An irreverent Wall Street Blog
Stormy Daniels Issue Hits FINRA Arbitration Remand
April 4, 2018
Among the more difficult roles that I have as the publisher of the BrokeAndBroker.com Blog is to present an analysis of a case in which I am troubled by the facts and angered by the decision. In reporting on Wall Street's legal, regulatory, and compliance developments, I frequently find myself at odds with the powers that be. I am an unabashed libertarian (with a small "l") and an unrepentant advocate for free-markets, robust competition, and fair play. I love the clash of ideas in the marketplace. I detest when vested interests unbalance the scales. I hate it when corrupt politicians and regulators do the bidding of their patrons and rig the system. Yes . . . your're right . . . I'm not always right, everyone else is not always wrong, and sometimes I just need to chill. That being said, you're an idiot and I fully respect that you have the right to be wrong. Having shown my magnanimous attitude, let me present to you today's featured court opinion about Wall Street arbitration . . . grrrrrrrrrr . . .
Case In Point
As set forth in Beverly Lenz, Darinda Williams, Terrance Brady, Dean A. Hoistad, Larry Vervick, and Richard W. Horton, Plaintiffs/Appellants, v. FSC Securities Corporation, Rocky Mountain Financial Advisors, LLC (f/k/a Rocky Mountain Financial, LLC), Eric D. Rolshoven, and John Does 1-10, Defendants/Appellees (Opinion, Supreme Court of the State of Montana, 2018 MT 67, April 3, 2018) http://brokeandbroker.com/PDF/LenzMontSCt.pdf, between 2003 and 2014, Rocky Mountain Financial ("RMF") provided licensed financial and securities brokerage services as registered representatives of broker-dealer FSC, and during that relevant time, RMF brokers and advisors recommended, among other ideas, that the Plaintiffs (the "Investors") purchase securities of Invizeon Corporation, which was purportedly raising investment capital to support various security-related technology products.
Montana District Court
After sustaining serious losses when Invizeon failed in 2015, the Investors filed a lawsuit in the Montana state District Court alleging that FSC had failed to adequately supervise its RMF registered representatives and that RMF wrongfully induced the Investors to invest in Invizeon. Defendants FSC and RMF moved to stay the court proceedings and compel arbitration before the Financial Industry Regulatory Authority ("FINRA"), which the state District Court granted.
Appeal to Montana Supreme Court
On appeal to the Montana Supreme Court, the Investors asserted that the:
District Court erroneously stayed litigation of their claims and compelled them to submit to arbitration on the asserted grounds that FSC and RMF failed to satisfy their burden of proving that Investors (1) knowingly entered into integrated contractual agreements providing for arbitration and (2) validly waived their Montana constitutional rights to full legal redress and jury trial. Investors further assert that the District Court erroneously concluded that the standard-form arbitration agreements were not unconscionable.
Page 11 of the Opinion
What Arbitration Agreement?
By way of further content and context, consider this:
Over the course of multiple, day-long hearings, the District Court heard testimony from each Investor regarding his or her recollection of the specific contract documents and related circumstances. All Investors testified that they did not recall reading or receiving a standard-form FSC customer agreement that included a detailed arbitration agreement. Each Investor described his or her educational background and prior investment experience. Though several Investors recalled receiving significant paperwork when they opened their RMF accounts, none recalled reading or receiving the customer agreement form. However, all Investors recalled seeing and reading an arbitration notice printed above the signature block on the separate client application form. The Investors testified that they had no recollection of anyone at RMF advising them of the legal significance of the arbitration agreement.
Pages 4 - 5 of the Opinion
The Montana Supreme Court found that the District Court had correctly concluded that the Investors knowingly, voluntarily, and intelligently assented to the terms of the standard-form arbitration agreements and validly waived their rights to a jury trial. Further, the Supreme Court affirmed the lower court's finding that the standard-form FSC arbitration agreements were not unconscionable. Accordingly, the litigation was remanded to FINRA arbitration.
Y'all Smart Enough -- So Y'all On "Actual Notice"
If you read between the lines of the Opinion, the brokerage firm couldn't produce original signed copies of the subject arbitration agreements or actually prove that any customer had read same. That must have pleased the Investors, who likely figured that an unsigned arbitration agreement would not be enforceable -- sort of like Stormy Daniels' argument. Reduced to basics, the Investors felt confident in demanding that their brokerage firm prove the condition precedent to enforcing an arbitration agreement that the customer had actually signed it. As further explained in the Opinion:
[B]ased on the testimony of individual Investors, the court found that each Investor received actual notice of the arbitration agreement. The court further found that all of Investors were highly educated and sophisticated market investors with extraordinary business acumen. The plaintiffs included a lawyer, a certified public accountant, two banking executives, and highly successful business people, all knowledgeable and experienced market investors. The court found that none of the investors were under any duress or "physical or emotional compulsion" and that there was no evidence or allegation that FSC or RMF induced Investors to enter into the subject brokerage agreements by duress, fraud, misrepresentation, or other unlawful conduct.
Pages 8 - 9 of the Opinion
Okay, a court could go with that "actual notice" thing but if there's no proof of execution of what you're on actual notice of, that should raise some issues. I mean, sure, I see that agreement you're holding up about 20 feet from me and I'm on actual notice that it exists but if I don't sign it, now what? The Montana courts sort of lose me when they assert that because lawyers, CPAs, and executives are sophisticated and educated that such accomplishments transform their actual knowledge of something into consent. If the Investors were high-school drop-outs would that have altered the analysis and outcome? More to the point, what about an inquiry into the Wall Street practice of bundling dozens of agreements and forms into a so-called standard New Account package and then incorporating by reference those various agreements?
Stacked Deck?
In addressing the Investors' assertions that they had not knowingly consented to arbitration, the Supreme Court found, in part, that:
Substantial evidence exists that the FSC brokerage contracts included a standardized client application form, an application form signature page, and a customer agreement form, inter alia. With minor variation, the signature page forms conspicuously, clearly, and unambiguously referenced a separate customer agreement form and conspicuously gave notice that the customer agreement form contained an arbitration agreement. Though generated and maintained in separate forms, the FSC system printed-out the application, customer agreement, and signature page forms in a single-document format for client review and signature. In both formats, the transaction documents clearly, conspicuously, and unambiguously stated and explained that the customer agreement form was an essential part of the contract terms to which Investors were assenting, the nature of arbitration in contrast to litigation, that all disputes arising from the agreement were subject to binding arbitration, and that the agreement effected a waiver of the rights to full legal redress and jury trial. The signature page form also clearly, conspicuously, and unambiguously stated and notified the signatory that, by signing, the client acknowledged receipt of a copy of the customer agreement form.
Page 16 of the Opinion
The three-page customer agreement form contained detailed language explaining the arbitration process relative to litigation, stated the parties' agreement to resolve any and all disputes through binding arbitration, and declared that the agreement effected a waiver of the client's litigation rights, including, inter alia, the right to a jury trial. Though FSC did not require Investors to initial or sign the customer agreement form, the application signature page forms conspicuously referenced the customer agreement form as part of the agreements and conspicuously stated in bold-print directly above one of two customer signature blocks that:
The Customer Agreement contains a pre-dispute Arbitration Provision. This Provision is contained in this agreement and appears in bold print. I hereby acknowledge by my signature below, receipt of a copy of this agreement. (Emphasis added.)
FSC did not require the initiating RMF representative to further discuss or explain the arbitration agreements with clients beyond the express language of the transaction forms
Pages 5 - 6 of the Opinion
The court found that each of the plaintiffs "signed at least one, and sometimes more than one, account opening document . . . confirm[ing that] ‘the Customer Agreement contain[ed] a pre-dispute Arbitration Provision'" and that each expressly acknowledged receipt of the customer agreement form by signature and through the following signature page advisory:
THE TRADITIONAL INDIVIDUAL RETIREMENT CUSTODIAL ACCOUNT PLAN ("ACCOUNT PLAN") THAT ACCOMPANIES THIS ADOPTION AGREEMENT CONTAINS A PREDISPUTE ARBITRATION CLAUSE, WHICH MAY AFFECT RIGHTS UNDER THE PLAN. THE PREDISPUTE ARBITRATION CLAUSE IS LOCATED IN ARTICLE VIII, SECTION 11(i) ON PAGES 7 & 8 OF THE ACCOUNT PLAN. BY SIGNING THIS IRA ADOPTION AGREEMENT, I ACKNOWLEDGE THAT I HAVE READ THE PREDISPUTE ARBITRATION CLAUSE, UNDERSTAND IT, AND AGREE TO BE BOUND BY IT.
Pages 9 - 1- of the Opinion
Buried in the Papers
Again, I'm puzzled. Who gives a crap what a Customer Agreement says and how bold the print is that's used to say it if you don't sign on the dotted line of a separate Arbitration Agreement? More to the point, isn't there a difference between acknowledging receipt of a document and consenting to its terms via execution?
If I send you a Retainer for my legal services and in 28 point bold type I state that you will pay me $25,000 within two days and that my hourly rate is $2,000, do you consent to those terms just because you sign a receipt from the FedEx guy who delivered the Retainer? After all, you acknowledged receipt of the Retainer, didn't you?
I come away with a feeling that there's a game played on Wall Street in which brokerage firms bury new customers with hundreds of pages of new account forms so that the really bad stuff gets lost in the volume of paper. In fairness to the industry, you shouldn't sign something if you haven't read it -- and the Montana courts are certainly standing on fair ground when they note that an agreement was signed that stated that customers had read various other documents of which the arbitration agreement was one. I'm not going to pretend otherwise simply to make a point. It is what it is.
Contracts of Adhesion (no big deal)
The larger concern and question is whether the process of opening a new account with a broker-dealer should include such dubious practices as playing hide-and-seek with an ominous mandatory customer arbitration provision. At some point, either a signature line serves a purpose and means something, or it doesn't. In considering the nature of the subject arbitration agreement and the fairness of imposing it upon the Investors, the Supreme Court admonished that:
Applied here, the standard-form FSC arbitration agreements were unquestionably contracts of adhesion. Whether a contract term of adhesion unreasonably favors the stronger party or is unduly oppressive to the weaker party, is a mixed question of fact and law under the totality of circumstances surrounding the execution of the contract. In addition to the non-exclusive Kortum factors, other relevant considerations may include, inter alia, whether the disputed term was common in prior dealings between the parties, whether the weaker party carefully reviewed the agreement, and whether the stronger party personally explained the nature and consequences of the disputed term. Woodruff, ¶ 15; Kloss, ¶ 28. However, absent a fiduciary relationship or other special relationship of trust and reliance, securities brokers and advisors have no duty to further explain the legal consequences of a clear, explicit, and conspicuous arbitration agreement. Chor, 261 Mont. at 149-53, 862 P.2d at 30-32. Absent special circumstances, such as the broker's exercise of discretionary authority "to buy and sell in a customer's account," the relationship between a securities broker/advisor and client is not a fiduciary or other special relationship of trust and reliance. Chor, 261 Mont. At 152-153, 862 P.2d at 32.
Pages 25 - 26 of the Opinion
So . . . the Supreme Court of Montana found the standard arbitration agreement at issue to be "unquestionably contracts of adhesion." The Court will enforce that adhesive contract sans proof of signature because, in part, it may not necessarily "favor" the broker-dealer over the investor. On top of that, there's no duty for the brokerage firm or its brokers/advisors to explain the legal consequences of this contract of adhesion because they are not fiduciaries of the clients.
Hey, It's a Regulated Industry!
Finally, in deliberating as to whether the subject arbitration agreements were unfair to the extent that they should be deemed unenforceable, among the factors cited by the Supreme Court in favorably resolving the question by enforcing the arbitration provision was this:
Page 27 of the OpinionFinally, there is substantial, uncontradicted evidence that the FSC brokerage agreement forms were subject to regulatory oversight and approval by the federal SEC and FINRA. There is no evidence or allegation that they did not comply with applicable SEC regulations. "Agreements to arbitrate disputes in accordance with SEC-approved procedures are not unconscionable as a matter of law." Chor, 261 Mont. at 149, 862 P.2d at 30 (citing Cohen v. Wedbush, Noble, Cooke, Inc., 841 F.2d 282, 286 (9th Cir. 1988)). Under the totality of the circumstances, we hold that the District Court correctly concluded that the standard-form FSC arbitration agreements were not unconscionable.
Bill Singer's Comment
Oh my, my, my . . . please don't get me started on this again.
The single-most used arrow in FINRA's regulatory quiver is FINRA Rule 2010: Standards of Commercial Honor and Principles of Trade "A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade." What unadulterated garbage it is for FINRA to drag out that commercial honor and equitable principles of trade claptrap for all sorts of minor transgressions committed by the lowly drudges who labor at its member firms but somehow, the high dudgeon of sanctimony isn't stirred when those same member firms compile a package of dozens of pages of new account documentation and sort of slip the old mandatory arbitration clause in there. More to the point, why doesn't FINRA require that the mandatory arbitration clause be set out in a separate agreement that requires execution by the industry's customers? How can FINRA promote itself as a sincere protector of the public investor yet permit what amounts to a 52-card-stacked-deck to be dealt to those customers?
When I see FINRA failing to implement pro-consumer protections such as requiring proof of an executed mandatory arbitration agreement as a condition precedent to opening the doors of its arbitration forum, I am compelled to describe FINRA as nothing more than a glorified trade group. When I'm really in a foul mood, I refer to the self-regulatory-organization as the lapdog of its large member firms. Truly, I'm not in that bad a mood today. On the other hand, only brokerage firms get to vote on proposed FINRA rules. Only brokerage firms get to vote for FINRA elected office. Despite all of that, wise judges on our nation's courts actually expect that such a conflicted regulator will constrain the industry's use of admittedly adhesive arbitration agreements? If the test for whether the standard business practices of FINRA member firms are unconscionable requires a good faith determination by FINRA, then all is indeed lost.