Petition for Writ of Certiorari — Hubbard, Securities Commissioner of Delaware v. Olde Discount Corp

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Text

FILED

OCT 29 1993

OFFICE OF THE GLERK

momen!

No. 93-____

In The

Supreme Court of the United States

October Term, 1993

RICHARD W. HUBBARD, Securities Commissioner

of the State of Delaware,

Petitioner,

OLDE DISCOUNT CORPORATION,

Respondent.

-¢

Petition For A Writ Of Certiorari

To The United States Court Of Appeals

For The Third Circuit

€

PETITION FOR A WRIT OF CERTIORARI

on +

CHARLES M. Ober y, III

Attorney General of the

State of Delaware

RiCHARD E. FAIRBANKS, JR.

Chief of Appeals Division

Counsel of Record

Delaware Department of Justice

820 North French Street

Wilmington, DE 19801

(302) 577-2500

Counsel for Petitioner

October 28, 1993

COCKLE LAW BRIEF PRINTING CO., (800) 225-6964

OR CALL COLLECT (402) 342-2831

QUESTIONS PRESENTED

1. Whether a federal court may enjoin a state securi-

ties commissioner from ordering restitution for investor

victims on the grounds that private parties have contrac-

ted away the state’s enforcement remedy which is autho-

rized by statute.

2. Whether a federal court, rather than abstain

under the Younger doctrine, may enjoin a state securities

commissioner from ordering restitution for investor vic-

tims in advance of the state’s administrative hearing on

the grounds that an alleged securities law violator’s Fed-

eral Arbitration Act preemption claim is subject to an

“immediate irreparable injury.”

TABLE OF CONTENTS

Page

Ouestions Presented. soo. es soe a ee ee i

Table of Authoties 305.052505 642 eee iii

Opinions Beiow «24 ings o cranes S0h eee ee 2

jurindiction. ......0<c1seuee ee eee eee 2

Statutory Provisions HAVOUIWEE «0.6202. cee es ees wees 2

Statement of (Gee (NE eo eek oe eee 4

Reasons for Granting Cie WPM coos 5g oso es cass ken 12

I. The Court Should Grant The Writ To Clarify

That A Federal Court May Not Enjoin A State

Securities Commissioner From Ordering Resti-

tution For Investor Victims On The Grounds

That Private Parties Have Contracted Away

The State’s Enforcement Remedy Which Is

Authorized Thy: SUNN. 6 i052 s05 cose eck eee 17

II. The Court Should Grant The Writ To Clarify

That A Federal Court May Not Enjoin A State

Securities Commissioner From Ordering Resti-

tution For Investor Victims In Advance Of The

State’s Administrative Hearing On The

Grounds That An Alleged Securities Law Vio-

lator’s Federal Arbitration Act Preemption

Conclusion .. oo ccowebetet eee 26

ADDONGIN. 0:45 665.0c2t sc snaae eee ene nae App. 1

ili

TABLE OF AUTHORITIES

Page

CASES:

Blinder, Robinson & Co. v. Bruton, 552 A.2d 466

RS Dorie aha airy Urns Nh VA os os na 23

Dole v. Local 427, 894 F.2d 607 (3d Cir. 1990)........ 20

General Telephone Co. v. EEOC, 446 U.S. 318 (1980) .... 19

Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. __,

111 S.Ct. 1647, 114 L. Ed. 2d 26 (1991)......... 14, 19

Kelly v. Robinson, 479 U.S. 36 (1986).......... iS, 18, 23

Mitchell v. Robert De Mario Jewelry, Inc., 361 U.S.

ESI ey a ae at 14

New Orleans Public Service, Inc. v. Council of City of

New Orleans, 491_U.S. 350 (1989)............... 15, 24

Occidental Life Insurance Co. v. EEOC, 432 U.S. 355

ee ken dA vad eh es oes hak a O08 wee 19

Ohio Civil Rights Commission v. Dayton Christian

penaos, Inc., 477 US. 619 (1986) ........... 15, 24, 25

Osterneck v. Merrill Lynch, Pierce, Fenner & Smith,

jr, wee ieee cue (a0 Cir. I968).............00056: 17

Porter v. Warner Holding Co., 328 U.S. 395

EG ee SOs pak psa a ek kone ¥en a oie 14, 18, 23

Prima Paint Corp. v. Flood & Conklin Manufacturing

ON Gh gL 3 rr 22

Securities Industry Ass‘n v. Connolly, 883 F.2d 1114

(1st Cir. 1989), cert. denied, 495 U.S. 956 (1990) .... 17

Singer v. Magnavox Co., 380 A.2d 969 (Del. 1977) .... 16

State ex rel. Day v. Southwest Mineral Energy, Inc.,

ge ee Wht |) 14

TABLE OF AUTHORITIES - Continued

Page

Volt Information Sciences, Inc. v. Stanford University,

SP A De Be CUD si Rk ve ohne eae 22

Wooley v. Maynard, 430 U.S. 705 (1977).............. 25

Younger v. fiarris, 400 U.S. Sf (I9T3). ... so ceseess 24, 25

STATUTES, CONSTITUTIONAL PROVISIONS, AND Court RULEs:

POR Ce RAG ca leek Sheree Raa er eae eae as 1

Ree eee RE me oe at ged, tatolace ate naan 4

wh Oe OB ey. Nee acer ee: Me wap eran ran passim

OF Sls ee NEED es Cea RCA Rater aeees 15

15 U.S.C. § 78bb(a) (1981 & 1992 Cum. Supp.)...... 15

18 U.S.C. §§ 1961-1968 (1984 & 1992 Cum. Supp.) .... 11

Be Us SS ea cee ace ee he eas 2

ee Ras ee CREE ne 2 ee Ok ee ee ee 2

Ariz. Comp. Apmin. R. & Recs. § 14-4-308............ 13

Ariz. Rev. Stat. ANN. § 44-2032(1) (1987)............. 13

Asx. Cope § 23-42-209(0) (1967) . oon ccc eccceaewss 13

Det. Cope ANN. tit. 6,

5 FUE) Chere CA. BO ee ce vee ee eae 16, 20

GFA) (Noe GM OMI) oc oii sec cee asaes cece 7

§ 7316 (1975 & 1992 Cum. Supp.)........... 3, 16, 17

TABLE OF AUTHORITIES — Continued

Page

BF FEIN aiiatecrats : deseo ee 16

§ 7322 (1992 Cum. St a neg nara 3, 14, 16, 17

§ 7323 (1975 & 1992 Cum. ge ee eee 16, 17

§ 7325(b) (1992 Cum. cs tt ERE CE Te passim

Det. Cope ANN. tit. 29, § 2504(9) (2 ees 11

D.C. Cope ANN. § 2-2614 Us) y Praia ee ene ae 13

IND. Cope ANN. § 23-2-1 17.1(a) (Burns 1993 Cum.

POD: cutis coun cease tc pel cya ee eee 13

Micv. Compr. Laws § 451-808(a) (1979)............... 13

TENN. Cope ANN. § 48-2-119(b) (1988) ............... 13

Va. Cope ANN. § 13.1-521(c) fn) Cee EN Men tA ie 13

OTHER AUTHORITIES:

1 Blue Sky L. Rep. (CCH) ¥ 5500 Oj IE ee eal 14

D. Dosss, Remepirs 222 CRee ees Sites an ree 14

12A J. Lone, Biur Sky Law § 9.05[6] (1992).......... 14

L. Loss & E. Cowett, Biue Sky Law ® URW. ca ccs 15

UNiFoRM Securities Act, § 408, reprinted in 1 Blue

Sky L. Rep. (CCH) ¥ 5548 at 1565 io: 13

No. 93-___

In The

Supreme Court of the United States

October Term, 1993

RICHARD W. HUBBARD, Securities Commissioner

of the State of Delaware,

Petitioner,

OLDE DISCOUNT CORPORATION,

Respondent.

Petition For A Writ Of Certiorari

To The United States Court Of Appeals

For The Third Circuit

PETITION FOR A WRIT OF CERTIORARI

The Delaware Securities Commissioner, Richard W.

Hubbard, respectfully petitions this Court to grant a writ

of certiorari to review the opinion and judgment of the

United States Court of Appeals for the Third Circuit in

this case.!

1 W. Michael Tupman, Eugene H. Engelhardt, and Carol D.

Engelhardt were also parties to this action in the court of

appeals. Petitioner does not believe that they have an interest in

this petition. Petitioner, contemporaneous with the filing of this

petition, has served upon them the notice required by Suprems

Court Rute 12.4.

OPINIONS BELOW

The opinion of the United States Court of Appeals for

the Third Circuit is reported at 1 F.3d 202 (3d Cir. 1993)

and is reprinted in the Appendix at 1. The order of the

court of appeals denying the securities commissioner’s

petition for rehearing is reprinted at App. 46. The opinion

of the United States District Court for the District of

Delaware, reported at 805 F. Supp. 1130 (D. Del. 1992), is

reprinted at App. 48. The order of the district court

enjoining the securities commissioner is reprinted at App.

75.

JURISDICTION

The opinion and judgment of the court of appeals

affirming the district court’s preliminary injunction were

entered on July 30, 1993. (App. 1). A timely motion for

rehearing was denied on August 26, 1993. (App. 46). This

Court’s jurisdiction is invoked under 28 U.S.C. § 1254(1).

In granting the preliminary injunction against the securi-

ties commissioner, the district court determined that it

had jurisdiction under 28 U.S.C. § 1331.

STATUTORY PROVISIONS INVOLVED

The two critical state and federal statutory provisions

and the Supremacy Clause of the Constitution are stated

below. Additional provisions of the Delaware Securities

Act referenced in this petition are reprinted at App. 89.

Section 7325(b) of the Delaware Securities Act, as

amended, Det. Cove ANN. tit. 6, § 7325(b) (1992 Cum.

Supp.), reads as follows:

(b) The Commissioner may make, amend and

rescind rules, regulations, forms and orders to

carry out and define the provisions of this chap-

ter. Such orders may provide for fines, assess-

ment of costs, restitution to investors,

conditional or probationary registration, censure

or reprimand, special reporting requirements, or

other provisions which the Commissioner deter-

mines to be in the public interest. Any person,

whether registered or not, who wilfully violates

any provision of this chapter, or who aids and

abets any person who wilfully violates any pro-

vision of this chapter, may be fined in accor-

dance with subsection 7316(g) and ordered to

pay restitution and costs (or to rescind the trans-

action or transactions and pay costs) if the Com-

missioner finds it in the public interest, and may

be criminally prosecuted under § 7322.

Section 2 of the Federal Arbitration Act, as amended,

9 U.S.C. § 2 (1970), reads as follows:

A written provision in any maritime transaction

or a contract evidencing a transaction involving

commerce to settle by arbitration a controversy

thereafter arising out of such contract or trans-

action, or the refusal to perform the whole or

any part thereof, or an agreement in writing to

submit to arbitration an existing controversy

arising out of such a contract, transaction, or

refusal, shall be valid, irrevocable, and enforce-

able, save upon such grounds as exist at law or

in equity for the revocation of any contract.

The Supremacy Clause of the United States Constitu-

tion provides that:

This Constitution, and the Law of the United

States which shall be made in pursuance

thereof; and all Treaties made, or which shall be

made, under the Authority of the United States,

shall be the supreme Law of the Land; and the

Judges in every State shall be bound thereby,

any Thing in the Constitution or Laws of any

State to the Contrary notwithstanding.

U.S. Const., art. VI, cl. 2.

STATEMENT OF THE CASE

On August 17, 1992, the Delaware Securities Division

issued administrative charges against Olde Discount Cor-

poration (Olde) and one of its agents alleging violations

of the Delaware Securities Act (Act). (App. 7). The admin-

istrative complaint sought to suspend Olde’s and the

agent’s registrations, impose fines for each violation of

the Act, and rescind the underlying allegedly fraudulent

sales. (App. 87). Eight days later, on August 25, 1992,

without requesting a hearing on the administrative com-

plaint, Olde filed an action in federal district court alleg-

ing violations of its federal rights by the Delaware

securities commissioner and the Division's staff counsel.

(App. 8). On September 16, 1992, the district court issued

a preliminary injunction against the securities commis-

sioner, enjoining him from seeking or ordering rescission

on behalf of the complaining investors. (App. 8-9). The

court ruled that because those investors had signed an

arbitration agreement with Olde, the Federal Arbitration

Act (FAA) preempted the securities commissioner from

seeking rescission as a remedy in his enforcement action.

(App. 72-74). The commissioner appealed, and on July 30,

1993, a fragmented panel of the Court of Appeals for the

Third Circuit, with one judge dissenting, affirmed. (App.

The record in this case consists of affidavits and

supporting documents submitted within 48 hours of the

filing of the original complaint and prior to the district

court’s hearing on Olde’s motion for a temporary

restraining order and preliminary injunction. (App. 49).

On those documents, and without any live testimony, the

district court in its memorandum opinion of September

16, 1992 made numerous findings of fact, some of which

were erroneously labeled “undisputed.”* (App. 49).

1. The Englehardts’ Complaint

Olde Discount Corporation is a securities firm that

maintains a branch office in Wilmington, Delaware. Olde

has been registered as a broker-dealer in Delaware since

October 1981. (App. 50). Although the firm holds itself

out as a discount broker, it makes a market in many

2 For example, although the investors told the Securities

Division investigator that the agent checked the investment

objective of “speculation” without their knowledge after they

had signed the account agreement, the court found as an undis-

puted fact that they had provided this information to the agent.

(App. 51).

securities which its agents recommend to customers.* In

1983, Eugene and Carol Engelhardt opened a joint

account with Olde in Michigan where they were then

living. When the Engelhardts moved to Delaware in 1986,

they transfered the account to Olde’s office in Wilm-

ington. (App. 50). In the spring of 1990, their account was

assigned to Michael Donohoe, the sole agent and branch

manager of the Wilmington office. (App. 50).

The administrative complaint alleged that Donohoe

repeatedly recommended that the Engelhardts purchase

common stock in a savings bank, Second National Fed-

eral Savings Bank (SNFS).* The Engelhardts, who were 56

and 50 years old, were initially reluctant to follow Don-

ohoe’s advice because they had invested most of their

savings into certificates of deposit and some stocks per-

sonally selected by Mr. Engelhardt. (App. 81). Donohoe

persisted, however, telling the couple that it was a local

bank, and he was thus personally knowledgeable about

the stock. Donohoe also said that the research report done

by Olde’s analysts gave the stock a “big buy recommen-

dation.” At another time, Donohoe told the Engelhardts

‘that he had “inside knowledge” that SNFS was about to

be bought by another bank. Donohoe went so far as to

say, “I'll even waive the commission” to induce them to

3 The court of appeals’ conclusion that Olde makes a mar-

ket in only “a few selected stocks” is incorrect. (App. 4). An

advertising brochure entitled “Modern Investing” that Olde

sent to Delaware residents in or about August 1993 listed

approximately 128 over-the-counter stocks in which Olde made

a market.

4 SNFS was a Maryland building and loan association until

1987, when it converted its charter to a federal savings bank.

make the purchase. (App. 82). Though Donohoe repeat-

edly sang the praises of SNFS, he did not tell the

Engelhardts that Olde actually made a market in SNFS.

(App. 83). Olde was thus on the other side of the transac-

tion from the Engelhardts, selling the stock out of its own

inventory with an undisclosed price mark-up. The appar-

ently neutral recommendation from Donohoe was tainted

by a conflict in interest,-and the undisclosed fact that

Olde was a market maker in the stock was a material

omission in violation of Det. Cope ANN. tit. 6, § 7303(2).

(App. 83).

The Engelhardts were eventually won over by Don-

ohoe’s importuning. On May 15, 1990, they bought 2000

shares of SNFS stock at 5'/s per share for $10,622, and

then an additional 3000 shares at 5%/s for $16,308. Don-

ohoe marked the trade tickets as “unsolicited.” (App. 83).

Ten days later, after the two initial purchases of SNFS

stock, and several years after they had started doing

business with Olde, the Engelhardts were asked by Don-

ohoe to sign an “Investors Account Agreement,” which

they did. Prior to May 25, 1990, there was no written

agreement. (App. 50).

2. The Arbitration Agreement And Further

Sales

Although the signature portion of the Agreement,

which was a single two-sided piece of paper, referred to a

””

“Predispute Arbitration Clause,” the actual arbitration

clause was in the form of a printed brochure separate

from the signature page. It provided that the investors

had to submit “any and all controversies or claims arising

out of the relationship established by this agreement to

arbitration to be conducted according to the rules and

procedures of the New York Stock Exchange, Inc. (NYSE)

or of the National Association of Securities Dealers, Inc.

(NASD).” (App. 4).

After the intitial sales and the signing of the Agree-

ment, Donohoe continued to urge the Engelhardts to

purchase more SNFS shares. Donohoe claimed the thrift

was “strong” and that he “knew of things going on,”

alluding to a potential acquisition of SNFS shares by

another bank, which would make their purchase of SNFS

shares “a really good deal.” (App. 84). On Donohoe’s

recommendation, the Engelhardts bought another 5000

shares of SNFS common stock on June 6, 1990 at 5'/s per

share for $26,250. Donohoe marked the trade ticket as

“unsolicited.” (App. 84).

Shortly thereafter, the stock price began to drop, and

it continued to fall as SNFS lost $16 million in income

during the quarter ending September 30, 1990. (App. 80).

By the end of 1990, SNFS stated in its Form 10-K financial

report that it was in violation of capital requirements and

in danger of a regulatory takeover. (App. 81). During this

period, Donohoe never apprised the Engelhardts of these

events but, in response to a call from Mr. Engelhardt,

encouraged them not to sell the stock. (App. 86). The

Engelhardts lost most of the value of their investment as

the share price of SNFS plummeted. (App. 80).

3. The Investigation, Draft Notice, And

Settlement Negotiations

In July 1991, the Engelhardts filed a complaint with

the Delaware Securities Division against Olde and Don-

ohoe. (App. 52). The Division’s investigator made written

inquiries to Olde and Donohoe. (App. 52-53). After the

investigation was completed in May 1992, the Securities

Division staff counsel forwarded to Olde’s counsel a draft

of the “Notice of Intent To Suspend or Revoke Broker-

Dealer Registration.” (App. 53). The notice, which if filed

would trigger an administrative proceeding, charged that

Olde and Donohoe had engaged in fraudulent, dishonest,

and unethical practices in connection with the sales of the

SNFS stocks to the Engelhardts. (App. 83-85). In addition,

it charged Olde with failing to supervise Donohoe rea-

sonably. (App. 84, 86).

In an effort to settle the charges, counsel for Olde and

the Securities Division discussed the complaint for sev-

eral months. In July 1992, Olde offered a $20,000 settle-

ment that would have paid the investors less than

half of their investment loss.° (App.6). As nego-

tiations broke down, Olde served a demand for arbitra-

tion on the Engelhardts. (App. 7). After the collapse of

settlement efforts, the Securities Division staff counsel

5 The district court found that this offer would have fully

compensated the Engelhardts for their loss during the period

when they had an account with Olde, (App. 54, 56), overlooking

the fact that there was subsequently no market for the stock,

making it effectively worthless.

recommended that the administrative notice be issued.®

On August 17, 1992, the commissioner issued the notice

of intent to suspend or revoke the registrations of Don-

ohoe and Olde in Delaware.” (App. 57).

4. Olde’s Action And The Decisions Below

Rather than defend itself on the administrative

charges, Olde filed an action in federal district court on

August 25, 1992, naming the securities commissioner, staff

counsel, and the investors as defendants. The original

complaint alleged, inter alia, that Delaware’s administra-

tive rescission remedy was preempted by the FAA and

6 The district court found that the draft notice sought a

$10,000 fine for each violation of the Act, (App. 53), but the

notice that was issued on August 17, 1992 sought only a $1000

fine for each violation. (App. 87).

7 The Delaware Department of Justice issued a brief press

release on August 17 reporting the initiation of proceedings

against Olde. A newspaper article appeared on August 18 in the

Wilmington News Journal, and in response to that article, Securi-

ties Division staff received additional complaints similar to

those made by the Engelhardts. On December 7, 1992, Securities

Division staff counsel recommended the issuance of a second

administrative complaint, charging Olde and Donohoe with fur-

ther violations committed in the sale of SNFS stock to 17 inves-

tors in Delaware. Also on December 7, 1992, the commissioner

issued the second notice of intent to suspend or revoke the

registration of Olde and Donohoe. The violations alleged in the

second notice involved conduct similar to that which was

alleged in the first administrative complaint.

that Olde’s federal civil rights were violated by the defen-

dants.® (App. 8).

On the basis of affidavits submitted soon after the

filing of Olde’s complaint, the district court issued its

September 16, 1992 memorandum opinion with detailed

findings of fact concerning the investment by the

Engelhardts and the settlement negotiations between

Olde and the Securities Division staff attorney. (App. 48).

The court accepted Olde’s argument as to an identity of

interest between the Engelhardts and the State, and the

court enjoined the securities commissioner from seeking

or ordering rescission on behalf of the Englehardts. (App.

71, 75). According to the district court, the FAA pre-

empted § 7325(b) of the Delaware Securities Act, Det.

Cope ANN. tit. 6, § 7325(b) (1992 Cum. Supp.), as that

statutory provision allowed the commissioner to order

rescission on behalf of individual investors who had

signed predispute arbitration agreements. (App. 74).

The defendants appealed the preliminary injunction

to the Third Circuit Court of Appeals, which issued its

decision on July 30, 1993.9 (App. 1). The court split three

8 Subsequently, on January 26, 1993, the complaint was

amended to allege violations of the Racketeer Influenced and

Corrupt Organizations Act (RICO), 18 U.S.C. §§ 1961-1968, by

the Delaware Division of Securities, which was alleged to be a

criminal enterprise that engages in criminal extortion.

9 In the district court and on appeal the Delaware Depart-

ment of Justice provided representation to the Engelhardts, as

witness victims who were being sued, pursuant to its specific

duty under 29 Det. Cope Ann. §2504(9). Judge Greenberg

thought this fact confirmed the “community of interest”

between the Securities Division and the Engelhardts for pur-

poses of preemption analysis. (App. 17).

ways: Judge Greenberg affirmed on the basis of preemp-

tion; Judge Rosenn concurred on the grounds that con-

tract principles supported the district court’s actions to

prevent the Engelhardts from an “end run” to evade their

contractual obligations; and Judge Nygaard dissented on

the grounds that the Delaware statutory scheme made the

commissioner’s enforcement action in the public interest

a different type of action than a civil suit by the

Englhardts in their own interest. (App. 3). The panel

agreed, however, that Younger abstention did not apply.

(App. 3). The defendants then filed a petition for rehear-

ing, which was denied on August 26, 1993. (App. 46).

As the preliminary injunction has been under appeal,

the administrative action has been stayed for the past

year while Olde pursues its RICO and civil rights claims

on the other counts in the district court. The parties are

now in the midst of discovery.

REASONS FOR GRANTING THE WRIT

This case presents a conflict between strong federal-

ism concerns and arbitration rights under the Federal

Arbitration Act (FAA): may private parties contractually

invalidate a state regulatory agency’s statutory remedy

for securities law violations? Attempting to deal with this

question, the court of appeals has issued a fractured,

three-way decision that promises to confuse and mislead

the other circuits. It is also a major departure from this

Court’s approach in the important areas of arbitration

and abstention. The court of appeals’ decision held that

the FAA precludes state regulators from seeking a rem-

edy that would benefit a victim in the same manner as

would an arbitration award. Ironically, two judges on the

panel below agreed that the state agency was not pre-

empted under the FAA; yet, the district court’s injunc-

tion, which was based on preemption analysis, was

affirmed. Moreover, the concurring opinion was

grounded in contract law, but it ignored the most funda-

mental contract principle: an entity that is not a party or

in privity with a party to a contract cannot be bound by

the terms of the agreement.

The issues in this case extend beyond the administra-

tive remedy in question and beyond the area of securities

law. Four states have administrative restitution or rescis-

sion provisions similar to Delaware’s.!° Twenty-six other

states have provisions in their securities acts specifically

authorizing the agency to seek court-ordered rescission,"

while three additional state statutes allow the agency to

seek disgorgement.'? Most of the remaining states have

adopted § 408 of the Uniform Securities Act, 1 Blue Sky L.

Rep. (CCH) { 5548, allowing the agency to seek ancillary

10 See Ariz. Rev. Stat. ANN. § 44-2032(1) (1987) and Ariz.

Comp. Apmin. R. & Recs. § 14-4-308; D.C. Cope ANN. § 2-2614

(1981); INp. Cope ANN. § 23-2-1-17.1(a) (Burns 1993 Cum. Supp.);

and Va. Cove ANN. § 13.1-521(c) (1993).

11 These states are: Alabama, California, Colorado, Con-

necticut, Florida, Georgia, Illinois, Indiana, lowa, Kansas,

Maine, Massachusetts, Mississippi, New Mexico, New York,

North Carolina, Oklahoma, Oregon, Pennsylvania, Rhode

Island, South Dakota, Texas, Utah, Vermont, Washington, and

Wisconsin.

12 See Ark. Cove § 23-42-209(b) (1987); Micu. Comp. Laws

§ 451.808(a) (1979); Tenn. Cope ANN. § 48-2-119(b) (1988).

relief in connection with the granting of an injunction.}3

Such ancillary relief has been interpreted to include resti-

tution and rescission.!4

Since bank credit card agreements have begun to

include arbitration clauses, the court of appeals’ decision

also bears directly on state consumer protection law. The

rationale of the two affirming opinions below would

apply to any consumer protection action brought by a

state attorney general seeking restitution if the consumer

victims had agreed to an arbitration clause.!> It would

also seem to extend to court-ordered restitution in a

criminal case (for example, securities fraud under Det.

Cove ANN. tit. 6, § 7322, a different section of the same

statute under which the Securities Division brought the

instant administrative action). This important issue in

federal law should not be determined by a confusing

opinion that blatantly disregards this Court’s holdings in

Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. __, 111

S.Ct. 1647, 114 L.Ed.2d 26, 38, 41 (1991) (EEOC may

prosecute action and seek equitable relief on basis of

complaint that is also subject of arbitration); Porter v.

Warner Holding Co., 328 U.S. 395, 402 (1946) (restitution in

the public interest is not the equivalent of damages

13 This Act has been adopted in 41 states and territorial

jurisdictions. See 1 Blue Sky L. Rep. (CCH) ¥ 5500 (1992).

14 See, e.g., Porter v. Warner Holding Co., 328 U.S. 395 (1946);

Mitchell v. Robert De Mario Jewelry, Inc., 361 U.S. 288 (1960); State

ex rel. Day v. Southwest Mineral Energy, Inc., 617 P.2d 1334 (Okla.

1980). See also 12A J. Lona, Biue Sky Law § 9.05[6] (1992).

15 Rescission is a form of restitution. D. Dosss, Remepies 222

(1973). The petitioner interprets the district court’s preliminary

injunction as barring restitution orders generally.

sought by a private party, even where the facts are the

same); Kelly v. Robinson, 479 U.S. 36, 52 (1986) (restitution

distinguishable from damages judgment for private indi-

vidual); Ohio Civil Rights Commission v. Dayton Christian

Schools, Inc., 477 U.S. 619, 627-28 (1986) (Younger absten-

tion applies even where federal right would have to be

asserted in state administrative proceeding); and New

Orleans Public Service, Inc. v. Council of City of New

Orleans, 491 U.S. 350, 365 (1989) (preeniption claim is no

different than other constitutional claims for purposes of

Younger abstention).

The Delaware Securities Act

Historically, the states have exercised their police

powers to regulate securities to protect the investing

public. “State securities laws, commonly referred to as

‘blue sky’ laws, were enacted long before the Securities

Act of 1933, and Congress specifically preserved those

laws instead of attempting to preempt the field from

federal legislation.” L. Loss & E. Cowertt, Bur Sky Law 3

(1958). Both the Securities Act of 1933 and the Securities

Exchange Act of 1934 expressly preserve the traditional

rights of the states to regulate securities transactions

within their own jurisdictions. See 1933 Act, 15 U.S.C.

§ 77r (1981); 1934 Act, 15 U.S.C. § 78bb(a) (1981 & 1992

Cum. Supp.). Accordingly, there is a presumption that in

enacting the FAA, Congress did not intend to preempt the

regulatory power of the states to enforce their securities

laws to protect the public interest.

The Delaware Securities Act (Act) is a “blue sky” law

which “with some specificity . . . requires registration of

securities offered or sold [in Delaware], states that certain

representations are unlawful, creates a registration pro-

cedure for broker-dealers and investment advisors, and

provides for administration by the Attorney General or a

designated Deputy.” Singer v. Magnavox Co., 380 A:2d 969,

981 (Del. 1977). The purpose of the Act is “to prevent the

public from being victimized by unscrupulous or over-

reaching broker-dealers, investment advisers or agents in

the context of selling securities or giving investment

advice, as well as to remedy any harm caused by securi-

ties law violations.” Det. Cope Ann. tit. 6, § 7301(b). The

statute contains one section that permits civil damages to

a private litigant from a person who “offers, sells or

purchases a security” by fraud. Det. Cope Ann. tit.6,

§ 7323(a). In addition to that limited private civil cause of

action, the Act creates an administrative regulatory

scheme and bestows broad enforcement powers on the

securities commissioner. “In the public interest,” the com-

missioner may 1) seek an injunction in Delaware’s Court

of Chancery (§ 7320), 2) seek a criminal indictment

(§ 7322), or 3) “by order deny, suspend, or revoke any

registration” in an administrative proceeding (§ 7316). As

a sanction for a proven state law violation, in an adminis-

trative proceeding under § 7316, the commissioner is

authorized to impose, inter alia, an award of rescission or

restitution in the public interest. Det. Cope ANN. tit. 6,

§ 7325(b). Similarly, the Court of Chancery, in an injunc-

tive proceeding brought by the commissioner, may order

rescission or restitution when appropriate in the public

interest. Det. Cope ANN. tit. 6, § 7320. And, in any crimi-

nal prosecution under the Act, the Superior Court may

similarly order restitution to defrauded investors as part

of the sentence. Det. Cope ANN. tit. 6, § 7322(e).

In this case, the Securities Division initiated an

administrative action under § 7316 and § 7325(b) before

the commissioner. Although a private civil action under

§7323 by investors (such as the Engelhardts) is precluded

by an arbitration agreement under the FAA, the commis-

sioner’s public enforcement action under § 7316 and

§ 7325(b) should not be preempted.

I. The Court Should Grant The Writ To Clarify That A

Federal Court May Not Enjoin A State Securities

Commissioner From Ordering Restitution For Inves-

tor Victims On The Grounds That Private Parties

Have Contracted Away The State’s Enforcement

Remedy Which Is Authorized By Statute.

The court of appeals’ holding effectively creates a

new, super-protected federal right to arbitrate. It over-

rides the Younger abstention doctrine as well as a stat-

utorily-authorized remedy under a state regulatory

scheme. This case marks the first time that FAA rights

have been successfully asserted, not to deflect state inter-

ference with the arbitration forum,!° but to assert the

primacy of arbitration rights over any possible arguable

'© See, e.g., Securities Industry Ass’n v. Connolly, 883 F.2d 1114

(1st Cir. 1989), cert. denied, 495 U.S. 956 (1990) (FAA held to preempt

Massachusetts regulation prohibiting brokers from requiring inves-

tors to sign an arbitration agreement as condition of opening an

account); Osterneck v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 841

F.2d 508 (3d Cir. 1988) (FAA held to preempt Pennsylvania Securi-

ties Act provision that precluded enforcement of agreement to arbi-

trate state law securities claims).

conflict in outcome between arbitration and a neutral

state regulatory procedure. In this case, the Delaware

statute did not even mention or address arbitration.

Under the court of appeals’ decision, the arbitration right

is superior to all other contract rights and, indeed, to

constitutional rights.

A. Restitution Is Not Equivalent To A Judgment

For Damages.

‘

Both the preemption and the “contractually bound”

rationales of the two opinions which affirm the injunction

rest on the unsound assumption that the rescission which

the commissioner could order in the public interest is

nothing more than the same remedy the Engelhardts

could seek in an arbitration forum. As this Court has

held, however, restitution in the public interest differs

greatly from damages sought by private parties. Porter v.

Warner Holding Co., 328 U.S. 395, 402 (1946). Indeed, in

Porter this Court upheld an award of restitution to over-

charged tenants in an action by a government price con-

trol administrator even though the tenants themselves

could not have brought their own actions to recover the

same payments. The action undertaken in the public

interest was not the same as a private cause of action.

More recently, in Kelly v. Robinson, 479 U.S. 36, 52 (1986),

this Court stated that even though “restitution does

resemble a judgment ‘for the benefit of’ the victim, the

context in which it is imposed undermines that conclu-

sion. The victim has no control over the amount of the

restitution awarded or over the decision to award restitu-

tion.”

+ ee

B. The Court Of Appeals’ Departure From Gilmer.

The court of appeals’ approach is also contrary to this

Court’s statement in Gilmer v. Interstate/Johnson Lane

Corp., 500 U.S. ____, 111 S.Ct. 1647, 114 L.Ed.2d 26 (1991),

that administrative agencies, enforcing the public inter-

est, are free to pursue issues and fashion remedies even

though the transaction in question may also fall within an

arbitration agreement. This Court held in Gilmer that an

arbitration agreement between a securities representative

and his employer required the employee to arbitrate a

statutory claim under the Age Discrimination in Employ-

ment Act (ADEA); but the contractual clause did not

preclude the employee from filing a complaint with the

Equal Employment Opportunity Commission (EEOC)

alleging the same statutory violation, nor did it “preclude

the EEOC from bringing actions seeking class-wide and

equitable relief.” 114 L.Ed.2d at 41. This is because “the

ADEA is designed not only to address individual griev-

ances, but also to further important social policies.” Id. at

38. Thus, “[a]n individual ADEA claimant subject to an

arbitration agreement will still be free to file a charge

with the EEOC, even though the claimant is not able to

institute a private judicial action.” Id.

Like the EEOC, the Delaware securities commissioner

“does not function simply as a vehicle for conducting

litigation on behalf of private parties.” Occidental Life

Insurance Co. v. EEOC, 432 U.S. 355, 368 (1977). See also

General Telephone Co. v. EEOC, 446 U.S. 318, 326 (1980)

(“When the EEOC acts, albeit at the behest of and for the

benefit of specific individuals, it acts also to vindicate the

public interest in preventing employment discrimina-

tion.”). The commissioner acts on behalf of the public

when he awards restitution or rescission in favor of a

defrauded investor. Such remedies, as they return the

parties to the status quo, help to deter and eliminate the

harmful consequences of securities fraud. These objec-

tives are explicitly defined as part of the “public interest”

by the Delaware General Assembly in the Delaware Secu-

rities Act. Det. Cope ANN. tit. 6, § 7301(b). While these

remedies may give an incidental compensatory benefit to

the individual investors, such relief does not give them

control of the regulatory action or make their interests

equivalent to the State’s broader interest in protecting the

investing public from securities fraud. Under the Dela-

ware scheme, the private investors do not control

whether their complaint will be investigated, whether a

prosecution will eventually be initiated, what remedies

the Division will seek, or what remedies the commis-

sioner and reviewing courts may impose. Suits by gov-

ernment regulators “frequently have specific private as

well as public beneficiaries,” but the “touchstone remains

the fact that public policies are served and the public

interest is advanced by the litigation, and the fact that the

fitrgation has private beneficiaries as well does not

detract from the public nature of the suit.” Dole v. Local

427, 894 F.2d 607, 612 (3d Cir. 1990).

C. Rescission Does Not Render The Arbitration

Agreement Meaningless.

The gist of the two affirming opinions in the court of

appeals is that the contractual right to arbitrate will be

meaningless if the Delaware commissioner in a regula-

tory action may order rescission on the same facts that

might be the basis of an arbitration. That view is incor-

rect, however, legally and practically. From a legal per-

spective, the agreement to arbitrate runs only against

those who were parties to the contract. From a practical

perspective, a brokerage firm may still derive a substan-

tial benefit from an arbitration agreement even if it

remains subject to state-ordered rescission in the public

interest.

The great benefit of an arbitration agreement is the

savings in the cost of litigating in an arbitration forum

rather than in a judicial lawsuit. This benefit is especially

valuable to a large brokerage firm with many clients.

Inevitably, such a firm will be faced with meritless claims

based on the fact of a client’s loss and nothing more.

These are the sort of claims that, if they end up in

prolonged court battles, can financially damage a busi-

ness significantly regardless of the level of care taken by

its managers. The state regulators, however, exercise a

screening function to weed out the frivolous compiaints,

the sour grapes, and the fodder for nuisance suits. Unlike

private attorneys who may see a large contingency tee in

these meritless complaints, the state regulators have no

personal financial interest in advancing them. Thus, the

real benefit of an arbitration agreement as a practical

matter is its effect on litigation initiated by private par-

ties, not on actions which may be initiated by state gov-

ernment officials. It is appropriate that the scope of this

practical benefit be limited to those who have agreed to

it, the private parties themselves.

D. The Right To Arbitrate Is Equal, Not Superior,

To Other Contract Rights.

The FAA was intended by Congress “to make arbitra-

tion agreements as enforceable as other contracts, but not

more so.” Prima Paint Corp. v. Flood & Conklin Manufactur-

ing Co., 388 U.S. 395, 404 n.12 (1967). The FAA “simply

requires courts to enforce privately negotiated agree-

ments to arbitrate, like other contracts, in accordance

with their terms.” Volt Information Sciences, Inc. v. Stanford

University, 489 U.S. 468, 478 (1989).

One of the most elementary of contract principles is

that a third party not in privity to a contract between two

others is not bound by the terms of their agreement.

Here, the securities commissioner never agreed to be

bound by the terms of any contract between Olde and the

Engelhardts. Moreover, the commissioner and the

Engelhardts were not in privity, nor did they have an

identity of interest. The court of appeals mischaracterized

the administrative proceeding, saying that it was “initi-

ated on the complaint of the Engelhardts,” and that the

State “is pursuing” civil claims “on behalf” of the

Engelhardts. (App. 17). In fact, the Engelhardts’ com-

plaint triggered only an investigation by the Securities

Division. The Division made the decision whether to file

a notice (with the commissioner’s approval), and the

commissioner and reviewing state courts would make the

decision whether an order of rescission would be neces-

sary to protect the public interest. As Judge Nygaard

stated in dissent, “[T]he Delaware statutory scheme

makes clear that the Commissioner is not a surrogate for

a plaintiff’s attorney, but is a public official who adminis-

ters the state’s blue sky laws ‘in the public interest’ and is

endowed with broad enforcement and rulemaking

powers.” (App. 38, citing Blinder, Robinson & Co. v.

Bruton, 552 A.2d 466, 475 (Del. 1989).)

E. There Is A Strong Public Interest In The

Remedies Of Rescission And Restitution.

Although the lower courts have focused on the rem-

edy of rescission, the Olde arbitration agreement itself

did not. Rather, the contract stated that “any and all

controversies or claims arising out of the relationship”

had to go to arbitration. (App. 4). On its face, this lan-

guage would extend to any hearing involving the same

factual dispute as would be involved at an arbitration.

Both lower courts in this case have held, however, that

this language does not preclude a hearing that would

result in a finding that Olde and Donohoe violated the

Delaware Securities Act and in the imposition of a license

suspension or a fine, but does preclude making the vic-

tims whole. The logic of this distinction, permitting paral-

lel proceedings for some sanctions but not restitution, is

elusive. This Court has held that a public interest inheres

in the remedy of restitution just as it does in the remedies

of a license suspension or a fine. See Kelly v. Robinson, 479

U.S. 36, 52 (1986); Porter v. Warner Holding Co., 328 U.S.

395, 402 (1946).

Not only does case law support the view that restitu-

tion is a necessary enforcement remedy that advances the

public interest, but practical considerations do as well.

The public interest may be better served by reducing or

avoiding the more severe sanction of a license suspension

or revocation. If a state securities administrator’s hands

are tied by the federal courts with respect to making

victims whole through an order of restitution, brokerage

firms may risk a greater chance of receiving a license

suspension or, if restitution is available only in criminal

prosecutions, of being prosecuted criminally. Through

their flawed decision, the federal courts will have skewed

decisionmaking among state securities regulators in a

manner detrimental to the public interest.

II. The Court Should Grant The Writ To Clarify That A

Federal Court May Not Enjoin A State Securities

Commissioner From Ordering Restitution For

Investor Victims In Advance Of The State’s Admin-

istrative Hearing On The Grounds That An Alleged

Securities Law Violator’s Federal Arbitration Act

Preemption Claim Is Subject To An “Immediate

Irreparable Injury.”

This case illustrates the utter disregard by the Court

of Appeals for the Third Circuit of the Younger v. Harris,

401 U.S. 37 (1971), abstention doctrine, especially as it

was articulated by this Court in Ohio Civil Rights Commis-

sion v. Dayton Christian Schools, Inc., 477 U.S. 619, 627-28

(1986), and New Orleans Public Service, Inc. v. Council of

City of New Orleans, 491 U.S. 350, 365 (1989) (NOPSI). In

the instant case, the court of appeals has held that Youn-

ger abstention is discretionary even when all elements

that normally counsel abstention are present. (App. 25).

Moreover, the court of appeals has effectively violated

this Court’s instruction in NOPSI that preemption claims

are to be treated no differently than other constitutional

claims for purposes of abstention under Younger.

To avoid application of the Younger doctrine, here the

court of appeals carved out a new exception for FAA

preemption claims. The court tried to avoid the impact of

NOPSI by asserting that that decision “did not confront a

collision between the normal application of Younger prin-

ciples and the highly favored right to arbitration which

the [Supreme] Court itself has developed in FAA

cases... . “(App. 30). Thus, even though this Court views

preemption claims as similar to other constitutional

claims for abstention purposes, the court of appeals

thinks this principle does not apply to FAA claims that

possibly have merit. Apparently, in its view, the right to

arbitrate has acquired a status that is superior to such

rights as due process and equal protection. Reaching for

authority for this anomalous proposition, the court of

appeals cites Wooley v. Maynard, 430 U.S. 705 (1977), to

assert that this case is the “very unusual situation” where

“an injunction is necessary to prevent great and immedi-

ate irreparable injury.” (App. 25, quoting Dayton Christian

Schools, 477 U.S. at 626). The great and immediate irrepar-

able injury, it seems, is the fact that Olde would have to

assert its FAA preemption defense at the state administra-

tive proceeding and in the reviewing state courts. How-

ever, this Court in Dayton Christian Schools held that this

type of alleged injury is insufficient to avoid application

of Younger abstention. 477 U.S. at 627-28.

CONCLUSION

For the foregoing reasons, this Court should grant

this petition for a writ of certiorari.

Respectfully submitted,

CHarLes M. Ober y, III

Attorney General of the

State of Delaware

RiCHARD E. FAIRBANKS, JR.

Chief of Appeals Division

Counsel of Record

Delaware Department of Justice

820 North French Street

Wilmington, DE 19801

(302) 577-2500

Counsel for Petitioner

Date: October 28, 1993

APPENDIX

INDEX TO APPENDIX

Page

Opinion, Olde Discount Corp. v. Tupman, No.

Sa-iaos (om Cit, fily OO, T9953). 006 ec csccsees App.

Order Amending Concurring Opinion, Olde Dis-

count Corp. v. Tupman, No. 92-7557, Rosenn, J. (3d

Co. POE Fy BOP sk sob asescncdesheeeeans App.

Order Denying Petition for Rehearing, Olde Dis-

count Corp. v. Tupman, No. 92-7557 (3d Cir.

PE Se, PN 6 0b ao bao Seder arabe abe App.

Opinion, Olde Discount Corp. v. Tupman, 805 F.

Se. BEBO CREME. BE e bce anne pes ee ees App.

Order, Olde Discount Corp. v. Tupman, No. 92-498-

SLR (D.Del. September 16, 1992) (enjoining Dela-

ware Securities Commissioner from ordering

CR: 3 5 a eV kos 6 0k as Po eee ec seadesun App.

Notice of Intent to Suspend or Revoke Broke r-

Dealer Registration, In the Matter of: Olde Discount

Corp. and Michael R. Donohoe, No. 91-07-01 (Del.

sec. Comms. Ameust 17, T99Z) occ ccscccacses App.

Order (that hearing be held), In the Matter of:

Olde Discount Corp. and Michael R. Donohoe,

No. 91-07-01 (Del. Sec. Comm. August 17,

Pos oe caw os heaped eauaevedeesousess App.

Additional Provisions Of The Delaware Securities

Poet, TA POTtOE FORE, . occ a ccc cvcccevcsceuce App.

App. 1

Filed July 30, 1993

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 92-7557

OLDE DISCOUNT CORPORATION

W. MICHAEL TUPMAN, and as Deputy Attorney

General of the State of Delaware; RICHARD W.

HUBBARD, Securities Commissioner of the State

of Delaware; EUGENE H. ENGELHARDT

and CAROL D. ENGELHARDT,

W. MICHAEL TUPMAN,

individually and as Deputy

Attorney General of the

State of Delaware; RICHARD

W. HUBBARD, Securities

Commissioner of the State of

Delaware; EUGENE H.

ENGELHARDT, CAROL D.

ENGELHARDT,

Appellants

On Appeal from the United States District Court

for the District of Delaware

(D.C. Civil No. 92-00498)

Argued June 10, 1993

BEFORE: GREENBERG, NYGAARD, and ROSENN,

Circuit Judges

(Filed: July 30, 1993)

App. 2

Richard E. Fairbanks, Jr.

(argued)

Chief of Appeals Division

Loren C. Meyers

Deputy Attorney General

Delaware Department of Justice

820 North French Street

Wilmington, DE 19801

Attorneys for Appellants

James S. Green

Duane, Morris & Heckscher

1201 Market Street

Suite 1500

P.O. Box 195

Wilmington, DE 19899

Robert P. Bramnik (argued)

Thomas P. Fitzgerald

Michael I. Behn

Altheimer & Gray

10 South Wacker Drive

Suite 4000

Chicago, IL 60606

Attorneys for Appellee

Joseph C. Long

300 Timberdell Road

Norman, OK 73019

Attorney for amici curiae

North American Securities

Administrators Association, Inc.

and National Consumers League

App. 3

OPINION

GREENBERG, Circuit Judge.

This case presents a novel question of the relation-

ship between a contracting party’s right to enforcement

of an arbitration agreement under the Federal Arbitration

Act, 9 U.S.C. §§ 1-16 (FAA), and a state’s interest in

pursuing a remedy of rescission in an administrative

proceeding. The district court enjoined the Delaware >

securities commissioner from seeking rescission on behalf

of two investors who had entered into a predispute arbi-

tration agreement. We will affirm the district court’s

order. Judge Greenberg votes to affirm on the grounds

that the FAA preempts Delaware’s rescission remedy in

these circumstances and this opinion reflects the reasons

why he has reached this conclusion. Judge Rosenn votes

to affirm on the ground that the rescission remedy is

barred by reason of contract law as set forth in his sepa-

rate concurring opinion. Judge Nygaard dissents on this

issue for the reasons set forth in his separate opinion. We

unanimously hold that this claim, i.e., that a state statute

is preempted to the extent it authorizes relief in conflict

with rights secured by the FAA, necessarily falls within

an exception to the abstention doctrine of Younger v.

Harris, 401 U.S. 37, 91 S.Ct. 746 (1971).

I. BACKGROUND

Appellee Olde Discount Corporation, a securities

broker-dealer, is a Michigan corporation with its principal

App. 4

place of business in Detroit and numerous offices

throughout the United States. Olde Discount is registered

in Delaware as a broker-dealer and has an office in Wil-

mington. Appellants Eugene and Carol Engelhardt are

former customers of Olde Discount. The Engelhardts,

then Michigan residents, opened a brokerage account

with Olde Discount’s Detroit office in 1983. When they

moved to Wilmington in 1986, the Engelhardts trans-

ferred their account to its Wilmington office.

Olde Discount is primarily, as its name implies, a

discount broker. It also makes a market in a few selected

stocks; at the times relevant to this action, Second

National Federal Savings Bank (SNFS) was among those

stocks. Allegedly at the instance of Olde Discount’s

Wilmington office manager, Michael Donohoe, the

Engelhardts purchased 5,000 shares of SNFS stock on

May 15, 1990. On May 25, 1990, the Engelhardts signed an

account agreement with Olde Discount that required

them “to submit any and all controversies or claims aris-

ing out of the relationship established by this agreement

to arbitration to be conducted according to the rules and

procedures of the New York Stock Exchange, Inc. (NYSE)

or of the National Association of Securities Dealers, Inc.

(NASD). ...” Investors Account Agreement, J 18, J.A. at

53. Also on May 25, 1990, the Engelhardts provided Olde

Discount with a “customer preference profile” that

expressed their interest in “aggressive” investments for

the purposes of “growth” and “speculation.” J.A. at 48.

On June 6, 1990, the Engelhardts purchased an additional

5,000 shares of SNFS. Thus, by early June 1990, the

Engelhardts had purchased 10,000 shares of SNFS. These

purchases cost the Engelhardts over $50,000.

App. 5

The price of SNFS stock declined steadily during the

summer and fall of 1990, as the bank suspended its divi-

dend and came under the scrutiny of federal regulators

because it failed to fulfill capital requirements. The

Engelardts, apparently because of their bad experience

with this investment, terminated their Olde Discount bro-

kerage account and removed their SNFS shares from Olde

Discount on September 6, 1990. By then the Engelhardts’

SNFS stock had declined in value to approximately

$32,500.

Nearly a year later, in July 1991, the Engelhardts first

contacted the Division of Securities of the Delaware

Department of Justice with a complaint about their pur-

chase of SNFS stock from Olde Discount. The Division,

primarily through appellant Michael Tupman, a Delaware

Deputy Attorney General responsible for securities law

enforcement, investigated the Engelhardts’ complaint. In

early June 1992, after the Division substantially had com-

pleted its investigation, it sent Olde Discount a draft

“Notice of Intent to Suspend or Revoke Broker-Dealer

Registration.” The draft Notice of Intent alleged that Olde

Discount and its agent Donohoe had engaged in fraudu-

lent and unethical practices in connection with the sales

of SNFS stock to the Engelhardts, in violation of Del.

Code Ann. tit. 6, §§ 7303(2) and 7316(a) (1974 & Supp.

1992).

In particular, the Notice asserted that Donohoe

repeatedly had urged the Engelhardts to invest in SNFS

and had made false statements of material fact about the

stock. Further, the Notice alleged that Olde Discount had

not kept the Engelhardts advised of information that

could have been pertinent to their decision whether to

App. 6

hold or sell the stock. The Notice indicated that the

Delaware securities commissioner sought the remedies of

suspension or revocation of Olde Discount’s broker-

dealer registration and imposition of fines; and, central to

the preemption question in this case, that the commis-

sioner would seek rescission of the SNFS stock transac-

tions between Olde Discount and the Engelhardts, as

authorized by Del. Code Ann. tit. 6, § 7325(b). The Notice,

however, did not suggest that either Olde Discount or

Donohoe had violated any duty to customers other than

the Engelhardts; the Notice thus proposed individual

relief for the Engelhardts only.

During the summer of 1992, the Division of Securities

and Olde Discount tried to negotiate a settlement of the

proposed charges. Ultimately Olde Discount, desiring to

bring the settlement negotiations to fruition, offered to

pay $15,000 to the Delaware Investors Protection Fund

and to pay $20,375 to the Engelhardts.! The proposed

payment to the Engelhardts represented the difference

between the total price they had paid for the SNFS stock,

and its value of approximately $32,500 on September 6,

1 In their opening brief, the appellants asserted that the

district court’s consideration of events that occurred during

settlement negotiations was contrary to Fed. R. Evid. 408, which

prohibits the admission of “[e]vidence of conduct or statements

made in compromise negotiations. . . .” However, as counsel for

Olde Discount has noted, the appellants have not preserved this

evidentiary point because they did not object to the introduction

of these facts before the district court. In any event, these facts

are background information, helpful to an understanding of the

context of the dispute; they are not critical to our disposition, as

we anchor our result on legal principles.

App. 7

1990, when the Engelhardts had closed their brokerage

account with Olde Discount.

The appellants do not dispute that Tupman agreed in

principle to accept $15,000 in partial settlement of the

Division’s proposed charges. Nevertheless, Tupman insis-

ted that Olde Discount also must rescind the Engelhardts’

SNFS purchases. This demand was not acceptable to Olde

Discount, which apparently had consistently maintained

that the securities commissioner could not properly pur-

sue a rescission, because Olde had a contractual right to

arbitrate the Engelhardts’ claims. Tupman, however,

viewed Olde Discount’s claims of its contractual right to

arbitration and of the federal preemption of Delaware’s

rescission remedy as “baffling.” See Tupman’s August 7,

1992 letter to Olde Discount, J.A. at 111. He consequently

would not abandon the demand that it rescind the SNES

sales to the Engelhardts.

Olde Discount determined to pursue its right to arbi-

tration, and served the Engelhardts with a demand to

arbitrate on August 5, 1992. Shortly thereafter, on August

17, 1992, Tupman issued the Notice of Intent in substan-

tially the same form as the June 1992 draft, i.e., including

the demand for rescission of the Engelhardts’ SNFS trans-

actions. Notice of Intent, | 43, J.A. at 139. The Notice

provided that Olde Discount would be entitled to a hear-

ing before the Delaware securities commissioner if it

made a written request within 30 days. However, if Olde

Discount did not request a hearing, the allegations would

be deemed admitted and the commissioner would issue a

final order of suspension,” revocation, rescission, fine

and/or costs.

App. 8

On August 25, 1992, Olde Discount commenced this

action against Tupman, Delaware Securities Commis-

sioner Richard W. Hubbard, and the Engelhardts. The

complaint’s four counts alleged that: (1) the rescission

remedy of Del. Code Ann. tit. 6, § 7325(b), as applied by

the defendants, circumvents Olde Discount’s rights under

the FAA and thus violates the Supremacy Clause; (2) the

application of Del. Code Ann. tit. 6, § 7325(b), to Olde

Discount’s transactions with the Engelhardts in SNFS

stock would constitute an ex post facto punishment in

violation of the Due Process Clause;? (3) Tupman and

Hubbard had violated 42 U.S.C. § 1983 by employing the

Delaware securities laws in a manner that impaired Olde

Discount’s federal constitutional and statutory rights; and

(4) Tupman’s actions constituted a common law abuse of

process. Olde Discount sought an injunction, a declara-

tory judgment, compensatory damages, and punitive

damages.

Olde Discount most immediately was concerned with

preserving its federal right to arbitration of the

Engelhardt dispute. It therefore vigorously pressed for a

preliminary injunction to halt further proceedings before

the Delaware Division of Securities. After expedited

briefing and argument, the district court, by order dated

September 16, 1992, accompanied by a comprehensive

memorandum opinion, partially granted Olde Discount’s

motion for preliminary relief, enjoining “the Securities

2 Olde Discount contends that at the time of its transactions

with the Engelhardts, Delaware law did not provide for a rescis-

sion remedy in proceedings concerning suspension or revoca-

tion of the registration of a broker.

App. 9

Commissioner[] [from pursuing] a rescission action under

[Del. Code Ann. tit. 6, § 7325(b)] on behalf of defendants

Engelhardt, individual investors who are parties to a

predispute arbitration agreement with plaintiff, which

agreement is enforceable under the Federal Arbitration

Act, 9 U.S.C. §2.” In its opinion, the district court deter-

mined that the FAA preempted the Delaware rescission

remedy. Furthermore, the district court declined to abs-

tain under Younger from issuing injunctive relief. Tup-

man, Hubbard, and the Engelhardts jointly appealed

from the September 16, 1992 order, contending that the

district court “erred as a matter of law” both in declining

to abstain under Younger and in holding that the rescis-

sion remedy was preempted.

Il. JURISDICTION AND STANDARD OF REVIEW

Before turning to the merits of the preemption and

abstention issues, we must resolve a challenge to our

jurisdiction raised by Olde Discount. It argues that the

appeal is from an interlocutory order “directing arbitra-

tion to proceed,” which is specifically nonappealable

under 9 U.S.C. § 16(b)(2). However, contrary to Olde

Discount’s characterization, the district court's order in

this case is not an order “directing arbitration to pro-

ceed.” Rather, the district court directed the Delaware

securities commissioner not to pursue a remedy of rescis-

sion in the administrative proceedings. Thus, the order

falls within the usual rule of 28 U.S.C. § 1292(a)(1), which

permits immediate appeals from “[i]nterlocutory

orders... granting [or] refusing .. . injunctions.”

App. 10

Our review of a determination regarding preliminary

injunctive relief is limited to examining whether the dis-

trict court abused its discretion, committed an obvious

error in applying the law, made a clear mistake in consid-

ering the proof, or improperly applied the law to the

facts. Kreimer v. Bureau of Police of Morristown, 958 F.2d

1242, 1250 n.9 (3d Cir. 1992); Philadelphia Marine Trade

Ass'n v. Local 1291, Int'l Longshoremen’s Ass’n, 909 F.2d

754, 756 (3d Cir. 1990), cert. denied, 111 S.Ct. 953 (1991).

This standard requires a plenary review here, as the

appellants contend that the district court erred as a mat-

ter of law in entering the injunction. We also exercise

plenary review over the abstention question because we

are resolving that issue by making a legal determination.

General Glass Indus. Corp. v. Monsour Medical Found., 973

F.2d 197, 200 (3d Cir. 1992); Gwynedd Properties, Inc. v.

Lower Gwynedd Township, 970 F.2d 1195, 1199 (3d Cir.

1992).

Il. PREEMPTION

The Supremacy Clause allows Congress to preempt

state legislation if it so intends.* See United States Dep’t of

Treasury v. Fabe, 61 U.S.L.W. 4579 (U.S. June 11, 1993). The

development of the law of federal preemption has

defined three ways of discerning a congressional intent to

preempt state law: express or explicit preemption,

implied preemption, or “actual conflict” preemption. The

3 While as a matter of convenience this section of the opin-

ion entitled “III. PREEMPTION” is written as if for the court, it

in fact is the opinion only of Judge Greenberg.

App. 11

Supreme Court thus has differentiated among the three

types of preemption:

Congress explicitly may define the extent to

which its enactments pre-empt state law. . . . In

the absence of explicit statutory language, how-

ever, Congress implicitly may indicate an intent

to occupy a given field to the exclusion of state

law. Such a purpose properly may be inferred

where the pervasiveness of the federal regula-

tion precludes supplementation by the states,

where the federal interest in the field is suffi-

ciently dominant, or where ‘the object sought to

be obtained by the federal law and the character

of obligations imposed by it. . . reveal the same

purpose’... . Finally, even where Congress has

not entirely displaced state regulation in a par-

ticular field, state law is pre-empted when it

actually conflicts with federal law. Such a con-

flict will be found ‘ “when it is impossible to

comply with both state and federal law .. . or

where the state law stands as an obstacle to the

accomplishment of the full purposes and objec-

tives of Congress....”’

Schneidewind v. ANR Pipeline Co., 485 U.S. 293, 299-300,

108 S.Ct. 1145, 1150-51 (1988) (citations omitted).

The preemption claim before us is that the FAA

demands enforcement of an agreement to arbitrate which

cannot be abrogated by a state agency’s pursuit of an

administrative remedy that would duplicate the remedy

sought in an arbitration. Section 2 of the FAA, 9 U.S.C.

§ 2, directs the enforcement of arbitration agreements as

broadly as Congress’ powers under the Commerce Clause

permit:

App. 12

A written provision in... a contract evidencing

a transaction involving commerce to settle by

arbitration a controversy thereafter arising out

of such contract or transaction, or the refusal to

perform the whole or any part thereof, or an

agreement in writing to submit to arbitration an

existing controversy arising out of such a con-

tract, transaction, or refusal, shall be valid, irre-

vocable, and enforceable, save upon such

grounds as exist at law or in equity for the

revocation of any contract.

Olde Discount contends that the FAA’s directive compels

enforcement of the arbitration clause of the Engelhardts’

account agreement. Thus, if the Delaware securities com-

missioner pursues rescission in the administrative pro-

ceeding, Olde Discount’s federal right to arbitration

would be impaired, as the merits of the claim that the

arbitration agreement reserves for an arbitral forum will

be resolved administratively.

Yet it is clear that the FAA does not explicitly pre-

empt any particular remedy that might be sought in state

administrative proceedings. Nor does the FAA entirely

occupy the field of securities regulation so as to give rise

to implied preemption; to the contrary, both the Securities

Act of 1933 and the Securities Exchange Act of 1934

specifically preserve the traditional rights of the states to

regulate securities transactions within their own jurisdic-

tions. See, e.g., 1933 Act, 15 U.S.C. § 77r (“[n]Jothing in this

subchapter shall affect the jurisdiction of the securities

commission .. . of any State or Territory ... over any

security or any person”); 1934 Act, 15 U.S.C. § 78bb(a)

(“[nJothing in this chapter shall affect the jurisdiction of

the securities commission . . . of any State over any

—————rrrrrrr—

App. 13

security or any person insofar as it does not conflict with

the provisions of this chapter”). In fact the FAA is not

concerned in particular with securities regulation as 9

U.S.C. § 2 deals generally with contracts involving com-

merce. Therefore, to preserve its right to a meaningful

arbitral forum Olde Discount relies on the third type of

preemption, “actual conflict” preemption.

There can be “actual conflict” preemption in two

circumstances, either where it is impossible to comply

with the conflicting demands of federal and state statutes,

or where the state law is an “obstacle” to the fulfillment

of the congressional purposes embodied in the federal

law. See, e.g., Florida Lime & Avocado Growers, Inc. v. Paul,

373 U.S. 132, 83 S.Ct. 1210 (1963) (holding federal regula-

tion concerning maturity of avocados did not preempt

California regulation, were it was not impossible for

growers to comply with both regulations); Hines v.

Davidowitz, 312 U.S. 52, 67, 61 S.Ct. 399, 404 (1941) (hold-

ing federal Alien Registration Act preempted Pennsy]l-

sé

vania Alien Registration Act because state law “stands as

an obstacle to the accomplishment and execution of the

full purposes and objectives of Congress”); Pennsylvania

Medical Soc’y v. Marconis, 942 F.2d 842, 848 (3d Cir. 1991)

(holding Pennsylvania statute governing limited aspects

of Medicare billing not preempted by federal Medicare

Act because state statute did not create obstacle to fulfill-

ment of Congress’ objectives). As our analysis of the

interaction between the Delaware administrative rescis-

sion remedy and Olde Discount’s arbitration agreement

with the Engelhardts will make clear, both factors indicat-

ing conflict preemption, conflicting statutory demands

App. 14

and an obstacle to Congress’ purposes, are present in this

Case.

The context of this preemption claim, i.e., the preser-

vation of a federal right to an arbitral forum, is critical. At

one time other substantive and procedural rights of par-

ties were thought to outweigh a right to arbitration. See

Wilko v. Swan, 346 U.S. 427, 74 S.Ct. 182 (1953) (stating

Securities Act of 1933 precluded waiver of judicial forum,

rendering arbitration agreement invalid). But that time is

no more. See Rodriguez de Quijas v. Shearson/American

Express, Inc., 490 U.S. 477, 109 S.Ct. 1917 (1989) (overrul-

ing Wilko v. Swan). The Supreme Court unstintingly has

promoted a favorable climate for arbitration through vig-

orous enforcement of the FAA over the last 20 years. The

gradual erosion of the principles of Wilko v. Swan began

with the 1974 decision of Scherk v. Alberto-Culver Co., 417

U.S. 506, 94 S.Ct. 2449, which held that a claim under the

Securities Exchange Act of 1934 would be arbitrable in

the distinctive context of an international business trans-

action. The international character of the dispute was also

an important consideration in Mitsubishi Motors Corp. v.

Soler Chrysler-Plymouth, 473 U.S. 614, 105 S.Ct. 3346

(1985), which upheld an order compelling submission of

Sherman Act claims to arbitration in Japan. More gener-

ally, Mitsubishi noted that there is “no warrant in the

Arbitration Act for implying in every contract within its

ken a presumption against arbitration of statutory

claims.” Id. at 625, 105 S.Ct. at 3353.

The Court moved beyond the specialized interna-

tional context and enforced arbitration of 1934 Act claims

and RICO claims, pursuant to a clause in a standard

brokerage agreement, in Shearson/American Express, Inc. v.

’

App. 15

McMahon, 482 U.S. 220, 107 S.Ct. 2332 (1987). Shortly

thereafter, the Court resolved the inconsistency between

McMahon and Wilko by expressly overruling Wilko in

Rodriguez de Quijas. Two Terms later, the Court extended

the ascendancy of arbitration beyond commercial dis-

putes to age-discrimination claims in Gilmer v. Interstate/

Johnson Lane Corp., 111 S.Ct. 1647 (1991), which rejected

the contention that the involvement of an agency, there

the Equal Employment Opportunity Commission, in a

scheme of enforcement created any impediment to the

private arbitration of the claims arising in a particular

case.

Two aspects of the development of the federal right

to arbitration that we have traced are particularly note-

worthy here. First, the arbitration of securities disputes

now is not only permitted, but favored, under federal

law, according to the line of decisions culminating in

McMahon and Rodriguez de Quijas. See also Osterneck v.

Merrill Lynch, Pierce, Fenner & Smith, Inc., 841 F.2d 508 (3d

Cir. 1988) (stating FAA preempts provision of Pennsyl-

vania Securities Act purporting to preclude enforcement

of agreements to arbitrate state law securities claims).

Second, there is no longer any doubt that statutory claims

are arbitrable, and the existence of an enforcing agency,

as in Gilmer, does not interfere with the arbitrability of

individual claims. Similarly, it is clear that state statutory

claims, as well as federal statutory claims, are subject to

the federal right to an arbitral forum. See Southland Corp.

v. Keating, 465 U.S. 1, 104 S.Ct. 852 (1984) (holding FAA

preempts California statutory provision requiring judicial

forum for claims under California Franchise Investment

Law); Osterneck v. Merrill Lynch, 841 F.2d at 512-13.

App. 16

Thus, the claims that the Delaware Division of Secu-

rities is pursuing on behalf of the Engelhardts, 1.e., claims

of fraudulent dealings in violation of Del. Code Ann. tit.

6, § 7303, certainly would be subject to arbitration if

pursued by the Engelhardts themselves. See Del. Code

Ann. tit. 6, § 7323 (creating private right of action for

securities fraud). However, the appellants argue that for

preemption purposes we must distinguish between the

advancement of essentially identical claims on the basis

of whether their proponent is a state agency or a private

litigant. The appellants contend that the state’s enforce-

ment action implicates the public interest, and not simply

the rights of the Engelhardts. Further, the appellants cite

Gilmer for the proposition that “arbitration agreements

will not preclude [an administrative agency] from bring-

ing actions seeking class-wide and equitable relief.” 111

S.Ct. at 1655. In the appellants’ view, the agency’s pursuit

of “equitable relief” sanctioned in Gilmer should include

the remedy of rescission of specific trades of securities

sought in this case. The appellants view the rescission

remedy as an integral component of the state’s regulation

of securities transactions which, they argue, should not

be weakened by the application of federal preemption.

However, we think the rescission remedy as applied

here necessarily wouid render Olde Discount’s right to

arbitration meaningless. The particular remedy therefore

must fall before the conflicting right to an arbitral forum

granted by the FAA. The FAA’s fundamental purpose was

to create “a liberal federal policy favoring arbitration

agreements, notwithstanding any state substantive or

procedural policies to the contrary.” Moses H. Cone Memo-

rial Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24, 103 S.Ct.

App. 17

927, 941 (1983). “In enacting § 2 of the federal Act, Con-

gress declared a national policy favoring arbitration and

withdrew the power of the states to require a judicial

forum for the resolution of claims which the contracting

parties agreed to resolve by arbitration.” Southland Corp.

v. Keating, 465 U.S. at 10, 104 S.Ct. at 858. Yet the Dela-

ware Division of Securities claims that it must be permit-

ted to adjudicate administratively the very same

questions regarding Olde Discount’s sale of SNFS stock to

the Engelhardts, that the Engelhardts themselves could

pursue only within an arbitration. In that regard, Dela-

ware has interfered with Olde Discount’s right under the

FAA to resolution of these issues through arbitration.

Therefore, in the application here of the rescission rem-

edy of Del. Code Ann. tit. 6, § 7325(b), Delaware has

created an “obstacle to the accomplishment and execution

of the full purposes and objectives of Congress.” Hines v.

Davidowitz, 312 U.S. at 67, 61 S.Ct. at 404.

The very community of interest between the state

appellants and the Engelhardts implicitly demonstrates

that the administrative proceedings are an obstacle to

Congress’ purpose in adopting the FAA. Clearly the

Engelhardts are relying on the state appellants to obtain a

remedy that would frustrate the arbitration. As the appel-

lants acknowledge, the administrative proceedings were

initiated on the complaint of the Engelhardts. Indeed, the

Notice of Intent issued to Olde Discount was concerned

exclusively with dealings between Olde Discount and the

Engelhardts. Furthermore, Tupman filed this appeal on

behalf of the Engelhardts, who are not represented by

separate counsel on appeal, and were not so represented

in the earlier settlement negotiations with Olde Discount.

App. 18

In the circumstances, the state administrative proceed-

ings, to the extent they concern claims and liabilities

between the Engelhardts and Olde Discount, are nothing

other than a substitute for the arbitration.

The circumstance that the state appellants are not

parties to the arbitration clause does not alter our result.

As the Supreme Court explained in Moses H. Cone Memo-

rial Hospital, “{uJnder the Arbitration Act, an arbitration

must be enforced notwithstanding the presence of other

persons who are parties to the underlying dispute but not

to the arbitration agreement.” 460 U.S. at 20, 103 S.Ct. at

939. In partial reliance on Moses H. Cone, we recently

upheld a district court’s eviction of a subtenant to facili-

tate an award arising from an arbitration between the

property owner and the tenant, even though the subten-

ant was not a party to the arbitration. See Isidor Paie-

wonsky Assocs. v. Sharp Properties, Inc., No. 92-7337 (3d

Cir. June 24, 1993).4

It is also apparent that, in any practical sense, Olde

Discount cannot simultaneously arbitrate its claims

against the Engelhardts and defend against the Delaware

securities commissioner’s pursuit of the rescission rem-

edy in an administrative proceeding. Notwithstanding

the appellants’ statement that they will not, and cannot,

prevent Olde Discount from commencing the arbitration,

the appellants’ view of a possible harmonious interaction

of the state and federal statutes is illusory. While in a

physical sense Olde Discount could be represented in two

4 We are not suggesting that an award in an arbitration

proceeding would be preclusive in administrative proceedings;

that issue is not presented by this appeal.

App. 19

proceedings at once, the potential for actual conflict in

that scenario is manifest. If an arbitration panel decides

that the Engelhardts’ claims are without merit and Olde

Discount has no liability to them, while the Delaware

securities commissioner concludes that the SNFS pur-

chases must be rescinded, the results of the proceedings

will be irreconcilable.

Even if the two proceedings were to reach similar

results on the merits, Olde Discount still would be

deprived of its right to the presumed simplicity and

efficiency of the arbitral forum. Thus, to the extent rescis-

sion is involved, it is impossible to fulfill the demands of

both the federal and state statutes. Therefore, Delaware’s

pursuit of the rescission remedy is preempted by the FAA

both because Del. Code Ann. tit. 6, § 7325(b) presents an

obstacle to the accomplishment of the congressional pur-

pose of enforcing arbitration agreements, and because it

is impossible to give effect to both the administrative

rescission remedy and the federal right to arbitration.

We also reject the appellants’ contention that an

administrative rescission remedy is not preempted

because Gilmer sanctions “equitable relief” by an agency

despite a parallel arbitration of private claims. First,

Gilmer on its facts did not address a question of equitable

relief and its statements thereon are not dispositive of

how the Supreme Court might resolve an actual contro-

versy involving private arbitration and an agency’s

“equitable” remedies. Second, we believe the precise

statement in Gilmer, i.e., “that arbitration agreements will

not preclude the EEOC from bringing actions seeking

class-wide and equitable relief,” 111 S.Ct. at 1655, was

meant to draw a distinction between private remedies

App. 20

available in arbitration for one employee, versus

remedies available through an action of the EEOC for a

group of employees. In other words, the reference in

Gilmer to class-wide equitable relief apparently was

directed toward a situation where the EEOC could bring

its enforcement powers to bear against an employer vio-

lating the law in its dealing with numerous employees by,

for example, seeking an injunction on behalf of a class of

employees against future acts of age discrimination. The

analog in our case would be that the Delaware Division

of Securities, if convinced that Olde Discount has com-

mitted widespread violations beyond those alleged in

relation to the Engelhardts’ stock purchases, is free to

protect Delaware investors by imposing fines or licensing

restrictions on Olde Discount, regardless of the progress

or outcome of any arbitration of the Engelhardts’ claims.°®

Thus, there is no foundation for appellants’ assertion that

Gilmer establishes that the state’s interest in the “equita-

ble” remedy of rescission should be given special exemp-

tion from standard preemption principles.

While our analysis might be different if a finding of

preemption were to work a substantial interference with

> It is conceivable that in the case of widespread violations

of uniform character, e.g., the distribution of fraudulently issued

securities, individualized relief for members of a victimized

class of customers might be possible notwithstanding the pres-

ence of arbitration agreements, on a theory that the violation

did not arise from the particular relationship between the cus-

tomer and the broker. We, of course, state no opinion on that

possibility as it is not before us. In this case, the Notice of Intent

was predicated on Olde Discount’s and Donohoe’s alleged indi-

vidual maltreatment of the Engelhardts, which the Notice

described in great detail.

App. 21

traditional state objectives of securities law enforcement,

that is not the case here. The district court did not enjoin

the Delaware securities commissioner from investigating

Olde Discount or from pursuing administrative remedies

other than rescission of the Engelhardts’ purchases.

Accordingly, Delaware may take whatever action it sees

fit consonant with federal law, concerning Olde Dis-

count’s state registration as a broker-dealer. Delaware is

also free to pursue individualized remedies, including

rescission, as to securities transactions not subject to arbi-

tration agreements.’ Delaware therefore retains many

avenues for the exercise of its proper role in dealing with

alleged violations of its securities laws. Accordingly, fed-

eral preemption of the rescission remedy for investors

6 On December 7, 1992, the Division of Securities initiated a

second proceeding against Olde Discount and Donohoe by rea-

son of alleged improprieties in their dealings with other inves-

tors in SNFS stock. We are not concerned with those

proceedings in this opinion.

? Although the appellants seem not to have stressed this

point before the district court, the Engelhardts’ initial purchase

of 5,000 shares of SNFS stock on May 15, 1990, was before they

signed the account agreement containing the arbitration clause

on May 25, 1990. The district court did not take this sequence of

events into account in reaching its result and neither will we as

there is no issue as to the arbitrability of disputes arising from

that purchase before us on this appeal. Nevertheless the district

court’s order of September 16, 1990, by its terms enjoins the

commissioner from pursuing a rescission remedy for the May

15, 1990 purchase of SNFS stock. Thus, we do not preclude the

appellants on remand from seeking an order modifying the

preliminary injunction so as to exclude that purchase.

App. 22

who have agreed to arbitration will narrow but not elimi-

nate the state regulators’ choices of means of enforcement

of the Delaware securities laws.®

IV. ABSTENTION

The appellants argue, aside from the merits of the

preemption question, that the district court should have

abstained from granting an injunction that will interfere

with Delaware’s ongoing administrative proceedings

against Olde Discount. The district court concluded that

the abstention doctrine of Younger v. Harris, 401 U.S. 37,

91 S.Ct. 746, was not applicable to Olde Discount’s pre-

emption claim under the FAA. We agree with the district

court’s resolution. Indeed, the circumstances presented

make clear that a nonfrivolous claim of FAA preemption

of a state statutory remedy necessarily presents an excep-

tion to the Younger doctrine.

8 The amici curiae in their brief contend that the district

court’s opinion could have a major impact in “the criminal law

area” because of an increasing tendency for courts to impose

restitution as part of a sentence. They suggest that if we affirm

the district court’s order, the state “could not seek nor could the

court grant such relief where the defendant had entered into an

arbitration agreement with his victims.” Brief at 8. We, of

course, cannot rule on what the law would be in the situation

the amici describe. However, it is apparent that a case involving

a criminal conviction is distinguishable from that involved here.

In this case the administrative proceeding was in part brought

for the express purpose of obtaining a rescission remedy. On the

other hand, a criminal case is brought to determine whether a

defendant is criminally liable and, if so, to fix the penalty for the

violation.

—EEEEEEE—>—~—eEeEeEeEeEeEeEeEeEeEeEeEeEeEeEeEeE———

é |

App. 23

Younger established that, despite the assertion of

claims based on the federal constitution or federal stat-

utes, a federal court should not enjoin pending state

proceedings where three elements are present: (1) the

ongoing state proceedings are “judicial” in nature; (2) the

proceedings implicate important state interests; and (3)

the proceedings afford an adequate opportunity: to raise

the federal claims. Middlesex County Ethics Comm. v. Gar-

den State Bar Ass'n, 457 U.S. 423, 432, 102 S.Ct. 2515, 2521

(1982). Nevertheless, the Supreme Court has emphasized

that a court should abstain only in rare cases.

The doctrine of abstention . . . is an extraordin-

ary and narrow exception to the duty of a Dis-

trict Court to adjudicate a controversy properly

before it. Abdication of the obligation to decide

cases can be justified under this doctrine only

in... exceptional circumstances... .

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

U.S. at 14, 103 S.Ct. at 936 (quotation marks omitted).

The Court recently reiterated the exceptional quality

of abstention in New Orleans Public Service, Inc. v. Council

of New Orleans, 109 S.Ct. 2506 (1989). The Court noted

that abstention is confined to rare circumstances because

it runs counter to “the proposition that federal courts lack

the authority to abstain from the exercise of jurisdiction

that has been conferred. . . . ‘They cannot abdicate their

authority or duty in any case in favor of another jurisdic-

tion.” ” Id. at 2512-13 (quoting Chicot County v. Sherwood,

148 U.S. 529, 534, 13 S.Ct. 695, 697-98 (1893)). Those

principles enunciated in New Orleans Public Service

guided our approach in Gwynedd Properties, Inc. v. Lower

Gwynedd Township, 970 F.2d 1195. In Gwynedd, mindful

sa ieecetnteeaieacenieeeeeeee

App. 24

that “a federal court has no authority to abstain from the

exercise of jurisdiction that has been properly conferred,”

id. at 1199, we partially reversed the district court’s dis-

missal of a complaint alleging federal constitutional

claims concerning municipal land use regulatory deci-

sions that were concurrently the subject of state court and

municipal zoning board proceedings.

Notwithstanding the strict limits of abstention, the

doctrine, where appropriate, forbids injunctive interfer-

ence with state administrative proceedings as well as

state court proceedings, though Younger itself forbade an

injunction against a state criminal prosecution. In Mid-

dlesex County Ethics Committee, which upheld a district

court’s refusal to enjoin a state bar disciplinary proceed-

ing on the grounds that the New Jersey Supreme Court

would review the plaintiff’s federal constitutional claims,

the Court made explicit that “[t]he policies underlying

Younger are fully applicable to noncriminal judicial pro-

ceedings when important state interests are involved.”

457 U.S. at 432, 102 S.Ct. at 2521. In Ohio Civil Rights

Commission v. Dayton Christian Schools, Inc., 477 U.S. 619,

106 S.Ct. 2718 (1986), the Court again endorsed Younger

abstention in relation to an ongoing state administrative

proceeding. In that case, a religious school sought a fed-

eral injunction on First Amendment free exercise grounds

against the state’s investigation of a sex-discrimination

complaint. The Court found that the third requisite of the

Younger doctrine, availability of an opportunity to raise

federal claims, was provided because the school’s “con-

stitutional claims may be raised in state-court judicial

review of the administrative proceeding.” Id. at 629, 106

S.Ct. at 2724.

App. 25

It is therefore clear that conceptually Younger absten-

tion can apply to the situation raised by Delaware’s

administrative proceedings against Olde Discount. The

investigation and pending hearing by the Delaware secu-

rities commissioner is an ongoing state proceeding, “judi-

cial” in nature, within the meaning of Younger, Middlesex

County, and Dayton Christian Schools. Delaware’s proceed-

ing also undoubtedly serves the important state interest

of regulating securities transactions, insofar as such

power of regulation is reserved to the states under both

the Securities Act of 1933 and the Securities Exchange Act

of 1934. See 15 U.S.C. §§ 77r, 78bb(a). Finally, even if the

Delaware Division of Securities has reached a conclusion

that its pursuit of a rescission remedy is not preempted

by the FAA, under Dayton Christian Schools it would be

sufficient that Olde Discount could raise its preemption

arguments again in a review of the administrative pro-

ceedings by the Delaware Court of Chancery. See Del.

Code Ann. tit. 6, § 7324(a).

However, our conclusion that this situation formally

fits within a Younger framework does not end our absten-

tion inquiry, for Younger abstention is not always appro-

priate even if its elements are present. Thus, if “a genuine

threat of prosecution exists, a litigant is entitled to resort

to a federal forum to seek redress for an alleged depriva-

tion of federal rights.” Wooley v. Maynard, 430 U.S. 705,

710, 97 S.Ct. 1428, 1433 (1977); see also Dayton Christian

Schools, 477 U.S. at 626, 106 S.Ct. at 2722 (interpreting

Younger to prevent injunctions against state proceedings

“except in the very unusual situation that an injunction is

necessary to prevent great and immediate irreparable

injury”); Harmon v. Forssenius, 380 U.S. 528, 537, 85 S.Ct.

cae

App. 26

1177, 1183 (1965) (stating that district court properly

refused to abstain “[g]liven the importance and imme-

diacy of the problem, and the delay inherent” in awaiting

guidance from state courts). We addressed a similar situa-

tion of immediate need for intervention by a federal court

in Ford Motor Co. v. Insurance Commissioner, 874 F.2d 926

(3d Cir. 1989). There, various insurers brought a preemp-

tion challenge to a Pennsylvania statute that prohibited

the insurers from owning interests in savings and loan

institutions. We applied the counsel of Wooley v. Maynard

to articulate an exception to the Younger doctrine for state

civil as well as criminal proceedings, in instances where

“deference to the state proceeding will present a signifi-

cant and immediate potential for irreparable harm to the

federal interests asserted.” Id. at 932.

Delaware’s insistence upon the rescission remedy

presents just such an immediate potential for irreparable

harm to Olde Discount’s right under the FAA to an

arbitral forum. The Delaware regulators have chosen to,

stand firm in their pursuit of administrative rescission

despite Olde Discount’s repeated invocation of the FAA,

its efforts to commence an actual arbitration with the

Engelhardts, and the district court’s suggestion that the

issue of rescission could be bifurcated from the state’s

determination concerning other proposed remedies.’

? Tupman, appearing.forthe State at the district court’s

August 27, 1992 hearing, rejected any separation of the rescis-

sion question from the State’s broader proceedings:

THE COURT: Mr. Tupman, just a comment or two. I

do have a question for you:

App. 27

Indeed the very nature of arbitration demonstrates

the irreparable harm Olde Discount faces, for its right to

arbitration is a contractual right sanctioned by statute, to

have claims addressed in a particular forum. Thus, if the

district court abstained in this case it would not simply be

declining to exercise its statutorily created jurisdiction,

which is the usual consequence of abstention. Rather, it

would be refusing to protect Olde Discount’s access to

the forum that it and the Engelhardts contractually

selected to resolve their disputes.

Furthermore, Olde Discount’s right to arbitration

cannot be satisfied if an alternate administrative forum is

determining at the same time whether a claim to the

identical remedy is available. The concern underlying a

federal right to enforcement of arbitration agreements is a

party’s entitlement to a proceeding and a forum that are,

at least ideally, speedy, efficient, and simpler than litiga-

tion in the courts or before agencies. See Rodriguez de

Quijas, 490 U.S. at 479-80, 109 S.Ct. at 1919; Mitsubishi, 473

U.S. at 628, 105 S.Ct. at 3354. Therefore, in the context of

Aside from Paragraph 42 of your notice of intent

to suspend or revoke, is there any reason why the

public regulatory part of the Commission’s prosecu-

tion can’t be bifurcated from the [rescission] rem-

edy...?

MR. TUPMAN.... . [S]Jince the statute and the Gen-

eral Assembly do clearly contemplate that all of this

will be resolved in a single administrative proceed-

ing, I don’t think that it is - serves any interest, since,

as we contend there’s no impairment of the arbitra-

tion agreement. If they want to go to arbitration, they

can go to arbitration. I can’t stop them.

Supplemental App. at 92-93.

= Sets F ae ed

App. 28

arbitration, a litigant’s procedural right to the agreed

forum is raised to a substantive right by the FAA. Accord-

ingly, if Olde Discount were forced to address rescission

of its sales to the Engelhardts in an administrative pro-

ceeding, even if it simultaneously could pursue an arbi-

tration, it would suffer an immediate, irreparable harm to

the federal right established by the FAA.

We find authority that Younger abstention would be

inappropriate here in Southland Corp. v. Keating, 465 U.S.

1, 104 S.Ct. 852. In Southland the Supreme Court deter-

mined to take jurisdiction over the appeal precisely

because of the immediacy of the harm suffered by a party

denied a right to arbitration. The California Supreme

Court had held that the FAA did not preempt a California

statute requiring a judicial forum for certain franchise

claims, and had remanded the case to the state trial court

for a disposition on the merits. Despite the remand,

which arguably rendered the state court’s decision not

final, the Supreme Court took jurisdiction, reasoning that

“[c]ontracts to arbitrate are not to be avoided by allowing

one party to ignore the contract and resort to the courts.

Such a course could lead to prolonged litigation, one of

the very risks the parties, by contracting for arbitration,

sought to eliminate,” 465 U.S. at 6-8, 104 S.Ct. at 856-57.

In this case, abstention would have precisely the same

consequence, /.e., it would permit the Engelhardts’ claims

to be brought before the Delaware securities commis-

sioner, thus circumventing the agreement to arbitrate. We

think Southland teaches that the federal courts ought not

countenance such frustration of the FAA’s mandate.

We also point out that abstention in this case would

be difficult to justify in light of the congressional intent

App. 29

reflected in 9 U.S.C. § 16. That section provides that while

orders compelling arbitration are not immediately

appealable, orders denying motions to compel arbitration

or to stay judicial proceedings pending arbitration are

immediately appealable. This dichotomy reflects the

paramount importance that Congress has placed on arbi-

tration. In effect, Congress has given the courts of appeals

broad authority to ensure that district courts are not

circumscribing the rights granted by the FAA in a manner

contrary to the expansive enforcement of arbitration

clauses that has been dictated by Congress itself and by

the Supreme Court in, e.g., McMahon, Rodriguez de Quijas,

and Gilmer.

We are mindful that generally a claim of federal

preemption, in and of itself, is not entitled to more defer-

ential treatment than other constitutional claims in the

face of an abstention challenge. The Supreme Court said

as much in New Orleans Public Service:

There is no greater federal interest in enforcing

the supremacy of federal statutes than in enforc-

ing the supremacy of explicit constitutional

guaranties, and constitutional challenges to

state action, no less than preemption-based chal-

lenges, call into question the legitimacy of the

State’s interest in its proceedings reviewing or

enforcing that action. Yet is clear that the mere

assertion of a substantial constitutional chal-

lenge to state action will not alone compel the

exercise of federal jurisdiction.

109 S.Ct. at 2516.

In New Orleans Public Service, the Court ultimately

found that the district court should not have abstained.

App. 30

However, the Court did not conclude that simply because

the case implicated findings of the Federal Energy Regu-

latory Commission which preempted a decision of local

rate-making authorities, a blanket exception to Younger

principles was warranted. See also Ford Motor Co., 874 F.2d

at 934 (“there is no absolute rule prohibiting the applica-

tion of Younger abstention doctrine whenever the

Supremacy Clause is invoked”).

But in New Orleans Public Service, the Court did not

confront a collision between the normal application of

Younger principles and the highly favored right to arbitra-

tion which the Court itself has developed in FAA cases

from Scherk v. Alberto-Culver through Rodriquez de Quijas

and Gilmer. The collision is imminent in the present case,

and we must resolve it by application of the Supreme

Court’s FAA cases and the Court’s recognition in Wooley

v. Maynard that, even when the Younger doctrine strictly

might be applicable, a threat of immediate, irreparable

harm to federal rights can warrant an injunction against

state proceedings. We think that where, as here, a state

~ agency is engaged in a course of action openly inconsis-

tent with a litigant’s rights under Section 2 of the FAA,

that litigant cannot be turned away from federal court by

an invocation of Younger abstention. This very narrow

exception to Younger will not create difficulties in cases

involving frivolous or weak claims of FAA preemption,

because such claims would not meet the traditional requi-

sites for injunctive relief and thus will not even require a

district court to reach a Younger challenge.!°

10 In its opinion, the district court cited Instant Air Freight

Co. v. C.F. Air Freight, Inc., 882 F.2d 797, 800 (3d Cir. 1989), with

App. 31

We make one final point. A district court’s decision

to abstain does not necessarily mean that a federal court

will never consider the proffered federal claim. Rather,

abstention delays the review by a federal court until a

state forum has had an opportunity to pass on the issue.

For example, if a criminal prosecution is claimed to vio-

late federal free speech, free exercise, or due process

rights, a defendant not satisfied by the state court’s reso-

lution of those claims ultimately can seek a federal forum

by petition for certiorari or petition for writ of habeas

corpus. In most — indeed, nearly all - circumstances in

which the elements of Younger abstention are present,

Younger counsels that such a delay is an appropriate price

to pay for the preservation of comity between the federal

government and the states.

In the context of arbitration, however, delayed

enforcement destroys the federal statutory right. It would

be incongruous if abstention, merely a prudential doc-

trine, could have such a consequence. In our case, the

district court correctly did not abstain because the Dela-

ware regulators’ repeated rejection of Olde Discount’s

FAA preemption claim already ensured that the right to

respect to the general showing that must be made for an appli-

cant for a preliminary injunction to obtain relief. The appellants’

brief is not cast in terms of whether the criteria have been met

but instead focuses on the preemption and abstention issues.

The brief of the amici, however, does discuss the Instant Air

Freight criteria. In these circumstances, we will not discuss these

criteria in detail but simply will indicate that in view of our

conclusions we agree that the district court properly issued the

preliminary injunction.

App. 32

arbitration would be lost, absent a federal court’s inter-

vention. Accordingly, despite the rule of Dayton Christian

Schools that a right to an ultimate state court appeal of

agency action suffices to support Younger abstention, we

hold that where Section 2 of the FAA provides the basis

for a federal preemption claim, a district court may not

abstain, but must address the merits of the FAA claim.

V. CONCLUSION

!n view of the aforesaid and Judge Rosenn’s concur-

ring opinion, we will affirm the district court’s order of

September 16, 1992, and will remand the case to the

district court for further proceedings.

ROSENN, Circuit Judge, concurring.

Although I agree with the majority’s conclusion that

the Delaware Securities Commissioner cannot seek rescis-

sion as a remedy under 6 Del. C. § 7325(b), I write

separately because I arrive at this result by way of con-

tract law rather than the doctrine of preemption.

When Congress enacted the Federal Arbitration Act

(FAA), it rejected the traditional hostility of the courts

towards arbitration as a remedy in civil disputes and

emphasized a strong federal policy in favor of arbitral

dispute resolution in cases where a contract exists evi-

dencing a transaction involving commerce. Mitsubishi

Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614

(1985). In Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213

i eeeeneaanameeenel

App. 33

(1985), a case similar to the one sub judice in that it

involved a dispute over a purchase of securities through

a broker-dealer, the Court held that the FAA requires

district courts to compel arbitration of pendent arbitrable

claims, even where the result would be the possible inef-

ficient maintenance of separate proceedings in different

forums. The Court observed:

The preeminent concern of Congress in passing

the Act was to enforce private agreements into

which parties had entered, and that concern

requires that we rigorously enforce agreements

to arbitrate .. . at least absent a countervailing

policy manifested in another federal statute. By

compelling arbitration of state-law claims, a dis-

trict court successfully protects the contractual

rights of the parties and their rights under the

Arbitration Act.

Id. at 221.

Significantly, the Court dwelt upon the necessity of

enforcing the contractual rights of the parties under the

agreement to arbitrate, also observing that “arbitration is

not a judicial proceeding.” Id. at 222 (citing McDonald v.

West Branch, 466 U.S. 284 (1984)). Thus, the right of a

party to enforce an arbitration agreement under the FAA

depends not upon the federal doctrine of preemption, but

upon the traditional duty of the courts to protect the

contractual rights of the parties.

In the present case, Olde’s investors’ account agree-

ment with the Engelhardts contained a provision stating:

You agree to submit any and all controversies or

claims arising out of this agreement to arbitra-

tion to be conducted according to the rules and

App. 34

procedures of the New York Stock Exchange,

Inc. (NYSE) or the National Association of Secu-

rities Dealers, Inc. (NASD) as you may elect....

The agreement further provides, “The parties are waiving

their right to seek remedies in court, including the right

to a jury trial.”

Recently, in Gilmer v. Interstate/Johnson Lane Corp., 111

S. Ct. 1647, 1652 (1991) (citations omitted), the United

States Supreme Court stated:

It is by now clear that statutory claims may be

the subject of an arbitration agreement, enforce-

able pursuant to the FAA... . [Bly agreeing to

arbitrate a statutory claim, a party does not

forgo the substantive rights afforded by the stat-

ute; it only submits to their resolution in an

arbitral, rather than a judicial, forum.

Therefore, Olde and the Engelhardts lawfully bound

themselves by the provisions of the agreement to arbi-

trate claims arising out of their securities transactions.

As noted by the majority, section 7325’s remedy of

rescission would interfere with the contractually created

arbitration agreement in this case. To the extent that the

Englehardts attempted an “end run” around the terms of

the arbitration agreement by seeking relief in a state

administrative proceeding, the district court properly

restrained them. Federal courts will not “permit a party

to a contract to circumvent an arbitration clause by com-

mencing litigation in a state court.” In re Mercury Constr.

Corp., 656 F.2d 933, 941 (4th Cir. 1981).

Finally, the mere involvement of an admin-

istrative agency in the enforcement of a statute

is not sufficient to preclude arbitration. For

App. 35

example, the Securities Exchange Commission is

heavily involved in the enforcement of the

Exchange Act of 1934 and the Securities Act of

1933, but we have held that claims under both of

these statutes may be subject to compulsory

arbitration. See McMahon; Rodriguez de Quijas.

Gilmer, 111 S. Ct. at 1653.

My disagreement with the majority stems from my

belief that the district court’s injunction should not be

based on preemption doctrine, but rather the law of

contracts. The fundament of Olde’s right to settle the

Engelhardts’ demand for rescission of the securities

transaction by arbitration is the arbitration provision con-

tained in the investors’ account contract, not the applica-

tion of the doctrine of preemption.

“[Flederal pre-emption of state law can occur in three

types of situations: where Congress explicitly pre-empts

state law, where pre-emption is implied because Congress

has occupied the entire field and where pre-emption is

implied because there is an actual conflict between fed-

eral and state law.” Pokorny v. Ford Motor Co., 902 F.2d

1116, 1120 (3d Cir. 1990) (citing Schneidewind v. ANR

Pipeline Co., 485 U.S. 293 (1988)), cert. denied, 498 U.S. 853

(1990).

The FAA “contains no express pre-emptive provision,

nor does it reflect a congressional intent to occupy the

entire field of arbitration.” Volt Info. Sciences, Inc. v. Stan-

ford University, 489 U.S. 468, 477 (1989). Nor has Congress

occupied the entire field of securities regulation. Merrill

Lynch, Pierce, Fenner & Smith, Inc. v. Ware, 414 U.S. 117,

135 (1973). The FAA, therefore, preempts a state securities

App. 36

law only “to the extent that it actually conflicts with

federal law.” Volt, 489 U.S. at 477.

In the case sub judice, however, the federal law and

the state law do not conflict. The Delaware Statute does

not even deal with arbitration, which is the subject of the

FAA. Rather, the conflict in this case arises between the

state statute, as it relates to rescission, and the parties’

contractually created right to arbitrate disputes relating

to the securities transaction. The FAA becomes relevant

only as it protects the enforcement of the contractual

right to arbitrate. Thus, there is no conflict for preemp-

tion purposes between a state law and a federal law in

this case, but rather a partial remedial conflict between a

state law and a contract. Cf. Osterneck v. Merrill Lynch,

Pierce, Fenner & Smith, Inc., 841 F.2d 508, 510 (state statute

precluding enforcement of an agreement to arbitrate con-

flicts with FAA).!

Therefore, for the foregoing reasons I would affirm

the district court’s order enjoining the Delaware Securi-

ties Commissioner from pursuing the remedy of rescis-

sion of the claims which are subject to the arbitration

agreement between Olde and the Engelhardts. I agree

with the majority that the district court was not required

! The agreement to arbitrate cannot usurp a state’s public

interest in enforcing its criminal laws for securities transactions

violations or its laws enacted under its police power to protect

the public interest generally. “The criminal justice system is not

operated primarily for the benefit of victims, but for the benefit

of society as a whole.” Kelly v. Robinson, 479 U.S. 36, 51 (1986).

Therefore, the district court was correct not to enjoin the Com-

missioner from seeking other penal remedies against Olde

besides rescission.

———————————

App. 37

to abstain from enjoining the Commissioner’s pursuit of

rescission.

NYGAARD, Circuit Judge, dissenting.

I disagree with the court’s conclusion that the Federal

Arbitration Act, 9 U.S.C. § 2, preempts 6 Del. Code Ann.

§ 7325(b) for essentially the same reasons articulated in

Judge Rosenn’s concurrence. There is no conflict between

federal and state law because, as Judge Rosenn notes, the

FAA protects the enforcement of the contractual right to

arbitrate. Where there has been an allegation of securities

fraud, section 7325(b) empowers the Delaware Securities

Commissioner to seek rescission at his discretion and in

the interest of the public; it says nothing about the val-

idity of the arbitration agreement or the arbitrability of

the dispute between Olde Discount and the Engelhardts.

Since section 7325(b) does not “require a judicial forum

for the resolution of claims which the contracting parties

agreed to resolve by arbitration,” Southland Corp. v. Keat-

ing, 465 U.S. 1, 104 S.Ct. 852, 858 (1984), the FAA does not

preempt the Delaware statute.

I depart from the reasoning of the concurrence, how-

ever, to the extent it concludes that the Engelhardts have

the capacity to contract away under Delaware law the

Commissioner’s authority to institute administrative pro-

ceedings and to seek remedies against securities firms

doing business in Delaware. The essence of Olde Dis-

count’s argument is that there is no distinction between

the Engelhardts’ civil suit in their own interest to seek a

si aeaaaleatieateeemie

App. 38

compensatory award and the Commissioner’s adminis-

trative actions in the public interest to seek appropriate

equitable or punitive measures. This argument is unper-

suasive in light of the statutory scheme.

The Delaware Securities Act was enacted “to prevent

the public from being victimized by unscrupulous or over-

reaching broker-dealers, investment advisers or agents in

the context of selling securities or giving investment

advice, as well as to remedy any harm caused by securi-

ties law violations.” 6 Del. Code Ann. § 7301(b) (emphasis

added). The Commissioner administers the statute and

serves this policy. Among other things, he may “deny,

suspend or revoke any registration if he finds that the

order is in the public interest”; and he may in his discre-

tion bring an action “to temporarily restrain or to enjoin

the acts or practices . . . [as well as seek] such other

ancillary relief as is in the public interest... . ” Id.

§§ 7316(a), 7320 (emphasis added). In section 7325(b), the

Delaware legislature gave the Commissioner the exclu-

sive power to bring administrative proceedings in which

he may order the violator “to pay restitution and costs (or

to rescind the transaction or transactions and pay costs) if

the Commissioner finds it in the public interest... . ”

(Emphasis added.) And in section 7323(a), the legislature

also gave “the person” who is a victim of securities fraud

a nonexclusive, private cause of action in law or equity.

Thus, the Delaware statutory scheme makes clear

that the Commissioner is not a surrogate for a plaintiff’s

attorney, but is a public official who administers the

state’s blue sky laws “in the public interest” and is

endowed with broad enforcement and rulemaking

powers. See Blinder, Robinson & Co. v. Bruton, 552 A.2d

——————————————————————

App. 39

466, 475 (Del. 1989) (“The Commissioner has discretion to

impose any penalty deemed necessary to protect the pub-

lic interest and further the Act’s prophylactic purpose.”)

Although the Engelhardts’ and the Commissioner’s suits

arise from the same transaction, their respective right or

power to sue arises from two separate and distinct statu-

tory provisions.

The arbitration agreement between the Engelhardts

and Olde Discount provides that the Engelhardts must

“submit any and all controversies or claims arising out of

this agreement to arbitration.” It also provides, “The par-

ties are waiving their right to seek remedies in court,

including the right to a jury trial.” Under the FAA and

this arbitration agreement, there is no doubt that the

Engelhardts cannot enforce a claim for legal damages or

equitable relief under section 7323(a) in a judicial forum.

But that is not at issue in this appeal because nothing in

the Delaware laws precludes the Engelhardts and Olde

Discount from arbitrating.

Here, Olde Discount contends, and the opinion of the

court agrees, that the arbitration agreement between it

and the Engelhardts precludes the Commissioner, acting

under the authority of the Delaware legislature, from

seeking appropriate remedies and sanctions in the public

interest if the Engelhardts have also asked for the “same”

relief in their civil complaint. Thus, while this case con-

cerns rescission as a remedy, had the Engelhardts sought

injunctive relief as well as money damages in arbitration,

there is no reason under the court’s opinion why these

private parties could not have also contracted away the

Commissioner’s authority under section 7320 to seek an

injunction against Olde Discount.

App. 40

The Commissioner cannot be bound by an agreement

to which he neither agreed nor was a party. One cannot

bargain away that which one does not possess; since the

power to sue under section 7325(b) and seek appropriate

equitable remedies on behalf of the State of Delaware and

in the public interest belongs exclusively to the Commis-

sioner, that power cannot be compromised by an agree-

ment between private individuals. Cf. Moses H. Cone

Memorial Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 103

S.Ct. 927, 939 (1983) (in a multi-party and -claim case,

arbitration agreemer.c will be enforced as to those parties

and claims subject to the agreement despite piecemeal

litigation in the arbitral and judicial forums). Further, the

Commissioner’s authority to sue and seek remedies exists

independently of a plaintiff’s right to sue and thus is not

derivative of the Engelhardts’ rights. See 6 Del. Code

Ann. § 7319 (“The Commissioner in his discretion may

make such public or private investigations within or out-

side of this State as he deems necessary... . ”). See also

Gilmer v. Interstate/Johnson Lane Corp., 111 S.Ct. 1647, 1653

(1991) (“In any event, the EEOC’s role in combating age

discrimination is not dependent on the filing of a charge;

the agency may receive information concerning alleged

violations of the ADEA ‘from any source,’ and it has

independent authority to investigate age discrimination).

Cf. Isidor Paiewonsky Assocs. v. Sharp Properties, Inc., No.

92-7337 (3d Cir., June 24, 1993) (a subtenant who was not

a party to an arbitration agreement was bound by the

conclusions of the arbitrator because the subtenant and

tenant are in privity and thus the subtenant’s rights are

derivative of the tenant’s under traditional landlord-ten-

ant laws).

App. 41

The argument that section 7325(b) is “preempted” by

the FAA or that the Commission is “contractually bound”

by the arbitration agreement rests on the unsound

assumption that legal damages by the Engelhardts and

rescission sought by the Commissioner in the public

interest are in essence the same remedies. In Porter v.

Warner Holding Co., 328 U.S. 395, 66 S.Ct. 1086 (1946),

although regulations provided that a landlord could not

be required to make a tender of illegally collected rent if

the suit was brought by any person who had commenced

an action against the defendant under Section 205(e) of

the Emergency Price Control Act of 1942, a federal agency

brought suit against the landlord and sought restitution

of illegally collected rent under the authority of § 205(a)

of the statute. The Supreme Court considered whether a

federal district court had jurisdiction, in an enforcement

proceeding brought by a federal agency under § 205(a), to

order restitution of illegally collected rents. The Court

held that it did, and reasoned:

It is true that § 205(e) authorizes an

aggrieved purchaser or tenant to sue for dam-

ages on his own behalf. .. . To the extent that

damages might properly be awarded by a court

of equity in the exercise of its jurisdiction under

§ 205(a), § 205(e) supersedes that possibility and

provides an exclusive remedy relative to dam-

ages. It establishes the sole means whereby individ-

uals may assert their private right to [legal]

damages. . . . Moreover, a court giving relief

under § 205(e) acts as a court of law rather than

as a court of equity. But with the exception of

damages, § 205(e) in no way conflicts with the

jurisdiction of equity courts under § 205(a) to

issue whatever “other orders” may be necessary

App. 42

to vindicate the public interest, to compel com-

pliance with the Act and to prevent and undo

inflationary tendencies.

Restitution, which lies within that equitable

jurisdiction, is consistent with and differs greatly

from the damages and penalties which may be

awarded under § 205(e). When the Administrator

seeks restitution under § 205(a) he does not

request the court to award statutory damages to

the purchaser or tenant or to pay to such person

part of the penalties which go to the United

States treasury in a suit by the Administrator

under § 205(e). Rather he asks the court to act in

the public interest by restoring the status quo and

ordering the return of that which rightfully

belongs to the purchaser or tenant. Such action

is within the recognized power and within the

highest tradition of a court of equity. Thus it is

plainly unaffected by the provisions of § 205(e).

66 S.Ct. at 1090-91 (emphasis added and citations omit-

ted). Thus, legal damages and equitable relief, such as

restitution and rescission, are different forms of relief,

serving different interests and arising from different

powers of the court; and even if an arbitrator decides that

the Engelhardts are not entitled to legal damages, that

decision neither conflicts with nor precludes a court of

equity from granting the remedy of rescission to the

Engelhardts in the interest of the public.

The Supreme Court recognized this difference in the

arbitration context. In Gilmer, the Supreme Court consid-

ered whether a claim under the Age Discrimination in

Employment Act of 1967 (ADEA) can be subject to arbi-

tration under the FAA. The Court held that ADEA claims

App. 43

were arbitrable. The Court found unpersuasive the argu-

ment that arbitration would undermine the role of the

EEOC in enforcing the ADEA. It reasoned, “An individ-

ual ADEA claimant subject to an arbitration agreement

will still be free to file a charge with the EEOC, even

though the claimant is not able to institute a private

judicial action.” 111 S.Ct. at 1653. Furthermore, “it should

be remembered that arbitration agreements will not pre-

clude the EEOC from bringing actions seeking class-wide

and equitable relief.” Id. at 1655 (emphasis in original).

Equitable relief includes such remedies as injunction and

rescission. Porter, 66 S.Ct. at 1090-91.

I believe that the opinion of the court unlawfully

transfers the authority vested in the Commissioner to

private parties. Thus, the boundaries of what the Com-

missioner, or any other agency with enforcement powers,

can or cannot do is not defined by statute, but is limited

by the agreements of private individuals. I would hold

that since section 7325(b) of the Delaware Securities Act

expressly provides that the Commissioner may seek

appropriate equitable relief against a violator of the

state’s securities laws, he is not bound by a private arbi-

tration agreement, nor need he refrain from seeking

rescission in the public interest simply because a private

party agreed to seek legal damages in an arbitral forum

rather than a court of law. I therefore respectfully dissent.

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

App. 44

Filed August 5, 1993

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

NO. 92-7557

OLDE DISCOUNT CORPORATION

W. MICHAEL TUPMAN, and as Deputy Attorney

General of the State of Delaware; RICHARD W.

HUBBARD, Securities Commissioner of the State of

Delaware; EUGENE H. ENGELHARDT and

CAROL D. ENGELHARDT,

Appellants

Appeal from the United States District Court

for the District of Delaware

(D.C. Civil No. 92-00498)

Argued June 10, 1993

Before: GREENBERG, NYGAARD, and ROSENN,

Circuit Judges

Opinion Filed July 30, 1993

ORDER AMENDING CONCURRING OPINION

It is hereby ordered that the concurring opinion of

the slip opinion in the above-entitled case be and is

hereby amended as follows:

App. 45

Page 26, line 1 —- change “the majority’s” to “Judge Green-

berg’s”;

Page 27, line 24 — change “the majority” to “Judge Green-

berg,”

Page 28, line 5 — change “the majority” to “Judge Green-

berg”;

Page 29, lines 8-9 - change “the majority” to “Judge

Greenberg.”

BY THE COURT:

/s/ Max Rosenn

Circuit Judge

Dated: August 5, 1993

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

App. 46

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

NO. 92-7557

OLDE DISCOUNT CORPORATION,

W. MICHAEL TUPMAN, and as Deputy Attorney

General of the State of Delaware; RICHARD W.

HUBBARD, Securities commissioner of the State of

Delaware; EUGENE H. ENGELHARDT AND

CAROL D. ENGELHARDT, |

W. MICHAEL TUPMAN,

individually and as Deputy

Attorney General of the

State of Delaware; RICHARD

W. HUBBARD, Securities

Commissioner of the State of

Delaware; EUGENE H.

ENGELHARDT, CAROL D.

ENGELHARDT,

Appellants

On Appeal from the United States District Court

for the District of Delaware

(D. Dei. Civil No. 92-0498)

SUR PETITION FOR REHEARING

BEFORE: SLOVITER, Chief Judge, and BECKER,

STAPLETON, MANSMANN, GREENBERG,

App. 47

HUTCHINSON, SCIRICA, COWEN, NYGAARD,

ALITO, ROTH, LEWIS, AND ROSENN, Circuit Judges

The petition for rehearing filed by the appellants W.

Michael Tupman, Richard W. Hubbard, Eugene H.

Engelhardt, and Carol D. Engelhardt in the above cap-

tioned matter having been submitted to the judges who

participated in the decision of this court and to all other

available circuit judges of the court in regular active

service, and no judge who concurred in the decision

having asked for rehearing, and a majority of the circuit

judges of the circuit in regular active service not having

voted for rehearing by the court in banc, the petition for

rehearing is denied. Judge Nygaard would grant rehear-

ing by the court in banc for the reasons set forth in his

dissenting opinion limited to the preemption issue.

BY THE COURT:

/s/ Morton I. Greenberg

Circuit Judge

DATED: AUG 26, 1993

App. 48

OLDE DISCOUNT CORPORATION,

Plaintiff,

Vv.

W. Michael TUPMAN, individually and as Deputy

Attorney General of the State of Delaware; Richard W.

Hubbard, Securities Commissioner of the State of Dela-

ware, Eugene H. Engelhardt, and Carol D. Engelhardt,

Defendants.

Civ. A. No. 92-498-SLR.

United States District Court,

D. Delaware.

Sept. 16, 1992.

James S. Green of Duane, Morris & Heckscher, Wilm-

ington, Del., for plaintiff. Of Counsel: Robert P. Bramnik,

Thomas P. Fitzgerald, and Michael I. Behn, of Altheimer

& Gray, Chicago, Ill.

W. Michael Tupman, Delaware Dept. of Justice,

Wilmington, Del., for defendants W. Michael Tupman and

Richard W. Hubbard.

MEMORANDUM OPINION

SUE L. ROBINSON, District Judge.

I. INTRODUCTION

Before the Court is a motion for temporary restrain-

ing order, preliminary injunction and other relief filed by

plaintiff OLDE Discount Corporation (“OLDE”) in order

to enjoin defendants from: “(1) pursuing a penal and

registration revocation action against the plaintiff which

will have the effect of violating plaintiff’s federal right to

arbitrate... . ; (2) pursuing an investigation of OLDE; and

App. 49

(3) instigating other actions against the plaintiff in Dela-

ware or any other state, pending a hearing and deter-

mination on the issuance of a preliminary injunction.”

(Docket item, “D.I.”, 4) Defendants Richard W. Hubbard

and W. Michael Tupman (hereinafter “the State defen-

dants”)!, the Securities Commissioner of the State of Del-

aware and the Deputy Attorney General representing

such, respectively, have responded and oral argument

was heard on August 27, 1992. Supplemental responses

have been received. (D.I. 19, 28)

II. JURISDICTION

Jurisdiction is grounded on plaintiff’s claim regard-

ing the Federal Arbitration Act (“FAA”), 9 U.S.C. §§ 1-10,

and 28 U.S.C. § 1331.

Venue is proper in this District under 28 U.S.C.

§ 1391(b) because all defendants reside in this District

and because the claims asserted by plaintiff arose in this

District. ;

III. FINDINGS OF FACT

For purposes of this proceeding, the material facts

are undisputed:

1. Plaintiff OLDE is a securities firm with its princi-

pal place of business located at 751 Griswold Street,

Detroit, Michigan 48226. OLDE also has a branch office

' Because the relief sought is directed at the State defen-

dants, defendants Eugene H. and Carol D. Engelhardt have not

participated in these proceedings.

App. 50

located at 208 West Tenth Street, Wilmington, Delaware

19801. (D.I. 12, Ex. 1, ¥ 12)

2. OLDE is and has been registered as a broker-

dealer in Delaware since October 6, 1981. Although OLDE

is primarily engaged in the discount brokerage business,

it does make a market in certain securities, which its

agents recommend to customers. In the spring of 1990,

one of the stocks was Second National Federal Savings

Bank (“SNFS”), a savings and loan association with

branches in Pennsylvania, Maryland, Delaware, Virginia,

and the District of Columbia. (D.I. 14, Ex. 1, § 15)

3. The Division of Securities of the State of Dela-

ware is a unit within the Department of Justice directed

by the Securities Commissioner under the auspices of the

Attorney General pursuant to the Delaware Securities

Act, 6 Del.C. § 7301 et seq.

4. In 1983, defendants Eugene H. and Carol D.

Engelhardt opened a joint account with OLDE in Michi-

gan, where they were then residing. When they moved to

Delaware in 1986, they transferred their account to

OLDE’s Wilmington office. In the spring of 1990, their

account was assigned to Michael R. Donohoe, the only

securities agent employed in OLDE’s Wilmington branch.

(D.I. 12, Ex. 1, ¥ 22)

5. The Engelhardt’s account with OLDE was gov-

erned by the terms of an Investors Account Agreement

between OLDE and the defendants Engelhardt. The

Investors Account Agreement in effect during the period

relevant to this proceeding was signed by the defendants

Engelhardt on May 25, 1990. According to their Customer

App. 51

Preference Profile, the defendants Engeliiardt had sub-

stantial investment experience, having invested in stocks

for approximately fifteen years, making an average of

three to five trades per year, and trading an average of

five to ten thousand shares per transaction. In describing

their investment objects, the defendants Engelhardt chose

the following adjectives: “aggressive”, “growth”, “spec-

ulation”. (D.I. 6, Ex. A)

6. The Investors Account Agreement entered

between OLDE and the defendants Engelhardt included a

“Predispute Arbitration Clause”. The inclusion of the

Predispute Arbitration Clause was disclosed in bold face

and in large type directly above the defendants’ signa-

tures. (D.I. 6, Ex. A)

7. The Predispute Arbitration Clause itself was

more specifically spelled out in the terms and conditions

portion of the agreement, clauses 17 and 18, in bold type.

In relevant part, the Predispute Arbitration Clause pro-

vides that the Engelhardts “agree to submit any and all

controversies or claims arising out of this agreement to

arbitration” according to the procedures of the New York

Stock Exchange, Inc. or the National Association of Secu-

rity Dealers, Inc. (D.I. 6, Ex. A)

8. In May and June 1990, the defendants Engelhardt

purchased a total of ten thousand shares of the common

stock of SNFS. The total purchase price of the ten thou-

sand shares of SNFS stock was $52,875.00. During the

course of the next several months, the market price of

SNFS stock declined, causing a parallel decline in the

market value of the defendants Engelhardts’ SNFS

account. (D.I. 1, J 13}

App. 52

9. In July or August 1990, the defendants

Engelhardt telephoned OLDE in Michigan to express

their dissatisfaction with their SNFS stock purchase,

given the drop in price. The defendants Engelhardt were

informed that there was no basis for their complaint, that

their SNFS stock purchases were not inappropriate. (D.I.

1, { 15)

10. According to the record, the defendants

Engelhardt were advised at that time that they should

submit a written complaint to OLDE regarding the cir-

cumstances of their claim if they wished to initiate a

complaint and/or a fuller review. (D.I. 1, { 15) No written

complaint was ever submitted, although the Investors

Account Agreement, clause 12, expressly requires inves-

tors to object, in writing, within ten days regarding any

transactions in their account which are in dispute. (D.I. 1,

7 18; D.I. 6, Ex. A)

11. On September 6, 1990, the defendants

Engelhardt transferred their SNFS stock out of OLDE.

The market value of their SNFS stock at the time of the

transfer was approximately $32,500.00, a decline of

approximately $20,375.00 from their initial investment.

(D.I. 1, J 17)

12. In July 1991, the Division of Securities of the

State of Delaware received a complaint from the defen-

dants Engelhardt against OLDE and its agent (by now a

former agent), Michael Donohoe, with regard to the pur-

chase of the SNFS stock in May and June of 1990. (D.I. 6,

Ex. C; D.L 12, ¥ 2).

13. By letter dated July 31, 1991, a securities investi-

gator for the Delaware Department of Justice advised

App. 53

OLDE of the Engelhardts’ complaint. The securities

investigator related that “[t]he Engelhardts allege that the

solicitation to purchase [the SNFS stock] involved omis-

sion of material facts (including the risk factor) and high

pressure selling techniques. They further allege that Mr.

Donohoe marked at least one purchase ‘unsolicited’.

Finally, they allege that this security was unsuitable for

persons in their circumstances.” The securities investiga-

tor requested that OLDE respond to these allegations by

August 26, 1991. (D.I. 6, Ex. C; D.I. 12, | 2) OLDE

responded to this and subsequent requests for documents

and information. (D.I. 6, Ex. E; D.I. 12, q 2-4)

14. By late May 1992, the Division of Securities had

completed its investigation of the Engelhardts’ complaint

and on June 5, 1992, defendant Tupman sent to OLDE a

draft “Notice of Intent to Suspend or Revoke Broker-

Dealer Registration”, alleging various violations of the

Delaware Securities Act, 6 Del.C. §§ 7301 et seq. (D.I. 12,

{1 5) In said Notice, defendant Tupman stated that it was

in the public interest that: 1) the broker-dealer registra-

tion of OLDE be suspended or revoked; 2) Donohoe be

permanently barred from engaging in the securities busi-

ness in Delaware; 3) OLDE rescind the three sales of

SNFS stock to the defendants Engelhardt, and pay the

Engelhardts back their purchase price of $52,875.00; and

4) OLDE be fined $10,000.00 for each and every violation

of the Act, and that OLDE pay all of the costs incurred by

the Division of Securities in connection with the investi-

gation and prosecution of the case. (D.I. 6, Ex. F)

15. By letter dated June 25, 1992, OLDE asserted

that the proposed administrative proceeding against

OLDE for Donohoe’s alleged sales practice abuses was

App. 54

not warranted. OLDE also offered to settle the

Engelhardts’ claim concerning their SNFS stock pur-

chases by offering $20,000.00 as compensation for all of

the losses which were allegedly caused by Donohoe’s

conduct. In the alternative, OLDE offered to “pay all

filing and form fees for the Engelhardts’ claim to be heard

and decided by an arbitration panel before the National

Association of Securities Dealers, Inc., the New York

Stock Exchange, Inc. or the American Arbitration Asso-

ciation.” (D.I. 6, Ex. G)

16. By letter dated July 6, 1992, defendant Tupman

responded:

In considering your offer of settlement, | assume

that the $20,000.00 figure represents the differ-

ence between the price paid by the Engelhardts

for their SNFS stock, and the current market

value. Given the allegations of unsuitability, I

think it much more appropriate for there to be a

rescission of the trades, with your firm receiving

the stock back and the Engelhardts their pur-

chase price ($52,875.00).

In addition, because of the seriousness of the

allegations, and the State’s preparedness to

prosecute, the public interest would require a

substantial contribution to the Investor Protec-

tion Fund, as well as written undertakings

regarding compliance procedures in your Wilm-

ington branch office.

I do not intend to continue any further written

dialogue on the allegations in the draft Notice. I

think you have fully set forth your position in

your last letter, and I am not amendable to any

continued “back and forth” responses. Instead, I

suggest you call me later this week (and in no

App. 55

event later than noon on Friday, July 10), to

discuss the terms of settlement. Otherwise, the

Securities Division is prepared to submit the

charges to the Commissioner for his approval on

July 13.

(D.I. 6, Ex. H)

17. At an August 5, 1992 settlement meeting

attended by defendant Tupman and representatives of

plaintiff OLDE, defendant Tupman once again rejected

OLDE’s offer of restitution to the Engelhardts in the

amount of $20,375.00 and instead demanded rescission in

the amount of $52,875.00, on the grounds that rescission

would be more beneficial and fair to the Engelhardts.

Defendant Tupman also stated that the Engelhardts

refused to arbitrate their civil claims; rather, the

Engelhardts had selected the Delaware Securities Com-

missioner’s Office to pursue their claim. (D.I. 6, Ex. I)

18. After the August 5, 1992 meeting with defen-

dant Tupman, OLDE gave written notice of its demand

that the Engelhardts arbitrate their civil claim against

OLDE concerning their SNFS stock purchases pursuant to

their arbitration agreement and the Federal Arbitration

Act, 9 U.S.C. §§ 1 et seq. The August 5, 1992 notice stated

as follows:

We have been informed by Delaware Deputy

Attorney General, W. Michael Tupman, that you

have complained to him about the purchase of

SNFS stock through OLDE Discount. He further

advises that you believe that you have & temedy

under the restitution provision set forth in sec-

tion 7325(b) of the Delaware Code. We disagree.

App. 56

You have agreed with OLDE Discount to resolve

any and all disputes by arbitration before either

the New York Stock Exchange (“NYSE”) or the

National Association of Security Dealers, Inc.

(“NASD”). You further have agreed to make an

election within five days of written demand of

such election. Please consider this letter our

written demand that you make such election.

(D.I. 6, Ex. K)

19. According to his affidavit, defendant Tupman

met with the defendants Engelhardt on August 10, 1992

to inform them that plaintiff OLDE had made a settle-

ment offer, to wit, to pay $15,000.00 to the Delaware

Investors Protection Fund, in lieu of a fine, and to pay

$20,375.00 in full restitution to the Engelhardts for the

depreciation in value of their SNFS stock during the

entire period of time that the stock was held in their

OLDE account. Both defendants Engelhardt “emphat-

ically agreed that they wanted the State to go forward

with its case.” (D.I. 12, ¥ 11)

20. Also on August 10, 1992, defendant Tupman

represented in a letter to OLDE the following:

[I]t has come to our attention that by letter

dated August 5, 1992 ..., you tried to pressure

the Engelhardts into an NASD arbitration, even

though we had discussed that legal issue at our

meeting the same day, and the State had dis-

agreed with your legal position. I find this fur-

ther evidence of your bad faith, and therefore

terminate settlement negotiations. Your last

offer is rejected.

Enclosed are written interrogatories served pur-

suant to Section 7319 of the Delaware Securities

App. 57

Act. An officer, director, or duly authorized

agent of OLDE must answer those interrogato-

ries, under oath, and return them to me no later

than seven business days after the date of this

letter. In addition, with regard to each individ-

ual identified in your response to Interrogatory

No. 1, we ask that you produce his or her new

account form and customer preference profile,

and with regard to each transaction identified in

your response to Interrogatory No. 2, we ask

that you produce the confirmation of purchase.

Further, we ask that you produce copies of any

letters of complaint, and any response your

made, from any Delaware residents with regard

to those transactions. You have until the close of

business on August 24, 1992 to produce that

documents.

(D.I. 6, Ex. M)

21. A Notice of Intent to Suspend or Revoke Broker-

Dealer Registration was filed by the Division of Securities

on August 17, 1992. Defendant Hubbard, the Securities

Commissioner, also signed an order of that same date

giving OLDE thirty days to request a hearing on the

matter. (D.I. 12, Ex. 1)

22. On August 17, 1992, the Department of Justice

issued a press release concerning the Notice of Intent

against OLDE. An article reporting the Notice appeared

the next day in the News Journal. (D.I. 6, Ex. N)

23. On August 19, 1992, OLDE provided timely

responses to defendant Tupman’s interrogatories. (D.I. 1,

{ 39)

24. Plaintiff filed its motion for temporary restrain-

ing order, preliminary injunction and other relief on

ies ee

App. 58

August 25, 1992, alleging, inter alia, that: 1) application

and enforcement of § 7325(b) of the Delaware Securities

Act, 6 Del.C. § 7325(b), is unconstitutional under Article

VI, clause 2 of the United States Constitution (the

“Supremacy Clause”); 2) the application of 6 Del.C.

§ 7325(b), as amended, to the actions of OLDE in 1990

constitutes the imposition of an ex post facto penalty in

violation of the Due Process Clause of the Fourteenth

Amendment of the Constitution of the United States; 3)

defendants Tupman and Hubbard have acted under color

of state law to deprive the plaintiff of its rights under the

Federal Arbitration Act and under the Due Process

Clause in violation of 42 U.S.C. § 1983; and 4) defendant

Tupman has committed willful acts in the use of process

not proper in the regular conduct of these administrative

proceedings. (D.I. 1)

IV. CONCLUSIONS OF LAW

The standard for obtaining a temporary restraining

order is the same as the standard for a preliminary

injunction. Fed. R.Civ.P. 65(b); Tootsie Roll Industries, Inc.

v. Sathers, Inc., 666 F.Supp. 655, 658 (D.Del.1987). It is

beyond dispute that “the grant of injunctive relief is an

‘extraordinary remedy, which should be granted only in

limited circumstances.’ ” Instant Air Freight Co. v. C.F. Air

Freight, Inc., 882 F.2d 797, 800 (3d Cir.1989), citing Frank’s

GMC Truck Center, Inc. v. General Motors Corp., 847 F.2d

100, 102 (3d Cir.1988). Thus, in ruling on a motion for a

preliminary injwRetion; this Court must consider:

(1) the likelihood that the [movant] will prevail

on the merits at final hearing; (2) the extent to

which the [movant] is irreparably harmed by the

——— «a

App. 59

conduct complained of; (3) the extent to which

the [nonmoving party] will suffer irreparable

harm if the preliminary injunction is issued; and

(4) the public interest.

Opticians Ass'n of America v. Independent Opticians of Amer-

ica, 920 F.2d 187, 191-92 (3d Cir.1990). As recently reaf-

firmed by the Third Circuit, an

injunction should issue only if the [movant] pro-

duces evidence sufficient to convince

the .. . [C]ourt that all four factors favor prelim-

inary relief.

Merchants & Evans, Inc. v. Roosevelt Bldg. Products, Co., 963

F.2d 628, 632-633 (3d Cir.1992). See also Instant Air Freight

Co. v. C.F. Air Freight, Inc., 882 F.2d at 800, quoting In re

Arthur Treachers Franchisee Litigation, 689 F.2d 1137, 1143

(3d Cir.1982).

A. Reasonable Probability of Success on the Merits

1. Pre-emption

Plaintiff’s primary argument in support of its request

for injunctive relief is that § 7325(b) of the Delaware

Securities Act, as amended, 6 Del.C. § 7325(b), is uncon-

stitutional because it directly conflicts with the Federal

Arbitration Act (“FAA”), 9 U.S.C. §§ 1-10. The primary

substantive provision of the FAA states that

[a] written provision in any maritime transac-

tion or a contract evidencing a transaction

involving commerce to settle by arbitration a

controversy thereafter arising out of such con-

tract or transaction . . . shall be valid, irrevoca-

ble, and enforceable, save upon such grounds as

App. 60

exists at |aw or in equity for the revocation of

any contract.

9 U.S.C. § 2. As explained by the Supreme Court in Perry

v. Thomas, 482 U.S. 483, 107 S.Ct. 2520, 96 L.Ed 2d 426

(1987),

“Section 2 is a congressional declaration of a

liberal federal policy favoring arbitration agree-

ments, notwithstanding any state substantive or

procedural policies to the contrary. The effect of

the section is to create a body of federal substan-

tive law of arbitrability, applicable to any arbi-

tration agreement within the coverage of the

Act.” Moses H. Cone Memorial Hospital v. Mercury

Construction Corp., 460 U.S. 1, 24, 103 S.Ct. 927,

941, 74 L.Ed.2d 765 (1983). Enacted pursuant to

the Commerce Clause, U.S. Const., Art. I, § 8, cl.

3, this body of substantive law is enforceable in

both state and federal courts. Southland Corp. v.

Keating, 465 U.S. 1, 11-12, 104 S.Ct. 852, 858-859,

79 L.Ed.2d 1 (1984). .. . As we stated in Keating,

“liJn enacting § 2 of the federal Act, Congress

declared a national policy favoring arbitration

and withdrew the power of the states to require

a judicial forum for the resolution of claims

which the contacting parties agreed to resolve

by arbitration.” Id., at 10, 104 S.Ct. at 858. “Con-

gress intended to foreclose state legislative

attempts to undercut the enforceability of arbi-

tration agreements.” Id., at 16, 104 S.Ct. at 861

(footnote omitted). Section 2, therefore,

embodies a clear federal policy of requiring

arbitration unless the agreement to arbitrate is

not part of a contract evidencing interstate com-

merce or is revocable “upon such grounds as

exist at law or in equity of the revocation of any

contact.” 9 U.S.C. § 2. “We see nothing in the

App. 61

Act indicating that the broad principle of enfor-

ceability is subject to any additional limitations

under state law.” Keating, supra, at 1i, 104 S.Ct.,

858.

Id. 482, U.S. at 489, 107 S.Ct. at 2525.

In the case of Perry v. Thomas, Thomas sued his

former employer, Kidder Peabody & Co., for breach of

contract, conversion, civil conspiracy to commit conver-

sion, and breach of fiduciary duty, for which he sought

compensatory and punitive damages. Thomas refused to

submit the dispute to arbitration based on § 229 of the

California Labor Code, which authorized Thomas to

maintain an action for wages. The Supreme Court, in

holding that the Supremacy Clause and § 2 of the FAA

pre-empted the state statute, concluded:

[T]he present appeal addresses the pre-emptive

effect of the Federal Arbitration Act, a statute

that embodies Congress’ intent to provide for

the enforcement of arbitration agreements

within the full reach of the Commerce Clause.

Its general applicability reflects that “[t]he pre-

eminent concern of Congress in passing the Act

was to enforce private agreements into which

parties had entered... . ” [Dean Witter Reynolds

Inc. v. Bird, 470 U.S. 213, 221, 105 S.Ct. 1238,

1242, 84 L.Ed.2d 158 (1985)]. We have accord-

ingly held that these agreements must be “rig-

orously enforce[d].” Ibid.; see Shearson/American

Express Inc. v. McMahon, 482 U.S. 220, 226 [107

S.Ct. 2332, 2337, 96 L.Ed.2d 185] . . . (1987);

Mitsubishi Motor Corp. v. Soler Chrysler-Plymouth,

Inc., 473 U.S. 614, 625-626 [105 S.Ct. 3346,

3353-3354, 87 L.Ed.2d 444]... (1985). This clear

App. 62

federal policy places § 2 of the Act in unmistak-

able conflict with California’s § 229 requirement

that litigants be provided a judicial forum for

resolving wage disputes. Therefore, under the

Supremacy Clause, the state statuie must give

way.

482 U.S. at 490, 107 S.Ct. at 2526. Accord, Securities Indus-

try Asso. v. Connolly, 883 F.2d 1114 (1st Cir.1989), cert.

denied, 495 U.S. 956, 110 S.Ct. 2559, 109 L.Ed.2d 742 (1990)

(a Massachusetts state regulation which: (1) barred firms

from requiring individuals to enter pre-dispute arbitra-

tion agreements as a nonnegotiable condition precedent

to account relationships; (2) ordered the prohibition

brought “conspicuously” to the attention of prospective

customers; and (3) demanded full written disclosure of

“the legal effect of the pre-dispute arbitration contract or

clause”, pre-empted by the FAA); Osterneck v. Merrill

Lynch, Pierce, Fenner & Smith, 841 F.2d 508 (3d Cir.1988)

(provision of the Pennsylvania Securities Act, identical to

§ 410(g) of the Uniform Securities Act and precluding

enforcement of an agreement to arbitrate, pre-empted by

the FAA).

Not only does the FAA pre-empt state statutes which

provide a judicial forum for resolving disputes, “[i]t is by

now clear that statutory claims may be the subject of an

arbitration agreement, enforceable pursuant to the FAA.”

Gilmer v. Interstate/Johnson Lane Corp., __ U.S. __, __,

111 S.Ct. 1647, 1652, 114 L.Ed.2d 26 (1991). The issue

before the Court in Gilmer was whether a claim under the

Age Discrimination and Employment Act of 1967

(“ADEA”), could be subjected to compulsory arbitration

App. 63

pursuant to an arbitration agreement in a securities regis-

tration application. The Court, recognizing that “the

ADEA is designed not only to address individual griev-

ances, but also to further important social policies”,

found no

inherent inconsistency between those [social]

policies . . . and enforcing agreements to arbi-

trate age discrimination claims. It is true that

arbitration focuses on specific disputes between

the parties involved. The same can be said, how-

ever, of judicial resolution of claims. Both of

these dispute resolution mechanisms neverthe-

less also can further broader social purposes.

The Sherman Act, the Securities Exchange Act of

1934, RICO, and the Securities Act of 1933 all are

designed to advance important public policies,

but, as noted above, claims under those statutes

are appropriate for arbitration. “ [S]o long as the

prospective litigant effectively may vindicate

[his or her] statutory cause of action in the arbi-

tral forum, the statute will continue to serve

both its remedial and deterrent function.” Mit-

subishi, supra, 473 U.S., at 637 [105 S.Ct. at

___ US. at __, 111 S.Ct. at 1653. Noting the “liberal

federal policy favoring arbitration agreements”, the

Court concluded that Gilmer’s ADEA claim was subject

to compulsory arbitration.

State defendants argue that the Delaware Securities

Act does not directly conflict with the FAA in that no

provision specifically preciudes plaintiff from pursuing

its right to arbitrate. And, indeed, no provision of the

Delaware Securities Act even mentions arbitration. There

is no question, however, that the regulatory scheme as

App. 64

currently drafted contemplates administrative proceed-

ings which effectively eliminate a party’s right to an

arbitral forum.

Under the Delaware Securities Act, 6 Del.C. §§ 7301

et seq., the Securities Commissioner is authorized to sus-

pend or revoke the registration of a broker-dealer or

agent, if he determines that such person is subject to one

of the disqualifying factors stated in that section and that

such action is in the public interest. 6 Del.C.§ 7316(a).

Subsection (g) of § 7316 also authorizes the Commis-

sioner, “upon notice and hearing”, to fine any broker-

dealer, investment advisor or agent in an amount not to

exceed $10,000.00 for each and every violation of the

chapter, plus the cost of investigation and prosecution.

In addition to the public enforcement authority

vested in the Securities Commissioner under § 7316,

§ 7323 provides as well for private causes of action for

rescission brought by injured investors. More specifically,

§ 7323 provides in relevant part that “[a]ny person

who... sells . . . a security by means of any untrue

statement of a material fact or any omission to state a

material fact . . . is liable to the person buying . . . the

security ..., who may sue either at law or in equity to

recover the consideration paid for the security. ... ”

Subsection (g) of § 7323, modeled after § 410(g) of the

Uniform Securities Act, provides:

(g) Any condition, stipulation, or provision

binding any person acquiring any security to

waive compliance with any provision of this

chapter or any rule or order hereunder is void.

App. 65

This subsection is identical to the Pennsylvania statute

reviewed by the Third Circuit in Osterneck, 841 F.2d at

510, which subsection was found to be pre-empted by the

FAA.

Although the Delaware Securities Act provides that

any person aggrieved by an order of the Securities Com-

missioner may obtain a review of the order in the Court

of Chancery, the commencement of the judicial review

proceedings does not, unless specifically ordered by the

Court of Chancery, operate as a stay of the Commis-

sioner’s order. 6 Del.C § 7324.

Section 7325(b) of the Delaware Securities Act, the

statutory provision primarily at issue, was amended in

July 1990 to provide:

(b) The Commissioner may make, amend and

rescind rules, regulations, forms and orders to

carry out and define the provisions of this chap-

ter. Such orders may provide for fines, assess-

ment of costs, restitution to investors,

conditional or probationary registration, centaur

[sic] or reprimand, special reporting require-

ments, or other provisions which the Commis-

sioner determines to be in the public interest.

Subsequently, in June 1991, subsection (b) was amended

once again to provide:

Any person, whether registered or not, who

willfully violates any provision of this chapter,

or who aides [sic] and abets any person who

willfully violates any provision of this chapter,

may be fined in accordance with subsection

7316(g) and order [sic] to pay restitution and

costs (or to rescind the transaction or transactions

and pay costs) if the Commissioner finds it in the

App. 66

public interest, any may be criminally pros-

ecuted under § 7322.?

Although there apparently is no caselaw directly on

point involving state administrative proceedings that

impede a party’s right to enforce a predispute arbitration

agreement, the Securities Commissioner cannot use his

authority under 6 Del.C § 7325(b) as both a sword - to

enforce under § 7325(b) investors’ personal rights to

rescission provided under § 7325(a) = and a shield - to

insulate the investors from a contracted to arbitral forum

by insisting on the primacy of the State’s administrative

forum — without running afoul of the Supremacy Clause

of the Constitution. There is no contention that the arbi-

tration agreement at issue is not enforceable under the

FAA. Neither is there a contention at bar that the defen-

dants Engelhardt may not effectively vindicate their stat-

utory cause of action in the arbitral forum.

Given the clear Congressional intent “to provide for the

[rigorous] enforcement of arbitration agreements within

the full reach of the Commerce Clause”, Perry v. Thomas,

2 Although the State defendants maintain that the Dela-

ware Securities Act is “modeled on the Uniform Securities Act”

(D.1. 10 at 21), the Court can find no counterpart in the Uniform

Act to § 7325(b) as amended.

3 The Supremacy Clause provides that:

This Constitution, and the Law of the United States

which shall be made in Pursuance thereof; and all

Treaties made, or which shall be made, under the

Authority of the United States, shall be the supreme

Law of the Land; and the Judges in every State shall

be bound thereby, any Thing in the Constitution or

Laws of any State to the Contrary notwithstanding.

U.S. Const., Art. VI, cl. 2.

App. 67

482 U.S. at 490, 107 S.Ct. at 2526, as given effect by the

Supreme Court’s interpretation of the FAA, the Court

concludes that the FAA serves to withdraw the power of

the states not only to require a judicial forum for the

resolution of claims, but to require an administrative

forum as well. In sum, then, the FAA pre-empts § 7325(b)

| insofar as that statute allows the Securities Commissioner

to order rescission on behalf of individual investors who

have signed predispute arbitration agreements.

2. Primary Jurisdiction

The State defendants argue that the FAA does not

pre-empt the administrative proceedings at bar by virtue

of the doctrines of primary jurisdiction or, alternatively,

the exhaustion of administrative remedies. As explained

by the United States Supreme Court in United States v.

Western Pacific Railroad Co., 352 U.S. 59, 77 S.Ct. 161, 1

L.Ed.2d 126 (1956),

[t]he doctrine of primary jurisdiction, like the

rule requiring exhaustion of administrative

remedies, is concerned with promoting proper

relationships between the courts and adminis-

trative agencies charged with particular regula-

tory duties. “Exhaustion” applies where a claim

is cognizable in the first instance by the admin-

istrative agency alone; judicial interference is

withheld until the administrative process has

run its course. “Primary jurisdiction,” on the

other hand, applies where a claim is originally

cognizable in the courts, and comes into play

whenever enforcement of the claim requires the

resolution of issues which, under a regulatory

scheme, have been placed within the special

App. 68

competence of an administrative body; in such a

case the judicial process is suspended pending

referral of such issues to the administrative

body for its views.

Id. at 63-4, 77 S.Ct. at 165.

Applying this lucid explanation to the facts at bar

the Court concludes, first, that the doctrine of primary

jurisdiction does not apply. As further illustrated by te

Supreme Court in United States v. Western Pacific Railroad

Co., “in cases raising issues of fact not within the conven-

tional experience of judges or cases requiring the exercise

of administrative discretion, agencies created by Con-

gress for regulating the subject matter should no* be

passed over.” 352 U.S. at 64, 77 S.Ct. at 165. Thus, in that

case, the Court concluded that

where the question is simply one of construction

[of a tariff] the courts may pass on it as an issue

“solely of law.” But where words in a tariff are

used in a peculiar or technical sense, and where

extrinsic evidence is necessary to determine

their meaning or proper application, so that “the

enquiry is essentially one of fact and of discre-

tion in technical matters,” then the issue of tariff

application must first go to the [Interstate Com-

merce] Commission. The reason is plainly set

forth: such a “determination is reached ordi-

narily upon voluminous and conflicting evi-

dence, for the adequate appreciation of which

acquaintance with many intricate facts of trans-

portation is indispensable; and such acquain-

tance is commonly to be found only in a body of

experts.”

352 U.S. at 65-66, 77 S.Ct. at 166 (citations omitted).

Unlike the interpretation of a tariff, which can involve

App. 69

complex and technical cost-allocation and accounting

problems, enforcement of the Engelhardts’ claim does not

require the resolution of any issue “placed within the

special competence of” the Delaware Securities Commis-

sioner. Indeed, the statutory scheme contemplates that

such claims are appropriately resolved in a judicial forum

at the investors’ discretion; such claims are within the

conventional experience of federal judges.

3. Exhaustion of Administrative Remedies

Nor does the doctrine of exhaustion of administrative

remedies apply, since the claim at issue, i.e., the

Engelhardts’ claim for rescission, is not cognizable in the

first instance by an administrative agency alone. Although

by amending § 7325(b) and giving to the Securities Com-

missioner the authority to order rescission, private liti-

gants (like the defendants Engelhardt) may no longer

need to sue in law or in equity for rescission under

§ 7323(a), the Delaware Securities Act still gives private

litigants that option and still specifically provides that,

“tt]he rights and remedies provided by this chapter are in

addition to any other rights or remedies that may exist at

law or in equity.” 6 Del.C. § 7323(h) (emphasis added).

Thus, unlike the “comprehensive system of review”

established by the National Association of Securities

Dealers, Inc. and the Securities and Exchange Commis-

sion, see First Jersey Securities, Inc. v. Bergen, 605 F.2d 690,

695 (3d Cir.1979), cert. denied, 444 U.S. 1074, 100 S.Ct.

1020, 62 L.Ed.2d 756 (1980), the statutory review pro-

cedure in question does not establish original and/or

exclusive jurisdiction in the administrative proceeding.

App. 70

Even if the exhaustion doctrine would normally

apply, the Third Circuit has “recognized two situations in

which the exhaustion requirement will not be adhered to:

(1) when the administrative procedure is clearly shown to

be inadequate to prevent irreparable injury; or (2) when

there is a clear and unambiguous statutory or constitu-

tional violation.” Id. at 696. Plaintiff asserts that both

exceptions apply to the facts at bar by virtue of the pre-

emption of the FAA. The Court agrees.

If the administrative process vis.a.vis the State’s

rescission action under 6 Del.C. § 7325(b) is allowed to go

forward, plaintiff’s right to enforce the arbitration agree-

ment entered into between it and the Engelhardts is ren-

dered a nullity, regardless of the substantive result of the

administrative proceeding. The loss of the federal sub-

stantive right to an arbitral forum is distinguishable from

the business losses claimed in First Jersey Securities, Inc. v.

Bergen, 605 F.2d at 696. Concomitantly, the Commis-

sioner’s usurpation of the parties’ contractual obligation

to arbitrate constitutes a clear and unambiguous violation

of the Supremacy Clause as interpreted by the Supreme

Court, as discussed above.

4. Abstention

In their supplemental submission (D.I. 19), the State

defendants assert that the abstention doctrine of Younger

v. Harris, 401 U.S. 37, 91 S.Ct. 746, 27 L.Ed.2d 669 (1971),

is applicable to the facts at bar. In Younger v. Harris, the

Supreme Court held that a federal court should not enjoin

a pending state criminal proceeding except in the very

App. 71

unusual situation that an injunction is necessary to pre-

vent great and

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