Arbitrability of Securities Law Claims in Common Law Nations

Arbitrability of Securities Law Claims in Common Law Nations by JOHN J. KERR, Jr.* I. INTRODUCTION THE ARBITRABILITY of securities law claims in common law jurisdictions reflects both die shared legal history of those countries and their divergent attitudes toward arbitration in general. This article examines legal doctrine on the issue in the United States, the United Kingdom, Canada and Australia. The survey demonstrates that the common law's general hostility to arbitration, 1 long abandoned in the UK itself, continues to be felt in Canadian and Australian practice with regard to securities law claims. Of all of the jurisdictions discussed, however, only the United States has ever expressly prohibited the arbitration of claims based on securities laws. In recent years, the US has reversed this practice and now not only permits but usually compels arbitration of securities claims where there is a written agreement between the parties to arbitrate. II. THE UNITED STATES (a) Summary Arbitration, formerly discouraged by United States law to resolve securities law claims, now possesses a place as a favoured form of dispute resolution. This doctrinal shift reflects both the increased maturity of the American securities industry and the growing effectiveness of arbitral tribunals developed by the industry's self-regulatory organizations (SROs). Courts now regularly compel * Partner, Simpson Thacher & Bartlett, New York. This article was presented to Committee D of the International Bar Association in Paris on 19 September 1995. The author gratefully acknowledges the assistance of Michael F. Rinzler in the preparation of this article. 1 See, e.g., Statute Against Fines and Penalties 1697 (8 & 9 Wm. Ill, c. 11); Act for Determining Differences by Arbitration 1698 (9 & 10 Will. Ill, c. 15). ARBITRATION INTERNATIONAL, Vol. 12, No. 2 LCIA, 1996 171

172 Arbitration International Volume 12 Number 2 arbitration where it was agreed to by parties in contracts, and areas of exception have been narrowed substantially. (b) History and Relevant Legislation Until the early part of this century, United States law shared with other jurisdictions the common law's general discomfort with arbitration. Arbitral tribunals were believed to lack the fairness, competence and wisdom of the judicial system. To counter diis presumption, the United States Congress enacted in 1925 the Federal Arbitration Act (FAA). 2 The FAA expressly made contracts to arbitrate enforceable by the courts. American securities laws, however, created a conflict with the FAA, thus preventing enforcement of arbitration agreements in the securities context. The Securities Act of 1933 (the 1933 Act) and the Securities Exchange Act of 1934 (the 1934 Act) were enacted to protect investors after the market crash of 1929. Both pieces of legislation called for securities disputes to be resolved in the courts and apparently prohibited waiver of any of the Acts' provisions. Thus, an apparent conflict arose between the FAA and the Securities Acts where parties agreed to arbitrate securities claims. The highest court of the United States initially resolved this conflict by holding that the Securities Acts prevailed over the FAA. In 1953, in the case of Wilko v. Swan, the United States Supreme Court held that in light of the imbalance in bargaining power between securities dealers and purchasers, Congress must have intended to preclude waiver of judicial review in the Securities Acts. 3 The Court remarked that arbitration lacked the judicial system's ability to provide investors with the level of protection necessitated by the Securities Acts. Thus, although disputants in a securities matter could enter into arbitration by mutual consent, courts would not compel arbitration. The Wilko doctrine was gradually eroded from 1953 to 1989, as the courts found cause to compel arbitration in several contexts. These included agreements to arbitrate made after the dispute had arisen 4 ; disputes between stock exchange members where the rules of the exchange called for arbitration 5 ; and disputes between domestic and foreign disputants. 6 Outside of the securities context, US courts gradually increased their acceptance of arbitration as a viable method of dispute resolution. In 1983, the Supreme Court held, in the context of a construction dispute, that 'any doubts concerning the scope of arbitral issues should be resolved in favour of 2 3 4 5 6 Now tided the United States Arbitration Act, 9 USC 1-14 (1982). 346 US 427 (1953). Although Wilko addressed the question only in the context of s. 12(2) of the 1933 Act, lower courts applied die case to other 1933 Act violations and to the 1934 Act. See, e.g., Gardner v. Shearson, Hammill & Co., 433 F 2d 367 (5th Cir. 1970), cert, denied, 401 US 978 (1971); Moran v. Paine Webber, Jackson & Curtis, 389 F 2d 242 (3rd Cir. 1968). Coenen v. R.W. Pressprich & Co., 453 F 2d 1209 (2nd Cir. 1971), cert, denied, 406 US 949 (1972). Scberk v. Alberto-Culver Co., 417 US 506, reh'g denied, 419 US 885 (1974).

Arbitrability of Securities Law Claims in Common Law Nations 173 arbitration'. 7 Two years later, in Mitsubishi Motors Corp. v. Soler Chrysler- Plymouth, Inc., an anti-trust action, the Court stated that arbitration was a favoured forum for the resolution of claims based on federal statutes 'unless Congress itself has evinced an intention to preclude a waiver of judicial remedies for the statutory rights at issue'. 8 The Court applied the Mitsubishi test in the securities context in 1987, reversing the presumption against arbitration of claims under the 1934 Act. In Shearson/American Express v. McMahon, the court re-examined Wilko's dictum that arbitral tribunals were inadequate protectors of investors' rights. 9 Without overruling Wilko, the McMahon Court held that securities arbitration had matured to provide sufficient protection to investors. The court emphasized that attentive regulation by the Securities and Exchange Commission (SEC) - the American regulatory body responsible for governing the securities industry - of arbitral tribunals affiliated with American stock exchanges. Two years later, the Supreme Court extended this logic to overrule Wilko. In Rodriguez de Quijas v. Shearson/American Express, the Court held that 'the old judicial hostility to arbitration' reflected in Wilko could not coexist with its erosion by McMahon and its predecessors. 10 Thus, since 1989, with some exceptions, agreements to arbitrate securities disputes have been enforced in the same manner as other contracts. 11 (c) Current Issues In the wake of Rodriguez, most secondary questions regarding arbitration of securities law claims have been answered in favour of arbitration. Some areas, however, do remain unsettled. These include arbitration of class actions and of non-statutory securities claims. (i) Arbitration of class actions As the capacity of arbitral tribunals in the United States to hear complex cases has increased, courts have found those tribunals competent to hear class 7 8 9 10 Moses H. Cone Memorial Hospital v. Mercury Construction Corp., 460 US 1 at 24 (1983). 473 US 614 at 628 (1985). Shearson/American Express v. McMahon, 482 US 220, reh'q denied, 483 US 1056 (1987). 490 US 477 at 480 (1989) (citing Kulukundis Shipping Co. v. Amtorg Trading Corp., 126 F 2d 978 at 985 (2nd Cir. 1942)). Two very recent US Supreme Court decisions have further strengthened the position of arbitration in general and of securities arbitration in particular. In Allied-Bruce Terminix Companies, Inc. v. Dobson, 115 S Ct. 834 (1995), the Court confirmed that the FAA governed an arbitration agreement, despite the apparently tenuous relationship of the transaction to interstate commerce. In Mastrobuono v. Shearson Lehman Hutton, Inc., 115 S Ct. 1212 (1995), the Court held that where contractual provisions governing arbitration procedures (in this case, regarding arbitrators' ability to award punitive damages) conflict with governing state law, the provisions of the agreement prevail.

174 Arbitration International Volume 12 Number 2 actions. 12 While ceding authority over substantive matters, however, courts often retain some control over procedural matters. Chief among tliese are certification of the relevant class 13 and choice of arbitral body. 14 Where parties have not explicitly agreed ex ante to consolidation, courts remain unlikely to compel it. 1-5 (ii) Arbitration of state law and non-statutory claims Although the federal Securities Acts and the regulations promulgated thereunder provide arbitrable causes of action for disgruntled investors, claims based on state statutes or the common law may also be arbitrable. State statutes, known as 'blue sky laws', generally resemble rights under federal law, but often require lower burdens of proof, knowledge or intent. Like claims arising under federal laws, courts are likely to find blue sky claims arbitrable. Rules promulgated by SROs, such as the New York Stock Exchange and the National Association of Securities Dealers, have generally been held not to create a private cause of action. 16 However, such actions may generally be asserted and brought to arbitration by claiming tliat they rise to the level of fraud, thus creating a cause of action under SEC rules. Finally, where statutes or regulations fail to provide a private cause of action, a claim may be brought to arbitration based on violation of common law contractual duties. These include fraud, negligence, churning, unsuitability, breach of fiduciary duty, and unfair dealing. Violations of laws or regulations that do not give rise to a private cause of action may be used in arbitration to demonstrate breach of these duties. III. UNITED KINGDOM (a) Summary Though the fountainhead of the common law system's mistrust of arbitration, the United Kingdom has surpassed its former colonies in acceptance of this method 12 13 15 See, e.g., Lewis v. Prudential Bache Sec, 225 Cal. Rptr. 69 (Cal. Ct. App. 4th Dist. 1986); Izzyv. Mesquite Country Club, 231 Cal. Rptr. 315 (Cal. Ct. App. 4th Dist. 1986); Harris v. Shearson Hayden Stone, Inc., 82 AD 2d 87, 441 NYS 2d 70 (1st Dep't 1981), aifd 56 NY 2d 627, 450 NYS 2d 482 (1982). See, e.g., Lewis v. Prudential Bache Sec, 225 Cal. Rptr. 69 (1986); Erickson v. Paine Webber, 1990 WL 104142 (ND 111. 1990); Weseleyv. Spear, Leeds & Kellog [1988-1989 Transfer Binder] Fed. Sec. L Rep. If 93,992 (EDNY 15 August 1988). Lewis v. Prudential-Bache Sec, n. 13 supra. See, e.g., Baeslerv. Continental Grain Co., 900 F 2d 1193 (8th Cir. 1990); Protective Life Ins. Corp. v. Lincoln Natl Life Ins. Corp., 873 F 2d 281 (11th Cir. 1989); Wayerbauser Co. v. Western Seas Shipping Co., 743 F 2d 635 (9th Cir.), cert, denied, 469 US 1061 (1984); In re Coastal Shipping Ltd. v. Southern Petroleum Tankers Ltd., 812 F Supp. 396 (SDNY 1993). However, one recent decision held that even parties that have not agreed to arbitration may be compelled to arbitrate as a class if their claims are identical to those of a parrs' with whom they have been joined in a judicial proceeding prior to arbitration. Cohen v. E.F. Hutton & Co., 1990 WL 36878 (ND 111. 1990).

Arbitrability of Securities Law Claims in Common Law Nations 175 of dispute resolution. 17 Indeed, in this century, the UK has developed among the most wide-reaching arbitration schemes for various forms of commercial disputes. Unlike US securities laws, British securities legislation and rules have never rendered judicial process obligatory. As a result, the general legality of arbitration of securities law claims has not been called into question in the UK, and arbitration is used regularly for settlement of securities-related disputes. (b) History and Relevant Legislation From as early as the 17th century, English law provided for extensive judicial review of arbitral decisions, rendering them non-binding in effect. 18 Starting in the late part of the last century, and culminating in 1979, new legislation reflected an increased acceptance of arbitration as a legitimate means of resolving disputes. 19 The Arbitration Act 1950 consolidated this legislation and added to it, supplemented most notably by the Arbitration Act 1979. As a result, English courts will now stay judicial proceedings and compel arbitration where there is a valid agreement between the parties to arbitrate covering the dispute, unless strong policy reasons exist not to enforce the contract as a whole. 20 As in the United States, arbitrator misconduct and unconscionability constitute the primary reasons. 21 Parties have limited rights of appeal, requiring consent of all parties or of the High Court, which grants leave only where a determination of the question of law could substantially affect a party's rights. 22 Moreover, appeal may be contracted out of in certain circumstances by mutual consent of the parties. 23 As in the case of the American FAA, the subject matter of arbitration is unlimited under English arbitration law. No restrictions exist in the Arbitration Acts themselves, and English case law generally holds that any civil claim may be submitted to arbitration as long as only damages are claimed. Courts, however, have declined to compel arbitration where claims of fraud are involved. 24 16 1 19 20 21 22 23 2 See Touche Ross & Co. v. Redington, 442 US 560 (1979). This section focuses on the arbitration law of England and Wales, given the prominence of London as a centre for securities trading. Scotland has its own laws governing arbitration, which bear a resemblance to those of England and Wales, though Scotland has adopted the UNCITRAL Model Law. See Arbitration (Scotland) Act 1894 57 &.58 Vict. c. 13; Administration of Justice (Scodand) Act 1972 (c..59). Securities legislation is consistent throughout die United Kingdom. See supra, n. 1. United Kingdom Statutes, Vol. 88, 1950. Arbitration Act 1950,. 4; Arbitration Act 1979,. 1; see O'Connor v. Norwich Union Insurance Society [1894] 2 IR 723; Pioneer Shipping Ltd. and Others v. B.T.P. Tioxide Ltd. (The Nema) [1982] AC 724; Antaios Compania Naviera SA v. Salen Rederierna AB (The Antaios) (1985] AC 191. Arbitration Act 1950,. 23(1). Arbitration Act 1979,. l(l)-(4). ibid.,. l(6a)-(7), amended by Supreme Court Act 1981,. 148(2),(4). Parties can contract out of an appeal in all international disputes except those relating to shipping, insurance and commodities. Arbitration Act 1950,. 24(2). Where there is an express stipulation in a contract that questions involving allegations of fraud should be submitted to arbitration, the courts have indicated a willingness to give effect to that stipulation and compel arbitration. See Renshawv. Queen Anne Mansions Co. 11897] 1 QB 662. In general, die court's attitude to allegations of fraud will, depend on: (a) die seriousness of the allegation of fraud and its suitability to be dealt with by an arbitrator; and (b) the comprehensiveness of the arbitration clause.

176 Arbitration International Volume 12 Number 2 Unlike the United States context, UK securities laws do not conflict with the Arbitration Acts. The quasi-private Securities and Investment Board and the many private SROs overseen by it provide the bulk of securities regulation in the United Kingdom. Ultimately, their authority is derived from securities and company acts, most notably the Financial Services Act 1986. 25 None of these selfregulatory or governmental laws or regulations explicitly requires or prohibits particular fora for dispute resolution, and thus no authority seems to stand in the way of arbitration of securities law claims in the United Kingdom. Some SROs in the financial sector have used this freedom to arbitrate and have established arbitral mechanisms to resolve disputes. Among these is die Securities and Futures Administration (SFA), which governs securities and derivatives dealers and advisers. The SFA's Consumer Arbitration Scheme receives an average of 25 references to arbitration each year. Arbitration is at the option of the customer and need not be agreed to ex ante. Others include the Financial Intermediaries, Managers and Brokers' Regulatory Association and the Investment Management Regulatory Organisation, soon to be replaced by the Personal Investment Authority. IV. CANADA (a) Summary Historically, Canada has adopted a more hostile stance towards arbitration than its sister jurisdictions. As a result, although no legal constraints prevent arbitrability of securities law claims, such actions are rarely brought before an arbitral tribunal in practice. Recent changes in Canadian arbitration laws and institutions, however, augur a possible growth in arbitration of securities law claims in Canada. (b) History and Relevant Legislation Until 1986, Canadian arbitration law, while in principle permitting arbitration in almost all contexts, rendered die process unattractive to disputants. In the realm of domestic arbitration, witii die exception of the province of British Columbia, these laws have remained basically unchanged, based in 19th century English doctrine. 26 Most provincial courts still exercise broad latitude in refusing to stay court proceedings or enforce arbitral awards, even in the presence of ex ante agreements to arbitrate. Whereas US and UK courts generally refuse to compel proceedings or enforce awards only in egregious cases such as unconscionability See Financial Services Act 1986; Companies Acts 1948, 1967, 1976, 1980, 1981 and 1989; Stock Transfer Act 1963; Stock Exchange Act 1976. This article generally excludes arbitrability of securities law claims in the province of Quebec, because its legal system is based on French civil law.

Arbitrability of Securities Law Claims in Common Law Nations 177 or arbitrator misconduct, Canadian courts have refused to compel arbitration in far less egregious circumstances. Arbitrations have been interfered wiui simply because drey include involvement of a complex issue, are limited to questions of law or interpretations of agreements, or give rise to the possibility of multiple proceedings. 27 Moreover, Canadian arbitration legislation retains the English 'stated case' doctrine, now dispensed with in die United Kingdom itself. The doctrine reserves to the courts the right to intervene in an arbitration at any time to setde a question of commercial law. In die area of international arbitration, Canada has evolved a highly sophisticated and modern arbitration law. In 1986, the federal government and most provinces enacted legislation based on the UNCITRAL Model Law. This new legislation provides strong protections to the international arbitral process. The new legislation's impact on securities law claims, however, has been minor. At die federal level, die law applies in born die international and domestic contexts, but arbitration of commercial law claims generally is governed by provincial law. At the provincial level, tire new legislation applies only to international arbitration, and domestic arbitration of securities claims thus remains governed by die old Canadian provincial law. The one exception is British Columbia, which has extended the realm of its new arbitration law to domestic arbitration. Neidier old nor new Canadian arbitration law prohibits or encourages arbitration of securities law claims. Canadian securities law is largely silent on the issue of arbitration of claims. For the most part, neither provincial legislation or regulations - which exercise the greatest control over securities - nor diose at the federal level address die question of dispute resolution fora. One exception is die Alberta Financial Consumers Act (FCA), which governs the actions of suppliers and agents of financial products and financial planners. The FCA requires that agreements between those professionals and consumers include agreements binding the professional to arbitration at tire consumer's option, applying die rules of the Alberta Arbitration Act. 28 However, die Alberta Stock Exchange has not established an arbitration forum. Canadian SROs' rules on arbitration are generally limited to disputes between members arising out of claims unrelated to the securities laws. However, in what began as a pilot project, the Vancouver Stock Exchange recendy implemented the first Canadian arbitral tribunal for resolving disputes between members and fheir customers. Member firms voluntarily agree with the exchange ex ante to arbitrate at the customer's option. Ten files have been opened since die tribunal was established early in 1993. The Alberta and Montreal Stock Exchanges have expressed interests in establishing similar tribunals. See Henri C. Alvarez, 'The Role of Arbitration in Canada, New Perspectives' in (1987) 21 UBCL Rev. 247 at p. 2,50. S.A. 1990 c. -9.5, 23.

178 Arbitration International Volume 12 Number 2 V. AUSTRALIA (a) Introduction Like Canada, but to a greater extent, Australia recently left behind its ties to 19th century common law legislation on arbitration. However, its transition has been more complete. Because its securities laws are silent on the question of dispute resolution fora, no apparent legal bars exist to the arbitration of securities law claims. (b) History and Relevant Legislation Domestic arbitration in Australia is primarily governed at the state level. In the late 1980s, all of the states and territories enacted uniform legislation giving effect to the Commercial Arbitration Act (CAA). The CAA provided arbitration a firmer place in Australia's domestic dispute resolution arena. 29 Rights of appeal are now severely limited. 30 Indeed, even prima facie mistake of fact or law does not constitute sufficient grounds for judicial intervention. The subject matter of arbitration is unconstrained by the CAA, and securities law arbitration is thus apparently not precluded. International commercial arbitration is governed primarily by federal legislation. Under the International Arbitration Act, Australia has implemented the New York Convention and adopted the UNCITRAL Model Law with an opt-out provision. However, the state Commercial Arbitration Acts still govern international arbitrations where the UNCITRAL Model Law does not apply, as, for instance, where parties have explicidy agreed not to be governed by it. Australian securities law is silent on the subject of arbitration. Legislation operates at both the federal and state levels and is consistent throughout the Commonwealth in effect. Regulations and policy statements are promulgated primarily by the Australian Securities Commission, a Commonwealth body with offices in each state. Only one SRO, the Australian Stock Exchange, possesses statutory authority to regulate securities transactions. None of these legislative acts, regulations, or SRO rules addresses the question of arbitration, and securities law claims appear to be arbitrable. Moreover, Australian case law appears to be silent on the arbitrability of securities law claims. Commercial Arbitration Act (Australian Capital Territory), [1986] Austl. Cap. Terr. Laws No. 86, as amended bv Commercial Arbitration Amendment Act 1990; Commercial Arbitration Act (New South Wales), [1984] NSW Stat. No. 160, as amended by Act No. 100 (1990); Commercial Arbitration Act (Northern Territory), [1985] N. Terr. Acts No. 50, as amended by Act No. 4 (1991); Commercial Arbitration Act (Queensland), 11990] Queensl. Acts. No. 7.5; Commercial Arbitration Act (South Australia), [1986] S. Austl. Stat. No. 102, as amended by Commercial Arbitration (Uniform Provisions) Amendment Act, No. 64 (1992); Commercial Arbitration Act (Tasmania) 1986] Tasm. Stat. No. 91, as amended by Act No. 38 (1991), Commercial Arbitration Act (Victoria), No. 10167, [1984] Vict. Acts. 1803-1840, as amended by Act No. 15 (1993); Commercial Arbitration Act (Western Australia), 11985] W. Austl. Stat. No. 109. See CAA, 38.