Big Guns Drawn In Controlled Arbitration Customer Experiment In Federal Court

August 25, 2014

The Financial Industry Regulatory Authority ("FINRA") has a seemingly short and sweet rule in its Code of Arbitration Procedure for Customer Disputes, which defines mandatory customer-industry arbitration as follows:

FINRA Rule 12200Arbitration Under an Arbitration Agreement or the Rules of FINRA

Parties must arbitrate a dispute under the Code if:
 Arbitration under the Code is either:
(1) Required by a written agreement, or
(2) Requested by the customer;

 The dispute is between a customer and a member or associated person of a member; and

 The dispute arises in connection with the business activities of the member or the associated person, except disputes involving the insurance business activities of a member that is also an insurance company.

At first glance, it all seems straightforward and, frankly, fairly simple to comprehend. But first impressions are notoriously misleading. In this case, you would be wrong, very wrong, if you thought that you truly understood all the nuances and implications of FINRA Rule 12200.

Ask And You Shall Receive (If You're A Customer)

FINRA arbitration is mandatory if there's a written agreement in place and the dispute is between a customer and member/associated person, and the dispute is in connection with the member/associated person's business activities. The alternative -- when there is no written agreement -- incorporates the same requirements of dispute and business activities but merely requires a "request" for arbitration be made by a customer. 

Look It Up

Things begin to get a tad less simple and tad  incomprehensible when we try to figure out what, at first blush, seemed like obvious terms: Member, Associated Person, Dispute, and Customer. You might have thought, wrongly, that those words didn't need any explanation -- that they're common enough terms. Again, you would be wrong. What you might not have known is that FINRA has a rule that defines those and other terms. When we look up "member", "associated person" "dispute" and "customer," we get these explanations:

FINRA Code of Arbitration Rule 12100. Definitions

Unless otherwise defined in the Code, terms used in the Rules and interpretive material, if defined in the FINRA By-Laws, shall have the meaning as defined in the FINRA By-Laws.

(a) Associated Person

The term "associated person" or "associated person of a member" means a person associated with a member, as that term is defined in paragraph (r).

. . .

(i) Customer

A customer shall not include a broker or dealer.

. . .

(l) Dispute

The term "dispute" means a dispute, claim or controversy. A dispute may consist of one or more claims.

. . .

(o) Member

For purposes of the Code, the term "member" means any broker or dealer admitted to membership in FINRA, whether or not the membership has been terminated or cancelled; and any broker or dealer admitted to membership in a self-regulatory organization that, with FINRA consent, has required its members to arbitrate pursuant to the Code and/or to be treated as members of FINRA for purposes of the Code, whether or not the membership has been terminated or cancelled.

. . .

(r) Person Associated with a Member

The term "person associated with a member" means:

(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 any 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.

The Challenge

So . . . howsabout a little challenge?  

According to FINRA's official rulebook, please define what is exactly meant  by the term "customer".  

Okay . . . time's up. And the answer is?  

Ummmm . . . whatsamatta, you can't really come up with a great explanation as to who is a customer, but you can come up with an explanation as to who isn't?  Yeah, you got it, a "customer" is anything or anyone in the Universe, apparently, who is not a broker or a dealer.  

You ain't feelin' all that cocky about defining that term now, are you?  In fact, what, at first blush, seemed fairly simple and easy to comprehend has now turned into one of those annoying mind games about the sound of one hand clapping or of that damn lone tree falling in the forest. As a federal court recently stated:

The proceedings conducted in this case amount to a controlled experiment in what happens when customer status entails inquiring into each communication, agreement, side agreement, understanding, and rendering of advice, and when big guns are drawn in contentious discovery disputes and at trial

Welcome To the Controlled Experiment

The fun thing about crappy statutes and codes is that they invite lots and lots of expensive litigation. Why is that a fun thing, you ask? Oh, that's because I'm an attorney and I can run up lots and lots of billable hours having to deal with such nonsense. 

Take the recent appeal in Citigroup Global Markets Inc. v. Abbar (2Cir, 13-2172, August 1, 2014)..As set forth in the United States Court of Appeals for the Second Circuit's preamble:

Ghazi Abbar, a Saudi businessman who managed Abbar family trusts, lost $383 million invested with a United Kingdom affiliate of Citigroup, Inc. He seeks to arbitrate his grievances under the rules of the Financial Industry Regulatory Authority ("FINRA") against a New York affiliate, which is a FINRA member. The United States District Court for the Southern District of New York (Stanton, J.) permanently enjoined the arbitration on the ground that Abbar is not a "customer" of the New York affiliate. 

The Abbar family trusts were administered through two wholly‐owned investment vehicles (defendants Amatra Leveraged Feeder Holdings, Limited and Ajial 1 Leveraged Feeder Holdings, Limited) that held the family portfolio. Abbar pursued a risky leveraged investment by purchasing options from Citigroup Global Markets Ltd. ("Citi UK"), which is incorporated in the United Kingdom under the laws of England and Wales. The options entitled Abbar to the value of certain assets in a fund held by Citi UK. Some of the investment bankers who helped develop Abbar's trading strategy, and some of the personnel who worked on the investments, were employed at another Citigroup affiliate, Citigroup Global Markets Inc. ("Citi NY"), which is incorporated under the laws of New York. When the investments lost all value, Abbar commenced a
FINRA arbitration in New York against Citi NY, a FINRA member.

Citi NY brought an action in the Southern District of New York to enjoin the arbitration, citing the FINRA Code of Arbitration Procedure for Customer Disputes ("FINRA Code"), which provides that a FINRA member consents to arbitration with its customers. After a bench trial, the district court ruled that Abbar, who purchased no goods or services from Citi NY and had no account with it, therefore lacked the indicia of a customer. Accordingly, the injunction was issued. We affirm.
Pages 3 - 4 of the Opinion


Our case lies in between. Citi NY employees certainly provided services to Abbar: they helped structure and manage the option transactions. However, Abbar did not purchase those services from Citi NY. His investment agreements were with Citi UK, and the fee for all services rendered by Citigroup personnel and offices was paid to Citi UK. Citi UK‐‐not Citi NY‐‐was the counterparty to the option agreements and the structuring services letters. While Abbar was certainly a "customer" of Citi UK, that relationship does not allow Abbar to compel arbitration against its corporate affiliate. See Wachovia, 661 F.3d at 171 (holding that a purchaser of a credit default swap from "Wachovia Bank, N.A." was not a "customer" of affiliate "Wachovia Capital Markets, LLC"). The district court found as fact that when Citi NY provided management services to Abbar,
it acted primarily for Citi UK in connection with the services Citi UK was providing to Abbar. CGMI v. Abbar, 1 943 F. Supp. 2d at 406‐07. That finding of fact is not clear error, and is well supported by the record.
Pages 16-17 of the Opinion


We are thus presented with an issue that, until now, this Court has been able to avoid: the "precise boundaries of the FINRA meaning of 'customer.'" Wachovia, 661 F.3d at 173‐74. We hold that 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.
Page 17 of the Opinion


The only relevant inquiry in assessing the existence of a customer relationship is whether an account was opened or a purchase made; parties and courts need not wonder whether myriad facts will "coalesce into a functional concept of the customer relationship." Id. To the extent and in the event such a bright‐line rule allows for evasion and abuse, we think that sufficient relief can be afforded by FINRA's power to discipline its members and adjust its rules, and by Judge Stanton's caveat that exceptions may be compelled in rare instances of injustice. See Oppenheimer, 56 F.3d at 357 (finding customer relationship with FINRA member, despite the claimant's lack of an account with the member, because the claimant would have had an account with the member but for the fraud asserted in the FINRA arbitration); cf. UBS, 660 F.3d at 650 (noting that a customer may also be one who "undertakes to purchase a good or service" from a FINRA member").

As this case illustrates, 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. The proceedings conducted in this case amount to a controlled experiment in what happens when customer status entails inquiring into each communication, agreement, side agreement, understanding, and rendering of advice, and when big guns are drawn in contentious discovery disputes and at trial. The sprawling litigation that can (and did) result defeats the express goals of arbitration to yield economical and swift outcomes.

A simple, predictable, and suitably broad definition of "customer" is therefore necessary. See UBS Fin. Servs., Inc. v. Carilion Clinic, 706 F.3d 319, 325 (4th Cir. 2013) (defining "customer" as "one, not a broker or dealer, who purchases commodities or services from a FINRA member in the course of the member's business activities . . . ."). True, the definition closes the FINRA forum to some foreign transactions with little connection to the United States. But 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.
Pages 19 -21 of the Opinion