Who Is A “Customer” for Purposes of FINRA Arbitration?

Securities broker-dealers are required to arbitrate all disputes with “customers” before the Financial Industry Regulatory Authority.

However, many Courts have found the term “customer” to be ambiguous. John Hancock Life Ins.v.Wilson, 254 F.3d 48,58 (2d Cir. 2001).

The FINRA Code states only that “[a] customer shall not include a broker or dealer.” FINRA Rule 12100(i). FINRA’s glossary states that a “customer” is “[a] person or entity (not acting in the capacity of an associated person or member) that transacts business with any member firm and/or associated person” but provides little additional guidance.

Under this definition, as one Court has observed, the meaning is plain. “[It] provide[s] that [the party] is a customer as long as [he, she it] is not a broker or dealer; nothing in the Code directs otherwise or requires more. Enforcing the limitation [the securities firm] seeks would be tantamount to reading language into the Code that is conspicuously absent.” Multi-Financial Securities Corp v. King, 386 F.3d 1364, 1368 (11th Cir. 2004)(“when Rule 12200 was proposed, the addition of the words ‘of a member’ after the word ‘customer’ w[as] explicitly rejected because it would ‘narrow the scope of claims that are required to be arbitrated under the Customer Code.” (quoting Waveland Capital Partners, LLC v. Tommerup, 2012 WL 70572, 6 (D.Mont., Jan.6, 2012) (citing Order Approving Proposed Rule Change to Amend NASD Arbitration Rules for Customer Disputes, 72 Fed. Reg. 4574, 4579 (2007)).

The Second Circuit suggests that the term “customer” is intentionally broad because FINRA intended to require its members to arbitrate disputes with the full array of parties as part of its “investor-protection mandate.” See UBS Fin. Servs. v. W. Va. Univ. Hosps., 660 F.3d 643, 651 (2d Cir. 2011) (“We also reject UBS’s contention that FINRA has a narrow ‘investor-protection mandate,’ such that ‘customers’ should include only those receiving ‘investment or brokerage services.”’).

Indeed, many commentators suggest that the term “customer” has been construed broadly to include all members of the “investing public.” as part of FINRA and the NASD’s express purpose “[t]o investigate and adjust grievances between the public and members and between members.” Restated Certificate of Incorporation of Financial Industry Regulatory Authority, Inc. § 3 (July 2, 2010)(emphasis added); See also, David E. Robbins, Securities Arbitration Procedure Manual § 5-6(i) (5th ed. 2009); Norman S. Poser & James A. Fanto, Broker-Dealer Law and Regulation § 28.07(A) (4th ed. 2009).

Customers Only Need To Be Members Of The Investing Public

A “customer” is not required to have an “account” with the member firm to compel arbitration pursuant to FINRA Rule 12200. First Montauk Securities Corp. v. Four Mile Ranch Development Company, Inc., 65 F. Supp. 2d 1371, 1381 (S. D. Fla 1999)(“[t]he NASD chose not to limit customers to investors with accounts with the member-firm); WMA Sec. v. Wynn, 191 F.R.D. 128, 130 (S.D. Ohio 1999) (“A Customer is defined as anyone who is not a broker or dealer. ‘Customer’ is not defined as WMA would have it, as a person who opened an account with a brokerage firm.”)(emphasis added).

Under the FINRA Rules, there is no exemption from the obligation to arbitrate claims based upon an assertion that the activities of the associated person were unknown to the firm or were outside the normal scope of the relationship. White Pacific Securities, Inc. v. Mattinen, Case No. 12 cv 151 YGR (N.D. Cal. March 19, 2012); O.N. Equity Sales Co. v. Maria Cui, 2008 WL 170584, *3 (N.D.Cal., January 17, 2008)(district courts in this circuit that have examined situations nearly identical to the one presented here have concluded that, even if the FINRA-member broker-dealer was not involved directly as the account issuer or as a participant).

Customers of the Stockbroker or Associated Person Are Customers of the Firm

As stated above, FINRA Rule 12200, in pertinent part, provides that “ Parties must arbitrate a dispute under the Code if the dispute is between a customer and a member or associated person of a member. (Emphasis added).

Rule 12100(r) of the FINRA Code defines an “associated person” as: (1) A natural person who is registered or has applied for registration under the Rules of FINRA; or (2) A sole proprietor, partner, officer, director, or branch manager of a member, or other natural person occupying a similar status or performing similar functions, or a natural person engaged in the investment banking or securities business who is directly or indirectly controlling or controlled by a member, whether or not such person is registered or exempt from registration with FINRA under the By-Laws or the Rules of FINRA. For purposes of the Code, a person formerly associated with a member is a person associated with a member. See also, NYSE Rule Interpretation 345(a) (“Independent Contractors” The establishment of “independent contractor” status between a natural person registered with and qualified by the Exchange and a member organization is permitted only if it does not in any way compromise such person’s characterization and treatment as an “employee” of their associated member organization for purposes of the Rules of the Exchange.

While in “selling away” cases, investors seeking to arbitrate their claims with the member firm, may not have a traditional account with the member firm, or engaged in the purchase or sale of securities at issue through the member firm, invariably, by definition, these investors are “customers” of the member’s “associated persons.”

Indeed, “no federal appellate court has prohibited the customer of an associated person, asserting a claim arising out of the associated person’s business, from compelling a member to arbitrate under [NASD] Rule 10301.” John Hancock Life Ins. Co. v. Wilson, 254 F.3d 48, 59 (2d Cir. 2001)(citing, Miller v. Flume, 139 F.3d 1130 (7th Cir. 1998).

In John Hancock Life Ins. Co. v. Wilson, 254 F.3d 48 (2d Cir. 2001), the defendant Investors filed arbitration claims against John Hancock arising out of their purchase of fraudulent promissory notes from Hancock’s agents (Fucilo and Palladino). The Investors were customers of Fucilo, but not John Hancock, and sought to hold John Hancock liable under a number of theories, including the failure to supervise.

In WMA Securities, Inc. v. Ruppert, 80 F. Supp. 2d 786 (W.D. Ohio 1999), defendants sought to arbitrate claimed losses from their investment in promissory notes issued by First Lenders Indemnity Corporation. In the underlying arbitration claim, defendants alleged that WMA securities violated NASD rules governing the supervision of registered representatives by broker-dealers. WMA argued, however, that defendants were not its customers and that the disputes embodied in defendants’ arbitration claims did not arise from WMA’s business, and based upon it own narrow definition of “customer,” sought to enjoin the arbitration.

The Court however found that the defendant was a customer of WMA’s registered representative, and accordingly, found WMA’s argument that the defendant was not a “customer” for purposes of NASD Rule 10301(a) to be “unavailing.” 80 F. Supp. 2d at 791 (emphasis added).

In dismissing Oppenheimer’s injunction action, the court found Plaintiff’s argument “fatally flawed” because Oppenheimer ignored the second part of the Code that requires that the claim arise either in connection with Plaintiff’s business or in connection with the activities of persons associated with Plaintiff.

Guiliano Law Group

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