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MAYO v. DEAN WITTER REYNOLDS

April 22, 2003

RICHARD MAYO, ON BEHALF OF HIMSELF AND THE PEOPLE OF CALIFORNIA, PLAINTIFF,
v.
DEAN WITTER REYNOLDS, INC., MORGAN STANLEY DEAN WITTER & CO. DBA MORGAN STANLEY DEAN WITTER, AND DOES 1-50, DEFENDANTS.



The opinion of the court was delivered by: Jeremy Fogel, District Judge.

ORDER DENYING PLAINTIFF'S MOTION TO VACATE ORDER COMPELLING ARBITRATION AND STAYING PROCEEDINGS

I. BACKGROUND

This suit arises out of allegedly unauthorized withdrawals from Plaintiff Richard Mayo's Morgan Stanley investment account. In June 2000, Plaintiff opened a Morgan Stanley "Active Assets Account" by completing and executing an account application, pursuant to which be agreed to abide by the terms and conditions of the Morgan Stanley Client Account Agreement. The Client Account Agreement includes a provision specifying that all disputes between the parties arising out of or concerning any Morgan Stanley account are subject to binding arbitration.

During October and November 2000, Plaintiff noticed a number of unauthorized withdrawals from his account, including thousands of dollars in point-of-sale transactions and automated teller machine ("ATM") withdrawals. After Plaintiff reported these unauthorized withdrawals, Morgan Stanley recredited to his account the approximate amount of the complained of point-of-sale transactions, but it refused to recredit the amount corresponding to the complained of ATM withdrawals.

On March 14, 2001, Plaintiff filed suit in the Santa Clara Superior Court alleging that Morgan Stanley's failure to reimburse him for the amount of the unauthorized ATM withdrawals violates the Electronic Funds Transfer Act, 15 U.S.C. § 1693, et seq., and the state Unfair Competition Law, Cal. Bus. & Prof. Code §§ 17200, et seq. Plaintiff seeks monetary damages, as well as injunctive and restitutionary relief on behalf of himself and the general public of California.

Morgan Stanley removed the action to this Court on the basis of both diversity jurisdiction and federal question jurisdiction, and thereafter moved to compel arbitration pursuant to the arbitration provision in its Client Account Agreement. On February 4, 2002, the Court granted Morgan Stanley's motion to compel arbitration under the Federal Arbitration Act, 9 U.S.C. § 1, et seq. ("FAA"), and stayed proceedings pending completion of the arbitration process. Order Granting Motion to Compel Arbitration and to Stay Proceedings, Feb. 4, 2002 ("Arbitration Order"). In reaching this decision, the Court determined that the parties' agreement to arbitrate was valid and enforceable under the FAA. Id.

The arbitration provision in the Client Account Agreement provides for arbitration "only before the New York Stock Exchange, Inc.; the National Association of Securities Dealers, Inc.; or the Municipal Securities Rulemaking Board, as [Plaintiff] may elect." Client Account Agreement at 14.*fn1 On February 22, 2002, Plaintiff commenced arbitration proceedings before the NYSE by filing a statement of claim and executing a Uniform Submission Agreement ("USA"). The USA provides that the arbitration "will be conducted in accordance with the Constitution, By-Laws, Rules, Regulations, and/or Code of Arbitration Procedure of the sponsoring organization."

In July 2002, the NYSE informed Plaintiff that it would not appoint an arbitrator in his case at that time because it temporarily was suspending the assignment of all arbitrators in California in response to new ethics standards for arbitrators promulgated by the Judicial Council of California ("the Judicial Council") that took effect on July 1, 2002. NASDDR also temporarily suspended the assignment of arbitrators in California.

A. The California Standards

The new California ethics standards for arbitrators are the result of legislation passed by the California Legislature and signed into law by the Governor in 2001. Senate Bill 475 requires that the Judicial Council "adopt ethical standards for all neutral arbitrators effective July 1, 2002." Cal. Code Civ. Proc. § 1281.85(a). SB 475 provides that the new standards, including arbitrator disclosure and disqualification requirements, apply to any person "serving as a neutral arbitrator pursuant to an arbitration agreement." Id. Pursuant to SB 475, in April 2002 the Judicial Council adopted new "Ethics Standards for Neutral Arbitrators in Contractual Arbitration" ("the California standards") that are codified at Division VI of the Appendix to the California Rules of Court. The California standards took effect on July 1, 2002. In December 2002, the Judicial Council approved various revisions to the California standards that took effect on January 1, 2003.

The California standards are intended "to promote public confidence in the arbitration process." Ethics Std. 1(a). Among other things, the California standards provide that: "[a] person who is nominated or appointed as an arbitrator must disclose all matters that could cause a person aware of the facts to reasonably entertain a doubt that the proposed arbitrator would be able to be impartial." Ethics Std. 7(d). Standard 7 expands on pre-existing statutory disclosure requirements by setting forth a non-exhaustive list of thirteen distinct categories of information that arbitrators must disclose. See Ethics Std. 7(d).*fn2 Standard 8 requires additional disclosures "in consumer arbitrations in which a dispute resolution provider organization is administering the arbitration." Comment to Ethics Std. 8. See Ethics Std. 8. The disclosures required by the California standards also are expressly mandated by statute. See Cal. Code Civ. Proc. § 1281.9(a)(2).

Standard 10 provides that a proposed arbitrator's failure to make the disclosures required by the California standards results in disqualification upon notice by any party entitled to receive the disclosure. See Ethics Std. 10(a). A proposed arbitrator also may be disqualified on the basis of a disclosure that is a ground for disqualification upon notice by any party entitled to receive the disclosure. See id. In addition, Standard 10 restates pre-existing disqualification requirements and procedures found in California Code of Civil Procedure § 1281.91. See id.

The grounds for vacatur of an arbitration award are established by statute, not the California standards. As amended by SB 475, California Code of Civil Procedure § 1286.2 provides that a court "shall vacate" an arbitration award if it determines that:

An arbitrator making the award either: (A) failed to disclose within the time required for disclosure a ground for disqualification of which the arbitrator was then aware; or (B) was subject to disqualification upon grounds specified in 1281.91 but failed upon receipt of timely demand to disqualify himself or herself as required by that provision.
Cal. Code Civ. Proc § 1286.2(a)(6). In other words, failure to comply with the disclosures required by the California standards results in mandatory vacatur of an arbitration award.

With the exception of Standard 8, the California standards apply to all neutral arbitrators appointed on or after July 1, 2002. See Ethics Std. 3. Standard 8 does not apply to neutral arbitrators appointed before January 1, 2003. Nothing in SB 475 purported to give the Judicial Council any authority to enforce the California standards. NASD Dispute Resolution, Inc. v. Judicial Council of California, 232 F. Supp.2d 1055, 1058 (N.D. Cal. 2002). Rather, SB 475 depends upon private implementation. Id. at 1066.

B. Self-Regulatory Organizations

The NYSE, the second oldest national securities exchange in the United States, and the National Association of Securities Dealers ("NASD"), a national securities association, are "self-regulatory organizations" ("SROs") registered with the SEC pursuant to the Securities Exchange Act of 1934, 15 U.S.C. § 78a, et seq. ("the Exchange Act"). As part of the comprehensive system of federal regulation of the securities industry, the Exchange Act authorizes SROs within the securities industry to self-regulate their members subject to oversight by the United States Securities and Exchange Commission ("SEC"). SROs are subject to extensive oversight, supervision, and control by the SEC on an ongoing basis. See 15 U.S.C. § 78s; Austin Mun. Securities, Inc. v. Nat'l Ass'n of Securities Dealers, Inc., 757 F.2d 676, 680 (5th Cir. 1985).

The Exchange Act directs SROs to adopt rules and by-laws that conform with the Exchange Act. See 15 U.S.C. § 78f(b), 78o-3(b). With some exceptions not relevant here, the SEC must approve all SRO rules, policies, practices, and interpretations prior to their implementation. See 15 U.S.C. § 78s(b). Each SRO must comply with the provisions of the Exchange Act as well as its own rules. See 15 U.S.C. § 78s(g).

One of the functions of the SROs is to provide arbitral fora for the resolution of securities industry disputes. "Arbitration has long been a preferred remedy in the securities industry." In re Piper Funds, Inc., Institutional Gov't Income Portfolio Litig., 71 F.3d 298, 301 (8th Cir. 1995). Securities broker-dealers routinely include arbitration clauses in their customer agreements. See Securities Industry Ass'n v. Connolly, 883 F.2d 1114, 1116 (1st Cir. 1989). As a result, both the NYSE and the NASD, through its wholly-owned subsidiary NASDDR, provide arbitration services to their members.*fn3 The SEC has expansive power to regulate the SRO arbitration programs. Roney & Co. v. Goren, 875 F.2d 1218, 1221 (6th Cir. 1989).

Arbitration services provided by the NYSE are conducted in accordance with the NYSE Arbitration Rules; those provided by NASDDR are conducted in accordance with the NASD Code of Arbitration Procedure. Intervenors the NYSE and NASDDR*fn4 contend that the obligations imposed by the California standards are in conflict with their obligations under their own SEC-approved rules. Prior to adoption of the California standards, Intervenors unsuccessfully had sought from the California Legislature and from the Judicial Council an exemption for themselves and other SROs from the California standards. See Declaration of Robert S. Clemente in Opposition to Plaintiff's Motion to Vacate Order Compelling Arbitration ("Clemente Decl.") ¶ 34.

C. Response by the NYSE to Adoption of the California Standards

On July 22, 2002, Intervenors filed in this district a complaint for declaratory relief against the Judicial Council and its members (in their official capacities) seeking an exemption for SROs from the California standards. Intervenors and the SEC, as amicus, argued that application of the California standards to SROs is preempted by the Exchange Act and by the FAA.

Shortly after filing the declaratory relief action, the NYSE began to offer California investors the option of having their arbitrations heard outside of California, in which case the California standards would not apply. The NYSE's temporary moratorium on assigning arbitrators in California remained in effect. Plaintiff filed the instant motion to vacate the Arbitration Order on August 5, 2002 on the ground that the NYSE's suspension of the assignment of arbitrators in California makes his agreement to arbitrate void for impossibility, void as unconscionable, and void for frustration of purpose. The NYSE subsequently designated Reno, Nevada as the location of Plaintiff's arbitration hearing.

On November 12, 2002, Judge Samuel Conti dismissed the declaratory relief action filed by Intervenors on the ground that the defendants are immune from suit under the Eleventh Amendment. NASD Dispute Resolution, Inc. v. Judicial Council of California, 232 F. Supp.2d 1055 (N.D. Cal. 2002).*fn5 Judge Conti did not reach the issue of whether application of the California standards to SROs is preempted by federal law. Id. On the same day that Judge Conti issued his decision, the SEC granted accelerated approval to an interim NYSE rule for California arbitrations.*fn6 See SEC Release No. 34-46816, 67 Fed. Reg. 69,793 (2002). The new rule, NYSE Arbitration Rule 600(g), requires California investors either to waive application of the California standards and proceed with arbitration in California or to proceed with arbitration out-of-state.*fn7 The SEC approved NYSE Arbitration Rule 600(g) as a six-month pilot program effective from November 12, 2002 to May 12, 2003. The NYSE notified affected investors, including Plaintiff, of the SEC's action.

Plaintiff refuses to proceed with arbitration pursuant to NYSE Arbitration Rule 600(g) on the ground that he is entitled to proceed with arbitration in California before an arbitration panel that is compliant with the California standards. By the instant motion, Plaintiff seeks to be relieved entirely from his obligation to arbitrate his dispute with Morgan Stanley. Morgan Stanley, Intervenors, and the SEC, as amicus, oppose the instant motion on ...


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