414 (1967) (legislative history

demonstrates that Act was not intended

to cover arbitration clauses offered to

captive customers or employees or a

take-it-or-leave-it bases) (Black, J.

dissenting) ‘citing Hearing on S. 4213

and S. 4214 before t Subcomittee o

the Senate Committee on the Judiciary,

67th Cong., 4th Sess. 9-11 (1923));

Shearson/American Express Co. v.

McMahon, 482 U.S. 220, 226, 230 (1987)

(voluntariness of agreement irrelevant

to whether Exchange Act of 1934 bars

waiver of judicial remedies but

well-founded claim of fraud or excessive

economic power would provide basis for

voiding agreement under ordinary

principles of contract law).

The Massachusetts regulations were

designed to "provide the customer with a

meaningful choice prior to making a

decision to sign the agreement," Mass.

Reg. No. 593 (October 14, 1988), in

market circumstances in which the

customer’s choice has been sharply

restricted. 2 Thus, the Massachusetts

9/ See SEC Order, 54 Fed. Reg. at

21,153 n. 51 (SEC study found that

nearly all brokerage firms required

(footnote continued)

- 44 -

regulations are faithful to the federal

policy favoring consensual arbitration.

The court below also found the

regulations preempted because they "take

their meaning precisely from the fact

that a contract to arbitrate is at

issue," App. 40a (quoting Perry v.

Thomas, 482 U.S. at 492 n.9), and thus

allegedly conflict with the Act’s

"principle of rigorous equality." App.

20a. The court rejected as "casuistry"

(footnote continued)

retail customers to sign a pre-dispute

arbitration agreement to open a margin

or option account; 39% of firms required

such agreements for cash accounts); see

also Ames v. Merrill Lynch, Pierce,

Fenner & Smith, 567 F.2d 1174, 1178 (2d

Cir. 1977) ("It ... became apparent [to

the CFTC] that in many cases arbitration

was not undertaken voluntarily by

customers, but that customers were

compelled to agree to predispute

arbitration clauses as a precondition to

doing business.")

- 45 -

the Commonwealth’s argument below that,

because the regulations apply conditions

to the formation of securities

arbitration agreements that are common

to, if not the rule of, Massachusetts

consumer contracts generally and

securities transactions in particular,

the regulations were consistent with the

Act’s "equal footing" objective. See

Dean Witter Reynolds, Inc. v. Byrd, 470

U.S. at 219 (Act was designed in part

"to place [arbitration] agreements ‘upon

the same footing as other contracts, ’")

(quoting H.R. Rep. No. 96, 68th Cong.,

lst Sess. 1, 2 (1924)) 22 The court

held: "Even if regulators find industry-

wide practices that would be grounds to

10/ This was the view of the district

court in Saturn Distribution Corp. v.

Williams, 717 F. Supp. at 1152-1153.

- 46 -

voiding arbitration agreements at common

law, e.g., fraud or coercion, any

separate regulatory action or sanction

Singling out arbitration agreements from

contracts generally would be preempted."

App. 24a-25a (emphasis in original).

Thus, according to the court below, a

state securities regulator may only

require disclosure or bargaining in the

formation of arbitration agreements in

the securities industry if the state

requires such disclosure or bargaining

in the formation of all contracts and

contract terms, and if the state does so

by means of a regulatory sanction.

This application of the Act’s "equal

footing" objective is irrational and

does violence to the objectives of the

FAA. Massachusetts does not require

disclosure and bargaining in all

contracts, because market circumstances

do not universally demand such

regulation, particularly as between

commercial enterprises. However, given

the circumstances in which securities

brokers generally employ arbitration

agreements (i.e., in a highly regulated

industry, with disparity in bargaining

power between brokers and retail

investors, the absence of competition

among brokers on arbitration terms,

investors’ lack of meaningful choice,

and investors’ right under the exchange

rules to demand arbitration even in the

absence of an arbitration agreement),

exempting securities arbitration

agreements from minimal consumer

protection regulation -- "Congress

barred the states from making

determinations about arbitration

contracts that states remained free to

make about, say, used car sales," App.

24a -- places arbitration agreements on

a footing well above other contracts,

contrary to the intent of Congress. See

Prima Paint v. Flood & Conklin

Manufacturing Co., 388 U.S. 395, 404

n.12 (1967) (Act was designed "to make

arbitration agreements as enforceable as

other contracts, but not more so").

Plenary review is necessary to rectify

the court’s misreading of congressional

intent and to prevent further harm to

legitimate state regulation.

- 49 -

CONCLUSION

For the reasons set forth above, the

petition for a writ of certiorari should

be granted.

Respectfully submitted,

JAMES M. SHANNON

ATTORNEY GENERAL

COMMONWEALTH OF MASSACHUSETTS

Thomas A. Barnico

Counsel of Record

Richard M. Brunell

Assistant Attorneys General

One Ashburton Place

Boston, MA 02108

(617) 727-2200, ext. 2086

Dated: November 29, 1989

TABLE OF CONTENTS

OF APPENDIX TO PETITION

Appendix A

Opinion of the United States

Court of Appeals for the

First Circuit

(August 31, 1989) la

Appendix B

Judgment of the United States

Court of Appeals for the

First Circuit

(August 31, 1989) 53a

Appendix C

Memorandum and Order for

Judgment of the United States

District Court for the

District of Massachusetts

(December 19, 1988) 55a

Appendix D

Judgment of the United States

District Court for the District

of Massachusetts

(December 19, 1988) l3la

APPENDIX A

UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

No. 89-1022

SECURITIES INDUSTRY ASSOCIATION, et al.,

Plaintiffs, Appellees,

Vv.

MICHAEL J. CONNOLLY, ETC., et al.,

Defendants, Appellants.

APPEAL FORM THE UNITED STATES

DISTRICT COURT FOR THE

DISTRICT OF OF MASSACHUSETTS

[Hon. Douglas P. Woodlock,

U.S. District Judge]

Before

Campbell, Chief Judge,

Selya, Circuit Judge,

and Caffrey,* Senior District Judge.

August 31, 1989

*of the district of Massachusetts,

Sitting by designation.

ete alll

SELYA, Circuit Ju . Hypertrophy

is the pathologic “overgrowth ... of

an organ or part .. . resulting from

unusually steady or severe use... ."

Webster’s Third New International

Dictionary 1114 (1981). Metaphorists

seem to find the condition

irresistible. Thus, hypertrophy has

been used as a partial explanation for

the collapse of entire intellectual

systems, e.g., Kuhn, The Structure of

Scientific Revolutions (2d ed. 1970),

and detailed mechanical intellectual

artifacts, e.g., Posner, Goodbye to the

Bluebook, 54 U. Chi. L. Rev. 1343

(1986). We succumb today to the same

temptation, for we find the metaphor

especially apt in discussing the rampant

growth of the civil docket in the United

States.

ain neinnemenaniaihimcnies

We need not belabor the point.

Increased resort to the courts, and the

consequent tumefaction of

already-swollen court calendars, have

received considerable attention, see,

e.gq., Heydebrand & Seron, The Rising

Demand for Court Services, 1l Just. Sys.

J. 303 (1986); Galanter, The Day After

the Litigation Explosion, 46 Md. L. Rev.

3 (1986); Lieberman, The Litigation

Society (1981), so we merely note the

phenomenon and do not comment further

upon it. We focus instead on

arbitration, a contracti'al device that

relieves some of the organic pressure by

operating as a shunt, allowing parties

to resolve disputes outside of the legal

system. Congress passed the Federal

Arbitration Act (FAA or Act), 9 U.S.C.

§§ 1-14 (1982), to help legitimate

- 2a -

arbitration and make it more readily

useful to disputants. The hope has long

been that the Act could serve as a

therapy for the ailment of the crowded

docket. As might be expected, there is

a rub: the patient, and others in

interest, often resist the treatment.

We are asked to decide today if

certain regulations, Mass. Regs. Code

tit. 950, §§ 12.204 (G) (1) (a)-(c)

(Regulations), set forth in the appendix

hereto, are preempted by the FAA. The

Regulations are part of a set which

governs the conduct of those who sell

securities in the Commonwealth. The

provisions at issue were promulgated at

one time. Neither party suggested to

the district court that any of the

provisions might be serverable, so we

treat them as a unit for purposes of our

preemption analysis. See Clauson v.

Smith, 823 F.2d 660, 666 (lst Cir. 1987)

(court of appeals will ordinarily eschew

consideration of theories not raised

below).

The contracts to which the

Regulations apply implicate interstate

and international commerce, as well as

the instrumentalities of that commerce,

thus subjecting them to the reach of the

FAA. ee 9 U.S.C. § 1; See generally

Societe Generale de Surveillance, S.A.

v. Ratheon European Management and

Systems Co., 643 F.2d 863, 867 (lst Cir.

1981) (the term "commerce" as used in

the Act is to be broadly construed).

Specifically, the Regulations are aimed

- 4a -

at broker-dealers who require customers

to sign pre-dispute arbitration

agreements (PDAAs) as a concomitant of

establishing account relationships. Not

coincidentally, many of the major

brokerage firms prefer to follow some

such praxis. Cf. Drayer v. Krasner, 572

F.2d 348, 353-54 (2d Cir.), cert.

denied, 436 U.S. 948 (1948) (discussing

industry-wide use of arbitration to

resolve disputes between broker-dealers

and registered representatives).

The Regulations not only regulate;

they do so in a manner patently

inhospitable to arbitration. They (i)

bar firms from requiring individuals to

enter PDAAs as a nonegotiable condition

precedent to account relationships, §

12.204(G)(1)(a); (11) order the

prohibition brought "conspicuously" to

the attention of prospective customers,

- 5a -

§ 12.204(G)(1)(b)? and (iii) demand full

written disclosure of "the legal effect

of the pre-dispute arbitration contract

or clause," § 12.204(G)(1)(c).

In Massachusetts, regulation of

securities falls within the province of

oie: Semainy of State, who superintends

the Securities Division. Immediately

upon adoption of the Regulations in

September 1988, the Securities Industry

- Association and ten brokerage firms

affiliated with itl’ sued in federal

l1/ The ten houses comprise Dean Witter

Reynolds, Inc., Donaldson, Lufkin &

Jenrette Securities Corp., Drexel

Burnham Lambert, Inc., Fidelity

Brokerage Services, Inc., Kidder Peabody

& Co., Merrill Lynch, Pierce, Fenner &

Smith, Inc., Painewebber Inc.,

Prudential-Bache Securities Inc.,

Shearson Lehman Hutton, Inc., and Smith

Barney, Harris Upham & Co. We refer to

them and the trade association

plaintiff, collectively, as "SIA" or

"appellees."

- 6a -

district court seeking a declaration

that the Regulations were

unconstitutional because they conflicted

with the provisions and policies of the

FAA. SIA also sought a preliminary

injunction barring enforcement of the

Regulations. The suit named the

Secretary of State and the director of

the Securities Division (appellants

before us) as defendants. Claiming that

the Commonwealth had power to issue the

Regulations as part of its concurrent

authority to regulate securities

transactions, see Mass. Gen. L. ch.

l1OA, §§ 201, 204 (1984) (governing

registration of broker-dealers),

appellants stood their ground.

Cross-motions for summary judgment were

- Ja-

eventually filed. In due course, in

district court granted declaratory and

injunctive relief in appellees’ favor.

Securities Indus. Ass’n-v. Connolly, 703

F. Supp. 146 (D. Mass. 1988). This

appeal followed.

Iti.

The Supremacy Clause of Article VI

of the federal Constitution prevents the

states from impinging overmuch on

federal law and policy. ee Louisiana

Pub. Serv. Comm’n v. FCC, 476 U.S. 355,

368 (1986). Preemption - the vehicle by

which the Supremacy Clause is generally

enforced - always boils down to a matter

- Ba -

mu era

of congressional intent. Schneidewind

v. ANR Pipeline Co., 108 S.Ct. 1145,

1150 (1988); California Fed. Se . an

Ass’n v. Guerra, 479 U.S. 272, 280

(1987); Wardair Canada, Inc. v. Florida

Dep’t of Revenue, 477 U.S. 1, 6 (1986);

French v. Pan Am Express, Inc. 869 F.2d

1, 2 (lst Cir. 1989); Wood v. General

Motors Corp., 865 F.2d 395, 401 (list

Cir. 1988). And, because Congress has

not expressly delineated the preemptive

reach of the FAA, our task is to

determine the extent of any implied

preemption vis-a-vis the state’s

Regulations.

We have acknowledged before that

"(t]he concept of implied preemption has

a certain protean quality," a

circumstance which tends to defeat

courts’ efforts to establish tidy

- 9a -

creedal subcategories. French, 869 F.

2d at 2. Yet, although we continue to

"abjure taxonomy for taxonomy’s sake,"

id., it is sometimes helpful to sketch

the borders of the doctrine by reference

to commonly used descriptions. Thus, it

has been said that implied preemption

prospers when Congress intends its

enactments “to occupy a given field to

the exclusion of state law."

Schneidewind, 108 S.Ct. at 1150. That

is not the case here: Congress did not

want the FAA to occupy the entire field

of arbitration law. Volt Information

Sciences, Inc. v. Board of Trustees of

Leland Stanford Junior Univ., 109 S.Ct.

1248, 1254 (1989); New England Energy

Inc. v. Keystone Shipping Co., 855 F.2d

1, 4 (lst Cir. 1988), cert. denied, 109

S. Ct. 1527 (1989). State law may also

- 10a -

be preempted "when it actually conflicts

with federal law." Schneidewind, 108 S.

Ct. at 1150; see also Perry v. Thomas,

482 U.S. 483, 491 (1987). In this

respect, substance takes precedence over

form; a direct, facial contradiction

between state and federal law is not

necessary to catalyze an “actual

conflict” within the doctrinal

parameters of the Supremacy Clause.

Whatever labels may be affixed, the

pivot upon which our inquiry turns

remains constant: where Congess has

failed explicitly to detail the

dimensions of displacement, courts must

decide if "the state law disturbs too

much the congressionally declared

scheme ... ." Palmer v. Liggett

Group, Inc., 825 F.2d 620, 626 (lst Cir.

1987); see also French, 869 F.2d at 2

(adopting a practical preemption

- lla-

analysis which focuses “on the effect

which the challenged enactment will have

on the federal plan"). Put another way,

a state law or regulation cannot take

root if it looms as an obstacle to

achievement of the full purposes and

ends which Congress has itself set out

to accomplish. Schneidewind, 108 S.Ct.

at 1151; California Coasta omm’n v.

Granite Rock Co., 107 S.Ct. 1419, 1425

(1987); Silkwood v. Kerr-McGee Corp.,

464 U.S. 238, 248 (1984); Hines v.

Davidowitz, 312 U.S. 52, 67 (1941).

Here, then, the critical inquiry is

whether the FAA is an enactment which

Congress meant to remain relatively

unfettered; and if so, whether the

Regulations intrude impermissibly. We

- 12a -

approach our task mindful both that

interpretation of a statute’s meaning

must start with the text itself, United

States v. James, 478 U.S. 597, 604

(1986), and that the language chosen by

Congress must be accorded its ordinary

meaning, American Tobacco Co. v.

Patterson, 456 U.S. 63, 68 (1982). In

this instance, the relevant statutory

phraseology is not technical, embodies

conventional terms, and has a virtue of

brevity:

A written provision in any maritime

transaction or a contract evidencing

a transaction involving commerce 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.

- 4138 =

9 U.S.C. § 2. The language sweeps

broadly and brooks little reservation.

We must, therefore, be chary of a

narrowing construction, lest such an

interpretive modality clog the channel

Congress has opened. See Volt, 109 S.

Ct. at 1254-55.

Reluctance to shrink the scope of

section 2 seems particularly well

advised given the Supreme Court’s

resounding endorsement of the "ordinary

language" technique in construing the

FAA. See, e.g., Prima Paint Corp. v.

Flood & Conklin Mfg. Co., 388 U.S. 395,

404 (1967). The Court has concluded

that this approach comports with

Congress’s "unmistakably clear

purpose that the arbitration procedure,

when selected by the parties to a

contract, be speedy and not subject to

- 14a -

a

delay and obstruction." Id. Nor is

Prima Paint in any sense aberrational;

just this year, in the course of

overruling Wilko v. Swan, 346 U.S. 427

(1953) (a decision voiding certain PDAAs

under § 14 of the Securities Act of

1933), the Court again emphasized "the

strong language” of the FAA and noted

the heavy burden borne by opponents of

the arbitral alternative. See Rodriguez

de Quijas v. Shearson/American Express,

Inc., 109 S.Ct. 1917, 1921 (1989).

Because the language of the Act

seems clear, and its meaning plain, we

are not obliged to plumb the Congress’s

collective consciousness to ascertain

legislative intent. James, 478 U.S. at

- 15a -

606; Rubin v. United States, 449 U.S.

424, 430 (1981). It nevertheless seems

prudent to do so, if only "{a]s a check

upon our reading of the statute."

Kwatcher v. Massachusetts Service

Employees Pension Fund, No. 88-1930,

slip op. at 9 (lst Cir. July 5, 1989).

: In recent decades, the Supreme Court

has faced a number of disputes involving

the FAA. - In case after case, the

Justices have read the Act’s legislative

history with an avuncular eye; as the

court below perspicaciously dbserved,

"“[r]jecent history has found the Supreme

Court offering endorsements of the

arbitration process by expansive

statements of the intent of Congress in

passing the Federal Arbitration Act."

703 F. Supp. at 150-51 (citing

representative cases). We have lately

witnessed yet another illustration of

- 16a -

this trend. See Rodriguez de Quijas,

109 S.Ct. at 1920 (acknowledging the

Court’s “current strong endorsement of

the federal statues favoring

[arbitration]"). Although an arbitral

remedy has not invariably prevailed,

see, e.g., Alexander v. Gardner~Denver

Co., 415 U.S. 36, 51-52 (1974) (Title

VII employment discrimination claim

could be litigated in a judicial forum

notwithstanding PDAA), the Court has

almost always given the Act a reading

which is both broad and deep.

Congress, we are told, enacted the

FAA to relieve parties from what, even

two-thirds of a century ago, was

characterized as "’the costliness and

delays of litigation.’" Dean Witter

Reynolds Inc. v. Byrd, 470 U.S. 213, 220

(1985) (quoting H.R. Rep. No. 96, 68th

Cong., 1st Sess. 2 (1924)). Common-law

= £78 -

courts had jealously guarded the

sovereign’s perceived prerogative to

handle disputes among its constituents,

preserving the courts’ jurisdiction to

resolve controversies once they had been

solemnized. Byrd, 479 U.S. at 220 n.6.

The FAA was enacted to overcome this

"anachronism." Id. In harmony with

that purpose, the Act declares "a

liberal federal policy favoring

arbitration agreements." Moses H. Cone

Memorial Hospital v. Mercury Constr.

Corp., 460 U.S. 1, 24 (1983); see also

Rodirguez de Quijas, 109 S.Ct. at 1919;

Mitsubishi Motors Corp. v. Soler

Chrysler-Plymouth, Inc., 473 U.S. 614,

625 (1985). Such a policy is desirable

because it best effectuates the

"congressional desire to enforce

agreements into which parties had

entered." Byrd, 470 U.S. at 220. At

- 18a -

r ry

the same time, courts must be on guard

for artifices in which the ancient

suspicion of arbitration might

reappear. See Shearson/American

Express, Inc. v. McMahon, 482 U.S. 220,

226 (1987); Byrd, 470 U.S. at 221.2/

In sum, the legislative history of

the FAA, like its text, indicates that

the courts must receive the Act

hospitably and defend its mechanisms

vigilantly and with some fervor.

D

The metaphors used to describe the

Court’s interpretations are somewhat

2/ We think that the Court, by taking

the formidable step of overruling its

own precedent, has demonstrated how

tightly impulses hostile to arbitration

must be constrained in order to remain

faithful to Congress’s mandate. See

Rodriguez de Quijas, 109 S.Ct. at 1920

(in part, Wilko must fall because it is

"pervaded by ... ‘the old judicial

hostility to arbitration’") (citation

omitted).

- 19a -

varied, but their common denominator is

a principle of rigorous equality under 9

7.8.¢. § 2.3/ Given this interpretive

3/ Volt is not to the contrary. There,

the Court ruled that “interpreting a

choice-of-law clause to make applicable

state rules governing the conduct of

arbitration - rules which are manifestly

-designed to encourage resort to the

arbitral process - simply does not

offend the rule of liberal construction

- « « nor does it offend any other

policy embodied in the FAA." 109 S. Ct.

at 1254 n.5. But, the choice-of-law

provision in Volt did not impinge on the

validity or enforceability of the

arbitral contract. See id. at 1254.

The California regulation filled in an

interstice in the FAA, id at 1254 n. 5,

whereas the Regulations here at issue

plainly undermine the presumption of

validity that the Act meant to confer on

arbitration contracts generally. See

Perry, 482 U.S. at 492 n.9 (making

distinctions between choosing which law

of unconscionability applies and not

(footnote continued)

- 20a -

model, and the statute’s twofold use of

the term "any" - it is, after all,

"difficult to imagine broader language,"

James, 478 U.S. at 604 (footnote

omitted) - the words of 9 U.S.C. § 2

must be ceded their full import. What

seems beyond dispute at this juncture is

that no state may simply subject

arbitration to individuated regulation

in the same manner as it might subject

some other unprotected contractual

device (say, a prescriptive period or

exculpatory clause contained within a

private contract). Thus, for example,

the Eighth Circuit struck down

Missouri’s effort to require that

(footnote continued)

whether law of unconscionability applies

to arbitration); see also New England

Energy, 855 F.2d at 4-5 (states may

enact regulations to fill gaps left by

the FAA).

- 2la -

contracts highlight the existence of

arbitration clauses by use of 10-point

capital letters, Webb v. R. Rowland &

Co., 800 F.2d 803, 806 (8th Cir. 1986),

and earlier refused to honor a state

requirement that arbitration agreements

bear an attorney’s acknowledgement

attesting that all parties had been

informed of the agreement’s effects,

Collins Radio Co. v. Ex-Cell-O-Corp.,

467 F.2d 995, 997 (8th Cir. 1972). Any

Similar limitary approach would

seemingly defeat the very aim of the

Act, allowing states to revivify the

ancient jurisdictional antagonism toward

arbitration by cloaking it in regulatory

garb. At the very least, such enmity,

however manifested in state law, 4/ is

4/ That the restriction is

administrative rather than legislative

or judge-made in no way validates

appellants’ maneuver.

(footnote continued)

- 22a -

preempted. Volt, 109 S. Ct. at 1253;

Perry, 482 U.S. at 492 n.9; Mitsubishi

Motors, 473 U.S. at 626-27; Byrd, 470

U.S. at 219-21; Sou orp. Vv.

Keating, 465 U.S. 1, 18-19 (1984); Moses

Cone, 460 U.S. at 24-25; Prima Paint,

388 U.S. at 404 n.12; New England

Energy, 855 F.2d at 4-5.

Appellants conceded before the

district court, 703 F. Supp. at 152, and

on appeal, that the Regulations apply

only to arbitration agreements. They

(footnote continued)

The gravamen of the FAA is to preserve

the arbitral bargain against external

onslaughts manifesting hostility to

arbitration, whatever their genesis.

The only excepted areas are those where

Congress (expressly, by fair

implication, or by delegation) has

itself exhibited a preference for some

other forum or rule. See McMahon, 482

U.S. at 226-27; Kroog v. Mait, 712 F.2d

1148, 1154 n.5 (7th Cir. 1983), cert.

denied, 465 U.S. 1007 (1984).

- 238 =

suggest, however, that this bespeaks no

unfriendliness: the Commonwealth treats

arbitration agreements like other

contracts between businesses and

consumers, that it, it regulates them as

extensively as necessary for the public

weal. In our view, that

self-congratulatory casuistry will not

wash. Indeed, we think it evident that

it was precisly this sort of

categorization error which Congress

sought to cure when it enacted the FAA.

In creating a body of substantive

law convering arbitration, Congress

barred the states from making

determinations about arbitration

contracts that the states remained free

to make about, say, used car sales.

Perry, 482 U.S. at 492 n.9; McMahon, 482

U.S. at 226. Even if regulators find

industry-wide practices that would be

- 24a -

grounds for voiding arbitration

agreements at common law, e.g., fraud or

coercion, any separate regulatory action

or sanction singling out arbitration

agreements from contracts generally

would be preempted. PDAAs may be void

on these grounds, exactly as would

contracts of other types conceived

fraudulently or in unduly coercive

circumstances - no more, no less. The

FAA prohibits a state from taking more

stringent action addressed specifically,

and limited, to arbitration contracts.

That is not to say that a state can

do nothing about a perceived problem.

The Commonwealth’s powers remain great,

so long as used evenhandedly. The FAA

does not prohibit judicial relief from

arbitration contracts which are shown to

result from fraud or enormous (unfair)

- 25a -

economic imbalance of the sort

sufficient to avoid contracts of all

types. >/ Rodriguez de Quijas, 109 S.

ct. at 1921. "Thus state law, whether

of legislative or judicial origin, is

applicable [and not preempted) if that

law arose to govern issues concerning

the validity, revocability, and

enforceability of contracts generally."

Perry, 482 U.S. 492 n.9 (emphasis in

Original). Massachusetts could also

pass legislation declaring all contracts

5/ Although any fraudulent, adhesive,

or economically coerced agreement to

arbitrate would be challengeable, the

Supreme Court has suggested that such

challenges must not only be brought on

grounds common to contracts generally,

but must also be proven on the facts of

the individual case, not automatically

shunted to one side according to

practices governing the formation of

arbitration agreements as a class of

contracts. See Rodriquez de Quijas, 109

S.ct. at 1921.

- 26a -

of adhesion presumptively unenforceable.

See Rakoff, Contracts of Adhesion: An

Essay in Reconstruction, 96 Harv. L.

Rev. 1173, 1248 n. 239 (1983). Sucha

rule would apply to arbitration

contracts, among others. But

Massachusetts may not say (judicially,

legislatively, or in a regulatory mode)

that “adhesion contracts are especially

bad when arbitration is included, so we

will therefore ban, or place gyves and

shackles upon, only those adhesive

contracts which contain arbitration

clauses." That kind of value judgment

is foreclosed precisely because the FAA

ordains that the state’s appulse toward

arbitration agreements must be the same

‘as its approach to contracts generally.

Perry, 482 U.S. at 492 n.9; McMahon, 482

U.S. at 226.

- 27a -

Appellants also urge us to find

that, notwithstanding the general rule,

Congress carved out an exception to the

Act by permitting states concurrently to

regulate securities transactions. We

need not linger long over this

asseveration. The Court has recently

addressed the theoretical overlap

between securities regulation and the

FAA, holding that claims under section

12(2) of the Securities Act of 1933, 15

U.S.C. § 771(2), could be the subjects

of arbitration. Rodriquez de Quijas,

109 S. Ct. at 1922. The same holds true

for claims arising under section 10(b)

of the Securities Exchange Act of 1934,

15 U.S.C. § 78j3(b). McMahon, 482 U.S.

at 227-28, 238. There, the Court noted

- 28a -

that "[w]jhen Congress enacted the

Exchange Act in 1934, it did not

specifically address the question of the

arbitrability of § 10(b) claims." Id.

at 227. Congress’s failure explicitly

to resolve the potential conflict

between the FAA and the 1933 and 1934

Acts has impelled the Court to determine

the proper boundaries. In so doing, the

Justices set forth an analytic framework

which we find important to our inquiry.

Starting with the premise that the

FAA was intended to have the full

breadth apparent from its plain

language, the Court. noted that the 1934

Act "provides no basis for disfavoring

agreements to arbitrate statutory claims

by skewing the otherwise hospitable

inquiry into arbitrability." McMahon,

482 U.S. at 226 (quoting Mitsubishi

- 29a -

Motors, 473 U.S. at 627); see also

Rodriguez de Quijas, 109 S.Ct. at

1920-21. If claims actually based on a

federal statute are not sacrosanct, then

we can see no reason why ordinary

—contractual relations between customers

and broker-dealers would not be

accessible to the reach of the FAA.

Such dealings strike us as well within

the universe of possible topics

“otherwise hospitable" to arbitration.

As such, they are subject to the full

force of the FAA’s core command: that

an arbitration contract be treated like

"any contract." 93 U.8.C. § 2.

Simply put, nothing in the

Securities Act, the Exchange Act, or the

grant of concurrent power to the states

to regulate securities manifests a

congressional intent to limit or

ees

prohibit waiver of a judicial forum for

a particular claim, or to abridge the

sweep of the FAA. Rodriguez de Quijas,

109 S.Ct. at 1920; McMahon, 482 U.S. at

226. And we are mindful that: "The

burden is on the party opposing

sthdedkion - »« »« to show that Congress

intended to preclude a waiver of

judicial remedies for the statutory

rights at issue." McMahon, 482 U.S. at

226; see also Mitsubishi Motors, 473

U.S. at 628 (parties should be held to

arbitral bargain "unless Congress itself

has evinced an intention to preclude a

waiver of judicial remedies for the

statutory rights at issue"); Page v.

Moseley, Hallgarten, Estabrook & Weeden,

Inc., 806 F.2d 291, 295 (lst Cir.

1986) (court must “enforce the [arbitral]

agreement unless .. . the Congressional

- 318 -

intent in enacting the [right-creating]

statute was to preclude the waiver of

judicial remedies") (emphasis in

original). That burden has not been

carried.

Nor are we willing to infer implicit

congressional approval of the

Commonwealth’s policy simply because the

Commodities Futures Trading Commission

(CFTC) has adopted rules, see 17 C.F.R.

§ 180.3 (1988), not dissimilar in spirit

from the Massachusetts regulations. The

same holds true of recent Securities and

Exchange Commission (SEC) activities,

including the SEC’s approval of rules

submitted by three self-regulatory

organizations requiring brokers to

discuss customer’s rights under

mandatory arbitration agreements and to

include language in arbitration clauses

= 3248 =

. —

informing customers that they are

waiving judicial fora. See Order

Approving Proposed Rule Changes, 54 Fed.

Reg. 21,144 (1989). Both CFTC’s

rulemaking and the SEC’s acquiescence

are products of federal, not state,

authority. That is a critical

distinction. See McMahon, 482 U.S. at

226 (the "Act’s mandate may be

overridden by a contrary congressional

command") (emphasis supplied); Felkner v.

Dean Witter Reynolds, Inc., 800 F.2d

1466, 1468 n.3 (9th Cir. 1986).

Congress has not structured a similar

arbitration exception for securities in

general and certainly not for state

regulation of securities in particular.

Kroog v. Mait, 712 F.2d 1148, 1154 n.5

(7th Cir. 1983), cert. denied, 465 U.S.

1007 (1984).

- 33a -

We go one extra step. If Congress

meant to exempt the regulation of

securities from the FAA’s sphere of

influence, "such an intent ’will be

deducible from [the statute’s]} text or

legislative history,’ or from an

inherent conflict between arbitration

and the statute’s underlying purpose."

McMahon, 482 U.S. at 227 (citations

omitted); accord Rodriguez de Quijas,

109 S.Ct. at 1920. There is nothing in

the language of the Securities Act, the

Exchange Act, or the pertinent

legislative history, which points in

such a direction. By the same token,

appellants have utterly failed to

demonstrate any inherent conflict or to

suggest any valid reason why

“arbitration is inadequate to protect

the substantive rights at issue."

- 34a -

McMahon, 482 U.S. at 229. The opposite

seems true: any remnants of Wilko’s

"outmoded presumption of disfavoring

arbitration proceedings" have been laid

to rest, once and for all. Rodriquez de

Quijas, 109 S.Ct. at 1920. 2/

The long and short of it is that we

can find no evidence of a clear

congressional command to override the

unambiguous pro-arbitration mandate of

the FAA in the securities field.

6/ McMahon adequately evinces the

point. There, only a dissenter, not the

Court’s majority, felt that arbitration

could fail to protect an investor’s

substantive rights. 482 U.S. at 257-66

(Blackmun, J., dissenting).

- 35a -

III

Ordinarily, our determination that

the Regulations conflict with the

requirement that arbitration contracts

be treated on a par with contracts

generally would end the matter. Here,

however, there is a further wrinkle. On

their face, the Regulations do not

govern PDAAs at all. Rather, they

purport to address broker-dealers who

would require customers to sign PDAAs.

This difference, appellants tell us, is

determinative.

The dialectic is too clever by

half. Even if we grant the claim that a

contract made in the face of such an

ethical order to a contracting party

would be enforceable - a claim open to

- 368 =

considerable doubt, and upon which we

express no opinion’ - the Regulations

would still be preempted. Without

recognizing it, appellants appear to

have trapped themselves in a trick box.

7/ It is hornbook law that one who

violates a licensing statute - which, as

here, is not a revenue measure, but a

public-protection statute - is generally

not allowed to enforce the contract.

The usual case arises where an

unlicensed party performs services

requiring a license. See, e.g.,

Shinberg v. Bruk, 875 F.2d 973, 976 (lst

Cir. 1989) (attorney not licensed as real

estate broker barred from claiming

finder’s fee). In this situation,

however, the terms of the contract

constitute the basis for the ethical

proscription. Thus, the closer analogy

would seem to be that if, "in making and

performing [the contract] he defrauded

the other party, the latter has a good

defense ... ." 6A A. Corbin, Corbin

on Contracts, § 1510 (1962); see also J.

Calamari & J. Perillo, Contracts § 22-7

(2d ed. 1977); Restatement (Second) of

Contracts § 181 (1981). Moreover, as

the district court pointed out, 703 F.

Supp. at 149, Mass. Gen. L. ch. 110A,

§ 410(f) would likely prevent a broker

from enforcing a contract made in

violation of the Regulations.

* 2a

As the district court noted and

documented, unconscionability is the

standard for voluntariness in

Massachusetts. 703 F. Supp. at 152-53.

Either the Regulations create a stricter

standard for PDAAs, or they are

functionally meaningless. If the

former, then the Regulations, by

requiring what is not generally required

to enter contracts in the Commonwealth,

e.g., certain negotiations,

explanations, and disclosures, inhibit a

party’s willingness to create an

arbitration contract or undermine the

contract’s enforceability (if the party

proceeds notwithstanding the edict). By

itself, such an ethical mandate is

sufficient to lead us to rule that the

Regulations go too far.

- 38a -

State law need not clash head on

with a federal enactment in order to be

preempted. If state law "stands as an

obstacle to the accomplishment of the

full purpose and objectives of

Congress," it must topple.

Schneidewind, 108 S. Ct. at 1151

(citations omitted); see also French,

869 F.2d at 7 (state statute preempted

when "too discommoding" to federal

scheme); Palmer, 825 F.2d at 629 (state

tort liability preempted when

enforcement would be "seriously

disruptive to the congressionally

calibrated balance of national

interests"). In enacting the FAA,

Congress evinced an unmistakable

"federal policy favoring arbitration

agreements," one which was to be applied

liberally. Moses Cone, 460 U.S. at 24.

- 39a -

Court are to do so even where "state

substantive or procedural policies" run

to the contrary, always resolving "any

doubts concerning the scope of

arbitrable issues . .. in favor of

arbitration." Id. at 24-25. Wherever

there is "an allegation of waiver,

delay, or a like defense to

arbitrability," we must heed the

underlying federal interest. Id. at

25. The lesson is entirely clear: "A

state law principle that takes its

meaning precisely from the fact that a

contract to arbitrate is at issue does

not comport with [the equality]

requirement of § 2." Perry, 482 U.S. at

492 n.9.2/ That is to say, courts

8/ Technically, as appellants are quick

to note, the statements of the Perry

Court contained in footnote 9 of its

opinion are dicta. But, we find them to

be considered dicta, reflective of the

applicable rule of law.

- 40a -

must follow congressional intent and

"foreclose state legislative attempts to

undercut the enforceability of

arbitration agreements." Southland, 465

U.S. at 16. The legal standard is

whether the Regulations take their

meaning from the fact that a contract to

arbitrate is at issue, or frustrate

arbitration, or provide a defense to

it. If so, the federal policy requires

that we resolve all doubts in favor or

arbitration, finding the Regulations

preempted.

In this instance, we conclude as a

matter of law that the Regulations

actually conflict with the FAA and the

federal policy embedded therein. The

Regulations leave no room for

speculation: it is unarguable from

their wording that they derive their

- 4la -

essential meaning from the fact that a

contract to arbitrate is at issue. As

the district court noted, the

Commonwealth’s wistful assertion that

the Regulations are not addressed to the

validity and enforceability of PDAAs

"can be maintained only by assuming that

no provision of state law other than one

directly governing contract validity or

enforceability comes within the

preemptive reach of the Arbitration

Act." 703 F. Supp. at 156. That

assumption is so seriously flawed that

it cannot be countenanced.

The Regulations must also fall

because they are at odds with the policy

which infuses the FAA. The power to

suspend a license is much more than a

shift in costs; it is the economic

equivalent of the death penalty. The

- 42a -

worry that requiring a PDAA might

forfeit a firm’s ability to function as

a broker-dealer at all is an obstacle of

greater proportions even than the chance

that, in a given dispute, an arbitration

agreement might be declared void. To

the extent that the substantive state

policy to foster "ethical"

broker-dealers, embodied in the

Regulations here at issue, conflicts

with the federal policy to "favor[ ]

arbitration agreements," Moses Cone, 460

U.S. at 24, it is preempted.

A policy designed to prevent one

party from enforcing an arbitration

contract or provision by visiting a

penalty on that party is, without much

- 43a -

question, contrary to the policies of

the FAA. But, there is at least one

other way in which the Massachusetts

policy would erode the goals of the

Act. The Regulations are aimed at

nonnegotiable “standard-form" PDAAs.

Arbitration is a positive good in the

eyes of the courts and Congress not just

because it relieves crowded calendars,

but because it relieves an often

unnecessary elaboration of social

practices. As the Court has stated,

resort to arbitration "trades the

procedures and opportunity for review of

the courtroom for the simplicity,

informaility, and expedition of

arbitration." Mitsubishi Motors, 473

U.S. at 628. We must, therefore, be

vagilant lest we recreate even the

beginnings of hypertrophy in the

- 44a -

se

formation of arbitration contracts. The

Regulations demand exactly the kind of

inefficiency which arbitration and

standard-from contracts (generally

legitimate under Massachusetts law) are

designed to minify.2/ By depriving

broker-dealers of the opportunity to

employ form contracts, even were there

no penalty attached to their use,

Massachusetts has acted to undercut the

policies of simplicity and expedition

that characterize the arbitral

alternative.

9/ The Court has not seen fit to

question use of standard-form contracts

in circumstances where parties having

apparently unequal bargaining power have

agreed to arbitrate. See, e.g.,

Rodriguez de Quijas, 109 S. Ct. at 1921;

Southland, 465 U.S. at 4; see also Webb,

800 F.2d at 807 ("The use of a standard

form contract between two parties of

admittedly unequal bargaining power does

not invalidate an otherwise valid

contractual provision.").

- 438 -

IV

The Commonwealth may well be correct

that PDAAs ought to be arrived at with

greater negotiation and disclosure

between broker-dealers and customers

than currently takes place. That

judgment, however, is not the

Commonwealth’s to make, at least in its

current embodiment, for it singles out

arbitration in an impermissible way.

The states are forbidden from critical

scrutiny expressed in a fashion which

might mask historic hostility toward

arbitration. Congress sought to avoid

having that possibility come to

fruition, choosing instead to emphasize

and endorse arbitral efficiencies. That

value judgment was within the

congressional domain - and only

- 46a -

Congress, not the states, may create

exceptions to it.

That is not to say, of course, that

a state must permit broker-dealers to

sail as close to the wind as their

consciences (or lack thereof) might

permit. Massachusetts has a plenitude

of lawful weapons in its ethical

armamentarium to preserve the integrity

of the securities business as conducted

in the Commonwealth and to protect

consumers. Cf., e.g., Volt, 109 S. Ct.

at 1254. But because the Regulations

treat standard-form PDAAs in the

securities industry more severly than

standard-from contracts are generally

treated under Massachusetts law, and

because the policies underlying the

Regulations, and their method of

enforcement, conflict with the national

- 47a -

policy favoring arbitration, the state

scheme is too discommoding to the

federal plan. The Regulations are,

therefore, preempted.

We need go no further .+2/ The

judgment of the district court must be

Affirmed.

10/ We do not address appellants’

contention that the district court erred

in denying their motion to defer brevis

_ disposition pending further discovery.

See Fed. R. Civ. P. 56(f). According to

a supporting affidavit, appellants

sought the delay to "assess the impact

of the regulations on broker and

customer behavior." The motion was not

directed at discovery of any facts

material to the legal question - whether

the FAA preempts the Regulations - which

we, like the lower court, have found

determinative. Thus, the Rule 56(f)

motion is, for our purposes, beside the

point. See Paterson-Leitch Co. v.

Massachusetts Municipal Wholesale Elec.

Co., 840 F.2d 985, 988 (lst Cir. 1988)

(to be effective, Rule 56(f) motion must

show that facts likely exist which, if

obtained, will "engender an issue both

genuine and material").

- 48a -

APPENDIX

[to Decision of Court of Appeals]

12.204: Denial, Revocation, Suspension,

Cancellation, and Withdrawal of

Registration

{{a)(1) through (a)(2)(F): Reserved]

[G) Dishonest or unethical

practices in the securities business.

1. Broker-dealers. Each

broker-dealer shall observe high

standards of commercial honor and just

and equitable principles of trade in the

conduct of its business. Act[s] and

practices, including but not limited to

the following, are considered contrary

to such standards and constitute

dishonest or unethical practices which

are grounds for denial, suspension or

revocation of registration or such other

action authorized by law:

- 69a -

Requiring on or after January

1, 1989, that a customer

located in Massachusetts, other

than a customer that is an

institutional investor or

financial institution specified

in 950 CMR 14.401(e), execute

either a mandatory pre-dispute

arbitration contract or a

customer agreement containing a

mandatory pre-dispute

arbitration clause that is a

non-negotiable precondition to

effecting transactions in

securities for the account of

the customer or opening a

securities cash account or

margin account by the customer

with such broker-dealer;

- 50a -

Requesting on or after January

1, 1989, that a customer

located in Massachusetts

execute either a mandatory

pre-dispute arbitration

contract or a customer account

agreement containing a

pre-dispute arbitration clause

where the contract or agreement

fails to conspicuously disclose

that the execution of the

contract or agreement cannot be

made a non-negotiable

precondition to the opening by

the customer of a securities

account with the broker-dealer;

Requesting on or after January

1, 1989, that a customer

located in Massachusetts

execute either a mandatory

pre-dispute arbitration

- 5la -

contract or a customer account

agreement containing a

pre-dispute arbitration clause

without fully disclosing to the

customer in writing the legal

effect of the pre-dispute

arbitration contract or clause;

Being found by a court of

competent jurisdiction to have

violated M.G.L. c. 93A in

connection with the sale of

securities; and

Being temporarily or

permanently enjoined by any

court of competent jurisdiction

from violating M.G.L. c. 93A in

connection with the sale of

securities.

~- S2a =

APPENDIX B

UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

No. 89-1022

SECURITIES INDUSTRY ASSOCIATION, et al.,

Plaintiffs, Appellees,

Vv.

MICHAEL J. CONNOLLY, ETC., et al.,

Defendants, Appellants.

JUDGMENT

ENTERED: AUGUST 31, 1989

This cause came on to be heard on

appeal from the United States District

Court for the District of Massachusetts,

and was argued by counsel.

« 3238 =

Upon consideration whereof, it is

now here ordered, adjudged and decreed

as follows: The judgment of the

district court is affirmed.

By the Court,

[s/f

Clerk

- 544 -

APPENDIX C

UNITED STATES DISTRICT COURT

DISTRICT OF MASSACHUSETTS

SECURITIES INDUSTRY ASSOCIATION,

DEAN WITTER REYNOLDS, INC.,

DONALDSON, LUFKIN & JENRETTE

SECURITIES CORPORATION,

DREXEL BURNHAM LAMBERT, INCORPORATED,

FIDELITY BROKERAGE SERVICES INC.,

KIDDER PEABODY & CO., INCORPORATED,

MERRILL LYNCH, PIERCE, FENNER &

SMITH, INC.,

PAINEWEBBER INCORPORATED,

PRUDENTIAL-BACHE SECURITIES INC.,

SHEARSON LEHMAN HUTTON INC., and

SMITH BARNEY, HARRIS UPHAM & CO.,

INCORPORATED,

Plaintiffs,

V.

MICHAEL J. CONNOLLY, Secretary of

State, and

BARRY Cc. GUTHARY, Director,

Massachusetts Securities Division,

Defendants.

MEMORANDUM AND ORDER FOR JUDGMENT

December 19, 1988

WOODLOCK, D.J.

~$59a-

The Commonwealth of Massachusetts,

acting under its Blue Sky law authority

over brokers and dealers in securities,

has issued prospective regulations

seeking to control the circumstances

under which a broker may require a

non-institutional customer located in

Massachusetts to agree to arbitration of

disputes between then.

The plaintiffs -- the trade

association for securities dealers and

ten brokerage firms registered to do

business as securities broker-dealers in

Massachusetts -- challenge these

regulations on federal constitutional

grounds, contending they are preempted

by the Federal Arbitration Act, > U.B.¢.

§ 1 et seq. The Act requires that in

matters affecting the validity,

revocability, and enforceability of

-56a-

arbitration agreements, those agreements

must be treated no differently than

other contracts.

Without adopting any view on the

advisability of such provisions, I find

that the Massachusetts Blue Sky

authorities are without power to enforce

them. The Massachusetts securities

arbitration regulations are not merely

state law supplementation concerning

matters collateral to the validity and

enforceability of arbitration

agreements. Rather, they go to the

heart of the process of forming

contracts to arbitrate. In doing so,

they single out arbitration agreements

for more demanding standards than are

imposed by the general law of contracts

in Massachusetts. Consequently, I will

grant the plaintiffs’ motion for summary

judgment and declare the Massachusetts

«-$78~

securities arbitration regulations

preempted by the Federal Arbitration Act.

I

In the wake of Shearson/American

Express, Inc. v. McMahon, 107 S.Ct. 2332

(1987), in which the Supreme Court

upheld the use of predispute arbitration

clauses to govern resolution of

controversies between brokers and their

customers, 2’ officials of the

Commonwealth of Massachusetts moved

quickly to crest the tide of proposals

1l/ Strictly speaking, McMahon addressed

arbitration of statutory securities law

Claims only under § 10(b) of the

Securities Exchange Act of 1934, 15

U.S.C. § 78j3(b), and did not expressly

overrule Wilko v. Swan, 346 U.S. 427

(1953), which had held that a predispute

agreement could not be enforced to

compel arbitration under § 12(2) of the

Securities Act of 1933, 15 U.S.C.

(footnote continued)

-58a-

to control the circumstances in which

such arbitration could be used. While

the North American Securities

Administrators Association was calling

for reform, =/ while the United States

(footnote continued)

§ 771(2). The expansive preemptive

scope accorded the Federal Arbitration

Act in McMahon, however, has placed the

continued vitality of Wilko in doubt. A

split has appeared in the circuits on

the question. Compare Rodriquez De

Quijas v. Shearson an Se Oe

845 F.2d 1296 (5th Cir.) (McMahon

effectively overruled Wilko), cert.

granted, 57 U.S.L.W. 3347 (U.S. Nov. 15,

1988) (No. 88-385) with Chang v. Lin,

824 F.2d 219 (2d Cir. 1987) (Wilko

remains good law in absence of express

overruling by the Supreme Court).

Presumably the Supreme Court’s grant of

the petition for certiorari in Rodriquez

will resolve this question.

2/ NASAA, in a Briefing Paper entitled

"Oversight of Securities Arbitration"

(June 1988), reported that it had

"unveiled in early June a detailed

proposal for reform of securities

arbitration." Id. at 6. NASAA also

announced that it "is exploring the

(footnote continued)

-59a-

Securities and Exchange Commission was

seeking further study and encouraging

rule making by the broker/dealer

self-regulatory organizations, >’

(footnote continued)

possibility of developing model language

for state laws or rules to govern

mandatory arbitration clauses in written

customer agreements." Id. In October

1988, after this litigation was

commenced, NASAA adopted a "Resolution

Concerning the Execution of Compulsory

Pre-Dispute Arbitration Agreements as a

Condition Precedent to Obtaining

Brokerage Services," in which it

expressed “support [for] the goals and

policies of the Massachusetts rules as

being consistent with NASAA’s purpose of

advancing the principle of investor

protection and affording choice to

investors in their decisions to

participate in the securities markets."

Second Affidavit of Barry C. Guthary,

Exhibit A.

3/ In letters dated July 8, 1988, SEC

Chairman David S. Ruder requested that

all the self-regulatory organizations in

the brokerage industry "review the

issues raised by the current use of

mandatory predispute arbitration

agreements" and "report back to the

commission by October 15, 1988."

(footnote Come)

= Oa-

while the United States Congress was

failing to enact proposed legislation

regarding securities dispute

arbitration, / the defendant Secretary

of State of the Commonwealth of

(footnote continued)

vi the

Subcomm. on Telecommunications and

Finance of the House Comm. on Energy and

Arbitration Process and the

Voluntariness of Agreements to Arbitrate

Broker-Dealer/Investor Disputes, July

12, 1988 (hereinafter Ruder Statement],

Attachment 3. The proposals of the

self-regulatory organizations have

apparently been received and are under

consideration by the Commission. See

Wurczinger, SEC Faces Mandatory

Arbitration Issue, Nat’l L.J., Nov. 14,

L986; Ge 2a- OOae i.

4/ Legislation introduced by

Congressmen Boucher, Dingell, and

Markey, H.R. 4960, 100th Cong., 2d Sess.

(June 30, 1988), see generally 134 Cong.

Rec. E 2233 (remarks of Cong. Boucher) ;

E 2239-41 (remarks of Cong. Dingell); E

2245-46 (remarks of Cong. Markey) (daily

ed. June 30, 1988), died in Committee

during the last Congress. 2

Congressional Index (CCH) at 35,106

(100th Cong.).

-6la-

Massachusetts, through the defendant

Director of the Massachusetts Securities

Division, was taking definitive action.

The defendants’ action came on

September 21, 1988, in the form of a

singular Massachusetts regulatory

definition of "dishonest or unethical

practices in the securities business" by

broker-dealers. See Mass. Regs. Code

tit. 950, § 12.204-(a) (2) (G)l.a.-c. 2/

5/ The new definition provides as

follows:

(G) Dishonest or Unethical

practices in the securities business.

1. Broker-dealers. Each

broker-dealer shall observe high

standards of commercial honor and just

and equitable principles of trade in the

conduct of its business. Act[s] and

practices, including but not limited to

the following, are considered contrary

to such standards and constitute

dishonest or unethical practices which

are grounds for denial, suspension or

revocation of registration or such other

action authorized by law:

(footnote continued)

-62a-

(footnote continued)

a. Requiring on or after January l,

1989, that a customer located in

Massachusetts, other than a customer

that is an institutional investor or

financial institution specified in 950

CMR 14.40l(e), execute either a

mandatory pre-dispute arbitration

contract or a customer agreement

containing a mandatory pre-dispute

arbitration clause that is a

non-negotiable precondition to effecting

transactions in securities for the

account of the customer or opening a

securities cash account or margin

account by the customer with such

broker-dealer;

b. Requesting on or after January l,

1989, that a customer located in

Massachusetts execute either a mandatory

pre-dispute arbitration contract or a

customer account agreement containing a

pre-dispute arbitration clause where the

contract or agreement fails to

conspicuously disclose that the

execution of the contract or agreement

cannot be made a non-negotiable

precondition to the opening by the

customer of a securities account with

the broker-dealer;

c. Requesting on or after January l,

1989, that a customer located in

Massachusetts execute either a mandatory

pre-dispute arbitration contract or a

-63a-

This regulatory definition forbids

broker-dealers licensed in Massachusetts

from requiring Massachusetts customers

to sign a mandatory pre-dispute

arbitration agreement as a

non-negotiable condition to opening a

brokerage account. The definition also

requires broker-dealers to disclose

fully the legal effects of arbitration

agreements before entering into a

negotiated contract with a customer.

What consitutes negotiability, and what

full disclosure of legal effects would

consist of, are left undefined by the

definition.

(footnote continued)

customer account agreement containing a

predispute arbitration clause without

fully disclosing to the customer in

writing the legal effect of the

pre-dispute arbitration contract or

clause;

-64a-

|

Under the Massachusetts securities

arbitration regulations,

non-negotiability of, and lack of full

disclosure of legal effects regarding,

arbitration agreements do not become

dishonest or unethical until January l,

1989.

Proscriptions against such

"dishonest or unethical practices" by

broker-dealers are enforced by the power

of the defendant Secretary of State to

deny, suspend, or revoke the

registration of a broker or brokerage

firm. Mass. Gen. L. ch. l1OA, § 204.

Because an unregistered broker may not

transact business in Massachusetts, id.

§ 201, any broker who wishes to do

business in Massachusetts must observe

the securities arbitration contract

regulations which the definition

establishes.

-65a-

Moreover, if a broker--or for that

matter a customer--were to attempt to

enforce a contract formed without

compliance with the Massachusetts

securities arbitration regulations, that

attempt would be unavailing. Under

Chapter 110A, § 410(f),

{n]o person who has made or engaged

in the performance of any contract

in violation of any provision of

this chapter or any rule or order

hereunder, or who has acquired any

purported right under any such

contract with knowledge of the facts

by reason of which its making or

performance was in violation, may

base any suit on the contract.

\

If implemented in January, these

proscriptions will have an immediate

effect on the contracts used by

broker-dealers transacting business with

customers located in Massachusetts. The

affidavits submitted by the plaintiff

brokerage firms indicate some variety in

- 66a -

their use of arbitration agreements, but

certain elements are common. 2/

Mandatory written pre-dispute

arbitration agreements in some form are

used by all the plaintiffs. And these

pre-dispute agreements do not purport to

advise customers of the "legal effects"

of the arbitration clauses.

6/ The written brokerage contracts in

which these agreements are contained

plainly concern transactions involving

interstate and international commerce.

For the most part, the purchase and sale

of securities is conducted over national

exchanges or through traders who are

located in New York. The

instrumentalities of interstate commerce

-- telephones and the mails -- are used

to execute and report brokerage trades.

Thus, the agreements at issue here fall

within the broad construction, see

Societe Generale de Surveillance, S.A.

v. Raytheon European Management and

Systems Co., 643 F.2d 863, 867 (lst Cir.

1981), given the reach of the Federal

Arbitration Act, which applies to any

"written [arbitration] provision in

- « a contract evidencing a

transaction involving commerce."

9 U.S.C. § 2.

-67a-

Each of the plaintiff brokerage

firms use arbitration agreements in its

standard margin and option account

contracts, with the exception of

Shearson Lehman Hutton Inc., which has

no arbitration clause in its option

account contract. A bare majority of

the plaintiffs, however, do not use

arbitration accounts in standard cash

accounts for individuals, although one

member of that majority, Donaldson

Lufkin & Jenrette Securities

Corporation, does have an arbitration

agreement for corporate customers. In

addition, Smith Barney, Harris Upham &

Co., which has an arbitration agreement

in its standard cash account, avers that

execution of that arbitration agreement

-68a-

is not a requirement for opening a Smith

Barney cash account .’

The plaintiffs are unanimous in

asserting a desire to require certain

customers to agree to arbitrate disputes

as a condition to opening an account.

7/ The plaintiffs’ present practice

appears to be fairly respresentative of

the brokerage business generally. The

Division of Market Regulation of the

United States Securities and Exchange

Commission in a 1987 study of the 65

firms which account for 90 percent of

the brokerage customer trading accounts,

see Ruder Statement, supra note 3, at 8,

found that arbitration agreements were

all but universal for margin accounts

(89 percent of the firms used such

agreements) and for option accounts (83

percent of the firms used such

agreements). With respect to straight

cash accounts, however, the percentage

of total accounts using arbitration

agreements is only about 40 percent.

However, 30 percent of the firms

surveyed in the SEC study reported that

they had under active consideration

plans to expand the number of accounts

for which an arbitration agreement would

be required. See SEC, Summary of Staff

Findings with Respect to the Use of

Predispute Arbitration Clauses, Ruder

Statement, Attachment 4.

-69a-

The Massachusetts securities

arbitration regulations would change

this practice by establishing additional

disclosure requirements in an as yet

undefined format. The Massachusetts

securities arbitration regulations would

also prevent broker-dealers from

implementing the apparently universal

practice of requiring at least certain

customers to enter into arbitration

agreements for their disputes.

Il

In confronting a preemption clain,

the "sole task" of the court is to

determine the intent of Congress.

Massachusetts Medical Soc’y v. Dukakis,

815 F.2d 790, 791 (ist Cir.), sere.

-70a-

denied, 108 S.Ct. 229 (1987) (quoting

Californi ed. Sav. & Loan Ass’n v.

| Guerra, 479 U.S. 272, 280 (1987). The

Federal Arbitration Act preempts the

Massachusetts broker arbitration

regulations "if and only if Congress

intended it to do so." Id.

The question to be addressed is

"whether Congress (expressly) did or

(impliedly) meant to displace state law

or state law concepts in enacting

the federal scheme set up by Congress."

Palmer v. Liggett Group, Inc., 825 F.2d

620, 625-26 (lst. Cir. 1987). In

answering that question, the principal

consideration is whether state

regulation creates a material

disturbance in the field of federal

concern. “If the state law disturbs too

much the congressionally declared

-J7la-

scheme-whether denominated as ‘occupying

the field’ or ‘actually conflicting with

federal law’ -- it will be displaced

through the force of preemption." Id.

at 626.

The question whether the

Massachusetts broker arbitration

regulations at issue here materially

disturb the federal arbitration scheme

may be answered by reference to the

history and the logic of the Arbitration

Act.

At its enactment in 1925, the Act

was intended to "revers[e] centuries of

judicial hostility to arbitration

agreements." Scherk v. Alberto-Culver

Co., 417 U.S. 506, 510 (1974).

-72a-

In 1953, the courts still harbored

reservations about full applicability of

the Arbitration Act. The decision that

year in Wilko v. Swan, see supra note l,

"reflect({ed] a general suspicion of the

desirability of arbitration and the

competence of arbitral tribunals."

S rica xpress nc. v.

McMahon, 482 U.S. 220 (1987).

In the years after Wilko, however,

the Supreme Court systematically

rejected the reasons supporting Wilko’s

suspicion of the arbitration process.

By 1987, the Supreme Court could observe

that "the mistrust of arbitration that

formed the basis for the Wilko opinion

in 1953 is difficult to square with the

assessment of arbitration that has

prevailed since that time." Shearson,

482 U.S at 233.

-73a-

Recent history has found the Supreme

Court offering forceful endorsements of

the arbitration process by expansive

statements of the intent of Congress in

passing the Federal Arbitration Act. In

the last five years, the Court has

variously found in the statute an

embodiment of "Congress’ intent to

provide for the enforcement of

arbitration agreements within the full

reach of the Commerce Clause," Perry v.

Thomas, 482 U.S. 483, 490 (1987); an

"emphatic federal policy in favor or

arbitral dispute resolution," Mitsubishi

Motors Corp. v. Soler Chrysler-Plymouth,

Inc., 473 U.S. 614, 631 (1985); "a

national policy favoring arbitration,"

Southland Corp. v. Keating, 465 U.S. l,

10 (1984); and "a liberal federal policy

favoring arbitration agreements,

~74a-

notwithstanding any state substantive or

procedural policies to the contrary,"

Moses H. Cone Memorial Hosp. v. Mercury

Constr. Corp., 460 U.S. 1, 24 (1983).

That policy has been set loose with

hydraulic pressure, sweeping away any

state law purporting to "override the

parties’ choice to arbitrate rather than

litigate in court." New England Energy

Inc. v. Keystone Shipping Co., 855 F.2d

1, 4 (lst Cir. 1988). Of course, "the

Federal Arbitration Act has never been

construed to preempt all state law on

arbitration." Id. Nevertheless, as the

First Circuit recently observed in New

England Energy, “the Supreme Court’s

decisions support a conclusion that all

state laws seeking to limit the use of

the arbitral process are superseded by

-75a-

federal law." Id. (emphasis in

original).

As a matter of logic, analysis of

whether state regulations affecting the

arbitration choice are preempted focuses

on whether the state regulations "single

out arbitration agreements" for special

treatment. Mitsubishi Motors Corp. v.

Soler Chrysler-Plymouth, Inc., 723 F.2d

155, 158 (lst Cir. 1983), aff’d in part,

rev’d in part, 473 U.S. 614 (1985) The

anti-singularity premise has been

articulated with both pedestrian and

intestinal metaphors. Because the

fundamental purpose of the Federal

Arbitration Act "was to place an

arbitration agreement ‘upon the same

footing as other contracts, where it

-76a-

belongs’," an Wi eylnolds, Inc.

v. Byrd, 470 U.S. 213, 219 (1985)

(quoting H.R. Rep. No. 96, 68th Cong.,

lst Sess. 1 (1924)), the courts have

been vigilant to ensure that state law

concepts specially directed at

arbitration contracts are not permitted

to “eviscerate”™ that purpose, even

indirectly. uthland Corp. v. Keating,

465 U.S. at 16 n.11; see, e.g., N&D

Fashions, Inc. v. DHJ Indus., 548 F.2d

722, 727-28 (8th Cir. 1976); Medical

Dev. Corp. v. Industrial Molding Corp.,

479 F.2d 345, 348 (10th Cir. 1973);

Michael v. NAP Consumer Elec. Corp., 574

F. Supp. 68, 70 (D.P.R. 1983)

(Torruella, J.).

The formation of arbitration

contracts can be wholly a matter of

state law "if that law arose to govern

-77a-

issues concerning the validity,

revocability, and enforceability of

contracts generally." Perry v. Thomas,

107 S.Ct. at 2527 n.9 (emphasis in

Original.) However, "[a]} state law

principle that takes its meaning

precisely from the fact that a contract

to arbitrate is at issue does not

comport with [§2 of the Federal

Arbitration Act]." Id. Asa

consequence, "§ 2 of the Act preempts

state statutory and case law that treats

arbitration agreements differently from

any other contract." Cook Chocolate Co.

v. Salomon, Inc., 684 F. Supp. 1177,

1182 (S.D.N.Y. 1988).

The metaphor of "equal footing" is

expressly embodied in §2, which provides

that written agreements "to settle by

arbitration a controversy thereafter

arising out of such contract .. . shall

be valid, irrevocable, and enforceable,

-78a-

Save upon such grounds as exist at law

or in equity for the revocation of any

contract." (emphasis supplied.) The

inherent logic of §2 was succinctly

summarized by Judge Weinfeld in Avila

Group, Inc. v. Norma J. of Cal., 426 F.

Supp. 537, 541 (S.D.N.¥. 1983): “Courts

applying federal law under the

Arbitration Act have rejected cases that

purport to apply special rules and

requirements to agreements to arbitrate

that are not applicable to other

contracts" (footnote omitted).

III

The defendants concede that the

regulations single out arbitration

agreements: "It is true," defendants

note in their Memorandum of Law on

Summary Judgment, "that the regulations

«79a

themselves apply only to arbitration

agreements." Id. at 46. In this sense,

the defendants recognize that the

securities arbitration regulations are

the paradigm of "[{a state law principle

that takes its] meaning precisely from

the fact that a contract to arbitrate is

at issue." Id. at 46-47 (quoting Perry

v. Thomas, 107 S.Ct. at 2527 n.9).

The defendants justify the

regulations, however, by an appeal to

another purpose evident in the

legislative history of, and case law

construing, the Federal Arbitration

Act: the concern to implement voluntary

agreements to arbitrate. 2/

8/ The Supreme Court has characterized

"([tjthe preeminent concern of Congress

in passing the Act [as]] enforce[ment

of] private agreements into which

parties ha[{ve] entered." Dean Witter

Reynolds, Inc. v. Byrd, 470 U.S. 213,

221 (1985).

-80a-

Alternatively, they rely upon the

overall pattern of securities broker

regulations, which they contend has

effectively modified the Arbitration Act

so as to permit their regulations.

whe

The defendants’ appeal to the

voluntariness concern of the Federal

Arbitration Act is a semantic sleight of

hand. There is no question that the

Federal Arbitration Act was designed to

give full force to the agreement of the

parties--a presumptively voluntary

undertaking. But, as used by the

defendant, the concept of voluntariness

addresses the fundamental principles of

contract formation upon which questions

of validity, revocability, and

enforceability of arbitration agreements

turn. As used in that way, the concept

of voluntariness is not a matter subject

-8la-

to idiosyncratic rules or definitions.

Massachusetts is not free under the

Federal Arbitration Act to develop a

definition of voluntariness applicable

only to the negotiation of arbitration

agreements and not to other contracts

generally. 2”

9/ Federal courts have refused to apply

similar state voluntariness enhancements

specially directed toward arbitration

agreements. The Eighth Circuit in

Collins Radio Co. v. Ex-Cell-o Corp.,

467 F.2d 995 (8th Cir. 1972), declined

on preemption grounds to enforce a Texas

law which allegedly required the advice

and signature of a Texas attorney for

each party to the arbitration

agreement. In Webb v. R. Rowland & Co.,

800 F.2d 803 (8th Cir. 1986), that court

declined on preemption grounds to apply

a choice of law provision in an

arbitration agreement which would have

invalidated the agreement for failure to

provide a statutorily required special

ten-point capital letter notice

regarding the binding character of the

arbitration provision and would possibly

have rendered unenforceable as a

contract of adhesion the preprinted

arbitration form contract. And in Wydel

(footnote continued)

-82a-

That, of course, is precisely what

the defendants’ purported voluntariness

(footnote continued)

Associates v. Thermasol, Ltd., 452 F.

Supp. 739 (W.D. Tex. 1978), Chief Judge

Spears of the Western District of Texas

refused to apply a provision of Texas’

version of the Uniform Partnership Act

to invalidate an arbitration agreement

signed by only one of the partners.

The two cases cited by defendants as

examples of singular state treatment of

arbitration contract formation

countenanced by the federal courts are,

respectively, inapposite and

nonpersuasive. In Hull v._Norcom, Inc.,

750 F.2d 1547 (11th Cir. 1985), the

court understood itself to be applying

"the general provisions of state

contract law to the determination of

‘the making of [the] arbitration

agreement’." Id. at 1551 (quoting 9

U.S.C. §4). Eassa Properties v.

Shearson Lehman Bros. Inc., 851 F.2d

1301 (llth Cir. 1988), disposed of the

issue by a brief footnote offering

dicta. Finding that a single partner

"had been vested with actual authority

by the remaining partners to bind the

partnership to the arbitration

agreements," id. at 1305, the Court had

no occasion to consider the effect of

Perry and Wydel on its general

observation that "state law governs the

question of whether [an arbitration]

agreement exists in the first instance,"

id. at 1304 n.7.

-83a-

enhancements do. There is no general

contractual duty in Massachusetts

requiring one party to describe

fully--or for that matter, at all--the

legal effect of a contractual provision

to another party with whom the first

party proposes to contract .+2/

10/ Indeed, as the Ninth Circuit noted

recently:

We know of no case holding that

parties dealing at arm’s length have

a duty to explain to each other the

terms of a written contract. We

decline to impose such an obligation

where the language of the contract

Clearly and explicitly provides for

arbitration of disputes arising out

of the contractual relationship.

Cohen v. Wedbush, Noble, Cooke, Inc.,

841 F.2d 282, 287 (9th Cir. 1988); cf.

Page v. Moseley, Hallgarten, Estabrook &

Weeden, Inc., 806 F.2d 291, 295 n.6 (1st

Cir. 1986) ("Despite .. . statement by

the Wilko Court that certain investors

may operate at a disadvantage vis a vis

their more sophisticated brokers, we do

not believe that it requires the

invalidation of all customer-broker

arbitration agreements ab initio")

(emphasis in original).

-~84a-

Nor is there any general restriction

requiring specific provisions to be

"negotiable. "2+/

1l1/ Massachusetts follows the

Restatement position that contracts of

adhesion are not unenforceable unless

they are unconscionable. See Zapatha v.

Dairy Mart, Inc., 381 Mass. 284, 291-95

& 292 n.12, 408 N.E.2d 1370 (1980);

Restatement (Second) of Contracts § 208

& comment d. Federal courts have

* consistently held that agreements to

arbitrate are, as a matter of law, not

unconscionable. See, e.g., Cohen v.

Wedbush, Noble, Cooke, Inc., 841 F.2d at

286 (rejecting conclusion of California

state courts that doctrine of

unconscionability applies to standard

securities arbitration contracts) ;

Pierson v. Dean Witter Reynolds, Inc.,

742 F.2d 334, 339 (7th Cir. 1984)

(rejecting unconscionability claim in

absence of showing that arbitration

clause is commercially unreasonable or

that plaintiffs lacked reasonable

opportunity to understand it); Surman v.

Me Lynch, Pierc Fenner & Smith,

733 F.2d 59, 61 n.2 (8th Cir. 1984)

(rejecting contention that standard

brokerage agreement arbitration clauses

are unconscionable); Hurlbut v.

Gantshar, 674 F. Supp. 385, 392 (D.

Mass. 1987) (holding that agreement to

arbitrate securities brokerage disputes

before independent, though

industry-related, panel of arbitrators

pursuant to standard form contract is

not unconscionable).

=

-§S5a-

Thus there can be no question that

the new arbitration provisions represent

a radical departure from the treatment

of contracts generally in the State’s

common law. To be sure, Massachusetts

law does contain a variety of

idiosyncratic statutory provisions which

require special treatment of--and

disclosure regarding--certain types of

contractual provisions. But the short

and sufficient answer to this point is

that these provisions-whether styled

voluntariness enhancements or not--are

the exception which prove the rule. For

example, when Massachusetts wanted to

require certain disclosures in the

consumer credit context, a special

truth-in-lending law, Mass. Gen. L. ch.

140D, was necessary, because the Act

represented a significant departure from

-86a-

the law which affects contracts

generally in Massachusetts.+2/ And of

course, neither the Massachusetts

truth-in-lending provisions, nor any of

the other exceptions cited by the

defendants as authority, purports to

single out arbitration agreements.

The Massachusetts securities

arbitration regulations are not

concerned with "matters collateral to

12/ And even in those circumstances,

statutory state law must not interfere

with the broader federal scheme. Thus,

under the Federal Truth in Lending Act,

15 U.S.C. § 1601 et seg., for example,

inconsistent state disclosure

requirements are preempted by the

federal statute. See, e.g., Truth in

Lending: Determinations of Effect on

Mississippi, New Jersey, Oklahoma, and

South Carolina State Laws, 48 Fed. Reg.

43,672 (1983); Mason v. General Finance

Corp. of Va., 542 F.2d 1226 (4th Cir.

1976); Trustees Loan & Discount Co. v.

Carswell, 435 So.2d 114 (Ala. Civ. App.

1983); Public Finance Corp. v. Riddle,

83 Ill. App.3d 417, 403 N.E.2d 1316

(1980).

-87a-

the agreement to arbitrate," such as the

procedural issues relating to

consolidation of arbitration proceedings

dealt with by the First Circuit in New

England Energy Inc. v. e ippin

Co., 855 F.2d 1, 4 n.2 (lst Cir. 1988).

Rather, the defendants’ regulations

govern the validity and enforceability

of arbitration agreements themselves by

establishing standards which, if not

met, render the arbitration agreements

unenforceable and the unsuccessful

makers of those agreements subject to

sanction. It is difficult to imagine

regulation more central to the arbitral

decision.

The defendants’ regulations assume

this central position by establishing

hurdles to the formation and execution

of securities arbitration agreements

-88a-

that are not found in the general

contract law of Massachusetts. Because

the voluntariness concerns expressed in

the unique Massachusetts securities

arbitration regulations impose

conditions on the formation and

execution of arbitration agreements

which are not part of the generally

applicable contract law of

Massachusetts, they cannot be given

effect under the Federal Arbitration Act.

But analysis does not stop with the

Arbitration Act alone. As the Supreme

Court observed in McMahon:

Like any statutory directive, the

Arbitration Act’s mandate may be

overridden by a contrary

congressional command. The burden

is on the party opposing

arbitration, however, to show that

-69a-

Congress intended to preclude a

waiver of judicial remedies for the

statutory rights at issue.

107 S.Ct. at 2337.

Defendants suggest that the role of

State Blue Sky law in securities

regulation as expressed in the various

Savings clauses of the federal

securities statutes*?/ provides that

contrary command. This argument finds

no support in the case law.

The Seventh Circuit in Kroog v.

Mait, 712 F.2d 1148 (7th Cir. 1983),

cert. denied, 465 U.S. 1007 (1984),

rejected the proposition that general

Savings language which permits

concurrent state and federal regulation

13/ See, e.g., 15 U.S.C. § 77r (1933

Act); 15 U.S.C. § 78bb(a) (1934 Act); 15

U.S.C. § 80b-18a (Investment Advisers

Act of 1940).

-90a-

of the securities business could sustain

a special treatment of arbitration

agreements under Wisconsin Blue Sky

law. In Kroog, the court declined to

indulge a Wisconsin effort to import

special arbitration regulation under

cover of Blue Sky law. The court found

that there was no conflict between

Congressional protection of state

securities regulation through the

savings clauses and the federal law of

arbitrability maintained under the

Federal Arbitration Act:

[T}he conflict we face is plainly

not one of federal arbitration

procedures versus Wisconsin

substantive securities regulation.

The conflict is rather between two

procedural demands-~-one that

commands, and the other that

prohibits, the arbitration of

brokerage contract claims. If the

Arbitration Act prevails, Wisconsin

substantive securities law remains

intact, and would indeed have to be

considered by the arbitrator of the

dispute here.

Id. at 1153 (emphasis in original).

-9la-

Needless to say, the Federal

Arbitration Act prevailed in Kroog.

Thus, even giving full scope to the

appropriate role of state Blue Sky law,

the savings provisions of the various

federal securities statutes do not

provide a "contrary Congressional

command" permitting state Blue Sky

regulators to establish special

conditions applicable to arbitration

contracts in derogation of the

directions of the Federal Arbitration

Act. Cf. Osterneck v. Merrill Lynch,

Pierce, Ferner & Smith, Inc., 841 F.2d

508, 512 (3d Cir. 1988) (holding

preempted § 507 of the Pennsylvania

Securities Act when applied to preclude

arbitration that falls within the FAA

because "(t]he overwhelming weight of

precedent militates against

-92a-

finding that Congress intended to exempt

state securities claims from the general

command of the [FAA]").

The defendants point to the

treatment given arbitrability by the

District of Columbia Blue Sky provisions

as authority for the Massachusetts

arbitration regulations. See Levin v.

Dean Witter Reynolds, Inc., 3 Blue Sky

L. Rep. (CCH) 4 71,812 (D.D.c. 1983).

But Levin rested on a Congressional

enactment concerned with the District of

Columbia as a federal enclave. This

provided Congressional authorization for

the District’s Blue Sky regulation

separate from the savings clauses.

Thus, the question in Levin was not

whether a state legislature could create

a Wilko-type exception to §2 of the

Arbitration Act, but rather whether

-93a-

Congress, in enacting the District of

Columbia Blue Sky provisions, had done

so. Cf. Southland Corp. v. Keating, 465

U.S. at 16 n.11. At issue in Levin was

a specific Congressional anti-waiver

provision of the type the Supreme Court

had found sufficient to override the

Arbitration Act in Wilko v. Swan, 346

U.S. 427 (1953). Massachusetts Blue Sky

law, however, is not supported by such

an independent Congressional

enactment. 24/

14/ For the same reason, the authority

granted by Congress to the Commodities

Futures Trading Commission to regulate

predispute arbitration agreements

involving commodities futures, see 17

C.F.R. pt. 180; see generally Ingbar v.

Drexel Burnham Lambert Inc., 683 F.2d

603 (lst Cir. 1982), is inapposite.

Nothing in that separate authority

suggests that Congress has empowered

Massachusetts to create similar

regulations to govern predispute

arbitration agreements for securities

disputes.

-94a-

Moreover, taking a broader view of

the authority of securities regulators

to address arbitration agreements, it is

uncertain whether Wilko itself remains

authoritative even on its limited

facts. See supra note 1. It is clear

that the Supreme Court has had second

thoughts about the role of anti-waiver

provisions of the type used in Wilko and

Levin to override the Federal

Arbitration Act.

In part, the careful restriction of

Wilko to its specific facts, see

Shearson/American Express, Inc. v.

McMahon, 107 S.Ct. 2332 (1987), and the

pending reconsideration of the narrowed

holding itself, see Rodriguez de Quijas

Vv. Shearson/Leahman Bros., Inc., 845

F.2d 1296 (5th Cir.), cert. granted, 57

U.S.L.W. 3347 (U.S. Nov. 15, 1988) (No.

-95a-

ae

88-385), appear to be premised on

supervening Congressional action

regarding the arbitrability of

securities law claims. As the Supreme

Court noted in McMahon, "[s]ince the

1975 amendments to §19 of the Exchange

Act [15 U.S.C. §78s, the United States

Securities and Exchange] Commission has

had expansive power to ensure the

adequacy of the arbitration procedures

employed by [the national securities

exchange and registered securities

associations]." 107 S.Ct. at 2341. The

Commission is now treading gingerly in

this area and is encouraging rulemaking

by the affected self-regulatory

organizations. See supra note 3, 22/

15/ Recognizing the limited vitality of

Wilko v. Swan after McMahon, the SEC

itself has actually withdrawn the

(footnote continued)

-96a-

Especially given what the Ninth Circuit

recently observed is the "virtually

plenary authority [of the SEC] over the

arbitration procedures adopted by the

national securities exchanges and

securities association," Cohen v.

Wedbush, Noble, Cooke, Inc., 841 F.2d at

286, there is nothing in the pattern

(footnote continued)

mandatory disclosure regulations it had

earlier required in connection with

securities arbitration agreements.

Barely three months after the Supreme

Court handed down McMahon, the

Commission reversed its previous

rulemaking proceeding, see Recourse to

the Courts Notwithstanding Arbitration

Clauses in Broker-Dealer Customer

Agreements, 48 Fed. Reg. 53,404 (1983),

and determined that a regulation

requiring disclosure of the

inapplicability of arbitration

agreements to federal securities law

Claims, 17 C.F.R. § 240.15c2-2, was "no

longer appropriate or accurate and,

accordingly, should be rescinded."

Rescission of Rule Governing Use of

Predispute Arbitration Clauses in

Broker-Dealer Customer Agreements, [1987

Transfer Binder] Fed. Sec. L. Rep. (CCH)

q 84,163 (Oct. 15, Po Be

of Congressional enactments regarding

securities regulation which can fairly

be read to contemplate a peculiar

Massachusetts rule in the regulation of

written arbitration agreements

concerning the purchase and sale of

a. . * . 6

securities in interstate commerce. +°/

16/ The SEC declined an invitation I

extended to file an amicus brief in this

case on grounds that "the underlying

preemption claim is based on the Federal

Arbitration Act, not the federal

securities laws." Letter of SEC General

Counsel Daniel L. Goelzer to the Court

(Nov. 14, 1988). The stated reason

appears less than candid in light of the

defendants’ reliance on federal

securities law for its opposition to the

motion for summary judgment. I

recognize, however, that various

prudential and strategic considerations,

including an interest in permitting the

case law to ripen and a desire not to

become committed even indirectly on an

issue as yet unresolved within the

agency, may govern the decision whether

to file an amicus brief. Cf. P. Irons,

The New Deal Lawyers 4-5 (1982). I draw

no inferences one way or the other from

the lack of a formal expression of the

SEC’s position on the issues presented

to me by this case.

-98a-

IV

The defendants seek to avoid

definitive resolution of this action

before the January 1, 1989 effective

date for the arbitration regulations.

They do so by interposing a motion under

Fed. Civ. P. 56(f) requesting further

discovery before the plaintiffs’ summary

judgment motion is resolved.

To be sure, the First Circuit has

been careful to note that in looking to

the effect the allegedly preemptive

state action "will have on the federal

scheme set up by Congress," courts must

require that "(t]he harm of the state

law on the federal scheme .. . be

actual, not potential." Palmer v.

Liggett Group, 825 F.2d at 626 & n.11.

But nothing in Palmer, or the line

of cases it represents, provides

justification for delay in entering

-99a-

.

summary judgment for the defendants.

The grounds for preemption are as

apparent here as they were in Palmer.

The actual harm inflicted on the federal

scheme for arbitration by the

Massachusetts securities arbitration

regulations is manifest in the

conditions they impose on the validity

and enforceability of securities dispute

arbitration agreements, conditions not

generally applicable to contracts in the

Commonwealth. No further factual

development is necessary to deal with

the legal consequences of that

circumstance.

In pressing this motion, the

defendants have adopted seemingly

inconsistent official positions. After

conducting what they presumably consider

sufficient proceedings to have a

-100a-

rational basis for promulgating the

Massachusetts securities arbitration

rules, the defendants now pose as

incapable of demonstrating facts

sufficient to defeat the plaintiffs’

motion because the effect of the

regulations is alleged by them to be in

dispute. Given this purported inability

to join issue with plaintiffs’ motion,

the defendant contend that no further

action on their regulations--now that

they have put them in place--should be

taken until additional inquiry--which

the defendants themselves did not feel

obliged to undertake before promulgating

the regulations--has been completed.

The defendants’ position is laid out

in a highly artificial manner. As a

matter of semantics, they contend that

the regulations are not addressed to the

-10la-

validity or enforceability of

arbitration contracts. This contention

can be maintained only by assuming that

no provision of the state law other than

one directly governing contract validity

or enforceability comes within the

preemptive reach of the Arbitration

Act. But, as Palmer suggests, indirect

regulation through a system of sanctions

can be every bit as "potent [a] method

of governing conduct and controlling

policy" as direct proscriptions

regarding arbitration. Cf. id. at

627-28 (quoting San Diego Bldg. Trades

Council v. Garmon, 359 U.S. 236, 247

(1959)). Justice Holmes, while sitting

on the Massachusetts Supreme Judicial

Court, described the system of sanctions

as the essence of the law. "If you want

to know the law and nothing else, you

-102a-

Deiniceeniidiiieenicaeieiiieaaaciaaiilll

must look at it as a bad man, who cares

only for the material consequences which

such knowledge enables him to predict

" O.W. Holmes, The Path of the

Law, in Collected Legal Papers 167, 171

(1920).

The material consequences are plain

here. Should a securities broker

attempt to deal with arbitration

agreements in Massachusetts after

January 1, 1989, in the manner

applicable to Massachusetts contracts

generally, she will find herself

labelled "dishonest" and "unethical" and

have her license to do business put in

jeopardy. Indeed, as noted above, a

contract in violation of the

Massachusetts securites arbitration

regulations is, as a matter of

Massachusetts Blue Sky law,

-103a-

unenforceable. Mass. Gen. L. ch. 110A,

§ 410(f). Massachusetts could not have

been clearer in its intention--despite

its oblique means of execution--to make

securities arbitration contracts subject

to different rules regarding validity

and enforceability from those that

govern other contracts. It takes no

further factual development to reach

that conclusion.

The specific additional discovery

defendants seek does not appear to

address any genuine issues of material

fact. The defendant Guthary in his

Third Affidavit submitted in support of

the defendants’ Rule 56(f) motion seek

to develop additional information on

"the marginal impact of the arbitration

regulations on individualization [of

customer accounts]," 4 4; whether "a

-104a-

two-tiered commission scheme" to reflect

different costs of pre-dispute and

non-predispute arbitration contracts

"could be implemented in ordinary

compliance and training materials," q{ 5;

"the degree to which negotiation over

arbitration clauses currently impairs

broker-customer relationships," q 6;

"how often securities customers who do

not sign arbitration agreements

currently choose arbitration over

litigation in the absence of a

pre-dispute agreement," 4 8; and "the

application of plaintiffs’ commodities

experience to securities" and "how many

commodities customers arbitrate even in

the absence of a pre-dispute arbitration

agreement," q 9.

None of these areas of inquiry--even

if likely to produce some genuine

-105a-

dispute, a matter defendants do not

address--concerns any issues material to

my determination. Thus defendants’

motion pursuant to Rulé 56(f) will be

denied. See generally Paterson-Leitch

Co. v. Massachusetts Mun. Wholesale

Elec. Co., 840 F. 2d 985, 988-89 (lst

Cir. 1988); Taylor v. Gallagher, 737

F.2d 134, 137 (lst Cir. 1984).

V.

Although I am prepared to grant

plaintiffs’ motion for summary judgment

in this matter as a predicate to entry

of the dispositive order, an excess of

caution prompts me to offer in the

alternative reasons for entering an

interim order of preliminary injunction

invalidating the Massachusetts

securities arbitration regulations,

should entry of summary judgment be

-106a-

ruled premature because of the denial of

defendants’ Rule 56(f) motion.

In response to my scheduling

conference observation that denial of

the motion for summary judgment would

not constitute a final order permitting

appeal, plaintiffs filed a motion for a

preliminary injunction in order to have

a serviceable back-up vehicle for

immediate appeal. If called upon to

rule in this matter only on an interim

basis, I would grant such a motion, as

plainly satisfying the traditional

four-pronged inquiry necessary to

support a summary judgment determination

in the First Circuit. See generally

Planned Parenthood League of Mass. v.

Bellotti, 641 F.2d 1006, 1009 (lst Cir.

1981).

-107a-

A. Success on the Merits

My treatment of the motion for

summary judgment makes clear my views

regarding the plaintiffs’ all but

certain success on the merits. To the

degree that additional positive findings

of an adverse effect on arbitration are

necessary, the materials presented by

the plaintiffs in support of their

summary judgment motion supply such

additional evidence.

The experience of certain of the

plaintiffs with commodities accounts,

for which pre-dispute arbitration

agreements are subject to special

disclosure rules and may not be made a

condition of doing business, indicates

that a significant number of commodity

accounts customers decline to enter into

such agreements. In the experience of

-108a-

plaintiff Shearson Lehman Hutton, 34

percent fewer commodities customers

execute pre-dispute arbitration

agreements than do securities

customers. Affidavit of Theodore A.

Krebsbach § 9. A random survey by

plaintiff PaineWebber found that 58

percent of commodities account customers

refuse arbitration under the

non-mandatory scheme. Affidavit of John

A. Borgese q 3.

To the degree that the Massachusetts

securities arbitration regulations are

modelled on the CFTC arbitration

regulation, 17 C.F.R. pt. 180, +

17/ It should be noted that the CFTC

regulations are significantly more

precise than the Massachusetts rules.

The required disclosure is set forth in

the CFTC regulations expressly. 17

C.F.R. § 180.3(b) (4)-(6). And rather

than requiring negotiability, the CFTC

regulations do not permit a pre-dispute

arbitration agreement to be a condition

of opening a commodities account. 17

C.F.R. § 180.3(b) (1).

-109a-

the affidavits submitted in support of a

preliminary injunction demonstrate that

the special Massachusetts securities

arbitration contract rules will have a

limiting effect on the formation of

arbitration agreements.

B. Harm to Plaintiffs

The harm to the plaintiffs is

irreparable if enforcement of the

regulation is not enjoined. The

patterns and practices of contract

formation regarding securities

arbitration will, or course, need costly

revision during the pendency of the

litigation in the absence of an

injunction. More significantly, the

evidence demonstrates that the costs of

dispute resolution itself will increase

~1Live~

in direct proportion to the number of

claims in which arbitration is

rejected. These are costs which cannot

be recovered from the defendant state

officials. Cf. National Tank Truck

Carriers c. v. Burke, 608 F.2d 819,

824 (lst Cir. 1979).

Moreover, they are substantial

costs. A report prepared by Deloitte

Haskins & Sells for the New York Stock

Exchange indicates that on average the

legal costs to brokerage firms from

arbitration are $12,000 less than the

legal costs for litigation in court.

Affidavit of Paul J. Dubow 9 ll. In the

aggregate, while the extent of the

plaintiffs’ monetary loss is difficult

if not impossible to calculate with any

precision, it appears reasonable to

assume that imposition of the

-1113a-

Massachusetts securities arbitration

regulations will add between one-quarter

to one-half million dollars annually to

the legal fees of certain of the

plaintiffs.

C. Harm to Defendants

The harm to the defendants if their

regulations are suspended before this

litigation reaches conclusion is modest

and highly speculative at best. The

defendants are in the peculiar posture

of defending a set of regulations the

effect of which they contend (by their

Fed. R. Civ. P. 56(f) submissions) they

are not now in a position to describe by

admissible evidence. If additional

evidence is necessary to demonstrate the

interference of these regulations with

-ll2a-

the Federal Arbitration Act - - a

proposition I do not accept but which

the defendants forward - - then a

further period of time during which the

impact of the singular Massachusetts

securities arbitration regulations is

studied and analyzed through discovery

and full trial would cause little harm.

That is the general approach taken by

the Securities and Exchange Commission,

see supra note 3, the federal agency the

Courts recognize as having virtual

plenary power to govern the arbitration

contracts of brokers, see Cohen v.

Wedbush, Noble, Cooke, Inc. 841 F.2d at

286.

The reasons adduced by the

plaintiffs for special securities

arbitration rules do not demonstrate

that there will be any significant harm

if the rules are held in suspension

pending a definitive determination of

the merits of this case. The suggestion

that litigation over the

unconscionability of mandatory

pre-dispute arbitration agreements will

be reduced is hardly persuasive. The

law that such agreements are not

unconscionable per se is so consistent

that a contention that they are should

not require any court to linger long

over the issue in any event.

To be sure, disclosure as a general

proposition is difficult to fault.

Certainly, full and fair disclosure is

the zeitgeist of securities regulation.

’ A case can be made that the fuller the

disclosure the better. But the

defendants have not undertaken to

describe with particularly what precise

-114a-

disclosure is necessary. Unlike the

CFTC disclosure requirements, see supra

note 17, the Massachusetts securities

arbitration regulations give no

direction about what full disclosure of

the "legal effects" of pre-dispute

arbitration agreements will entail. The

disclosure concerns of the defendants

have not been crystallized. In the

unformed state in which they are

presented by the Massachusetts

securities arbitiation regulations,

these generalized concerns for

disclosure do not lend immediacy to the

speculative claim of harm to the

defendants if interim injunctive relief

is granted.

The defendants’ interest in

"negotiability" is no more compelling as

a basis for finding injunctive harn.

The defendants speak broadly of

unidentified benefits and inducements

that brokers will be encouraged to offer

to secure pre-dispute arbitration

agreements with customers. To the

degree these benefits and inducements

are specified, however, they seem to

center around commission rates. This

potential impact on commission rates

involves a secondary effect of the

Massachusetts securities arbitration

regulations which, far from suggesting

harm to the defendants, raises troubling

questions about the anticipated

regulatory scope of defendants’

treatment of arbitration by brokers and

their customers.

The defendant Guthary, while

professing to believe that the effect of

his regulations on the plaintiffs’

-l1l16a-

business as evidenced in plaintiffs’

affidavits is "speculative, without

substantive factual support," offers his

own "opinion [that] it would be

practical for brokers to adopt a

two-tiered commission scheme" to

compensate for the cost differential

between arbitrable customer accounts and

those which are not. Third Affidavit of

Barry C. Guthary 44 2, 5. This

reference to the influence the

Massachusetts securities arbitration

regulations will have on commission rate

structure suggests insinuation by local

Blue Sky authorities ifito brokerage

commission rate making, an area in which

the SEC exercises full authority. See

generally 17 C.F.R. § 240.19b-3;

Adoption of Securities Exchange Act Rule

19b-3, Exchange Act Release No. 11,203,

“i 78-

[1974-75 Transfer Binder] Fed. Sec. L.

Rep. (CCH) ¢ 80,067, at 84,955-57 (Jan.

23, 1975).

Moreover, it is by no means clear

that such a two-tiered rate structure

will be of economic benefit to

customers. To the degree that

arbitration consitutes a more economical

form of dispute resolution, it may be

anticipated that regulations which

discourage arbitration will have the

effect of raising commission rates - -

at least on non-arbitration contracts -

- to absorb the costs. +8/ Et is

18/ Of course, to the degree that

individual brokerage firms perceive a

demand for non-arbitration customer

agreements, it may also be assumed that

such agreements will be offered--and

priced accordingly--by some brokers

irrespective of whether state

regulations encourage such agreements or

not.

-118a-

difficult to conceive what harm there

will be to defendants if an interim

injunction prevents (at least until

completion of this litigation)

institution of the "two-tier commission

scheme" contemplated by defendants.

D. Public Interest

With respect to the question of the

public interest, the Congress and the

Supreme Court have offered the

definitive word. In enforcing the

"emphatic federal policy in favor of

arbitral dispute resolution" implemented

by the Federal Arbitration Act,

Mitsubishi Motors Corp. v. Soler

Chrysler- oeem. Ine., 473 U.S. at

631, the Supreme Court described the

benefits of arbitration favorably in the

@-239a-~

antitrust context:

[A]daptablility and access to

expertise are hallmarks of

arbitration. The anticipated

subject matter of the dispute may be

taken into account when the

arbitrators are appointed, and

arbitral rules typically provide for

the participation of experts either

employed by the parties or appointed

by the tribunal. Moreover, it is

often a judgment that streamlined

proceedings and expeditious results

will best serve their needs that

causes parties to agree to arbitrate

their disputes; it is typically a

desire to keep the effort and

expense required to resolve a

dispute within manageable bounds

that prompts them mutually to forgo

access to judicial remedies.

at 633 (footnote omitted.)

This is a form of dispute resolution

Congress intended to facilitate in the

securities context as well, where the

Supreme Court has recently held that

"agreements to arbitrate Exchange Act

Claims [are] ’enforcefable] ... in

-120a-

accord with the explicit provisions of

the Arbitration Act’." McMahon, 107

S.Ct at 2343 (quoting Scherk v.

Alberto-Culver Co., 417 U.S at 520).

The evidence adduced in plaintiffs’

affidavits in support of a preliminary

injunction tends to show that

arbitration is a benefit both to public

customers and to brokers like

plaintiffs. Customer legal expenses are

likely to mirror broker legal expenses;

the finding of the Deloitte Haskins &

Sells study that broker-dealer legal

expenses are significantly less in

arbitration than in court Stink ted may

accordingly also be interpreted as

predicting relative economic benefit

favoring arbitration for the customer.

-iZia~

The Deloitte study shows that

customers receive on average a

significantly higher percentage of their

original claims by pursuing their

disputes in arbitration (19.57 percent

of claim recovered) then in court

litigation (2.60 percent of claim

recovered). Affidavit of Paul J. Dubow

G 11. The plaintiff Dean Witter reports

an even more favorable recovery for

customer claimants who pursued

arbitration in cases completed in 1987;

for those Dean Witter claimants,

arbitration yielded 37 percent of total

compensatory damages sought, compared

with 17.02 percent of such damages for

those pursuing litigation. Id. 4 12.

In short, on the evidence before me

it appears that court litigation affords

customers the opportunity to pay more in

~122a-

legal costs to get less in recovery.

Moreover, this opportunity will

apparently be preserved only after

paying for brokerage services at the

higher level of the “two-tiered

commission scheme" the defendant Guthary

opines will be the likely industry

response to the Massachusetts securities

arbitration regulations.

Finally, it should be noted that

shifting securities disputes from

arbitration to court litigation will

bring these disputes to a federal court

system already overburdened by a heavy

caseload. It is a rare securities claim

which cannot be styled as a federal

question under § 10(b) of the Securities

Exchange Act of 1934, 15 U.S.C. §

78j}(b), 17 C.F.R. § 240.10b-5. Such a

case can be brought in the federal

-423a-

courts without regard to the amount in

controversy under 28 U.S.C. § 1337 and

15 U.S.C. § 78aa. It would be ironic -

- and hardly in furtherance of the

public interest in efficient federal

courts - - if such actions by

non-institutional customers were now to

come into federal court in greater

numbers at precisely the time that

Congress has moved to limit smaller

claims in federal court litigation by

raising to $50,000 the amount in

controversy minimum for diversity

action. Judicial Improvements and

Access to Justice Act, Pub. L. No.

190-702, § 201, 102 Stat. 4642 (1988)

(to be codified at 28 U.S.C. § 1332).

On the evidence before me, I find

Significant functional benefits to the

public generally, and to the structuring

-124a-

of efficient and economic dispute

resolution, if the likely limits on

securities dispute arbitration proposed

through the Massachusetts securities

arbitration regulations are deferred

pending conclusion of this case on the

merits.

E. Conclusion

Evaluating these four prongs to

preliminary injunction analysis inter

se, I conclude that given the

plaintiffs’ clear likelihocd of ultimate

success on the merits of their

preemption claim, the prospect of

substantial irreparable harm to the

plaintiffs if the injunction is not

granted--as balanced against the

potential for minimal harm to the

-125a-

defendants if the injunction is

granted--and the public interest on the

part of both customers as a class and

the public at large in furthering the

emphatic national policy in favor of the

efficiencies of arbitral dispute

resolution, an interim injunction

staying implementation of the

Massachusetts securities arbitration

regulations until conclusion of this

litigation would be appropriate.

VI

I fully recognize the importance of

permitting states to experiment with

reform in economic regulation. Federal

courts must be reticent about

interposing their powers to prevent such

experimentation. The principles were

-~126a-

stated with plain spoken eloquence by

Justice Brandeis:

To stay experimentation in things

social and economic is a grave

responsibility. Denial of the right

to experiment may be fraught with

serious consequences to the Nation.

It is one of the happy incidents of

the federal system that a single

courageous state may, if its

citizens choose, serve as a

laboratory; and try novel social and

economic experiments without risk to

the rest of the country.

New State Ice Co. v. Liebmann, 285 U.S.

262, 311 (1932) (Brandeis, J.,

dissenting).

This reticence has been given

expression by the First Circuit in the

preemption context. The court has noted

that the federal courts have an

obligation to control preemption

doctrine for two basic reasons rooted in

principles of federalism and separation

-127a-

of powers fundamental to our system of

government. First, "diffusion of power

to the states is said to further

democracy," and second, "a finding of no

preemption is regarded as preferable

because Congress can overrule it by

appropriate legislation, while a finding

of preemption_cannot be changed by the

states." Agency Rent-A-Car, Inc. v.

Connolly, 686 F.2d 1029, 1038 (lst Cir.

1982).

The key, however, is Congress--and

here, the agency Congress has selected

for supervision of securities

arbitration: the United States

Securities and Exchange Commission.

Where Congress has been heard to have

spoken as emphatically as it has been

heard by the Supreme Court concerning

the broad preemptive intent of the

-128a-

Federal Arbitration Act in the area of

securities disputes, any modification of

that intent must come from Congress

itself. The courts cannot evade the

principles established by broadly

preemptive legislation in order to

permit state experimentation. Until

Congress establishes exceptions to the

Federal Arbitration Act permitting

states to adopt singular legal

principles for the formation and

execution of arbitration agreements,

state law provisions like the

Massachusetts securities arbitration

regulations cannot stand.

Finding that the Massachusetts

securities arbitration regulations

disturb too much the Congressionally

declared scheme of treating the

formation, validity, and enforceability

LE

of arbitration contracts in the same

manner as contracts generally, I

conclude that I must order the

Massachusetts securities arbitration

regulations displaced by the force of

preemption and allow the plaintiffs’

motion for summary judgment.

Accordingly, it is hereby ORDERED

that a judgment enter

1. declaring that the Massachusetts

securities arbitration regulations,

Mass. Reg. Code tit. 950, §

12:204(a) (2) (G)1.a.-c. are preempted by

the Federal Arbitration Act, 9 U.S.C.

§ 1 et seq.; and

2. enjoining the defendants from

enforcing the Massachusetts securities

arbitration regulations in any manner.

Douglas P. Woodlock

United States District Judge

-130a-

Deanna tel

APPENDIX D

UNITED STATES DISTRICT COURT

DISTRICT OF MASSACHUSETTS

|

|

CIVIL ACTION NO. 88-2153-WD

|

SECURITIES INDUSTRY ASSOCIATION,

et al.,

Plaintiffs,

Ve

MICHAEL J. CONNOLLY, Secretary of State,

et al.,

Defendants.

me ee ee ee ee ee ee ee”

JUDGMENT

December 19, 1988

In accordance with the Memorandum

and Order for Judgment issued this day,

-4131a-

it is hereby ORDERED, ADJUDGED and

DECREED

1. That the Massachusetts

securities arbitration regulations,

Mass. Reg. Code tit. 950,

§ 12:204(a) (2) (G)1.a.-c., are violative

of the Supremacy Clause of the

Constitution of the United States, art.

VI, cl. 2, in that they are preempted by

the Federal Arbitration Act, 9 U.S.C.

§ 1 et seg., and

2. That the defendants shall

refrain from enforcing the Massachusetts

securities arbitration regulations in

any manner.

Ls/

Douglas P. Woodlock

United States District Judge

-132a-