Opposition Brief — Kelly v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

“Buerse fou, US

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No. 93-486 | Koy 17 1898

No. ,

seca

Iu the Supreme Court of the United States

OCTOBER TERM, 1993

FRANK KELLY, ET AL., PETITIONERS

MERRILL LYNCH, PIERCE, FENNER & SMITH. INC.

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE ELEVENTH CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

PETER BUSCEMI

JOHN P. SIMMONS

MORGAN, LEWIS & BOcKIUS

1800 M Street, N.W.

BENNETT FALK

MORGAN, LEWIS & BOCKIUS

5300 Southeast Financial

Center

200 South Biscayne Washington, D.C, 20036

Boulevard (202) 467-7190

Miami, Florida 33131 Counsel for Respondent

(305) 579-0390 ;

Counsel of Record

WILSON . EPES PRINTING CO Inc. - 789-O096 - WASHINGTON. [ 20001

BEST AVAILABLE COPY

QUESTIONS PRESENTED

This case involves the res judicata effect of a district

court judgment against petitioners and in favor of. re-

spondent Merrill Lynch, Pierce, Fenner & Smith, Inc.

(“Merrill Lynch”). That judgment was affirmed by the

court of appeals, and petitioners did not seek review in

this Court. Soon after the district court entered its judg-

ment, petitioners began an arbitration against Merrill

Lynch. The arbitration arose from the same facts as the

earlier district court litigation, but petitioners asserted

theory of liability diametrically opposite from the one tha’

they had pursued unsuccessfully in the district court.

Merrill Lynch asked the district court to enforce its own

judgment and enjoin the arbitration on res judicata

grounds. The district court entered the requested injunc-

tion, and the court of appeals again affirmed. The ques-

tions presented are:

1. Whether the district court was entitled to consider

and decide Merrill Lynch’s claim of res judicata.

2. Whether the district court properly ruled that peti-

tioners’ arbitration is barred by res judicata.

(i)

ii

STATEMENT UNDER RULE 29.1

In accordance with Rule 29.1 of the Rules of this

Court, respondent Merrill Lynch, Pierce, Fenner & Smith,

Inc. states that its parent company is Merrill Lynch &

Co., Inc. and that it has the following subsidiaries (other

than wholly owned subsidiaries) :

Merrill Lynch Life Agency, Inc. (Ohio)

Merrill Lynch Life Agency, Inc. (Oklahoma)

Merrill Lynch Life Agency, Ltd. (Mississippi)

Merrill Lynch-Nomura Management Company, Inc.

ML Life Agency Inc.

Wagner Stott Clearing Corp.

TABLE OF CONTENTS

QUESTIONS PRESENTED ................... Saddcedaaidadaitonmniaa

STATEMENT UNDER RULE 29.1

RE I BED EID eccirerecevcececccosrccecncnsueconséseenee

STATEMENT OF THE CASE

A. The Trading Activity That Gave Rise To Peti-

ph RES

B. Petitioners’ Federal Lawsuit ..................-.0-.-.0.-00---

C. Petitioners’ Claims In Arbitration .....................

D. Merrill Lynch’s Request For An Injunction On

The Ground Of Res Judicata —......0-00..o

E. The Decisions Below

a RAE ES

I. THE DISTRICT COURT WAS ENTITLED TO

ENFORCE ITS OWN JUDGMENT AND AD-

DRESS MERRILL LYNCH’S CLAIM OF RES

TR a ip AEN Se ls

Il. THE COURTS BELOW CORRECTLY CON-

CLUDED THAT PETITIONERS’ ARBITRA-

TION IS BARRED BY RES JUDICATA

ee eccrcduseoueneuamenene PWR ei Ds Bae

APPENDIX i diakametientiaiiie ee

(iii)

10

iv

TABLE OF AUTHORITIES

CASES Page

American Train Dispatchers Assoc. v. Burlington

N. R.R. Co., 784 F. Supp. 899 (D.D.C. 1992) .... 12

Ank Shipping Co. v. Seychelles Nat’l Commodity

Co., Ltd., 596 F. Supp. 1455 (S.D.N.Y. 1984)... 13

Blue Gray Corporations I & II v. Merrill Lynch,

Pierce, Fenner & Smith, Inc., 921 F.2d 267

I: 6 ee 18

Burmah Oil Tankers, Ltd. v. Trisun Tankers, Ltd.,

687 F. Supp. 897 (S.D.N.Y. 1988) _.......... 13

Clark v. Bear Stearns & Co., 966 F.2d 1318 (9th

Cir. 1992) .......... sc ccaminuinaehies 19

Clemens v. Central R. R. Co. of New Jeroen, 399

F.2d 825 (3d Cir. 1968), cert. denied, 393 U.S.

1023 (1969) ay ce ane ee ana e 12

Commissioner v. Sunnen, 333 U Ss. 591, 597

(1948) = a 15

Dean Witter Reynolds v. Byrd, 470 U.S. 213

(1985) hs ; TE nN aerate ON 10, 11

E.C. Ernst, Inc. v. Manhattan Construction Co.,

551 F.2d 1026 (5th Cir.), modified on petition

for reh’g, 559 F.2d 268, 269 (5th Cir. 1977),

cert. denied, 434 U.S. 1067 (1978) ............ SRS: 21

Enterprise Ass’n Metal Trades Branch Local

Union 638 v. Empire Mechanical, Inc., 122 Lab.

Cas. © 10,284, 1992 Westlaw 84689 (S.D.N.Y.

1992) . . aad 10-11

Federated Department Stores, “Ine. v. Moitie, 452

eS ss ESSERE EEC ER CER Reels AO ee eae 15

Fremont Cake & Meal Co. v. Wilson & Co., Inc.,

183 F.2d 57 (8th Cir. 1950) .. ae 12

Hart Steel Co. v. Railroad Supply Co., 244 ‘U.

294, 299 (1917). Seacamiie 15

International Ladies’ Garment W orkere’ Union v.

Ashland Indus., Inc., 488 F.2d 641 (5th Cir.),

cert. denied, 419 U.S. 840 (1974) 14

Interstate Pipe Maintenance, Inc. v. FMC Corp.,

775 F.2d 1495, 1497 (11th Cir. 1985) 15

J.D. Marshall International, Inc. v. Redstart, Inc.,

656 F. Supp. 830 (N.D. Ill. 1987) Sees 16

v

TABLE OF AUTHORITIES—Continued

John Alden Life Ins. Co. v. Cavendes, 591 F. Supp.

S62, 367 (S.D. Fila. 1964) .........2....ccccccccccceocessseees

Liberty Univ., Inc. v. Kemper Sec. Group, Inc., 758

We eee. BGS Cra ee ee

Local Union No, 4-248, Oil Workers Int’l Union v.

Mobil Oil Corp., 558 F.2d 233 (5th Cir. 1977)...

Midwest Window Systems v. Amcor Industries,

630 F.2d 535 (7th Cir. 1980) ...........000000.. eee.

Miller Brewing Co. v. Fort Worth Distributing

Co., 781 F.2d 494 (5th Cir. 1986) ..........000000000......

National R.R. Passenger Corp. v. Boston and

Maine Corp., 850 F.2d 756 (D.C. Cir. 1988)........

National Shipping & Trading Corp. v. Buck Ship-

ping Int'l Ltd., No. 81 Civ. 3818-CSH (S.D.N-Y.

April 3, 1985) RAISE ABE DRIES a Td TF

New Process Steel Corp. v. ‘Tital Indus. Corp., 555

F. Supp. 1018 (S.D. Tex. 1988) ...............0......-000

Olmstead v. Amoco Oil Co., 725 F.2d 627, 632

(l1lth Cir. 1984) SA ee Dennou: eles

Peterson v. Shearson/American Express, Inc., 849

F.2d 464, 467-68 (10th Cir. 1988) .. ;

Prima Paint Corp. v. Flood & Conklin Mfg. Co.,

388 U.S. 395 (1967) pakepetenededicdnimmiaheniin ae

Rodriquez de Quijas v. Shearson/American Ex-

press, Inc., 490 U.S. 477 (1989) .............00....000....

S & H Contractors, Inc. v. A.J. Taft Coal Co., 906

F.2d 1507 (11th Cir. 1990), cert. denied, 498

U.S. 1026 (1991) 20000000... seattle tadeldeaioneienteaniain

Shearson/American Express, Inc. v. McMahon,

482 U.S. 220 (1987) MEER RNase

Sprague & Rhodes Commodity Core. v. Instituto

Mexicano Del Cafe, 566 F.2d 861 (2d Cir.

ROUCD sivivscsctenntectssctdentonninaneatiendiiandiadanaeaincaaee

Stone v. E.F. Hutton & Co., 898 F.2d 1542 (11th

Cath. RID ncewnsintidvchtssinsbehcgeopuestemineiibiamiomes

Telephone Workers Union, Local 827 1 _ New Jer-

sey Bell Tel. Co., 584 F.2d 31 (3d Cir. 1978) ........

Page

16

14

14

20

vi

TABLE OF AUTHORITIES—Continued

Page

Virginia Carolina Tools, Inc. v. International Tool

Supply, Inc., 793 F. Supp. 664 (W.D.N.C.

1992), aff'd, 984 F.2d 113 (4th Cir.), cert. de-

nied, 113 S. Ct. 2930 (1993) 14

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

STATUTES AND REGULATIONS

17 C.F.R. § 240.10b-5 3

17 C.F.R. § 240.10b-16 3

Federal Arbitration Act, 9 U.S.C. §§ 1 et seq. 10

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

§ 78) (b) icauiatuieiiaeimmnas eaieaanaie Ad Ea ad 3

OTHER AUTHORITIES

Currie, Res Judicata: The Neglected Defense, 45

U. Chi. L. Rev. 317 (1978) 15

In the Supreme Court of the United States

OCTOBER TERM, 1993

No. 93-486

FRANK KELLY, ET AL.. PETITIONERS

v.

MERRILL LYNCH, PIERCE, FENNER & SMITH. INC.

ON PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE ELEVENTH CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

Respondent Merrill Lynch, Pierce, Fenner & Smith, Inc.

(“Merrill Lynch”), by its undersigned counsel, submits

this brief in opposition to the petition for a writ of cer-

tiorari in this case.

STATEMENT OF THE CASE

A. The Trading Activity That Gave Rise To Petitioners’

Claims

Petitioner Frank Kelly is a former Merrill Lynch ac-

count executive. The other petitioners are Kelly's wife

and 15 of Kelly's former customers, including one cor-

sorate investor.’ During the period from late 1982

I

' Many of the relevant facts are set forth in the district court’s

opinion granting summary judgment for Merrill Lynch. That opin-

ion, which is unreported, was not reproduced in the appendix to

the petition. It is reprinted as an appendix to this brief.

2

through late 1986, all of the petitioners, including Kelly

and his wife, opened individual or joint trading accounts

at the Merrill Lynch office in Coral Gables, Florida, where |

Kelly worked.

Petitioner Kelly, by his own admission an experienced

and knowledgeable investor who had been employed as a

securities broker with both Dean Witter and PaineWebber

before working for Merrill Lynch, devised an investment

Strategy that petitioners used in trading stock index op-

tions. The strategy involved the short sale of options

based on the Standard & Poor’s 100 stock index. These

options, known by the trading symbol “OEX”, are traded

on the Chicago Board of Options Exchange. Kelly’s strat-

egy generally consisted of the simultaneous sale of OEX

“calls” (i.e., options to buy) and OEX “puts” (i.e., op-

tions to sell). Petitioners’ sales of these options were

“short” sales because petitioners sold options that they did

not own at the time of sale. Petitioners could earn a

profit if the options expired unexercised (thus enabling

petitioners to retain the full price they received when they

sold the options), or if the price of the options declined

(thus enabling petitioners to cover their “short” positions

and retain the difference between the price at which they

had sold the options and the price at which they subse-

quently purchased them).

Petitioners’ strategy could be successful only in periods

of relative market stability. As the district court observed

(App. 3a), in periods of market volatility, “this kind

of trading results in losses.” If the market moves sharply

up, the prices of “calls” increase significantly; if the mar-

ket moves sharply down, the prices of “puts” increase

significantly. In either event, those increases can produce

substantial losses for short sellers, losses that are by no

means limited by the amount of the original price at

which an option was sold.

a |

3

When petitioners opened their accounts, they received

all of the required disclosure documents, including a

brochure entitled “Characteristics and Risks of Standard-

ized Options,” which detailed in plain language the opera-

tion of standardized option markets. Petitioners also

signed a “Standard Option Agreement” and a “Customer

Agreement”. These documents clearly spelled out the

risks of options trading. In addition, Kelly himself ad-

vised each petitioner on the trading of index options.

Against the background of these disclosures, each peti-

tioner individually chose to engage in the trading strategy

masterminded by Kelly.

In early 1987, “the stock market moved dramatically

against the option positions held by [petitioners].” App.

3a. Accordingly, Merrill Lynch exercised its right to

require petitioners to increase the amount of money on

deposit in petitioners’ accounts to ensure petitioners’ abil-

ity to perform their obligations with respect to the options

sold short. Some petitioners initially complied with Mer-

rill Lynch’s new requirements, but most did not. As the

market continued to move against petitioners’ positions,

Merrill Lynch bought the options needed to close peti-

tioners’ short positions and charged petitioners’ accounts

for the purchase price of those options. As a result,

petitioners realized the losses that they had suffered due

to the adverse movement of the market. App. 3a-4a,

Sa n.4.

B. Petitioners’ Federal Lawsuit

In December 1987, petiticners sued Merrill Lynch in

the United States District Court for the Southern District

of Florida, alleging violations of Section 10(b) of the

Securities Exchange Act of 1934, 15 U.S.C. § 78j(b).

and Securities and Exchange Commission Rules 10b-5

and 10b-16 promulgated under that statute, 17 C.F.R.

§ 240.10b-5 and § 240.10b-16. Petitioners charged Mer-

rill Lynch with fraud in connection with the purchase or

sale of securities, in violation of Rule 10b-5, and with

inadequate disclosure wf evedit terms and information

4

regarding the extension of credit in securities transactions,

in viclation of Rule i0b-16. The thrust of both claims

was that Merrill Lynch had improperly raised the collat-

eral requirements for petitioners’ short sales of stock index

options and that, as a result, petitioners’ existing positions

were prematurely liquidated and petitioners were pre-

cluded from continuing with their trading strategy—a

Strategy that, according to petitioners’ allegations. even-

tually would have produced substantial profits.

After more than two years of litigation and extensive

discovery, Merrill Lynch moved for summary judgment

on both counts of the complaint. With respect to the

Rule 10b-16 count, Merrill Lynch explained that petition-

ers’ options trading did not involve any extensions of

credit, that in fact options are not permitted to be pur-

chased or sold on credit, and that therefore the rule

simply did not apply to the transactions about which peti-

tioners were complaining. Petitioners then decided to

“narrow the focus” of their case by moving to dismiss

their Rule 10b-16 claim without prejudice. Petitioners

informed the district court that they could “obtain all the

relief necessary to make them whole through their 10b-5

claim.” App. 5a n.3. The district court correctly ruied

that the Rule 10b-16 count should be dismissed with

prejudice, and petitioners did not challenge that decision.

Turning to the Rule 10b-5 count, Merrill Lynch argued

(1) that Merrill Lynch did not make any misstatement or

omission of material fact; (2) that Merrill Lynch did not

act with scienter; and (3) that Merrill Lynch did not

proximately cause any of the losses suffered by appellants.

The district court granted summary judgment for Merri!!

Lynch on the grounds that petitioners had not adduced

sufficient evidence to create any genuine issue of material

fact with respect to the scienter and loss causation ele-

ments of the 10b-S claim. App. S5a-16a. The court of

appeals summarily affirmed. 948 F.2d 1297 (1991).

5

C. Petitioners’ Claims In Arbitration

In August 1990, three weeks after the district court

granted summary judgment, and nearly three and one half

years after the latest of the operative events, petitioners

began the controversy all over again by initiating an arbi-

tration against Merrill Lynch before the National Associa-

tion of Securities Dealers, Inc. (“NASD”). Having failed

in their effort to blame Merrill Lynch for terminating

their trading strategy, petitioners abandoned that theory

and switched to one looking in precisely the opposit-

direction.

Suddenly, the trading strategy that, according to peti-

tioners’ submissions in the district court, would have led

inexorably to profits became a strategy that was flawed

from the outset. Petitioners contended that their short

sales of index options were unsuitable investments in vicw

of petitioners’ investment objectives, investment experi-

ence, and net worth. They also alleged that Merrill Lynch

failed to supervise adequately the trading in petitioners’

accounts and the activities of petitioner Kelly. In addi-

tion, petitioners complained about Merrill Lynch’s alleged

failure to disclose adequately the risks of petitioners’

trading strategy and to subject petitioners’ trading to the

firm’s customary approval process. Based on these alle-

gations, petitioners asserted state law claims of breach of

fiduciary duty, negligence, breach of contract, and negli-

gent misrepresentation.

Petitioners sought in the arbitration to recover the very

losses that they had tried unsuccessfully to recoup in the

federal litigation. Their claims in arbitration, however,

marked an abrupt about-face from the theories that peti-

tioners had attempted unsuccessfully to foist on the dis-

trict court during nearly three years of litigation (and

that petitioners continued to pursue in the court of ap-

peals even after the arbitration was under way). Petition-

ers withheld these new claims from the district court, but

it was not for lack of the legal ability to raise those

6

claims in the litigation. Indeed, petitioners themselves

conceded in the district court that that court “would have

enjoyed subject-matter jurisdiction as a technical matter

..” R2-153, at 9 (Petitioners’ Motion to Compel Arbi-

tration). Rather, petitioners refrained from pursuing their

common law claims in the litigation for the obvious prac-

tical reason that the gross inconsistencies in their position

would have done irreparable damage to their credibility

before the district court.

D. Merrill Lynch’s Request For An Injunction On-The

Ground Of Res Judicata

Merrill Lynch undertook discovery in the arbitration,

largely for the purpose of confirming what seemed appar-

ent from petitioners’ Statements of Claim, namely. that

petitioners were simply trying to assert new claims based

on the same facts that had already been litigated... Once

the pre-hearing preparation had been completed, and peti-

tioners had failed to identify any new facts on which they

were seeking to rely, Merrill Lynch returned to the dis-

trict court and moved for an order enforcing the district

court’s judgment and precluding petitioners from proceed-

ing with the arbitration. Merrill Lynch explained that

““(bJecause the claims raised by appellants in the arbitra-

tion arose not only from the same nucleus of operative

facts, but the identical set of facts, and could have been

raised in this action, they are barred by res judicata.”

R2-151, at 2 (emphasis in original).

Petitioners opposed Merrill Lynch’s motion and moved

to compel arbitration. Petitioners first argued that the

res judicata claim could be decided only in the arbitration

and that, in any event, the district court lacked authority

to enjoin petitioners from proceeding with the arbitration.

As to the merits of the res judicata claim, petitioners

relied primarily on the arbitration clause in their customer

agreements with Merrill Lynch, contending that this con-

stituted a waiver of any right to assert the preclusive effect

of the district court’s judgment. Although conceding that

2

- 7

the district court would have had subject-matter jurisdic-

tion Over petitioners’ pendent state law claims, petitioners

also attempted to argue that their arbitration claims “could

not have been raised in the prior federal-court action,”

because Merrill Lynch could have sought to compel arbi-

tration of those claims. R2-153, at 2-3.

E. The Decisions Below

The district court rejected petitioners’ arguments and

entered an order enjoining petitioners from proceeding

with their arbitration. Pet. App. B-1 to B-5. The court

explained:

where Plaintiffs attempt to relitigate in another tri-

bunal claims decided by a federal court, the court

may properly enjoin those proceedings. Under the

doctrine of res judicata, the parties are prohibited

from relitigating a final judgment “as to all claims

that were raised or could have been raised [in the

federal proceeding].” . . . The prohibition on re-

litigation includes those state claims that could have

been brought in federal court under the doctrine of

pendent jurisdiction, that is, claims which arise out

of the same “operative nucleus of fact.”

. .. Plaintiffs’ claims arise from the same “opera-

tive nucleus of fact” as their 10(b)(5) claim, which

was previously adjudicated by this Court... .

. . Allowing NASD to determine whether the

claims are barred by the doctrine of res judicata

clearly would fail to protect the district court’s final

judgment. Rather than waiting until this Court de-

cided the merits of their 10(b)(5) claim to raise

these additional claims, the Plaintiffs should have

brought the pendent claims in the federal action in

December of 1987—regardless of whether Merrill

Lynch could have compelled arbitration of these

claims. If Plaintiffs had brought all of their claims

at that time, this Court could have determined the

best manner to adjudicate all of Plaintiffs’ claims

8

without the possibility of conflicting decision by

various tribunals on the same issues.

Pet. App. B-3 to B-4 (citations omitted; brackets in

original).

The court of appeals affirmed. Pet. App. A-1 to A-7.

The court rejected petitioners’ argument that the res

judicata issue could be decided only in the arbitration.

The court did not seek to preclude arbitrators from ad-

dressing res judicata claims, but it did insist that courts

must be permitted to protect their own judgments, even

in the face of a demand for arbitration. In the court’s

words, “the better rule is that courts can decide res judi-

cata. . . . Courts should not have to stand by while

parties re-assert claims that have already been resolved.

The issue is not just one of preventing the piece-

meal litigation that occurs when parties simultaneously

assert claims in several forums, but of protecting prior

judgments.” Pet. App. A-4 to A-5.

Turning to the merits, the court cf appeals sustained

the district court’s injunction. The court rejected peti-

tioners’ attempt to characterize the arbitration clause in

the parties’ customer agreements as a waiver of res judi-

cata or a blanket authorization to split claims. The court

stated (Pet. App. A-5):

We cannot read the agreement as an express or

implied waiver of res judicata. The agreement simply |

allowed [petitioners] to institute two suits based on

the same events. Nothing shows that the parties

understood—r that [Merrill Lynch] led [petitioners]

to believe—that the end of the first action would not

preclude the start of the second.

Because petitioners could have raised all of their claims

in the district court, and the district court would have

had pendent or diversity jurisdiction over all of those

claims, the court of appeals upheld the district court’s

injunction. The court correctly ruled that speculation

about whether Merrill Lynch could have or would have

9

sought to compel arbitration of the state law claims is

not relevant to the res judicata determination. Pet. App.

A-6 to A-7.

ARGUMENT

The court of appeals’ decision is correct, and further

review is not warranted. Despite petitioners’ hyperbole,

no unresolved or controversial question of federal law is

presented here. Federal district courts have the unques-

tioned authority to protect and enforce their own judg-

ments, and nothing in the Federal Arbitration Act was

intended to remove or restrict that authority. Similarly,

the arbitration clause in the parties’ customer agreements

did not address, much less waive, the res judicata protec-

tion. Rather, it simply enabled either party to compel

arbitration of state law claims. It said nothing about

arbitrations not commenced until after an adverse federal

judgment on the same facts. There is no conflict among

the circuits with regard to any of the issues that peti-

tioners seek to present, no conflict with general federal

policy, and no conflict with any decision of this Court.

Moreover, the contractual arbitration clause that has

given rise to the present dispute is a remnant of a bygone

era during which, as a result of this Court’s decision in

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

arbitrate under the federal securities laws were not en-

forceable. Arbitration clauses, like the one at issue here,

therefore acknowledged that securities law claims could

be litigated. Now. however, Wilko has been overruled in

Shearson American Express, Inc. v. McMahon, 482 U.S.

220 (1987), and Rodriguez de Quijas v. Shearson/Ameri-

can Express, Inc., 490 U.S. 477 (1989), and most cus-

tomer agreements between brokerage firms and investors

provide for arbitration of all claims, including claims

under the securities laws. Accordingly, the situation pre-

sented here is unlikely to recur, and the petition for review

should be denied.

10

I. THE DISTRICT COURT WAS ENTITLED TO EN-

FORCE ITS OWN JUDGMENT AND ADDRESS

MERRILL LYNCH’S CLAIM OF RES JUDICATA

Petitioners’ characterization of the lower courts’ rulings

is inaccurate. Neither the district court nor the court of

appeals “carved out a broad and unprecedented excep-

tion” (Pet. 5) to the important federal policies embodied

in the Federal Arbitration Act, 9 U.S.C. $$ 1 ef seq.

Rather, the court of appeals, in affirming the district court's

ruling, expressly recognized that courts ordinarily should

not reach the merits of arbitrable issues. Pet. App. A-4

(citing Dean Witter Reynolds v. Byrd, 470 U.S. 213,

218 (1985); Prima Paint Corp. v. Flood & Conklin Mfg.

Co., 388 U.S. 395 (1967)). The courts below also

recognized, however, what petitioners would prefer to

ignore, namely, that federal courts have well-established

authority to enforce their own judgments and to deter-

mine the res judicata effect of prior decisions.

None of the authorities on which petitioners rely deals

with a claim of res judicata or with a district court’s

authority to enforce its prior judgments. Petitioners’

arguments simply disregard the significance of the district

court’s final judgment in favor of Merrill Lynch. The

Federal Arbitration Act does not address the question of

how a claim of res judicata based on a district court judg-

ment should be resolved; certainly the Act does not

purport to impose limits that would not otherwise exist

on the authority of district courts to effectuate their deci-

sions. Likewise, the cases on which petitioners rely sim-

ply do not address a district court’s authority vel non to

enforce its own judgments by refusing to permit a party

from pursuing in another forum claims that were or

could have been raised in a case that the district court

has already decided.”

2 Contrary to petitioners’ assertion (Pet. 7 n.5), the unreported

district court decision cited by the court of appeals did not involve

a situation like that presented here. Instead, Enterprise Ass'n

|

11

Prima Paint Corp., for example, is inapposite precisely

because it does not involve the preclusive effect of a prior

district court judgment. The case held that a defense of

“fraud in the inducement” as to the contract as a whole

(not merely the arbitration agreement) is an issue on

the merits for the arbitrators to decide. 388 U.S. at 404.

Here, however. Merrill Lynch did not ask the district

court to evaluate the underlying merits of the parties’

conduct; it sought merely to give effect to the court’s own

final judgment, separately from and independently of the

arbitration.

Similarly. petitioners’ reliance on Dean Witter Reynolds

v. Byrd is misplaced. Byrd held that arbitrable and non-

arbitrable claims may proceed simultaneously in an arbi-

tral forum and a court. Byrd did not hold that an arbi-

tration may proceed even after there has been a final

judgment entered in the court action. To the contrary,

this Court expressly acknowledged that a prior decision

in one forum could have a preclusive effect in the other,

and it left to the lower federal courts the task of deter-

mining. in the first instance, to what extent and under

what circumstances arbitration decisions should be given

preclusive effect in litigation. 470 U.S. at 222-23. The

Court never suggested that the federal policy favoring

arbitration somehow bars federal district courts from en-

forcing their own judgments or that the courts are not

the appropriate entities to determine the preclusive effect

of their own decisions.

Metal Trades Branch Local Union 638 v. Empire Mechanical, Inc.,

122 Lab. Cas. © 10,284, 1992 Westlaw 84685 (S.D.N.Y. 1992), in-

volved a defendant corporation that unsuccessfully asserted a res

judicata defense during the course of an arbitration and then tried

to reassert that defense when the arbitration claimant sought judi-

cial enforcement of the arbitration award. The district court re-

fused to reconsider a defense already rejected by the arbitration

panel. Such a defense, the court said, is “not for the Court on a

petition to confirm the award.” Slip op. at 2-3.

12

General disctissions about the extent to which federal

law encourages arbitration are no substitute for precedent

dealing with the discrete issue presented here. That issue

is whether a district court, having fully adjudicated a

controversy between two parties through protracted liti-

gation extending over a period of years, must sit idly by

while the unsuccessful party attempts. in derogation of

the district court’s judgment, to relitigate its case in an-

other forum on the basis of a new theory inconsistent

with the one previously litigated. The courts below cor-

rectly held that the answer to this question is negative.

Petitioners inaccurately depict the court of appeals’

ruling as “ignor[ing] fifty years of federal precedent.”

Pet. 8. In fact, federal courts have long exercised their

inherent power to determine the res judicata effect of

prior federal court rulings notwithstanding parties’ agree-

ments to submit the merits of their disputes to arbitra-

tion.’ Perhaps the leading decision is Miller Brewing Co.

3 See, e.g., Telephone Workers Union, Local 827 v. New Jersey

Bell Tel. Co., 584 F.2d 31, 33 (3d Cir. 1978) (“When a federal

court is presented with the contention that a prior federal judg-

ment determined issues now sought to be relitigated in an arbitral

forum [the court] must first determine the effect of the judgment.

. The federal policy favoring [arbitration] clauses . . . does not

come into play until the court first determines whether prior

completed litigation has already finally determined all issues.’’) ;

Sprague & Rhodes Commodity Corp. v. Instituto Mexicano Del

Cafe, 566 F.2d 861, 863 (2d Cir. 1977) (instructing district court

in appropriate circumstances to determine res judicata effect of a

foreign judgment on a petition to compel arbitration) ; Clemens vr.

Central R.R. Co. of New Jersey, 399 F.2d 825 (3d Cir. 1968) (hold-

ing plaintiffs’ claims barred by res judicata and not properly sub-

mitted to arbitration), cert. denied, 393 U.S. 1023 (1969); Ameri-

can Train Dispatchers Assoc. v. Burlington N. R.R. Co., 784 F.

Supp. 899, 903 (D.D.C. 1992) (“[C]ourts have the right of plenary

review when asked to determine the preclusive effects of a federal

judgment on relitigation of the same issues in an arbitral forum.

If we have finally decided something as a matter of law, an arbitral

panel may not completely disregard that conclusion.”) ; F’remont

Cake & Meal Co. v. Wilson & Co., Inc., 183 F.2d 57 (8th Cir. 1950)

(holding that district court properly determined that, based on

13

v. Fort Worth Distributing Co., 781 F.2d 494 (Sth Cir.

1986), which petitioners relegate to a footnote in this

Court, as they did in the court of appeals. See Pet. 7-8

n.5. Miller Brewing held that a res judicata defense con-

stitutes “good ground for enjoining arbitration proceed-

ings,” and that “parties should be barred from seeking

relief from arbitration panels when, under the doctrine

of res judicata, they would be barred from seeking reliet

in the courts.” Jd. at 498, 499. The court of appeals

explicitly rejected the very kind of argument made by

petitioners based on federal law’s general encouragement

of arbitration:

We are mindful of the admonition . . . that arbitra-

tion is ordinarily preferable to litigation, but to allow

arbitration on top of the protracted litigation in this

case would be to add insult to injury. The doctrine

of res judicata . . . [has] probably done more to

prevent useless and wasteful litigation than arbitra-

tion ever could.

Id. at 497 n.3. Although res judicata provides what is

probably the strongest justification for a judicial refusal

to defer indiscriminately to arbitration, petitioners are

also misinformed in their contention that the court of

appeals has singled out the claim of res judicata as the

sole bar to arbitration that can ever be considered by a

prior adjudication, there was no controversy to arbitrate and prop-

erly dismissed with prejudice the action to compel arbitration ) ;

Burmah Oil Tankers, Ltd. ». Trisun Tankers, Ltd., 687 F. Supp.

897, 899 (S.D.N.Y. 1988) (‘A federal court may enjoin state court

actions that threaten to relitigate and impair a federal judgment.

It would be incongruous if the federal courts could not exercise

the same power to protect judgments against later arbitration pro-

ceedings.”) ; National Shipping & Trading Corp. v. Buck Shipping

Int’l Ltd.. No. 81 Civ. 3818-CSH (S.D.N.Y. April 3, 1985) (“an

asserted res judicata bar is appropriate for consideration by the

court in a motion to compel (or to stay) arbitration”) ; Ank Ship-

ping Co. v. Seychelles Nat’l Commodity Co., Ltd., 596 F. Supp. 1455

(S.D.N.Y. 1984) (holding petition to compel arbitration barred by

res judicata).

14

district court. Federal courts have addressed a number

of other arguments that, if found meritorious, similarly

would preclude the need for an arbitration to address the

merits of the dispute."

The court of appeals therefore was correct in con-

cluding that “the better rule is that courts can decide

res judicata.” Pet. App. A-4. The federal policy favoring

arbitration is not implicated until the district court has

had an opportunity to decide the issue of whether or not

all claims have already been resolved by prior litigation.

Il. THE COURTS BELOW CORRECTLY CONCLUDED

THAT PETITIONERS’ ARBITRATION IS BARRED

BY RES JUDICATA

Petitioners do not take issue with the district court's

finding that their state law claims arise from the same

“operative nucleus of fact” as the 10(b)(5) claim that

was previously adjudicated by the district court. Pet.

4 See, e.g.. National R.R. Passenger Corp. v. Boston and Maine

Corp., 850 F.2d 756 (D.C. Cir. 1988) (holding that the court rather

than the arbitrator properly considered the defense that the duty

to arbitrate did not survive the termination date of the agreement) ;

Local Union No, 4-243, Oil Workers Int’l Union v. Mobil Oil Corp.,

558 F.2d 233 (5th Cir. 1977) (holding that the district court prop-

erly considered the background and setting of the dispute in ad-

dressing the defense that there was no remaining dispute for the

arbitrators to arbitrate); Jnternational Ladies’ Garment Workers’

Union v. Ashland Indus., Inc., 488 F.2d 641 (5th Cir.), cert. denied,

419 U.S. 840 (1974) (holding that, in labor dispute, district court

rather than arbitrator should determine whether, in arbitration

subsequent to district court ruling on the same facts, an incon-

sistent defense should be barred); Virginia Carolina Tools, Inc. v.

International Tool Supply, Inc., 793 F. Supp. 664 (W.D.N.C. 1992),

aff'd, 984 F.2d 113 (4th Cir.), cert. denied, 113 S. Ct. 2930 (1993)

(holding that the court rather than the arbitrators properly con-

sidered the defense that a contract had not been extended beyond

its expiration date by the parties); Liberty Univ., Inc. ». Kemper

Sec. Group, Inc., 758 F. Supp. 1148 (W.D. Va. 1991) (holding that

the court rather than the arbitrator properly considered the defense

that the duty to arbitrate did not survive the termination date of

the agreement).

15

App. B-4. Nor do petitioners deny that, as they them-

selves conceded in the district court, that court would have

had jurisdiction over the claims that petitioners later

sought to arbitrate. Pet. App. B-4; sce also Pet. App.

A-6. Petitioners were thus able to bring all of their claims

in the district court, but they failed to do so. When the

district court then entered a final judgment on the claims

that were litigated, the pendent state law claims were

lost forever.

As this Court held in Federated Department Stores,

Inc. v. Moitie, 452 U.S. 394 (1981), “[a] final judgment

on the merits of an action precludes the parties or their

privies from relitigating issues that were or could have

been raised in that action.” /d. at 398 (emphasis added).

The Court in Federated Department Stores reiterated the

importance of res judicata: “‘[the] doctrine of res judi-

cata is not a mere matter of practice or procedure in-

herited from a more technical time than ours. /t is a

rule of fundamental and substantial justice . . . which

should he cordially regarded and enforced by the courts

....” Id. at 401, quoting Hart Steel Co. v. Railroad

Supply Co., 244 U.S. 294, 299 (1917) (brackets in

original) (emphasis added). See also Commissioner v.

Sunnen, 333 U.S. 591, 597 (1948); Currie, Res Judi-

cata: The Neglected Defense, 45 U. Chi. L. Rev. 317,

325 (1978) (“to allow a party to advance arguments

in a second proceeding that he could have made in a

prior proceeding but did not . . . imposes unnecessary

costs on both opposing parties and the judicial system”).

Res judicata “extends not only to the precise legal

theory presented in the previous litigation, but to all legal

theories and claims arising out of the same ‘operative

nucleus of fact.’” Olmstead v. Amoco Oil Co., 725 F.2d

627. 632 (llth Cir. 1984). See also Interstate Pipe

Maintenance, Inc. v. FMC Corp., 775 F.2d 1495, 1497

(11th Cir. 1985) (“final judgment by a court of com-

petent jurisdiction bars a subsequent suit between the

same parties and on the same cause of action not only

16

as to all matters that were litigated in the first proceeding

but also as to all issues that could have been litigated”);

John Alden Life Ins. Co. v. Cavendes, 591 F. Supp. 362,

367 (S.D. Fla. 1984) (“Res judicata precludes all claims

which might have been made by the parties in the earlier

case as well as those issues that were actually litigated”).

In J.D. Marshall International, Inc. v. Redstart, Inc.,

656 F. Supp. 830 (N.D. Ill. 1987), the district court

recognized that a federal judgment can have “full res

judicata and collateral estoppel effects” on a pending

arbitration. The parties had contractually agreed that

either one ot them could compel arbitration as to claims

arising out of the sale of an export business from Red-

start to JDM. After differences arose between the par-

ties, JDM filed a federal RICO claim in federal court

and a complaint in arbitration. The court observed that,

as in the present case, the claims in the two proceedings

were based on the same underlying facts: “The predicate

offenses JDM alleges in its RICO claims are based entirely

on transactions underlying its breach of contract claims in

the arbitration proceeding.” Jd. at 834. The court then

decided to stay the federal action in recognition of the

fact that “[ilf JDM’s action here proceeds to judgment

first, that judgment would have full res judicata and col-

lateral estoppel effects on the arbitration... .” Id.

Because a judgment rendered in a contemporaneous

federal action has res judicata effect on a pending arbi-

tration, it irrefutably has the same effect on a subsequently

filed arbitration. At the outset of this litigation, petition-

ers had the following choices: (1) file in federal court a

10b-5 and 10b-16 action for only some of their claims

and forgo any remaining claims; (2) file in federal

court all possible claims, even if the claims that petition-

ers later sought to arbitrate were inconsistent with peti-

tioners’ primary litigation theory; (3) file all claims in

arbitration; or (4) proceed simultaneously in litigation

and arbitration. recognizing the potential preclusive effect

of the decision rendered first. Petitioners chose none of

17

these options. Instead, they chose the one option that

was not available to them. They litigated some of their

claims to a conclusion in federal court, lost, and then

filed a subsequent arbitration seeking the same recovery.

The doctrine of res judicata does not permit that option.

Petitioners do not dispute these basic res judicata

principles. Rather, they contend that the arbitration clause

in the customer agreements they signed with Merrill Lynch

renders the res judicata doctrine inffective or inapplicable.

Petitioners reach this conclusion by two different routes.

First, they argue (Pet. 11-13) that the arbitration

clause “is an explicit written consent to the splitting of

Petitioners’ claims.” Second, they assert (Pet. 16) that,

as a result of the arbitration clause, “Petitioners were

precluded by contract from pursuing their state-law claims

in federal court.” Both arguments are without merit.

We begin with the language of the arbitration clause.

Petitioners’ customer agreements with Merrill Lynch

provided:

Except to the extent that controversies involving

claims arising under the federal securities laws may

be litigated, any controversy between us arising out

of such option transactions or this agreement shall

be settled by arbitration only before the National

Association of Securities Dealers, Inc. or the New

York Stock Exchange, or an Exchange located in the

United States upon which listed options transactions

are executed.

R2-151, at 12-13. This language did not purport to

waive the protection of res judicata. It did not even at-

tempt to address the impact that a final federal court

judgment would have on a subsequent arbitration. Rather,

the arbitration clause merely recognized that, given the

state of the law at the time the customer agreements were

signed. arbitration of claims under the federal securities

laws could not be contractually compelled.

18

Petitioners simply mischaracterize the nature of the

parties’ arbitration agreement. The clause is not. as peti-

tioners maintain, an agreement to litigate part of a case

and to reserve the rest for resolution in another forum.

The agreement neither explicitly nor implicitly authorizes

a party to proceed to final judgment in one forum and

then to begin the controversy all over again in another,

without any concern for the possibility that the first out-

come would have a preclusive effect. The arbitration

clause did not waive res judicata or any other claim or

defense. The clause said nothing about what would hap-

pen if securities law claims were litigated to final judg-

ment and petitioners subsequently began an arbitration

arising out of the same transactions. Even petitioners do

not contend that any such issue was ever actually nego-

tiated and agreed upon by the parties.

Appellants’ citation (Pet. 3, 11 n.8) of Blue Gray

Corporations IT & II v. Merrill Lynch, Pierce, Fenner &

Smith, Inc., 921 F.2d 267 (11th Cir. 1991), is inappo-

site. Blue Gray held only that, under customer agree-

ments like those involved here, Merrill Lynch cannot,

from the outset of the proceedings, force a customer to

arbitrate a federal securities claim that the customer wants

to litigate, and the customer in turn cannot, from the

outset of the proceedings, force Merrill Lynch to litigate

a state law claim that Merrill Lynch would prefer to

arbitrate. Nothing in the court of appeals’ opinion or

reasoning says or implies anything about the res judicata

significance of a final federal court judgment in the con-

text of a later attempt to arbitrate claims arising from

the same transactions.

In sum, none of the arguments or authorities advanced

by petitioners reveals any waiver of Merrill Lynch’s res

judicata claim. Nor do petitioners fare any better with

their second rationale for opposing Merrill Lynch’s posi-

tion. Contrary to petitioners’ contention. nothing in the

parties’ arbitration clause precluded petitioners from pur-

19

Suing their state law claims in federal court. The fact

that Merrill Lynch had the right to compel arbitration

of those claims if it elected to do so is wholly irrelevant

to whether petitioners could have filed those claims in the

district court in the first instance. There was no require-

ment that Merrill Lynch move to compel arbitration of

those claims.” The court of appeals correctly held, there-

fore, that “[t]he uncertainty of whether [Merrill Lynch]

would move to compel arbitration of the state claims did

not justify two proceedings.” Pet. App. A-6.

Patting themselves on the back, petitioners contend

that the “bifurcated proceedings” in this case were

“brought about solely because Petitioners complied with

an arbitration agreement” between the parties. Pet. 16-17.

Petitioners warn that the rule adopted by the court of

appeals “will force litigants to breach valid arbitration

agreements in order to save their state-law claims from

a claim preclusion defense . . . .” Pet. 16. This dis-

ingenuous spectre is belied by petitioners’ actual conduct

in this case. Petitioners were the ones who chose to

pursue diametrically inconsistent theories. and petitioners

were the ones who chose to wait until they had lost on

one theory before making a 180-degree turn and asserting

another. Petitioners’ predicament is a product of peti-

tioners’ own tactical choices and their attempt to manipu-

late the system so as to enable themselves to take con-

trary positions without embarrassment or criticism. Their

litigation posture has nothing to do with compliance with

an arbitration agreement and everything to do with try-

ing to play both ends against the middle.

Finally, petitioners err in Suggesting that the decision

below is somehow inconsistent with Clark v. Bear Stearns

& Co., 966 F.2d 1318 (9th Cir. 1992). The plaintiff

> See New Process Steel Corp. v. Tital Indus. Corp., 555 F. Supp.

1018, 1020 (S.D. Tex. 1983) (“There is no basis in the case law to

support the defendants’ assertion that simply because a matter may

be referable to arbitration, the Court is deprived of jurisdiction.”’).

aia

20

in that case did just what petitioners here did not do—

she brought a// of her claims, including both federal

securities law claims and state common law claims, in a

single federal lawsuit. In response to Bear Stearns’ mo-

tion, and in accordance with the parties’ pre-existing arbi-

tration agreement, the district court then ordered arbitra-

tion of the state common law claims; it retained juris-

diction of the federal securities law claims because the

parties’ agreement did not authorize Bear Stearns to com:

pel arbitration of such claims. The arbitration panel

subsequently dismissed all of the common law claims

against Bear Stearns.

It was under these circumstances that both the district

court and the court of appeals held that the federal secu-

rities law claims—i.e., the claims that remained in federal

court from the outset—were not barred by res judicata.

Those claims were originally filed in federal court, and

the federal court at all times retained jurisdiction over

them. The plaintiff did not try, as petitioners have here,

to proceed first in one forum and then in another.°

6 Although the court of appeals did not address the point, the

injunction preventing petitioners from continuing with their arbi-

tration was also proper because petitioners waived their right to

arbitrate. Such a waiver can occur even if it is not subjectively

intended. Despite the federal policy favoring arbitration, courts

frequently find that a party, by its acts or omissions, has waived

its right to compel arbitration. Such a waiver can occur in a vari-

ety of circumstances, but it usually arises from delay in requesting

arbitration or other conduct that is found to be inconsistent with

an arbitration demand, such as engaging in extended discovery or

taking other significant litigation steps before seeking to compel

arbitration. Here, petitioners waited for more than three years

before demanding arbitration and during that period petitioners

engaged in protracted litigation, including extensive pre-trial dis-

covery. In such circumstances, courts have held, even in the absence

of the preclusive effect of a final judgment, that parties have

waived their right to arbitrate. See, e.y., Midwest Window Systems

ve. Amcor Industries, 630 F.2d 535 (7th Cir. 1980); S & H Con-

tractors, Ine. v. A.J. Taft Coal Co., 906 F.2d 1507 (11th Cir. 1990),

cert. denied, 498 U.S. 1026 (1991); Stone v. E.F. Hutton & Co.,

21

CONCLUSION

The petition for a writ of certiorari should be denied.

Respectfully submitted,

BENNETT FALK PETER BUSCEMI *

MORGAN, LEwIs & BockIus JOHN P. SIMMONS

5300 Southeast Financial MORGAN, LEWIS & BockIvs

Center 1800 M Street, N.W.

200 South Biscayne Washington, D.C. 20036

Boulevard (202) 467-7190

Miami, Florida 33131

(305) 579-0390

November 17, 1993

Counsel for Respondent

* Counsel of Record

898 F.2d 1542 (11th Cir. 1990); Peterson v. Shearson American

Express, Inc., 849 F.2d 464, 467-68 (10th Cir. 1988); E.C. Ernst,

Inc. v. Manhattan Construction Co., 551 F.2d 1026 (5th Cir.),

modified on petition for reh’g, 559 F.2d 268, 269 (Sth Cir. 1977),

cert. denied, 434 U.S. 1067 (1978).