Amicus Curiae Brief — Connolly v. Securities Industry Ass'n

} Supreme Court, U.S.

/ H- Si HED

No. 89-894 MA @ BR

JOSEPH F- SPANIOL, JR.

CLERK

In the Supreme Court of the Unit tr

OCTOBER TERM, 1989

MICHAEL J. CONNOLLY, SECRETARY OF STATE

OF MASSACHUSETTS, ET AL., PETITIONERS

vs

SECURITIES INDUSTRY ASSOCIATION, ET AL.

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

BRIEF FOR THE UNITED STATES AS AMICUS CURIAE

KENNETH W. STARR

Solicitor General

STUART M. GERSON

Assistant Attorney General

JOHN G. ROBERTS, JR.

Deputy Solicitor General

MICHAEL P.. LAZERWITZ

Assistant to the Solicitor General

WILLIAM KANTER

IRA C. LUPU

Attorneys

Department of Justice

Washington, D.C. 20530

(202) 633-2217

RECT AVAILARIE CODY Ee

QUESTION PRESENTED

Whether Section 2 of the Federal Arbitration Act, 9

U.S.C. 2, which provides that an arbitration agreement

in “a contract evidencing a transaction involving com-

merce * * * shall be valid, irrevocable, and enforceable,

save upon such grounds as exist at law or in equity for

the revocation of any contract,” precludes the Common-

wealth of Massachusetts from adopting regulations con-

cerned exclusively with arbitration provisions in contracts

used to open securities brokerage accounts.

en

TABLE OF CONTENTS

Page

Statement ........ Peas 521 RRS Ne Bice. IR ORS CTL ERD 1

Discussion .......... Si ceiteatateaciestensndess cuales aiteueucnipinccstedocs aan 10

Conclusion _......... cL aM ae Nex EEA lhe EEF eS , 20

TABLE OF AUTHORITIES

Cases:

Collins Radio Co. v. Ex-Cell-O Corp., 467 F.2d 995

Ds Rete eA Nn IE Ica le Paseo R IDI 16

Cook Chocolate Co. Vv. Salomon, Inc., 684 F. Supp.

4377 (B.0.N.2. 1968) ......:..... 6, 17

Fidelity Fed. Sav. & Loan Ass’n V. De le Cuesde.

LE TB Be. Sankt ea ean ee eee 11

Medical Dev. Corp. Vv. Industrial Molding Corp.,

479 F.2d 345 (10th Cir. 1973) ................ 17

Moses H. Cone Memorial Hosp. v. Mercury Constr.

BO ee | BE | a ae

Perry V. Thomas, 482 U.S. 483 (1987) ..9, 10, 12, 13, 15, 17

Rodriguez de Quijas v. Shearson/American Ex-

press, Inc., 109 S. Ct. 1917 (1989) ........... 2

Saturn Distrib. Corp. v. Williams, 717 F. Supp.

1147 (E.D. Va. 1989), appeal pending, No. 89-

2773 (4th Cir.) 18

Scherk v. Alberto-Culver Co., 417 U.S. 506 (1974) _.1, 2, 13

Shearson/American Express Inc. Vv. McMahon, 482

U.S. 220 (1987) . 2,9, 15

Southland Corp. Vv. Keating, 465 U.S. 1 (1984) 2, 10,

12, 15

Supak & Sons Mfg. Co. v. Pervel Indus., Inc., 593

F.2d 135 (4th Cir. 1979) 17

Volt Information Sciences, Inc. V. Board of Trust-

ees, 109 S. Ct. 1248 (1989) 13, 14

Webb v. R. Rowland & Co., 800 F.2d 803 (8th Cir.

Sie oer 17

Wilko v. Swan, 346 U.S. 427 (1953) 2

Zapatha Vv. Dairy Mart, Inc., 381 Mass. 284, 408

N.E.2d 1370 (1980) =. ss 16

(111)

IV

Constitution, statutes, regulations, and rule: Page

U.S. Const. Art. VI, Cl. 2 (Supremacy Clause)... 11,12

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

§ 1,9 U.S.C. : LTO nn Meteo ORE Se fee oe aon 5

$2, 9US.C. 2 ...... NL SAY eI NOEL ID SEF IPE OO ALD. S passim

: EN Ss es en eee Z

§ 4,9 U.S.C. % SE NOLE aeRO N RSA Ea ERR EE 2

Securities Act of 1933, 15 U.S.C. 77a et seq.:

By iy te Be ee oo) > tc 2

RT Mb 2AM ORY y (See peso arel ere PRE 7

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

seq.:

52000). 1605.0. TEN(@) oe. 2

Re i a IN gaits son ces chnetcaeess 19

pO et Bae 8 oes TF) ee 7

Pe, WO eo RETEST ERROR Keepin der 19

7 U.S.C. 21 (b) (10) Be Diana wade awit te 19

15 U.S.C. 80b-18a 7

42 U.S.C. 1983 . Race ae 5

Tex. Rev. Civ. Stat. Ann. art. 224 (Vernon Supp.

EE eae hearer eee aay Pena 16

U.C.C. § 2-207 (1976) CE ee At een nbd ih Be Ol ta 3 ig |

Uniform Securities Act, Mass. Gen. L. ch. 110A,

$$ 101 et seq. (1985 & Supp. 1990) _......... - 3, 4

BU ae etaceesas sy kare aes 3

§ 204 ... ERS SO ee 6

§ 204(a) (G) ew ; Re

$ 406(0) 3

§ 410(f) _... ; : fa 4,6

§ 412 ae hs os Pres 4

Va. Code Ann. § 46.1-550.5: 7(10) (1988) = 18

17 C.F.R.:

Section 180.3... Vist caeneucabenaedaceme aioe 19

Section 180.3 (b) (1) 000-000... 19

Section 180.3 (b) (6) ; x= 19

Mass. Reg. No. 593 (Oct. 14, 1988) . 3

Mass. Regs. Code tit. 950 (1988) :

§ 12.204(G) (1)

S$ 12.204(G) (1) (a) -......

y

Regulations and rule—Continued: Page

S$ 12.204(G) (1) (b) 4

S$ 12.204(G) (1) (c) Se aeceeee 4

Fed. R. Civ. P. 56(f) Whe Bein ihe 2 8

Miscellaneous:

H.R. Rep. No. 96, 68th Cong., Ist Sess. (1924)... 1,13

Self-Regulatory Organizations, Order Approving

Proposed Rule Changes by the New York Stock

Eechange, Tne., National Association of Securi-

ties Dealers, Inc., and the American Stock Ev-

change, Inc. Relating to the Arbitration Process

and the Use of Predispute Arbitration Clauses,

o4 Fed. Reg. 21,114 (1989) 000000. 19

Iu the Suprenw Court of the United States

OCTOBER TERM, 1989

No. 89-894

MICHAEL J. CONNOLLY, SECRETARY OF STATE

OF MASSACHUSETTS, ET AL., PETITIONERS

Vv.

SECURITIES INDUSTRY ASSOCIATION, ET AL.

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT

BRIEF FOR THE UNITED STATES AS AMICUS CURIAE

This brief is submitted in response to the Court’s order

inviting the Solicitor General to express the views of the

United States.

STATEMENT

1. Congress enacted the Federal Arbitration Act, 9

U.S.C. 1 et seq., in order to “revers|e] centuries of judi-

cial hostility to arbitration agreements” and to “place

arbitration agreements ‘upon the same footing as other

contracts.’ ”” Scherl: v. Alberto-Culver Co., 417 U.S. 506,

910-511 (1974) (quoting H.R. Rep. No. 96, 68th Cong.,

Ist Sess. 1, 1 (19241). In order to accomplish that over-

arching purpose, the Act provides in Section 2 that arbi-

tration agreements ‘shall be valid, irrevocable, and en-

forceable, save upon such grounds as exist at law or in

equity for the revocation of any contract.” 9 U.S.C. 2.

“In enacting $2 of the federal Act,” this Court has ob-

served, “Congress declared a national policy favoring ar-

bitration and withdrew the power of the states to require

(1)

2

a judicial forum for the resolution of claims which the

contracting parties agreed to resolve by arbitration.”

Southland Corp. v. Keating, 465 U.S. 1, 10 (1984). In

other words, “Congress intended to foreclose state legisla-

tive attempts to undercut the enforceability of arbitration

agreements.” /d. at 16 (footnote omitted).

In order to promote the “federal policy favoring arbi-

tration,” Moses H. Cone Memorial Hosp. v. Mercury

Constr. Corp., 460 U.S. 1, 24 (1983), the Federal Arbi-

tration Act also provides that a court must stay its pro-

ceedings if it is satisfied that an issue before it is subject

to an arbitration agreement under the Act, 9 U.S.C. 3.

Moreover, the Act authorizes a federal district court to

issue an order compelling arbitration if there has been

a “failure, neglect, or refusal” to comply with such an

agreement, 9 U.S.C. 4. See Shearson American Express

Inc. V. McMahon, 482 U.S. 220, 226 (1987).

2. In Shearson American Express Ine. v. McMahon,

supra, this Court held that agreements to arbitrate claims

against brokerage firms under Section 10(b) of the Secu-

rities Exchange Act of 1934, 15 U.S.C. 78j(bi, were

“enforce|able] ... in accord with the explicit provisions

of the Arbitration Act,’”’ 482 U.S. at 238 (quoting Scherk

Vv. Alberto-Culver Co., 417 U.S. at 520).' In that deci-

sion’s wake, the Secretary of State of the Commonwealth

of Massachusetts took steps to regulate securities broker-

1 Before Shearson American Evpress Ine. vy. McMahon, supra, it

was unclear whether agreements to arbitrate claims under either the

Securities Exchange Act of 1934 or the Securities Act of 1933 were

enforceable in light of Wilko v. Swan, 346 U.S. 427 (1952). See

Shearson American Express Inc. Vv. McMahon, 482 U.S. at 225 nl.

In Wilko v. Swan, supra, the Court had held that a pre-dispute

agreement could not be enforced to compel arbitration of a claim

arising under Section 12(2) of the Securities Act of 1923. 15 U.S.C.

T7(2).

The McMahon decision called into question the continued vitality

of Wilko v. Swan. In Rodriguez de Quijas v. Shearson’ American

Express, Inc., 109 S. Ct. 1917, 1922 (1989), the Court overruled

Wilko v. Swan, holding that pre-dispute agreements to arbitrate

claims against brokerage firms under the Securities Act of 1923 are

enforceable under the Federal Arbitration Act.

3

dealers’ use of pre-dispute arbitration provisions in con-

tracts opening brokerage accounts.” Under Massachusetts

law, broker-dealers must be registered with the Common-

wealth in order to transact securities business. Mass.

Gen. L. ch. 110A, § 201 (1985). The Secretary may

“deny, suspend, or revoke” that registration upon finding

that a broker-dealer “has engaged in dishonest or un-

ethical practices in the securities business.”” Mass. Gen.

L. ch. 110A, § 204/41) (1G) (1985).

On September 21, 1988, after public hearing and com-

ment, the Secretary amended the definition of proscribed

“dishonest or unethical practices in the securities busi-

ness” to take account of securities broker-dealers’ use of

pre-dispute arbitration provisions in contracts opening

brokerage accounts. The Secretary declared that the pur-

pose of the amended regulations was to “provide the cus-

tomer with a meaningful choice prior to making a deci-

sion to sign the |arbitration] agreement.” Mass. Reg.

No. 593 (Oct. 14, 1988).

The amended regulations prohibited broker-dealers

from engaging in the following practices as of January 1,

1989: (1) requiring customers (‘other than institutional

investors or financial institutions) to “execute either a

mandatory pre-dispute arbitration contract or a customer

agreement containing a mandatory predispute arbitra-

tion clause that is a non-negotiable precondition” to open-

ing or transacting business in a securities account, Mass.

Regs. Code tit. 950, $12.204(G@) (lita) (1988); (2)

requesting any customer to enter into such pre-dispute

arbitration contracts or agreements without first ‘‘con-

spicuously disclos!ing| that the execution of the contract

or agreement cannot be made a non-negotiable precondi-

tion” to opening or transacting business in a securities

?-Under Massachusetts law, the Commonwealth's Secretary of

State regulates securities matters under the Uniform Securities Act,

Mass. Gen. L. ch. 110A, S$ 101 ef seq. (1985 & Supp. 1990). See

Mass. Gen. L. ch. LOA, § 40604 1985). The Secretary has dele-

gated his reculatory authority to the Director of the Massachusetts

Securities Division. See Pet. App. 6a, 6la-62a.

4

account, Mass. Regs. Code tit. 950, $ 12.204(G) (1) (b)

(1988); and (3) requesting any customer to enter into

such pre-dispute arbitration contracts or agreements

“without fully disclosing to the customer in writing the

legal effect of the pre-dispute arbitration contract or

clause,” Mass. Regs. Code tit. 950, $ 12.204(G@) (1) (¢)

(1988).

The amended regulations declared that those prohibited

practices “constitute dishonest or unethical practices

which are grounds for denial, suspension or revocation of

registration or such other action authorized by law.”

Mass. Regs. Code tit. 950, § 12.204(G) (1) (1988); see

Mass. Gen. L. ch. 110A, $ 204(a)(G) (1985). In addi-

tion, Massachusetts law provides that

[n]o person who has made or engaged in the per-

formance of any contract in violation of any provi-

sion of {the Uniform Securities Act, Mass. Gen. L.

ch. 110A, $$ 101 et seg. (1985 & Supp. 1990) ] 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 mak-

ing or performance was in violation, may base any

suit on the contract.

Mass. Gen. L. ch. 110A, § 410(f) (1985).

3. On September 22, 1988, respondents, Securities In-

dustry Association, the trade association for securities

dealers, and ten brokerage firms registered to sell securi-

ties in Massachusetts, filed an action in the United States

District Court for the District of Massachusetts against

petitioners, the Commonwealth’s Secretary of State and

the Director of the Massachusetts Securities Division.

Respondents challenged the validity of petitioners’ arbi-

tration regulations, alleging that Section 2 of the Fed-

eral Arbitration Act, 9 U.S.C. 2, which provides that an

arbitration agreement ‘shall be valid, irrevocable, and

enforceable, save upon such grounds as exist at law or

* The Secretary promulgated these regulations under his generai

rulemaking authority. Mass. Gen. L. ch. 110A, §$ 412 (1985). That

state law authority was not challenged in this case.

ee w

5)

in equity for the revocation of any contract,” preempts

those regulations targeted only at pre-dispute arbitration

provisions. Respondents sought declaratory and injunc-

tive relief. Pet. App. 56a-58a.'

4. On cross-motions for summary judgment, the dis-

trict court, on December 19, 1988, declared “the Massa-

chusetts securities arbitration regulations * * * violative

of the Supremacy Clause * * *, in that they are preempted

by the Federal Arbitration Act,” Pet. App. 132a, and

enjoined petitioners “from enforcing [those] regulations

in any manner,” ibid.

a. The district court found that “[m]andatory written

pre-dispute arbitration agreements in some form are used

by all [respondents], Pet. App. 67a, that “these pre-

dispute agreements do not purport to advise customers of

the ‘legal effects’ of the arbitration clauses,” ibid., and

that respondents “are unanimous in asserting a desire to

require certain customers to agree to arbitrate disputes

as a condition to opening an account,” id. at 69a.° The

41It was not disputed that the brokerage contracts containing

arbitration agreements used by respondent brokerage firms are

“contract|s] evidencing a transaction involving commerce” under

Section 2 of the Federal Arbitration Act, 9 U.S.C. 2. See 9 U.S.C.

1; Pet. App. 4a, 67a n.6.

Respondents also claimed that the Commonwealth’s amended reg-

ulations constituted unlawful state action in violation of 42 U.S.C.

1983. See Compl. § 42, Securities Industry Ass’n Vv. Connolly, Civ.

No. 88-2153-WD (D. Mass. filed Sept. 22, 1988). Neither the dis-

trict court nor the court of appeals addressed that claim separately

and thus it is not presented here.

5 The district court noted that each respondent brokerage firm

uses “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.”

Pet. App. 68a. The court also found that six of respondent brokerage

firms “do not use arbitration accounts in standard cash accounts for

individuals, although one |of those firms,| Donaldson Lufkin &

Jenrette Securities Corporation, does have an arbitration agreement

for corporate customers.” Jbid. And citing a recent study by the

Division of Market Regulation of the Securities and Exchange Com-

mission, the court observed that respondents’ “present practice

[with respect to pre-dispute arbitration agreements] appears to be

6

court also found that “any broker who wishes to do busi-

ness in Massachusetts must observe the securities arbi-

tration contract regulations,” id. at 65a, since petitioners

had authority to revoke the registration of any firm

which engaged in the proscribed “dishonest or unethical

practices,” ibid. ‘citing Mass. Gen. L. ch. 110A, § 204

(1985) ). Moreover, the court found that

if a broker—or for that matter a customer—were to

attempt to enforce a contract formed without com-

pliance with the Massachusetts securities arbitration

regulations, that attempt would be unavailing.

Pet. App. 66a (citing Mass. Gen. L. ch. 110A, § 410(f)

(1985); see p. 4, supra). Accordingly, the court deter-

mined that those regulations “will have an immediate

effect on the contracts used by broker-dealers transacting

business with customers located in Massachusetts * * * by

establishing additional disclosure requirements [and]

prevent/ing] broker-dealers from implementing the ap-

parently universal practice of requiring at least certain

customers to enter into arbitration agreements for their

disputes.” Pet. App. 66a, 70a.

b. Turning to respondents’ preemption claim under the

Federal Arbitration Act, the district court “focus[sed]

on whether the state regulations single out arbitration

agreements for special treatment.” Pet. App. 76a (in-

ternal quotation marks omitted). The court noted that

“the fundamental purpose of the Federal Arbitration Act

was to place an arbitration agreement upon the same

footing as other contracts, where it belongs,” id. at 76a-

77a ‘internal quotation marks omitted), and that that

congressional mandate was “expressly embodied in | Sec-

tion 2 of the Act],” id. at 78a. Accordingly, Section 2 of

the Act “preempts state statutory and case law that

treats arbitration agreements differently from any other

contract.” Ibid. (quoting Cook Chocolate Co. v. Salomon,

Inc., 684 F. Supp. 1177, 1182 (S.D.N.Y. 1988) ).

fairly representative of the brokerage business generally.” Jd. at

69a n.7.

i

Petitioners conceded that the challenged regulations

“single out arbitration agreements,” Pet. App. 79a, but

sought to avoid preemption on the ground that those

regulations furthered another purpose of the Federal

Arbitration Act—‘the concern to implement voluntary

agreements to arbitrate,” id. at 80a. The district court

rejected that contention as a “semantic sleight of hand.”

Id. at 8la. As the court explained:

[T]he concept of voluntariness addresses the funda-

mental 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 to idiosyneratic rules or definitions. [Peti-

tioners are] 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.

That, of course, is precisely what [petitioners’ |

purported voluntariness enhancements do.

Id. at 8la-84a (footnote omitted).° The court therefore

held that “‘{b]ecause the voluntariness concerns expressed

in [the challenged regulations] impose conditions on the

formation ‘and execution of arbitration agreements which

are not part of the generally applicable contract law of

Massachusetts, [those regulations] cannot be given effect

under the Federal Arbitration Act.” Jd. at 89a.

® The district court noted that “[t]here 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.” Pet.

App. 84a. The court also found that Massachusetts law does not

impose ‘‘any general restriction requiring specific provisions to be

‘negotiable.’ ’”’ Jd. at 85a.

7 Petitioners also contended that “savings clauses” in federal

securities statutes (15 U.S.C. 77r; 15 U.S.C. 7&bb(a); 15 U.S.C.

80b-18a), which provide for complementary state regulation in the

securities markets, show Congress’s intention to permit otherwise

complementary state regulation of securities arbitration provisions.

The district court rejected that argument, Pet. App. 97a-98a, as did

8

ec. Finally, the district court concluded that if its entry

of summary judgment were vacated as premature, re-

spondents were nevertheless entitled to preliminary in-

junctive relief. Pet. App. 106a-126a.°

5. On August 31, 1989, the court of appeals unani-

mously affirmed. Pet. App. la-52a. The court acknowl-

edged that “a state law or regulation cannot take root if

it looms as an obstacle to achievement of the full pur-

poses and ends which Congress has itself set out to ac-

complish.” Jd. at 12a (citing cases). After reviewing

this Court’s recent decisions construing the Federal Arbi-

tration Act, the court of appeals noted that “their com-

mon denominator is a principle of rigorous equality un-

der 9 U.S.C. $2.” Jd. at 20a. Accordingly, by virtue of

Section 2 of the Federal Arbitration Act, “no state may

simply subject arbitration to individuated regulation in

the same manner as it might subject some other unpro-

tected contractual device (say, a prescriptive period or

exculpatory clause contained within a private contract).

Id. at 21a.

Petitioners conceded that the challenged regulations

apply only to arbitration agreements, but claimed that

those regulations were a needed means of consumer pro-

tection and thus fell outside the proscription of Section 2

the court of appeals, 7d. at 30a-3la. Petitioners have abandoned

that argument in this Court.

* Petitioners had filed a motion under Fed. R. Civ. P. 56(f), re-

questing the district court to delay its decision pending further

discovery. The district court denied that motion. Pet. App. 99a-

106a. As the court explained:

The material consequences are plain here. ~ * * Massachu-

setts could not have been clearer in its intention—despite its

oblique means of execution—to make securities arbitration con-

tracts subject to different rules regarding validity and enforce-

ability from those that govern other contracts, It takes no fur-

ther factual development to reach that conclusion.

Id. at 103a-104a. Petitioners renewed that claim on appeal, but the

court of appeals declined to resolve it, concluding that “the Rule

56(f) motion is * * * beside the point.” Jd. at 48a n.10. Peti-

tioners have not sought further review of that aspect of the court

of appeals’ judgment.

9

of the Federal Arbitration Act. Pet. App. 23a-24a.° The

court of appeals dismissed that contention, explaining

that “[i]n creating a body of substantive law co| | vering

arbitration, Congress barred the states from making de

terminations about arbitration contracts that the states

remained free to make about, say, used car sales.” Jd.

at 24a (citing Perry v. Thomas, 482 U.S. 483, 492 n.9

(1987)). In other words, the Federal Arbitration Act

“prohibits a state from taking more stringent action ad-

dressed specifically, and limited, to arbitration contracts.”

Pet. App. 25a.""

The court of appeals acknowledged recent rules regard-

ing pre-dispute arbitration provisions adopted by the

Commodity Futures Trading Commission and the Securi-

ties and Exchange Commission that were similar to peti-

tioners’ regulations. Pet. App. 32a-33a; see pp. 18-19,

infra. But the court pointed out the “critical distinetion”’

that those provisions “are products of federal, not state,

authority.” Jd. at 33a ‘citing Shearson American Ex-

press Inc. V. McMahon, 482 U.S. at 226). The court

therefore concluded that petitioners erred in relying on

those federal regulatory efforts, since “Congress has not

* The court of appeals noted that neither petitioners nor respond-

ents “suggested * * that any of the provisions [of the regula-

tions] might be severable.” Pet. App. 3a-4a. Accordingly, the court

“treatied| them as a unit for purposes of * * preemption analy-

sis.” Jd, at 4a. Petitioners have maintained the same position in

this Court.

‘* The court of appeals pointed out that petitioners were not

powerless to remedy ‘fa perceived problem” with respect to securi-

ties arbitration agreements. Pet. App. 25a. To the contrary, peti-

tioners’ “powers remain great, so long as used evenhandedly.” Jbid.

The court of appeals referred (id. at 26a) to Perry v. Thomas, 482

U.S. 483 (1987), where the Court determined that “‘state law * *

is applicable 7f that law arose to govern issues concerning the

validity, revocability, and enforceability of contracts generally,”

id. at 493 n.9 (emphasis in original). Moreover, the court suggested

that petitioners could “pass leyislation declaring all contracts of

adhesion presumptively unenforceable. * * Such a rule would

apply to arbitration contracts, amony others.” Pet. App. 26a-27a

(emphasis in original).

10

structured a similar arbitration exception for securities

in general and certainly not for state regulation of secu-

rities in particular.” Pet. App. 33a.

Lastly, the court of appeals rejected petitioners’ argu-

ment that. since broker-dealers remained free to use pre-

dispute arbitration agreements (and those agreements

would be enforceable under state law), so long as broker-

dealers complied with the arbitration regulations, those

regulations did not contravene the Federal Arbitration

Act. The court of appeals found that the regulations,

by requiring what is not generally required to enter

contracts in the Commonwealth, e.g., certain nego-

tiations, 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).

Pet. App. 38a." As the Court stated in Perry v. Thomas,

482 U.S. at 493 n.9, “[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.” The court of appeals therefore

heeded Congress’s direction in Section 2 to “foreclose

state legislative attempts to undercut the enforceability

of arbitration agreements.” Pet. App. 41a ‘quoting

Southland Corp. v. Keating, 465 U.S. at 16). Moreover,

the court concluded that a firm’s “worry that requiring

a {pre-dispute arbitration agreement] might forfeit [its]

ability to function as a broker-dealer at all is [also] an

obstacle” to fulfilling “the federal policy to ‘favor|] ar-

bitration agreements.’” Pet. App. 43a (quoting Moses

H. Cone Memorial Hosp. v. Mercury Constr. Corp., 460

U.S. 1, 24 (1983) ).

DISCUSSION

This case involves the legal question whether Section

2 of the Federal Arbitration Act, 9 U.S.C. 2, precludes

11 Despite that express finding, in another portion of its opinion

the court of appeals noted, but ‘“express[ed] no opinion” on, Pet.

App. 37a, the district court’s finding that an arbitration agreement

made in violation of the regulations would be unenforceable under

state law. See id. at 66a; p. 6, supra.

ETE EE EE EEO

11

state regulation of securities arbitration agreements to

the extent those regulatory efforts subject such agree-

ments to treatment not generally accorded other similar

contractual provisions under applicable state law.? Al-

though it has not squarely decided that issue, the Court

has consistently drawn the distinction between imper-

missible state arbitration regulations that single out and

subject arbitration provisions to a different enforcement

regime under state law, and permissible state regulations

of general application that necessarily encompass arbi-

tration provisions in contracts. The Federal Arbitration

Act bars the former regulatory efforts precisely because

such state action violates the anti-discrimination princi-

ple embodied in Section 2 of the Act.

Here, the court of appeals applied the distinction drawn

by this Court to hold that Section 2 preempts petitioners’

securities arbitration regulations, where petitioners con-

ceded ‘see, e.g., Pet. App. 23a-24a, 79a) that such regu-

lations subjected arbitration provisions to special treat-

ment under state law. That decision is consistent with

the Court’s case law construing the Federal Arbitration

Act and does not conflict with any other court of appeals’

decision. In light of these factors, and in the absence of

any indication that the decision will effectively undermine

state and federal regulatory efforts to police securities

arbitration provisions, we believe that further review is

unwarranted.

A. 1. Under the Supremacy Clause, U.S. Const. Art.

VI, Cl. 2, Congress may preempt state law in several

ways. See, e.g., Fidelity Fed. Sav. & Loan Ass’n v. De

la Cuesta, 458 U.S. 141, 152-153 (1982). Preemption

cases often present difficult questions concerning congres-

sional intent and whether state law intrudes on a field

'* Petitioners discuss at length the asserted laudable policies

underlying their securities arbitration regulations and point out

that federal regulatory authorities appear to share that vis wpoint.

See, e.g., Pet. 13-32, 38-40, 48-49. This case, however, raises the

legal issue of whether the Federal Arbitration Act precludes peti-

tioners’ regulations, not whether those regulations are based on

sound public policy. See pp. 18-19, infra.

12

occupied by Congress, inhibits accomplishment of federal

purposes, or actually conflicts with federal law. This case

does not. Here, Congress has provided that arbitration

agreements “shall be valid, irrevocable, and enforceable,

save upon such grounds as exist at law or in equity for

the revocation of any contract.” 9 U.S.C. 2. The state

regulations at issue purport to prohibit the formation of

arbitration agreements on grounds that are applicable

only to such agreements, not to ‘‘any contract.” While.

the parties and lower courts have viewed the issue pre-

sented as one of preemption—and while that does provide

a useful analytic framework—the case may be more

starkly viewed as one in which the state regulations sim-

ply violate federal law. In this case it is not so much that

the state has attempted to regulate a subject matter in a

way that intrudes upon or conflicts with federal regula-

tion of the same matter; rather, the state has attempted

to do precisely that which federal law says it may not do

—treat arbitration agreements differently than other con-

tracts. This is thus a preemption case, but only in the

sense that every Supremacy Clause case is a preemption

case.

Section 2 of the Federal Arbitration Act ‘embodies a

clear federal policy of requiring arbitration unless the

agreement to arbitrate is not part of a contract evidenc-

ing interstate commerce or is revocable ‘upon such

grounds as exist at law or in equity for the revocation

of any contract.’” Perry v. Thomas, 482 U.S. at 489

‘quoting 9 U.S.C. 2). “In enacting $2 of the federal

Act,” the Court has observed, “Congress declared a na-

tional policy favoring arbitration and withdrew the power

of the states to require a judicial forum for the resolu-

tion of claims which the contracting parties agreed to

resolve by arbitration.” Southland Corp. v. Keating, 465

U.S. at 10. “Congress intended to foreclose state legis-

lative attempts to undercut the enforceability of arbitra-

tion agreements.” Jd. at 16. Moreover, the Court has

“see/n!| nothing in the Act indicating that the broad

principle of enforceability is subject te any additional

13

limitations under state law.” 7d. at 11; see Perry V.

Thomas, 482 U.S. at 489-490.

The anti-discrimination policy embodied in the succinct

language of Section 2 stems from the principal reason

Congress enacted the Federal Arbitration Act—to “re-

vers{e] centuries of judicial hostility to arbitration agree-

ments.”’ Scherk v. Alberto-Culver Co., 417 U.S. at 510.

As the House Report explained:

The need for the law arises from an anachronism

of our American law. Some centuries ago, because

of the jealously of the English courts for their own

jurisdiction, they refused to enforce specific agree-

ments to arbitrate upon the ground that the courts

were thereby ousted from their jurisdiction. This

jealousy survived for so lon{g] a period that the

principle became firmly embedded in the English

common law and was adopted with it by the Amer-

ican courts.

H.R. Rep. No. 96, supra, at 1-2. The Act therefore

“place{s] arbitration agreements ‘upon the same footing

as other contracts.’” Scherk v. Alberto-Culver Co., 417

U.S. at 511 ‘quoting H.R. Rep. No. 96, supra, at 1); see,

e.g., Volt Information Sciences, Inc. v. Board of Trustees,

109 S. Ct. 1248, 1253 (1989). In other words, the anti-

discrimination principle of Section 2 reflects Congress’s

considered judgment, given the historical antipathy of

courts and state legislatures to arbitration, that differ-

ential state law treatment of arbitration provisions would

undermine the “declared * * * national policy favoring

arbitration.” Southland Corp. v. Keating, 465 U.S. at 10.

2. Accordingly, in both South/and Corp. v. Keating,

465 U.S. at 16, and Perry v. Thomas, 482 U.S. at 491-

493, the Court held that Section 2 preempted state law

provisions which singled out certain arbitration agree-

ments as unenforceable. As the Court explained in Perry

V. Thomas:

(Sitate law, whether of legislative or judicial origin,

is applicable 7f that law arose to govern issues con-

cerning the validity, revocability, and enforceability

.

14

of contracts generally. A state-law principle that

takes its meaning precisely from the fact that a con-

tract to arbitrate is at issue does not comport with

| Section 2 and is preempted}.

482 U.S. at 493 n.9 ‘emphasis in original). If Section 2

were construed otherwise, the Court has recognized,

“states could wholly eviscerate congressional intent to

place arbitration agreements ‘upon the same footing as

other contracts,’ “ * simply by passing statutes [ex-

cepting certain arbitration agreements from the state

law of contract|.”’ Southland Corp. V. Keating, 465 U.S.

at 17 n.11.

B. 1. Despite the principles described above, petition-

ers contend (Pet. 32-49) that the court of appeals erred

in holding that the Federal Arbitration Act preempts

securities arbitration regulations “that simply require

disclosure and bargaining in the formation of arbit ‘ation

agreements in a regulated industry,” Pet. 35, where, as

here, “they do not limit the ability of parties to enter

into arbitration agreements, nor limit the enforcement

of arbitration agreements once entered,” Pet. 36. Peti-

tioners thus seek to distinguish this case from Perry and

Keating, and also take it outside the purview of the anti-

discrimination principle of Section 2 of the Federal Ar-

bitration Act, on the ground that the securities arbitra-

tion regulations do not foreclose broker-dealers from seek-

ing ‘and customers from agreeing to) mandatory and

enforceable pre-dispute arbitration agreements, so long

as the prerequisites of the state regulations are met.

None of this Court's decisions construing the Federal

Arbitration Act has specifically considered the distinc-

tion petitioners seek to draw.'* Nevertheless, the Court

'’ Petitioners err in relying (Pet. 41-42) on Volt Information

Sciences, Ine. v. Board of Trustees, supra, In Volt, the Court held

that the Federal Arbitration Act does not preempt application of a

state law arbitration provision where the parties agreed that their

arbitration agreement will be governed by that state law. As the

Court explained, “{wlhere, as here, the parties have agreed to

abide by state rules of arbitration, enforcing those rules according

to the terms of the agreement is fully consistent with the goals of

15

has consistently determined that Section 2 of the Act pre-

empts state law to the extent it singles out and subjects

arbitration—as opposed to other contractual—provisions

to a different enforcement regime under state law. See,

€.g., Perry Vv. Thomas, 482 U.S. at 491-493: Southland

Corp. Vv. Keating, 465 U.S. at 16. Indeed, the Court has

made plain that

[a]bsent a well-founded claim that an arbitration

agreement resulted from the sort of fraud or exces-

sive economic power that would provide grounds for

the revocation of any contract, * * * the Arbitration

Act provides no basis for disfavoring agreements to

arbitrate statutory claims by skewing the otherwise

hospitable inquiry into arbitrability.

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

at 226 ‘internal quotation marks omitted).

Here, the challenged securities arbitration regulations

plainly single out and subject arbitration provisions to

treatment not accorded other contractual provisions under

state law. Indeed, petitioners conceded as much. See, e.9.,

Pet. 23a-24a, 79a.'' And the record confirms that those

the [Federal Arbitration Act], even if the result is that arbitration

is stayed where the Act would otherwise permit it to go forward.”

109 S, Ct. at 1255. In Volt, the Court had no occasion to consider

the preemptive force of Section 2, since the California law incor-

porated by the parties’ choice-of-law provision did not purport to

render the arbitration agreement unenforceable under state law.

Here, by contrast, the record confirms that the challenged regula-

tions would render mandatory pre-dispute arbitration agreements

unenforceable under Massachusetts law, absent compliance with

those regulatory provisions. See Pet. App. 38a, 66a; pp. 6, 10,

supra.

4In passing, petitioners assert—-without citation to any state

law authority—that “the regulations apply conditions to the forma-

tion of securities arbitration agreements that are common to, if not

the rule of, Massachusetts consumer contracts generally and securi-

ties transactions in particular.” Pet. 46. That sort of vague and

unsupported assertion scarcely calls into question the documented

finding of the district court that “[t]here 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.” Pet.

17

Similarly, in Medical Dev. Corp. v. Industrial Molding

Corp., 479 F.2d 345, 348 (10th Cir. 1973), the court of

appeals rejected a contracting party’s request to hold

that an arbitration provision was not part of the con-

tract on the basis of California state law “rules appli-

eable to arbitration agreements.” The court concluded

that, under Section 2 of the Federal Arbitration Act,

“federal courts do not apply state statutes and decisions

which limit arbitration agreements with rules not ap-

plicable to other contracts.” Jbid.; see, e.g., Webb v.

R. Rowland & Co., 800 F.2d 803, 806-807 (8th Cir. 1986)

(court refuses to apply a Missouri law that requires all

arbitration provisions to be accompanied by a notice, in

ten point capital letters, that the contract contains such

a provision); Cook Chocolate Co. v. Salomon, Inc., 684

F. Supp. 1177, 1182 (S.D.N.Y. 1988) (citing Perry v.

Thomas, supra, court refuses to apply New York case

law that “applies the incorporation doctrine more strictly

to arbitration agreements than nonarbitration agreements

and requires a specific reference to arbitration within

the body of the principal agreement”).

Petitioners’ amici Br. 3-5) contend that the court of

appeals’ decision conflicts with Supak & Sons Mfq. Co. v.

Pervel Indus., Inc., 593 F.2d 135 (4th Cir. 1979). There,

the Fourth Circuit held that an arbitration provision in a

written confirmation materially altered the previous oral

contract between the parties and thus did not become

part of the contract under U.C.C. § 2-207 (1976). The

court of appeals specifically noted that Section 2-207 “is

* * * a general rule of contract formation” that applies

broadly to all terms that materially affect the parties’

expectations. 593 F.2d at 137. Here, by contrast, it is

undisputed that the securities arbitration regulations, by

definition, apply only to arbitration provisions. For that

reason, the decision below is consistent with Supak.

In any event, the Fourth Circuit in Supak suggested

that tne Federal Arbitration Act “would preempt a state

rule of contract formation which applied only to arbitra-

tion clauses and which placed an unreasonable burden on

the parties’ ability to commit themselves to arbitration.”

18

593 F.2d at 137." Of course, petitioners’ regulations,

which, among other things, effectively inhibit broker-

dealers from requiring customers to execute mandatory

pre-dispute arbitration agreements, impose precisely that

sort of impermissible burden. See, e.g., Pet. App. 48a.

Since there is no conflict among the courts of appeals on

the preemption issue presented, further review is not

warranted.

C. Finally, contrary to claims raised by petitioners

‘Pet, 13-32) and their amici (Br. 12-15), the court of

appeals’ decision wiil not effectively undermine state and

federal regulatory efforts to police securities arbitration

provisions. First, the decision will not effect federal reg-

ulation in this area. As petitioners point out (Pet. 17-

2). both the CFTC and the SEC—the federal agencies

responsible for regulating the commodities and securities

markets nationwide—have already taken steps to promote

Petitioners contend (Pet. 30-31) that the court of a

ontlicts with Saturn Distrib. Corp. v. Williams, 71

ppeals’ de-

ision 7 F. Supp.

1147 (E.D. Va. 1989), appeal pending, No. 89-2773 (4th Cir.)

d Dec. 6. 1989). In that case, the district court held that the

Federal Arbitration Act did not preempt a Virginia law which

ed automobile manufacturers from requiring franchise

‘on arbitration clauses as a condition of dealership

acreements. Va. Code Ann. § 46.1-550.5:27(10) (1988). The court

concluded that “{b]y ensuring consensual rather than forced arbi-

l the Virginia statute is entirely in harmony with the Fed-

ral Arbitration Act.’ 717 F. Supp. at 1151. The court also dis-

lished the district court’s decision here on the ground that

the Virginia statute ‘does not single out arbitration agreements

for special treatment, but rather forms an unexceptional part of the

] ] + ° J + id ]

Virginia applicable to the formation of contracts. Id. at

1152

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19

the efficient and fair use of arbitration provisions. Un-

der its statutory authority to regulate dispute resolution

between commodities brokers and customers, see 7 U.S.C.

7ai5), 21(b)(10), the CFTC has adopted regulations

concerning the use of pre-dispute arbitration provisions.

See 17 C.F.R. 180.3. Those regulations, among other

things, forbid brokers from making a customer’s execut-

ing a pre-dispute arbitration provision a condition for

transacting business, see 17 C.F.R. 180.3(b) (1), and re-

quire brokers to disclose, in large bold-face type, the

customer’s rights and legal effect of an arbitration pro-

vision, 17 C.F.R. 180.3(b) (6).

Similarly, the SEC, under its statutory authority to

regulate self-regulatory organizations in the securities

industry, see 15 U.S.C. 7&sib), has recently approved

self-regulatory organization rules requiring brokers to

disclose and highlight the effects of signing an arbitration

clause. Those rules, among other things, also prohibit

brokers from using an arbitration clause to limit the re-

lief available in arbitration. See Se/f-Reqgulatory Orga-

nizations, Order Approving Proposed Rule Changes hy

the New York Stock Exchange, Inc., National Associa-

tion of Securitie Ss De ale rs, Tne., and t lie American Sto I:

Baechange, Inc. Relating to the Arbitration Proc (1)

the Use of Predispute Arbitration Clauses, 54 Fed. Reg.

21,144 (1989).

Second, as the court of appeals pointed out, petitioners

are not powerless to remedy “a perceived problem” wit!

respect to securities arbitration agreements. Pet. \pp

25a. To the contrary, petitioners’ “powers remain ere

so long as used evenhandedly.”’ Ibid. Absent controlling

federal law, the state legislature presu DIV could ac-

20

tions by enacting a state law providing, for example, that

forum selection clauses in all consumer contracts must be

the subject of negotiation and full disclosure. See also

Pet. App. 26a-27a. In other words, application of the

anti-discrimination principle of Section 2 of the Federal

Arbitration Act is by no means tantamount to outlawing

state regulation of arbitration provisions. Federal law

simply guarantees that arbitration agreements not be

singled out for special treatment. That is precisely what

Massachusetts attempted to do here.

CONCLUSION

The petition for a writ of certiorari should be denied.

Respectfully submitted.

KENNETH W. STARR

Solicitor General

STUART M. GERSON

Assistant Attorney General

JOHN G. ROBERTS, JR.

Deputy Solicitor General

MICHAEL R. LAZERWITZ

Assistant to the Solicitor General

WILLIAM KANTER

IRA C, LUPU

Attorneys

May 1990

w U. S&S GOVERNMENT PAINTING OFFICE 1990 262203 ava