The U.S. Court of Appeals for the Second Circuit has provided a measure of clarity in limiting the definition of a “customer” who may bring a FINRA arbitration under FINRA Rule 12200. The decision is significant for those member firms that provide a broad array of financial services through various entities. In Citigroup Global Markets Inc. v. Abbar, decided August 1, 2014, the court defined the “precise boundaries of the FINRA meaning of ‘customer’” as follows:
[A] ‘customer’ under FINRA Rule 12200 is one who, while not a broker or dealer, either (1) purchases a good or service from a FINRA member, or (2) has an account with a FINRA member.1
The meaning of “customer” is essential to determining whether a potential dispute must be arbitrated. The FINRA Code of Arbitration Procedure for Customer Disputes requires member firms to consent to arbitrate disputes with their customers. Absent a written agreement to arbitrate, FINRA Rule 12200 requires member firms to consent to arbitration if a “customer” of the firm requests it and the dispute “arises in connection with the business activities of the member or the associated person.”
In Abbar, the Second Circuit recognized the broad array of services provided by many member firms: “finance nowadays often involves worldwide sources, networks of information, talent and technology. But multiple inputs do not necessarily create customer relationships in different places simultaneously.” In determining whether the provision of those services gives rise to a customer relationship, the court rejected an amorphous facts and circumstances approach. Instead, the court adopted the bright-line definition set out above.
The claimant in Abbar had invested with a United Kingdom affiliate of Citigroup, Inc. (“Citi UK”), and later filed a FINRA arbitration against its New York affiliate (“CGMI”). Abbar and CGMI had no written agreement to arbitrate. CGMI brought suit in the Southern District of New York to enjoin the arbitration, on the grounds that the claimant was not its customer. Without an agreement to arbitrate, the question of arbitrability was one for the court. After nearly two years of litigation and a nine-day bench trial, the district court permanently enjoined the arbitration.2 The court had exhaustively reviewed the relationships between Abbar, Citi UK, and CGMI, and found that CGMI’s role was “ancillary and collateral” to Citi UK’s relationship with Abbar. The lower court’s ruling, however, rested more fundamentally on the ordinary meaning of “customer,” finding that Abbar neither held an account with CGMI nor purchased goods or services from CGMI. The Second Circuit affirmed the court’s order and its reasoning.
The Second Circuit observed that the proceeding fell in a gray area where a member firm had a role in servicing a claimant, but the claimant did not purchase services from the member firm. In adopting a bright-line approach, the court noted that by providing an account to an entity, “or by selling securities to an entity, a FINRA member understands that it may be compelled to arbitrate if a dispute arises.” The court cited FINRA Regulatory Notice 12-55, defining a “customer” for suitability purposes as “a person who is not a broker or dealer who opens a brokerage account at a broker-dealer or purchases a security for which the broker-dealer receives or will receive, directly or indirectly, compensation.”
The Second Circuit disagreed with Abbar that it must resolve any ambiguity in favor of arbitration, because the question was whether there was an obligation to arbitrate at all, rather than the scope of an arbitration agreement. Dispensing with any concern that its bright-line rule would invite abuse — by, for example, a broker-dealer not completing an account opening — the court noted that FINRA may “discipline its members and adjust its rules.” The court conceded that its definition may not be comprehensive, “but it captures virtually all customer relationships.” The Second Circuit also noted that a court could find an exception to the bright-line rule if “compelled in rare instances of injustice.” While its ruling could foreclose some foreign transactions from FINRA arbitration, the court suggested that “a foreign business that wants to assure access to FINRA arbitration for its grievances need only transact business with a FINRA member or hold an account with one.”
The Second Circuit’s ruling is significant for member firms facing disputes arising outside of the traditional brokerage relationship. The court’s bright-line approach will serve as a guidepost for parties seeking or opposing the FINRA arbitration forum, and may result in quicker decisions on arbitrability.
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1 Citigroup Global Markets, Inc. v. Abbar, --- F.3d ----, No. 13-2172, 2014 WL 3765867 (2d Cir. Aug. 1, 2014).
2 Citigroup Global Markets, Inc. v. Abbar, 943 F. Supp. 2d 404 (S.D.N.Y. 2013).
This article was originally published by Bingham McCutchen LLP.