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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 1990
- **Citation:** 493 U.S. 1054

## Text

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

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385020_0718%3A5. Public record. Not legal advice.