GUEST BLOG: Who Is A Customer For Purposes of FINRA Arbitration Rule 12200 by Martin P. Unger Esq

September 16, 2016


FINRA Rule 12200: Arbitration Under an Arbitration Agreement or the Rules of FINRA provides that:

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.
Accordingly, within the context of disputes between a customer and member/associated person, FINRA Rule 12200 raises two pertinent questions:
  1. Who is a  "customer;" and
  2. Whether the dispute "arises in connection with the business activities of the member or the associated person."
Public customer claimants continue to argue for an expansion of the definition of "customer," whereas broker/dealers and associated persons take a contrary view; notwithstanding, most courts that have visited the issue now provide a working definition.

Any Person Not A Broker-Dealer

Relying on what many viewed as the first and foremost decision attempting to define "customer," John Hancock Life, Inc. v. Wilson, 254 F.3d 48 (2d Cir. 2001), courts initially took the view that a customer is any person who is not a broker-dealer. SeeMulti-Financial Securities Corp. v. King, 386 F.3d 1364 (11th Cir. 2004), and Vestax Securities Corporation v. McWood, 280 F.3d 1078 (6th Cir. 2002). As held in the concluding paragraph in the 2nd Circuit's John Hancock Life, Inc.:

John Hancock and Signator ably present an argument that, as a policy matter, has considerable force:  because the record does not show the requisite indicia of customer relationship between them and the Investors, they should not be responsible for defending the Investors' claims before an NASD arbitration panel rather than in court.   In other words, the Investors must be customers of Hancock and not simply of an associated person in order to be covered by NASD Rule 10301(a). Today the Court holds that, by a plain meaning analysis of Rule 10301(a), or in the alternative, by construing any ambiguity in favor of arbitration as the rules of construction require, the district court properly compelled arbitration of the Investors' claims. I believe that Rule 10301 is susceptible of more than one interpretation, but agree with the Court that the relevant presumption requires resolution of the ambiguity in favor of arbitration.   No extrinsic evidence has been presented that, for example, the drafters of NASD Rule 10301(a) intended that an investor must be a customer of the member-and not just a customer of an associated person of the member-in order to force the member to arbitrate. In the absence of such support, this Court is left with the words of the Rule:   "[a]ny dispute, claim, or controversy . . . between a customer and a member and/or associated person arising in connection with the business of such member or in connection with the activities of such associated persons shall be arbitrated under this Code . . . upon the demand of the customer." We are constrained by the rules of construction which we must apply to the language before us. We are without authority to venture beyond our province, and must leave the very legitimate policy issues identified by the appellants to those charged with developing and approving NASD policy. See 15 U.S.C. § 78s(b)(1)(requiring  "self-regulatory organization[s]" such as the NASD to submit proposed policy changes to the Securities and Exchange Commission for public notice, comment and approval);  17 C.F.R. § 240.19b-4 (governing filings with respect to proposed rule changes by self-regulatory organizations).

Defining Customer

In this author's opinion, earlier Courts often misconstrued John Hancock and, therefore, wrongly applied it. See Citigroup Global Markets, Inc. v. Abbarinfra at pp.3-4; see also Wheat First Securities, Inc. v. Green, 993 F.2d 814 (11th Cir. 1993) (rejecting the interpretation that anyone not a broker or dealer is a "customer" for purposes of requiring arbitration).  The Eleventh Circuit in Multi - Financial did not expressly overrule Wheat First. See also, Chelsey Morgan Securities, Inc. v. Rapport, 3 F.Supp. 3d 791 (C.D.CA. 2014)Sparks v. Saxon Investments, LLC, 2009 WL 2886029 (D. Utah 2009) (plaintiffs were actual customers of the broker-dealer).  

Notwithstanding the early misinterpretations of John Hancock, in fact, most Courts got it right when it comes to the proper definition of "customer." For example, in Investors Capital Corp. v. Brown, 145 F.Supp. 2d 1302 (M.D. Fla. 2001) (relying on Wheat First Securities, Inc. v. Greensupra), the Court noted that:

[B]eing a customer of an associated person is not, in itself, a sufficient basis for compelling arbitration with a member.

The Court went on to conclude that

[I]n joining the NASD, ICC agreed to arbitrate disputes with its customers, rather than customers of every person associated with ICC . . . To compel arbitration as "customers" the Defendants must established that they were ICC customers at the time of the transactions giving rise to their arbitration claims . . . Because they did not have ICC accounts or other evidence of a traditional customer relationship with ICC, the Defendants must show that they established an informal business relationship with ICC . . .or at least attempted to do so, . . ."

See, Mony Securities Corp. v. Vazquez, 238 F.Supp. 2d 1304 (M.D. Fla. 2002) (investing through person associated with the broker-dealer is insufficient to require the broker-dealer to arbitrate the dispute).  The most recent decision, from a court in the Second Circuit, Deutsche Bank Securities, Inc. v. Roskos, NO. 15-CV-534 (S.D.N.Y. 8/4/2016), held that absent an arbitration agreement, as at bar, a person seeking to compel a FINRA member to arbitrate as its  "customer" must (1) have an account with the FINRA  member or (2) have purchased goods and services from the member.

The Courts Align

All other federal appellate courts, as well as federal district courts and state appellate courts, have found contrary to Multi-Financial Securities Corp. and Vestax.  Thus, the Eighth Circuit in FleetBoston Robertson Stephens, Inc. v. Innovex, Inc., 264 F.3d 770 (8th Cir. 2001) held the term  "customer" is defined as  "one who receives investment and brokerage services or otherwise deals more directly with securities than what occurred here".  The Court went on to hold that  "we agree with the district court that  "customer" does not include an entity such as Ad Flex, which only received financial advice, without receiving investment or brokerage related services from an NASD member."  The Eighth Circuit further refined this definition of  "customer" in Berthel Fisher & Company Financial Services, Inc. v. Larmon, 695 F.3d 749 (8th Cir. 2012).  There, the Court reaffirmed that "customer" "refer[s] to one involved in a business relationship with [a FINRA] member that is related directly to investment or brokerage services".  

This was recognized and expanded upon in UBS Financial Services, Inc. v. Carilion Clinic, 706 F.3d 319 (4th Cir. 2013).  While noting that the term  "business activities" in Rule 12200 involved  "investment banking or securities business," the Court went on to hold that

[W]hen FINRA uses "customer" in Rule 12200, it refers to one, not a broker or dealer, who purchases commodities or services from a FINRA  member in the course of the member's business activities insofar as those activities are covered by FINRA's regulation, namely the activities of investment banking and the securities business.  

The Fourth Circuit in a case involving a registered representative, Raymond James Financial Services, Inc. v. Cary, 709 F.3d 382 (4th Cir. 2013), in which, as at bar, " the investors made their decision to invest independently of any recommendation on the part of RJFS," held that appellants are not RJFS' customers because  "they did not purchase any  "commodities or services" from RJFS or Keough [an RJFS associated person] in the course of the firm's business activities."  

Not Much Obliged

The Second Circuit followed suit in Citigroup Global Markets, Inc. v. Abbar, 761 F.3d 268 (2d Cir. 2014).  There, the Court distinguished its John Hancock decision, which, according to the Court which decided it, involved the presumption in favor of arbitration, not the obligation to arbitrate [the issue in Citigroup], noting that  "the word  "customer" must be construed in a manner consistent with reasonable expectations of FINRA members..  The Court went on to hold that:

[T'he purchase of a good or service from a FINRA member creates a customer relationship . . . Likewise, when it is clear that no goods or services were provided by the FINRA member,  "there is no need to grapple with the precise boundaries of the FINRA meaning of  "customer" because  "no rational factfinder could infer a customer relationship on such facts."

See also, Pershing, LLC v. Bevis, 2014 WL 1818098 (M.D. La. 2014), aff'd, 606 Fed. Appx. 754 (5th Cir. 2015).

Another case involving the obligation to arbitrate, not the presumption in favor of arbitration, is Grant v. Rotolante, 147 So. 3d 128 (2014).  There, Grant, an associated person, advised Ms. Rotolante concerning her investments.  Ms. Rotolante did not open an account with Grant, and did not:

[D]eposit any monies or securities with him, purchase or sell any securities from or through him, and never paid Mr. Grant any compensation.  

Under these facts, the Florida Appellate Court held

Ms. Rotolante was not Mr. Grant's customer under FINRA Rule 12200. Mrs. Rotolante did not open any account with Mr. Grant, deposit any money or securities with him, purchase or sell any securities from or through him, and never paid Mr. Grant any compensation . . .Therefore, Ms. Rotolante was not Mr. Grant's customer under FINRA 12200 . . .  Expanding the definition to include Ms. Rotolante under the facts of this case would upset the reasonable expectation of FINRA members.

Selling Out Over Selling Away?

Claimants also point to FINRA's apparent position that  "selling away" claims are arbitrable. FINRA has stated that  "under the Codes, FINRA accepts cases brought by customers against associated persons in selling away cases, and cases by customers against the associated person's member firm if there is any allegation that the member was or should have been involved in the events, such as an alleged failure to supervise the associated person."  Order Approving Proposed Rule Change, 74 Fed. Reg. 731, 736 and 37 (January 7, 2009).  The problem with this argument is that it appears to take the cart before the horse.  Even FINRA recognizes that before the issue of  "selling awayis considered, the issue of whether Claimant is a  "customer " must be resolved - only if Claimant is a "customer" does the issue of  "selling away" arise.

Claimant's argument that the broker/dealer failed to supervise its associated person also does not pass muster.  As the court in Raymond James Financial Services, Inc. v. Cary, supra, recognized,  "any question as to whether RJFS failed to adequately supervise Keough [the associated person] and is thus potentially liable for his arguably unauthorized activities goes to the merits of appellant's claim, not the arbitrability of those claims. Therefore, we do not address the matter here."  Resolution of the  "arbitrabilityissue revolves solely around whether the Claimant was a  "customer" of the broker/dealer.  

In conclusion, therefore, it appears clear that a "customerfor purposes of a broker/dealer's obligation to arbitrate, is one who purchases a good or service from a member and arguments concerning  "selling away" or failure to supervise are irrelevant to resolution of these issues.


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Martin P. Unger concentrates his practice in the area of complex commercial litigation in both Federal and State Courts.  Since 1971, Mr. Unger has focused on representing clients in litigation, arbitration and regulatory matters involving the securities and commodities laws. Mr. Unger has represented clients in law suits, arbitrations, reparations and administrative proceedings before various courts, arbitration forums, self-regulatory organizations, the Securities and Exchange Commission and the Commodity Futures Trading Commission.  He has provided counsel concerning regulatory issues in both the securities and commodities areas.

Prior to joining Wexler Burkhart Hirschberg & Unger, LLP, Mr. Unger was a partner in major law firms in New York City and Long Island and prior to that served as a Law Clerk to a Federal Judge.  Mr. Unger is admitted to practice in New York, the United States Supreme Court, the U.S. Court of Appeals for the 2nd, 5th, 9th, 10th and 11th Circuits and the U.S. District Courts for the Southern District of New York, Eastern District of New York and Eastern District of Wisconsin.  Mr. Unger received his Juris Doctor, Cum Laude, from New York University School of Law where he was a member of Law Review and admitted to Order of the Coif.   Subsequent thereto, Mr. Unger received his Master of Laws from Brooklyn Law School.

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