California Court of Appeal Holds that Agent of FINRA Member Firm Can Compel Arbitration Even Where the Contracting Member Firm Could Not Due to a Lapse in its FINRA Membership

On May 23, 2013, in Ronay Family Ltd. P’ship v. Tweed, D062195, 2013 WL 2300117 (Cal. Ct. App. May 23, 2013), the Fourth District of the California Court of Appeal held that agents or third party beneficiaries of a Financial Industry Regulatory Authority (“FINRA”) member’s arbitration agreement may enforce the agreement and compel arbitration even where the contracting member firm cannot due to a lapse in its membership status.

In Tweed, plaintiff Ronay Family Limited Partnership brought claims against defendants Robert R. Tweed and Tweed Financial Services, Inc. concerning plaintiff’s purchase of securities offered by CapWest Securities, Inc. The defendants acted as registered agents for CapWest in selling the securities to plaintiff, and they opened an account for plaintiff with CapWest. In opening the account, the defendants, acting as CapWest’s registered representative, and plaintiff signed an agreement containing an arbitration clause, which stated that any controversy arising out of the account or transactions with CapWest would be subject to arbitration in accordance with the rules then in effect of the National Association of Securities Dealers, Inc. (NASD). Id. at *2. While CapWest was a securities broker and registered member of FINRA at the time of the sale, the defendants were registered with FINRA but not members. Id. at *1.

After the investments failed, plaintiff sued numerous entities, including defendants, to recover the losses it incurred. The defendants moved to compel arbitration before FINRA based on the signed arbitration agreement with CapWest containing the arbitration clause. Id. at *2. In response to the defendants’ petition to compel, plaintiff argued that the arbitration clause was not enforceable because CapWest was now defunct and FINRA had cancelled its membership. Specifically, plaintiff argued that FINRA Rule 12202 makes ineligible for arbitration claims by or against inactive members unless the customer agrees in writing to arbitrate. Id. The trial court agreed and held that the defendants’ rights to compel arbitration were dependent on CapWest’s rights. Since CapWest had no right to arbitration due to a lapse in its membership, the defendants could not compel arbitration. Id.

On appeal, the California Court of Appeal held that the trial court erred in denying the petition to compel arbitration. The court noted that there was no dispute that the claims at issue fall under the scope of the arbitration clause, but that the sole dispute concerned the enforceability of the arbitration clause. Id. at *3. The court concluded that the defendants could enforce the arbitration clause as agents or third party beneficiaries. Although the defendants were not parties to the agreement, they acted as agents for CapWest in opening the account for plaintiff. Id. at *4. The court also found that the defendants were members of a class of persons for whose benefit the arbitration clause was made and that, by its terms, the arbitration clause specifically covered agents and registered representatives. Id.

In reversing the trial court, the court rejected plaintiff’s argument that the defendants were precluded from enforcing the arbitration agreement because CapWest could no longer enforce it under FINRA rules. Id. at *5-6. The court interpreted FINRA Rule 12202 as making claims “ineligible for arbitration” that are “by or against a member” whose FINRA membership has lapsed. Id. at *6. The court, however, noted that the Rule says nothing about the arbitrability of a customer’s claims against associated persons or others. Id. The court also reviewed the NASD’s interpretation of the Rule and concluded that “the deprivation of the right to compel arbitration upon termination of a member’s FINRA membership under FINRA Rule 1202 extends only to the member.” Id.

The court also noted that under FINRA rules “members and associated persons are defined as separate entities with separate rights concerning arbitration of customer disputes.” Id. at *8 (citing FINRA Rule 12100). Thus, “by requiring arbitration of disputes ‘between a customer and a member or associated person’ arising out of ‘the business activities of the member or the associated person’ FINRA Rule 12200 recognizes that members and associated persons have independent rights to compel arbitration of disputes with customers.” Id.

CONCLUSION

In sum, even where an agent or associated person is not a party to an agreement containing an arbitration clause, they may be able to enforce the arbitration clause and compel arbitration against a customer as a third party beneficiary and agent of the contracting FINRA member. Further, even where the FINRA member is precluded from enforcing the arbitration agreement, associated persons may still be able to enforce the agreement and compel arbitration.

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