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

Supreme Court, U.S,

; FIL ED

/ JAM 2

No. 89-894 JOSEPH F. SPANIOL, JR,

wee

IN THE

| Supnzax Counvestxx Uxivxe Scares

‘ OCTOBER TERM, 1989

MICHAEL J. CONNOLLY,

Massachusetts Secretary of State,

and

BARRY C. GUTHARY, Director,

Massachusetts Secuntties Division,

Petitioners,

+.

SECURITIES INDUSTRY ASSOCIATION, et al.,

Respondents.

Petition for Writ of Certiorari to

the United States Court of Appeals

for the First Circuit

SECURITIES ADMINISTRATORS

ASSOCIATION, INC.,

AS AMICUS CURIAE

JOSEPH C. LONG

SPECIAL COUNSEL FOR

NORTH AMERICAN SECURITIES

ADMINISTRATORS ASSOCIATION, INC.

300 Timberdell Road

Norman, Oklahoma 73019

(405) 364-5471

OF COUNSEL:

LEE R. POLSON

EXECUTIVE DIRECTOR AND GENERAL COUNSEL

NORTH AMERICAN SECURITIES ADMINISTRATORS

ASSOCIATION, INC.

' 555 New Jersey Avenue, N.W., Suite 750

Washington, D.C. 20001

(202) 737-0900

No. 89-894

IN THE

, SupnzaxCounresrxx Unies Starzs

OCTOBER TERM, 1989

MICHAEL J. CONNOLLY,

Massachusetts Secretary of State,

and

BARRY C. GUTHARY, Director,

Massachusetts Securities Division,

Petitioners,

¥,

SECURITIES INDUSTRY ASSOCIATION, et al.,

Respondents.

Petition for Writ of Certiorari to

the United States Court of Appeals

for the First Circus

BRIEF FOR NORTH AMERICAN

SECURITIES ADMINISTRATORS

ASSOCIATION, INC.,

AS AMICUS CURIAE

JOSEPH C. LONG

SPECIAL COUNSEL FOR

» NORTH AMERICAN SECURITIES

ADMINISTRATORS ASSOCIATION, INC.

300 Timberdell Road

Norman, Oklahoma 73019

(405) 364-5471

OF COUNSEL:

LEE R. POLSON

EXECUTIVE DIRECTOR AND GENERAL COUNSEL

% NORTH AMERICAN SECURITIES ADMINISTRATORS

ASSOCIATION, INC.

555 New Jersey Avenue, N.W., Suite 750

. Washington, D.C. 20001

(202) 737-0900

TABLE OF CONTENTS

Page

TABLE OF AUTHORITIES ..........4

AUTHORITY TO FILE AND POSITION

OF AMICUS CURIAE ......... 1

STATEMENT OF THE INTEREST OF

THE AMICUS CURIAE......... 2

REASONS FOR GRANTING THE WRIT .... 8

I. THE DECISION BELOW PRESENTS AN

IMPORTANT QUESTION CONCERNING

THE PREEMPTION OF THE STATE'S

AUTHORITY TO PROTECT INVESTORS

IN THE FORMATION OF ARBITRATION

ae rere T

II. THE COURT SHOULD GRANT

CERTIORARI BECAUSE THE CASE HAS

NATIONAL INTEREST TO ALL

SECURITIES REGULATORS... . . 14

III. THE COURT SHOULD GRANT

CERTIORARI BECAUSE THE PRESENT

CASE HAS WIDE INTEREST BEYOND

THE SECURITIES AREA... .. . 25

IV. THE COURT SHOULD GRANT

CERTIORARI IN THE PRESENT

CASE BECAUSE THERE Is A

POTENTIAL CONFLICT OF

INTEREST BETWEEN THE

ii

THE COURT SHOULD GRANT

CERTIORARI IN THE PRESENT CASE

BECAUSE THE FIRST CIRCUIT

MISCONSTRUED THE PURPOSES AND

OBJECTIVES OF THE FAA... . . . 32

COMCLUSIO“ . 2. sce cee see ee se 8

iii

TABLE OF AUTHORITIES

Page

Aloha Airlines v. Director of Taxation,

464 U.S. 7 (1983) . . «2 «© «© © ©» ~ 12

California Federal Savings & Loan

Ass'n v. Guerra, 479 U.S. 272, 281

(1987) . . . . . . . . . . . . .

12

City of New Orleans v. Dukes,

me ey, |

Cook Chocolate Co. v. Salomon, Inc.,

684 F. Supp. 1177

omens SNP ec sc ewe ee ec ew ew wl

EASSA Properties v. Shearson

Lehman Bros., Inc., 852 F.2d

1301, 1304 n.7 (llth Cir. 1988) . . 35

Ex Parte Warren,

548 So.2d 157 (Ala. 1989),

cert. filed, Doc. No. 89-567, 58

U.S.L.W. 3291 (Oct. 4, 1989) ... 28

Florida Lime & Avocado Growers,

Inc. v. Paul, 373 U.S. 132 (1963) . 12

Graniteville Co. v. Star Knits

of Calif. Inc., 680 F. Supp. 587

Seeteteaeee) 2 « « : - 36

Hall v. Geiger-Jones,

wre ey CELE) « « « eo eo eo ec eo «(Ch

Hillsborough County v. Automated

ca nc., U.S. 707,

ioe Bete @ «© «¢ « ee oe AS

iv

Jones v. Rath Packing Co.,

a ome Bee Seerts « « « « «© « Al, 12

Maryland v. Louisiana,

See Wane Fame £0 (1961) .. - - -- 12

Motor Vehicle Manufacturers Ass'n

v. Abrams, 697 F. Supp. 726

(S.D.N.¥Y. 1988) ... 29

Perry v. Thomas,

S02 U.e. S63, 492 n.9 (1987) ... 36

Prima Paint Corp. v. Flood &

Conklin Mfg., 388 U.S.395 (1967) . 35

Rice v. Santa Fe Elevator Corp.,

an as ee Cees e « 6 et el lel elCURD, 13

Rush v. Oppenheimer,

681 F. Supp. 1045 (S.D.N.Y. 1988) . 36

Saturn Distribution Corp. v.

Williams, Commissioner of the

Department of Motor Vehicles of

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

Va.1989), appeal pending Doc.

No. 89-2773 (4th Cir.) (oral

argument heard Dec. 6, 1989) . 28, 31

Shearson/American Express, Inc. vy

McMahon, 482 U.S. 220

Dice hacl. 6 «4 5 « 6 « G6, 16, 37

Southland Corp. v. Keating,

465 U.S. 1 (1984) . .... +--+. 24

Supak & Sons Mfg. Co. v.

Pervel Indus. Inc., 593 F.2d

35, 137 (4th Cir. 1979) ..... 35

United States v. Bass,

owe ( 1) . . . . . . . 12

Vv

Volt Information Sciences, Inc.

v. Board of Trustees of Leland

Stanford Junior University,

U.S. , 109 S.Ct. 1248

(T5989) 2 1 we we ew ee ww oe «1S, 33

Statutes

Federal Arbitration Act,

9 U.S.C. §1 et seq. . . ~~ - - - - 2D

Dees (en « e @ e« «© 6¢ & 6 eo ee eC

Permer 26 UcS-C. $1256(2) .« «© we wee eo e §

The Securities Act of 1933

Deememite @ POE 5 « ¢ « «© «© 6 «© © © oe @

The Securities Exchange Act of 1934

15 U.S.C. § 78bbB . . «© © © we we w we « 2

15 U.S.C. §78s, Section 19 .... 23

Legislative Material

Cal. SB No. 1889,

discussed in 20 Sec. Reg.

& L. Rep. (BNA) 381 (mer.

11, 1988) ..... pDeseecee es’

Hearing on S. 4213 and S. 4214

before the Subcommittee of the

Judiciary, 67th Cong., 4th

Sees. Gt 9 (1923) . ~ ew we we we we wo ew 94

HR 4960, 100th Cong. 2d Sess.,

om Jume 30, 1986 ..-+« «eee « 8 2l

La. SB No. 74,

o 18528322 in 21 Sec. Reg.

p- NA) 745 (May

19. "1989) . . . . . . . . . . . . . . 5

vi

Md. SB No. 72,

discussed in 21 Sec. Reg.

& L. Rep. (BNA) 82 (Jan 13,

~~~ Ti (S| G6 « 6 6 ¢« « « « « « « « §

Ore. SB No. 925,

discussed in 21 Sec. Reg.

& L. Rep. (BNA) 1805

EE ee ee ee

Record Before the Secretary at 30-50,

Ee ee ee ee ee ee

S. Rep. No. 536, 68th saa ,

lst Sess. at3 .. a0 a a ae ee

Subcomm. on Telecommunications

and Finance of the House Comm.

on Energy and Commerce, Statement

of James C. Meyer _— 16,

DE eis © 6 @ e een « « Fe 29

Wash. SB No. 5787,

discussed in 21 Sec. Reg.

& L. Rep (BNA) 980 opel

SS... | ree . Pea eo ee

Miscellaneous

Chicago Tribune, Chicagoland Section, p.2

(Sept. 19, 1989)(avail. on Nexis) . 27

Committee of Commerce, Trade &

Commercial Law, The United

States Arbitration Law and

Its Bppricer sen. ll ABA J.

, ) . . . - . . . . * © 36

DiFiore, Problems in Alternative

Dispute Resolution: Arbitration

Sareemeants as Contracts of

esion n onsumer Securities

vii

Disputes, 90 Commercial L.J. 259

i re iis ge « ~¢ «¢ « « @@e oe

Fed. Sec. L. Rep. (CCH) 484,241

{1987-1988 Transfer —

(June 8, 1988) ..... “ee ee ee

Katsoris, The Arbitration of A

Public Securities Dispute,

53 Fordham L. Rev. 279

(1984) ate se ees & € @«¢ 06 ¢ 2a, af

Lender Liability and Arbitration:

Preserving the Fabric of

Relationship, 42 Vand. L.

Rev. Dn eh « 5 « » « © @¢ » 26

McCauliff and Tyms, New Protections

in Arbitrating Public Securities

Disputes in _ the Wake of McMahon:

Foregone Conclusion or Will-O

zs paar’ 34 VILL. L. Rev. 25,

(1 8 ) >. >. >. . . > . . . . >. 21

Pitts, Arbitrating Lender Liability

Claims, 106 Bank. L.J. 227

(1989) a oo se . «ee eee « « 20

SEC Exchange Act Rel. No. 15984

(July 2, 1979), 17 SEC Docket

1167 . . . . . . . . . . . . 20

Spotlight Report, Business

Insurance 72, 74 (Nov. 6, 1989)

(avail. Om Mexis) . . -« «© «© «© « ee 27

Stern, Gressman, and Shapiro,

pptare for Mandatory

urisdiction, ABA J. 66,

DT EMD cos ew ec ee tw eo ee G

19 Sec. Reg. & L. Rep.

(BNA) 1388 (Sept. 18, 1987) .... 18

20

20

20

20

20

20

21

21

viii

Sec. Reg. & L. Rep.

(BNA) 492 (Apr. 1, 1988)

Sec. Reg. & L. Rep.

(BNA) 870 (June 10, 1988)

Sec. Reg. & L. Rep.

(BNA) 1054 (July 8, 1988)

Sec. Reg. & L. Rep.

(BNA) 1436 (Sept. 23, 1988)

Sec. Reg. & L. Rep.

(BNA) 850 (June 3, 1988)

Sec. Reg. & L. Rep.

(BNA) 1436 (Sept. 23, 1988)

Sec. Reg. & L. Rep.

(BNA) 1805 (Dec. 8, 1989)

Sec. Reg. & L. Rep.

(BNA) 1103 (July 8, 1989)

No. 89-894

In The

. SUPREME COURT OF THE UNITED STATES

October Term, 1989

MICHAEL J. CONNOLLY,

Massachusetts Secretary of State,

and

BARRY C. GUTHARY, Director,

Massachusetts Securities Division,

Petitioners,

Vv.

SECURITIES INDUSTRY ASSOCIATION, et al.,

Respondents.

Petition for Writ of Certiorari to

the United States Court of Appeals

for the First Circuit

BRIEF FOR NORTH AMERICAN

SECURITIES ADMINISTRATORS

ASSOCIATION, INC.,

AS AMICUS CURIAE

AUTHORITY TO FILE AND POSITION

OF AMICUS CURIAE

This brief is filed pursuant to Rule

36.1 of the Court's Rules by written

permission of the parties to the case.

Such written permission is filed herewith.

The brief supports the position of the

petitioners.

2

STATEMENT OF THE INTEREST

OF THE AMICUS CURIAE

The North American Securities

Administrators Association, Inc. ("NASAA")

is an association of state and provincial

securities administrators in the United

States, including the District of Columbia

and Puerto Rico, Canada and Mexico, which,

since 1918, has worked for investor

protection. State securities

commissioners are charged with regulating

the securities markets and combatting

securities frauds in their respective

jurisdictions.

The dual system of federal and state

regulation of securities is recognized by

Section i8 of the Securities Act of 1933,

15 U.S.C. § 77r, and Section 28 of the

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

§ 78bb, which reserve jurisdiction of

state securities commissioners over any

security or person. Through this dual

3

system, the coordinated enforcement

efforts of NASAA and the Securities and

Exchange Commission ("SEC") have resulted

in a most effective system for the

enforcement of the securities laws. The

SEC concentrates in large scale

enforcement actions on international or

multi-state levels, with the state

commissioners either serving in a back-up

Or assisting role in such large scale

actions or concentration on more local or

regional enforcement actions.

The interest of NASAA in the present

case is three fold. First, the

Massachusetts Division of Securities, a

NASAA member, has asked NASAA to

participate in the present proceedings and

to file an amicus curiae brief because of

the impact that the decisions below will

have upon the regulations he adopted and

the Act that he administrates. NASAA has

already participated in the proceedings

+

before the Securities Division by having

its General Counsel, Lee Polson testify.

See Record Before the Secretary at 30-50;

104-176. It also filed an amicus curiae

brief with the First Circuit.

Second, many other NASAA member

agencies or states would like to consider

adopting statutes or rules similar to the

one adopted by the Massachusetts Division

in the present case. In September 1988,

NASAA released a report which indicated

that fifteen of its member agencies were

considering rules similar to that adopted

by the Massachusetts Division. Among

these states were: Florida, Georgia,

Idaho, Iowa, North Dakota, Ohio,

Pennsylvania, South Dakota, Washington,

and Wisconsin. 20 Sec. Reg. & L. Rep.

(BNA) 1436 (Sept. 23, 1988). In addition

bilis have been introduced in the

legislatures of five states, California,

Louisiana, Maryland, Oregon, and

a

\*

5

Washington, to bar broker-dealers from

requiring mandatory arbitration clauses in

their brokerage contracts as a condition

for opening an account. See Cal. SB No.

1889, discussed in 20 Sec. Reg. & L. Rep.

(BNA) 381 (Mar. 11, 1988); La. SB No. 74,

discussed in 21 Sec. Reg. & L. Rep. (BNA)

745 (May 19, 1989); Md. SB No. 72,

discussed in 21 Sec. Reg. & L. Rep. (BNA)

82 (Jan 13, 1989); Ore. SB No. 925,

discussed in 21 Sec. Reg. & L. Rep. (BNA)

1805 (Dec. 8, 1989); Wash. SB No. 5787,

discussed in 21 Sec. Reg. & L. Rep (BNA)

980 (July 7, 1989).

Since the decision by the First Circuit

in the present case, an informal survey of

its member agencies by NASAA shows that

three members, Delaware, North Carolina,

and Iowa, have plans to consider rules

Similar to the Massachusetts rule in 1990.

In addition, the Oregon legislature has

established an interim legislative

ee il

6

committee to consider mandatory

arbitration clauses with a view toward

introducing bar legislation in the 1991

session. 21 Sec. Reg. & L. Rep. (BNA) 1805

(Dec. 8, 1989).

Finally, NASAA, as an organization, is

extremely interested in ensuring that the

investors are treated in a fair and

unbiased manner in the arbitration

process. This concern has lead NASAA to

call continually for federal and state

regulation to ensure the voluntariness of

arbitration agreements. In September

1987, immediately following this Court's

decision in Shearson/American Express,

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

NASAA formed an Ad Hoc Committee to study

arbitration and to make recommendations

how the process could be improved to

provide greater investor protection. In

December 1987, NASAA urged Congress to

require brokers to negotiate arbitration

7

agreements and to provide potential

customers with a separate disclosure

document which would explain the terms and

implications of mandatory arbitration

clauses. Statement of James C. Meyer

Before the Subcomm. on Telecommunications

and Finance of the House Comm. on Energy

and Commerce (Dec. 16, 1987). NASAA's

concern were noted in the comments of

Subcommittee Chairman Markey and member

Boucher and several witnesses at a hearing

before this same subcommittee on March 3l,

1988. 20 Sec. Reg. & L. Rep. (BNA) 492

(Apr. 1, 1988). On June 1, 1988, NASAA's

Ad Hoc Committee published its

recommendations for a "top-to-bottom

overhaul” of the securities arbitration

procedures including a prohibition on

broker-dealers denying services to

customer who refuse to sign predispute

arbitration agreements. 20 Sec. Reg. & L.

Rep. 850 (June 3, 1988). A week later,

8

NASAA's president James Meyer, Director of

the Tennessee Division of Securities,

appeared before the House Energy

Subcommittee and again urged Congress to

prohibit broker-dealers from demanding the

Signing of predispute arbitration

agreements as a condition for opening a

brokerage account. 20 Sec. Reg. & L. Rep.

(BNA) 870 (June 10, 1988). This

testimony lead, in part, to the

introduction by Representative Boucher of

HR 4960, 100th Cong. 2d Sess., on June 30,

1988, which included a provision barring

arbitration clauses as a precondition for

opening a securities account. 20 Sec. Reg.

& L. Rep. (BNA) 1054 (July 8, 1988).

REASONS FOR GRANTING THE WRIT

A year ago this case would have come to

the Court by appeal as a matter of right

under former 28 U.S.C. §1254(2). Cf. City

of New Orleans v. Dukes, 427 U.S. 297

(1976). Today the case comes before the

9

Court under the discretionary writ of

certiorari. As will be seen below, the

outcome should not change. The Court

should grant full review becayse the case

meets the Court's traditional test for the

granting of certiorari formulated by Chief

Justice Taft that it "“involve[s)

principles, the application of which are

of wide public importance or governmental

interest, and which should be

authoritatively declared by the final

court." Stern, Gressman, and Shapiro,

Epitaph for Mandatory Jurisdiction, 74 ABA

J. 66, 68 (Dec. 1988). The case also

meets other often-cited tests for the

granting of certiorari in that there is a

potential conflict between the Circuits

and that the lower courts made a major

mistake in the interpretation of the

relevant federal statute which will have

wide impact. Each of these points will be

examined below.

10

I. THE DECISION BELOW PRESENTS

AN IMPORTANT QUESTION

CONCERNING THE PREEMPTION OF

THE STATE'S AUTHORITY TO

PROTECT INVESTORS IN THE

FORMATION OF ARBITRATION

AGREEMENTS .

The case involves a Rule adopted by the

Massachusetts Securities Division under

the Massachusetts Uniform Securities Act.

The Rule declared, among other things,

that it was an unethical business

practice for a broker-dealer to demand

that a customer sign a predispute

Mandatory arbitration clause as a

condition for the opening of a brokerage

account. The Rule also required the

broker-dealer to disclose the legal effect

of such predispute arbitration agreements.

The Rule did not prohibit predispute

arbitration clauses. Instead it required

two things: (1) that such clauses be the

product of negotiation between the

parties, and voluntarily accepted by the

brokerage customer, rather than being a

11

contract of adhesion imposed upon the

customer by the broker as a condition of

doing business; and, (2) that the

customer be given information about the

effect of such agreement so that he could

make an intelligent choice as to whether

he wished to accept it. Such Rule is

Clearly within the police power of the

Commonwealth. Hall v. Geiger-Jones, 242

U.S. 539 (1917). The First Circuit,

however, held that the Rule was implied

pre-empted because it conflicted with the

Congressional policy behind the Federal

Arbitration Act, 9 U.S.C. §1 et seq.

Because of the delicate balance between

the dual sovereigns within. our Federal

system, this Court, on a number of

occasions, has indicated that federal

preemption should be cautiously

approached when a federal-state balancing

of reepective governmental powers between

the two sovereignties is involved. Jones

12

v. Rath Packing Co., 430 U.S. 519 (1977);

United States v. Bass, 404 U.S. 336

(1971); Florida Lime & Avocado Growers,

Inc. v. Paul, 373 U.S. 132 (1963); Rice v.

Santa Fe Elevator Corp., 331 U.S. 218

(1947). Thus preemption "is not to be

lightly presumed". California Federal

Savings & Loan Ass'n v. Guerra, 479 U.S.

272, 281 (1987); Maryland v. Louisiana,

451 U.S. 725, 746 (1981). This is

particularly true where the claim to

preemption is implied rather than express,

Aloha Airlines v. Director of Taxation,

464 U.S. 7 (1983), and where the field

claimed to be preempted is one within the

traditional police power of the state.

Hillsborough County v. Automated Medical

Inc., 471 U.S. 707, 715 (1985); Jones v.

Rath Packing Co., supra. As a result this

Court has stated: “We start with the

assumption that the historic police powers

of the State were not to be superseded by

SS. Ls - ae

'

13

the Federal Act unless that was the clear

and manifest purpose of Congress.” Rice

v. Santa Fe Elevator, supra, at 230.

Because of the delicate balance between

federal government as the superior

sovereign and Commonwealth of

Massachusetts as the inferior sovereign in

the present case, the extreme caution

which this Court has indicated should be

exercised when implied rather than express

preemption is involved, and the

presumption against such preemption in

areas traditional within the police power

of the states, the Commonwealth of

Massachusetts has a right to expect that

the final decision on preemption of the

Rule adopted by its Securities Division

will be made by this Court rather than

some inferior federal court. In the words

of Chief Justice Taft, this is a case

which “involves principles, the

application of which are of wide

14

«+-governmental interest, and which should

be authoritatively declared by the final

court.” While the right of the

Commonwealth to demand such hearing ended

with the repeal of Section 1254(2), this

Court should exercise its discretion,

Qrant review by certiorari, and

definitively determine whether the

Massachusetts Rule is implied preempted by

the Federal Arbitration Act.

II. THE COURT SHOULD GRANT

CERTIORARI BECAUSE THE CASE

HAS NATIONAL INTEREST TO ALL

SECURITIES REGULATORS.

The second part of Chief Justice Taft's

test for the granting of certiorari is

that the case has national significance

and be one which should be authoritatively

settled by the final court. Again the

present case meets these criteria.

NASAA and its member state agencies

have been increasingly concerned that

mandatory , edispute arbitration clauses

15

are becoming contracts of adhesion. As

such, the individual investor has little

Or no choice as to whether he wishes to

accept such an agreement. If he wishes to

participate in the public securities

Market utilizing the services of a

broker-dealer, he must agree to such a

provision. As will be seen below, this is

Clearly contrary to the intent of Congress

in adopting the Federal Arbitration Act.

Congress intended to make sure that a

contract to arbitrate voluntarily agreed

to by the parties would be enforced

according to their agreement. Volt

Information Sciences, Inc. v. Board of

Trustees of Leland Stanford Junior

University, U.S. , 109 §.Ct. 1248

(1989). It clearly did not intend to

force persons to arbitrate when there was

no voluntary agreement to do so. a

contract of adhesion requiring a mandatory

predispute agreement to arbitrate where

16

the individual investor has no choice, but

to accept or refrain from participating in

the market, is not a voluntary agreement.

This is especially true when viewed in

light of the fact that the regulations of

the New York and American Stock Exchanges

and the National Association of Securities

Dealers require all their members to

arbitrate claims with their customers, if

the customer so requests.

The industry's own statistics bear out

that the mandatory arbitration clause is

rapidly becoming a contract of adhesion.

The industry figures reported to the

Securities and Exchange Commission

indicate that a year after this Court's

Gecision in Shearson/American Express,

Inc. v. McMahon, supra, in June 1988,

that members of the brokerage community

required a mandatory arbitration clause in

90 percent of their margin accounts and in

95 percent of their option accounts. 20

17

Sec. Reg. & L. Rep. (BNA) 833 (June 3,

1988). This percentage will become even

greater as a result of the adoption by the

Securities Industry Association of its new

Model Customer Agreement form on July 17,

1989. This form contains a mandatory

arbitration agreement for all margin

customers. SIA has recommended that all

its member firms adopt the Model Agreement

form. 21 Sec. Reg. & L. Rep. (BNA) 1103

(July 8, 1989).

Industry spokesmen point out, however,

that such mandatory agreements are

required in less than 50 percent of the

industry's cash accounts. This figure,

while accurate at the time it was made, is

now misleading for several reasons. First,

many of the people who have cash accounts

also have margin or option agreements,

whether or not they actually trade on

margin or _ in options. Typically, such

margin or option agreements require the

18

arbitration of all disputes with the

broker whether they arise out of a margin

Or option transaction or not. As a

result, a very large number of cash

account disputes are covered. It is only

the cash customer who does not execute a

margin or option agreement who will avoid

the broker's mandatory agreement.

Second, both the industry spokesmen and

the SEC Staff admit that the practice of

requiring mandatory arbitration clauses in

cash accounts is increasing. Three months

after the McMahon decision, in September

1987, industry official predicted that

companies will be encouraged by their own

legal advisers to have cash customers sign

predispute arbitration agreements. 19

Sec. Reg. & L. Rep. (BNA) 1388 (Sept. 18,

1987). This trend was confirmed by the

SEC Staff in June 1988 when the Director

of Market Regulation reported that there

was a growing broad based trend toward

19

requiring predispute arbitration

agreements in cash accounts. 20 Sec. Reg.

& L. Rep. (BNA) 833 (June 3, 1988).

Recognizing this growing trend, NASAA

and its member state agencies have

attempted to secure federal and state

statutes or regulations which will ensure

voluntariness in the arbitration

agreement process. In December 1987,

NASAA recommended that Congress require

broker-dealers to negotiate arbitration

agreements. Statement of James C. Meyer

Before the Subcomm. on Telecommunications

and Finance of House Comm. on Energy and

Commerce (Dec. 16, 1987). This call was

renewed in June 1988. 20 Sec. Reg. & L.

Rep. (BNA) 850 (June 3, 1988). In

September 1988, at the time, the

Massachusetts Securities Division adopted

the Rule challenged in the present case,

NASAA reported that some 15 of its other

members were considering the adoption of

20

similar regulations. 20 Sec. Reg. & L.

Rep. (BNA) 1436 (Sept. 23, 1988).

Nor is NASAA the only group concerned

about the proliferation of the mandatory

arbitration agreements in brokerage

contracts through contracts of adhesion.

As noted above at p.4, five state

legislatures have considered bills which

would prohibit brokerage contracts of

adhesion requiring mandatory arbitration.

As early as 1979, the SEC also became

concerned about these contracts. In SEC

Exchange Act Rel. No. 15984 (July 2,

1979), 17 SEC Docket 1167, the Commission

recognized that arbitration clauses were

“routinely required for margin accounts

and often for cash accounts" The

Commission went on to state: "Moreover,

the customer may be precluded from doing

business with the broker-dealer if he or

she refuses to sign the agreement or the

SOY eS ee ee Pacis Saar

21

broker-dealer is unwilling to accept any

modifications of its terms." Id. at 1169.

More recently a study conducted by the

SEC Staff lead the staff to recommend that

the SEC initiate legislation to curb the

use of these contracts of adhesion. See

[1987-1988 Transfer Binder] Fed. Sec. L.

Rep. (CCH) %84,241 (June 8, 1988). The

Commission, however, refused to initiate

such legislation or support HR 4960, 100th

Cong. 2d Sess. (June 30, 1988), introduced

by Representative Boucher, which would

also outlaw such agreements. 20 Sec. Reg.

& L. Rep. (BNA) 1054 (July 8, 1988).

The academic community is also

concerned about the spread of these non-

negotiable contracts of adhesion

requiring arbitration in brokerage

contracts. McCauliff and Tyms in their

article New Protections in Arbitrating

Public Securities Disputes in the Wake of

McMahon: Foregone Conclusion or Will-O'-

22

The Wisp?, 34 VILL. L. Rev. 25, 56 (1989)

said:

[Public confidence in the

arbitration process] can only be

earned by maintaining a de facto as

well as a de jure image of

fairness." The de facto image of

fairness can be promoted by removing

any appearance of adhesion

contracts. A contract of adhesion

arises when a party with superior

bargaining power presents a

standardized form contract to a

party of lesser bargaining power

whose choice is limited to accepting

or rejecting the contract without

opportunity to negotiate. While it

is true that mere inequality in

bargaining power does not make a

contract unenforceable, nonetheless,

when the arbitration agreement is

presented as a precondition to

opening an account, the image of de

facto fairness is seriously

compromised. Therefore, it should

be clear to the investor that the

agreement is entirely optional.

{Footnotes omitted. ] See also DiFiore,

Problems in Alternative Dispute

Resolution: Arbitration Agreements as

Contracts of Adhesion in Consumer

Securities Disputes, 90 Commercial L.J.

259 (1988); Katsoris, The Arbitration of A

23

Public Securities Dispute, 53 Fordham L.

Rev. 279 (1984).

Nor is the concern of NASAA limited to

mandatory arbitration contracts in the

brokerage area. NASAA members are

increasingly seeing private placement

memoranda for offering sold under the

securities registration exemptive

provisions of both the state and federal

securities acts which contain mandatory

predispute arbitration agreements. Again,

these offering are being made on a take-

it-or-leave-it basis with the purchaser

having no opportunity to reject the

arbitraticn clause. Unlike brokerage

agreements which this Court in McMahon

held could be supervised by The SEC under

Section 19 of the Exchange Act of 1934, 15

U.S.C. §78s, these mandatory arbitration

agreements are not subject to direct SEC

control or. do not have to call for

arbitration in a system subject to SEC

24

control. Thus the investor, if he wishes

to invest in these products, has no choice

but to agree to arbitrate, possibly ina

forum which is not subject to regu'ation

by the SEC. If the present case is

allowed to stand, the states will be

powerless to protect investors from such

overreaching. Southland Corp. v. Keating,

465 U.S. 1 (1984).

Thus, there is wide support for the

curbing of contracts of adhesion which

require mandatory arbitration in the

securities area. However, the ability to

implement these reforms at the state level

is left in question by the First Circuit's

decision in the present case. While the

decision is not binding outside that

Circuit, and some agencies and

legislatures appear willing to push ahead

with Rule or statutes similar to the

Massachusetts Rule declared preempted, it

would be better if the issue was finally

25

resolved by this Court. Therefore, NASAA

urges this Court, on the basis of the

public interest in this issue as outlined

above, to grant certiorari and finally

resolve the dispute.

III. THE COURT SHOULD GRANT

CERTIORARI BECAUSE THE

PRESENT CASE HAS WIDE

INTEREST BEYOND THE

SECURITIES AREA.

Following Chief Justice Taft's

criteria, the Court should grant

certiorari in the present case because it

has wide interest beyond the securities

field. Non-negotiable contracts of

adhesion requiring predispute consent to

arbitrate are proliferating in many areas

other than securities. The Commonwealth

identified a number of these areas in

Point II of their brief. NASAA's

research has identified a number of

others.

26

The Commonwealth pointed out that the

Bank of America and Marathon National Bank

of Los Angeles are extensively using non-

negotiable arbitration clauses in a wide

variety of situations. The text of the

Bank of America General Arbitration Clause

and the one used in its Safety Deposit

Agreements are reprinted in the Appendix

to Comment, Lender Liability and

Arbitration: Preserving the Fabric of

Relationship, 42 Vand. L. Rev. 947,981

(1989). This article indicates that the

Bank of California is also extensively

using such clauses and reports the text of

that Bank's clause. Id. at 982-983. The

article also points out the advantages to

banks of the wide-spread use of such

clauses as an aid in the control of lender

liability in commercial lender

situations. Use of such clauses in lender

situations as a means to control

“excessive lender liability judgments" was

27

advocated by James Pitts in Pitts,

Arbitrating Lender Liability Claims, 106

Bank. L.J. 227 (1989).

Such non-negotiable clause are

appearing more frequently in the insurance

areas. The Commonwealth pointed out their

use in the malpractice and health care

area. NASAA's research shows that such

clauses are also being used in insurance

re-insurance contracts, see Spotlight

Report, Business Insurance 72, 74 (Nov.

6, 1989) (avail. on Nexis), and by State

Farm, one of the largest retail insurance

companies, in connection with its

uninsured motorists coverage. Chicago

Tribune, Chicagoland Section, p.2 (Sept.

19, 1989)(avail. on Nexis).

Finally, the Commonwealth noted the use

of these agreements in connection with

disputes between the automobile

manufacturer and their dealers. In

contrast to the decision by the First

28

Circuit in the present case, the court in

Saturn Distribution Corp. v. Williams,

Commissioner of the Department of Motor

Vehic.es of Virginia, 717 F. Supp. 1147

(E.D. Va.1989), appeal pending Doc. No.

89-2773 (4th Cir.) (oral argument heard

Dec. 6, 1989); upheld the authority of the

Commissioner to restrict the use of such

Clauses. NASAA has discovered that these

clauses are also being used in connection

with disputes between the automobile

dealers and their retail customers. Ex

Parte Warren, 548 So.2d 157 (Ala. 1989),

cert. filed, Doc. No. 89-567, 58 U.S.L.W.

3291 (Oct. 4, 1989).

The First Circuit decision in the

present case was extremely broad. In

essence, it held that the states could not

adopt any statutes or regulation affecting

the use of arbitration clauses unless such

legislation or rules applied to contracts

generally. Thus, the state could not

ladies 5. le aba Ait emo

29

adopt limiting rules or legislation which

was industry specific such as securities,

banking, or insurance. If this decision

is allowed to stand and followed by the

other Courts of Appeal, it will have an

extremely limiting effect on the ability

of the states to protect their citizens

from abusive arbitration practices in such

traditional consumer protection areas as

consumer credit, truth-in-lending, and

automobile lemon laws. See Motor Vehicle

Manufacturers Ass'n v. Abrams, 697 F.

Supp. 726 (S.D.N.Y. 1988).

Concern about the extraordinary breadth

of the First Circuit's decision in the

present case and its application to areas

beyond the securities area into other

areas traditionally considered within the

police powers of the states, NASAA

understands has caused the Attorney

General of Virginia to file a brief in

support of the granting of certiorari in

30

the present case. It is NASAA‘s further

understanding twenty-seven other state

Attorney Generals joined in the filing of

this brief. The fact of its filing and

the support by the large number of other

state attorneys general indicate the wide

spread interest by the states and their

regulatory agencies outside the

securities area in the present case.

NASAA joins with the state attorney

generals in urging the Court to grant

certiorari in the present case because of

this wide spread interest it has generated

in other areas of state regulation beyond

securities.

Iv. THE COURT SHOULD GRANT

CERTIORARI IN THE PRESENT

CASE BECAUSE THERE IS A

POTENTIAL CONFLICT OF

INTEREST BETWEEN THE

CIRCUITS.

Another traditional test used by the

Court to determine whether to grant

certiorari is whether there is a conflict

31

among the circuits on the issue presented.

To date, NASAA is aware of only two cases

which have considered the power of the

states to regulate or control the use of

non-negotiable contracts of adhesion

requiring mandatory arbitration. They

have reached opposite results. MThe First

Circuit's decision in the present case

held that the states could not adopt such

statutes or regulations unless that

applied to all contracts generally. fThe

decision by the district court in Saturn

Distribution corp. v. Williams,

Commissioner of the Department of Motor

Vehicles of Virginia, 717 F. Supp. 1147

(E.D.Va. 1989), appeal pending, was that

such regulation was not preempted by the

Federal Arbitration Act. Thus there is a

potential conflict between the circuits on

the issue which this Court should resolve.

32

V. THE COURT SHOULD GRANT

CERTIORARI IN THE PRESENT

CASE BECAUSE THE FIRST

CIRCUIT MISCONSTRUED THE

PURPOSES AND OBJECTIVES OF

THE FAA.

Finally the Court should grant

certiorari because the First Circuit

misconstrued the purposes and objectives

of the Federal Arbitration Act in two very

important ways. First, the First Circuit

ignored the clear legislative history that

the FAA was intended to apply only to

voluntary agreements to arbitrate and was

specifically not intended to cover

contracts of adhesion. Second, the First

Circuit also failed to recognize that

state law governs the contracting process

by which an agreement to arbitrate is

formed and that the states have

traditionally had the power to refuse to

enforce unconscionable contracts.

The legislative history of the FAA

33

makes clear that it is intended to apply

only to voluntary agreements to arbitrate:

The record... shows 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.

S. Rep. No. 536, 68th Cong., lst Sess. at

3. [Emphasis added.] This Court has on

Numerous occasions recognized this

principle. Most recently the Court said

in Volt Information Sciences, Inc. v.

Board of Trustees of Leland Stanford

Junior University, 0.8. ,» 209 8.Ct.

1248, 1256 (1989), that "Arbitration under

the Act is a matter of consent, not

coercion."

More specifically, during the hearings

leading to the adoption of the Act, the

question was raised by Senator Walsh as

to the intent of the Act to cover

arbitration in those situations where the

agreement to arbitrate was a product of a

—_— => =

saad

34

non-negotiable contract of adhesion.

Senator Walsh said:

The trouble about the matter is that

a great many of these contracts that

are entered into are not really

voluntarily [sic] things at all.

Take an insurance policy: there is

blank in it. You can take that or

you can leave it. The agent has no

power at all to decide it. Either

you can make ;that contract or you

can not make any contract. It is

the same with a good many contracts

of employment. A man says: "These

are our terms. All right, take it

Or leave it." Well, there is

nothing for the man to do except

sign it; and then he surrenders his

right to have his case tried by the

court, and has to have it tried

before a tribunal in which he has no

confidence at all.

Hearing on S. 4213 and S. 4214 before the

Subcommittee of the Judiciary, 67th

Cong., 4th Sess. at 9 (1923). Senator

Walsh went on to ask similar questions

concerning contracts of adhesion in the

shipping and construction industries. Id.

at 10-11. In all cases, the proponents of

the bill indicated that they did not

intend the bill to cover such contracts.

35

This legislative history was recognized

and accepted by three members of this

Court in Prima Paint Corp. v. Flood &

Conklin Mfg., 388 U.S.395 (1967). Justice

Black speaking for the three in dissent

said:

Senator Walsh cited insurance,

employment construction and shipping

contracts as routinely containing

arbitration clauses and being

offered on a take-it-or-leave it

basis to captive customers or

employees. He noted that such

contracts "are really not voluntary

things at all." because "there is

nothing for the man to do except to

sign it; and then he surrenders his

right to have his case tried by the

court...." He was emphatically

assured by the supports of the bill

that it was not their intention to

cover such cases.

Id. at 414. (Black, J. dissenting)

{Emphasis added. }

Second, it has long been held that

state, not federal, law controls as to

whether the parties have entered into a

binding contract to arbitrate. EASSA

Properties v. Shearson Lehman Bros., Inc.,

36

852 F.2d 1301, 1304 n.7 (llth Cir. 1988);

Supak & Sons Mfg. Co. v. Pervel Indus.

Inc., 593 F.2d 135, 137 (4th Cir. 1979);

Cook Chocolate Co. v. Salomon, Inc., 684

F. Supp. 1177 (S.D.N.Y. 1988); Rush v.

Oppenheimer, 681 F. Supp. 1045 (S.D.N.Y.

1988); Graniteville Co. v. Star Knits of

Calift. Ine., 680 FP. Supp. 587

(S.D.N.¥.1988). Cf. Perry v. Thomas, 482

U.S. 483, 492 n.9 (1987). This conclusion

is consistent with the opinion expressed

by the proponents of the FAA as expressed

in a 1925 article written immediately

following the passage of the Act. They

said:

It is no infringement upon the right

of each State to decide for itself

what contracts shall or shall not

exist under its laws. To be sure

whether or not a contract exists is

a question of the substantive law of

the jurisdiction wherein the

contract was made.

Committee of Commerce, Trade & Commercial

Law, The United States Arbitration Law and

eT aS eee a eee

37

Its Application, 11 ABA J. 153, 154

(1925).

NASAA submits that the same should be

true under that portion of Section 2 of

the Act which provides 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.

[Emphasis Added, )} This Court in

Shearson/American Express Co. v. McMahon,

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

that excessive economic power would

provide a basis for voiding an arbitration

agreement under ordinary principles of

contract law under Section 2. See also,

Katsoris, The Arbitration of A Public

Securities Dispute, 53 Fordham L. Rev.

279, 307 (1984). Such contract would be

unconscionable.

The determination of excessive economic

power or unconscionability, however,

38

should be a matter of state, not federal,

law. Further, a finding of such

unconscionability can be made through

legislative or administrative rule-making

process as well as by court decision.

The findings of the Secretary in adopting

the Rule in the present case amounted to a

finding of unconscionability. Such

conclusion finds support in the academic

literature, see e.g., DiFiore, Problems in

Alternative Dispute Resolution:

Arbitration Agreements as Contracts of

Adhesion in Consumer Securities Disputes,

93 Commercial L.J. 259 (1988), and should

have been respected by the First Circuit.

CONCLUSION

For the reasons set forth above and

those outlined in the brief of the

Commonwealth, NASAA joins with the

Commonwealth in urging the Court to grant

39

the petition for writ of certiorari and

hear the case on its full merits.

Respectfully submitted,

g

SpecrYal Counsel for t

North American Administrators

Association, Inc.

300 Timberdell Road

Norman, Oklahoma 73019

(405) 364-5471