Court Says No Second Bite of FINRA Arbitration Apple

March 23, 2020

In today's blog, we have the fascinating legal question of whether public customers had waived their right to pursue a FINRA arbitration. Things started off fairly mundane when the customers filed their FINRA Arbitration Statement of Claim. And then the customers entered into a stipulated dismissal of their FINRA claims. No longer parties in an arbitration, the customers hastened to the local courthouse and filed their claims in a civil Complaint. And then the customers had what comes off as a colossal second thought when they attempted to stop the state-court litigation and return to FINRA arbitration. It's as oddball a start-and-stop-and-start-and-lets-try-to-stop mess as it sounds.

FINRA Arbitration

In September 2016, public customer Claimants Thomas S. Leith and Lynda Reiner Leith filed a FINRA Arbitration Statement of Claim against FINRA member firm Berthel, Fisher & Company Financial Services, Inc. and Shawn B. Davis. As set forth in part in Thomas S. Leith et al., Plaintiffs/Appellants, v. Berthel, Fisher & Company Financial Services, Inc., et al., Defendants/Respondents (Opinion, Court of Appeal of the State of California, Third Appellate District / C088365) (the "App Opinion)

[T]he Leiths alleged that between 2005 and 2010, based on recommendations and advice from Davis, they purchased investments that were illiquid, risky, and unsuitable for them based on their financial situation, investment objectives, and risk criteria. The Leiths alleged that Davis failed to disclose the risky and illiquid nature of the investments and falsely assured them that purchasing the investments would allow them to earn higher returns while at the same time reducing their overall portfolio risk. The Leiths further alleged that after persuading them to purchase the investments, Davis concealed the poor performance of the investments by misrepresenting their actual value in annual "score card" reports. The Leiths allegedly discovered the "truth" about their investments in April 2016, and filed their arbitration claim five months later.

Pages 2 - 3 of the App. Opinion

Stipulation of Dismissal of FINRA Arbitration

After filing their Answer to the FINRA Arbitration Statement of Claim in January 2017, the Respondents in the FINRA case notified Claimants that they would moved to dismiss under FINRA Code of Arbitration Procedure for Customer Disputes Rule 12206: Time Limits based upon the lapse of six or more years from the occurrence or event underlying the claims. In response to that anticipated motion, and having concluded that said motion was meritorious and would likely prevail, the Claimants stipulated to the voluntary dismissal of their FINRA arbitration without prejudice and with the right to pursue their claims in court -- and Respondents agreed to not raise the existence of an arbitration agreement as a defense to claims raised in court. Accordingly, the FINRA arbitration parties entered into a January 31, 2017, stipulation of dismissal.

California Superior Court

On September 27, 2017, the Leiths raised what were essentially the same claims in their FINRA Statement of Claim in a Complaint filed in California Superior Court.  The Defendants denied the allegations and asserted affirmative defenses. After retaining new counsel, the Leiths unsuccessfully pursued mediation. 

We Want A Mulligan

In response to Defendants Discovery demands and deposition notices, on July 31, 2018, the Leiths notified Defendants of their intention to return to arbitration, which the Defendants rejected based upon their position that said recourse had been waived via the previous stipulated withdrawal and the filing of the Complaint in court. 

Temporary Victory

On August 29, 2018, the Leiths moved to compel arbitration, which the Superior Court  temporarily granted before any hearing, apparently predicated upon the lower court's belief that the Defendants had failed to demonstrate that they had been prejudiced. Umm . . . okay, but, I gotta interject here: WTF?  

Permanent Defeat

In any event, after hearing argument (which, as far as that goes is a really, really sound thing to do by any court), the Superior Court reversed itself and denied the Leiths' Petition to Compel Arbitration. In its rationale for denying the Petition:

[T]he trial court relied on three factors, namely that (1) returning to arbitration would not vindicate the purpose of arbitration to serve as an expeditious, efficient, and cost-effective method of resolving the underlying dispute, (2) a renewed FINRA rule 12206 motion likely "would in the end result in return of the matter to the Superior Court," and (3) the claims at issue likely could not be consolidated with a related arbitration claim pending against defendant Davis and his new employer, WFG Investments, Inc. No statement of decision was requested or issued.

Page 5 of the App. Opinion

Prejudice Demonstrated to Superior Court 

In further articulating its basis for finding prejudice, the Superior Court's Order set forth the following:

[T]he court is convinced that prejudice has been adequately demonstrated by the defendants. Once the first arbitration was dismissed, the defense has incurred the time and expense in preparing this matter for trial. The court is convinced that a return to arbitrate at this remote date will not vindicate the general purpose of arbitration to expeditiously resolve disputes. While the court expressly takes no position on whether a renewed motion under FINRA rule 12206 would likely be successful or not, the defense convincingly demonstrates a substantial likelihood that [FINRA] rule 12206 procedures would in the end result in return of the matter to the Superior Court, after a lengthy digression into arbitration. Moreover, its [sic] seems unlikely that granting the petition would, as plaintiffs forecast, easily result in consolidation with the already-pending FINRA arbitration, given the advanced procedural posture of the already-pending arbitration. These factors, taken together in this atypical arbitration petition, demonstrate the requisite prejudice. Accordingly, the court does not adopt that portion of its tentative ruling which granted the petition, and instead the court denies the petition.

Page 5 of the App. Opinion at Footnote 5

Appeal to Court of Appeal

On appeal from the Superior Court to the Court of Appeal, the Leiths raised two arguments:

First, they argue the trial court erred in finding that the Leiths waived the right to arbitrate their claims. In particular, the Leiths argue that a party seeking to establish waiver must demonstrate prejudice, and that defendants failed to do so. Second, the Leiths argue that the trial court, in assessing prejudice, improperly considered the likelihood that a renewed FINRA rule 12206 motion would result in return of the matter to the court. . .  

Page 6 of the App. Opinion

In affirming the Superior Court, the Court of Appeal found that the Leiths had expressly and impliedly waived their rights to arbitrate and that any error committed by the lower court in considering how an arbitrator might rule on a Motion to Dismiss was harmless.

7-Point Waiver Test

In considering whether the Leiths had waived their right to compel FINRA arbitration, the Court of Appeal found that a valid arbitration agreement was in place and covered the claims at issue. In first addressing the issue as to whether the Leiths had, in fact, waived their right to a FINRA arbitration, the Court of Appeal noted that the California Supreme Court had identified several factors to be considered per the question of waiver:

(1) whether the party has taken actions inconsistent with the right to arbitrate; (2) whether the litigation machinery was substantially invoked and whether the parties were well into preparation of a lawsuit before the party notified the opposing party of an intent to arbitrate; (3) whether a party requested arbitration close to the date of trial or unreasonably delayed seeking arbitration; (4) whether a defendant seeking arbitration filed a counterclaim without demanding arbitration; (5) whether important intervening steps took place before the party demanded arbitration (e.g., the party took advantage of discovery procedures not available in arbitration); (6) whether the party demanding arbitration engaged in bad faith or willful misconduct; and (7) whether the party delayed the demand for arbitration in a way that affected, misled, or prejudiced the opposing party.

Pages 7 - 8 of the App. Opinion

Expressly Waived Bye-Bye

In finding that the Leiths had expressly waived their right to arbitrate when they voluntarily abandoned their pending FINRA claim, the Court of Appeal 

[W]e conclude that the Leiths expressly waived their contractual right to arbitration when, in knowing disregard of their right to arbitrate, they voluntarily and intentionally stipulated to dismiss their arbitration case in favor of proceeding in a judicial forum. 

We reject the Leith's [sic] argument that the stipulated dismissal did not effect a waiver because the arbitration was dismissed "without prejudice." Although the Leiths would have us ascribe to this phrase its usual meaning in litigation (under which a party may refile a complaint at their discretion), it is clear to us that the intent of dismissing the arbitration without prejudice was simply to permit the Leiths to pursue "the claim in a court of competent jurisdiction"-"consistent with FINRA Rule 12206(b)"-without the specter of a res judicata bar. In other words, the dismissal was "without prejudice" to the filing of a new action on the same allegations, but the parties intended the new action would be filed in a different forum. (See Syufy Enterprises v. City of Oakland (2002) 104 Cal.App.4th 869, 879 [a voluntary dismissal without prejudice means there has been no decision of the controversy on the merits]; Chambreau v. Coughlan (1968) 263 Cal.App.2d 712, 718 [same]; see also Sanchez v. Carmax Auto Superstores California, LLC (2014) 224 Cal.App.4th 398, 407 [doctrine of res judicata applies to arbitration proceedings].) 

Nothing in the record suggests an intent to preserve for the Leiths a right to return to arbitration should they have second thoughts about their decision to dismiss. (See Spirs Trading Co. v. Occidental Yarns, Inc. (N.Y.App.Div. 1979) 73 A.D.2d 542, 543 [423 N.Y.S.2d 13, 15].) The stipulation explicitly states what the parties sought to avoid with the agreement, i.e., the cost and expense associated with defendants' FINRA rule 12206 motion to dismiss-an objective that could only be met if the Leiths abandoned the arbitration proceeding and went to court. Further, defendants had to agree not to raise the arbitration agreement as a defense in court. This concession makes sense only if the Leiths intended to pursue their claims in court, rather than arbitration.

Pages 11 -12 of the App. Opinion

Running on Both the Express and Implied Tracks

Notwithstanding its finding of an express waiver by the Leiths, the Court of Appeal nonetheless found that there was substantial evidence supporting the Superior Court's finding of both prejudice and an implied waiver. As to its finding of prejudice, the Court of Appeal explains in part that:

Without deciding whether unreasonable delay alone would be enough to establish prejudice, we conclude that prejudice can be inferred in this case based on the combination of defendant's change of position due to the voluntary abandonment of the prior arbitration claim (including defendant's waiver of the right to demand arbitration), the unreasonable delay in demanding a return to arbitration (after abandonment of the prior arbitration), the time and expense incurred by defendants in mediating the case and then preparing the matter for trial, and the timing of the petition-after a failed mediation, in the midst of discovery, and close to the scheduled trial date. 

Since at least September 2016, the Leiths have been aware both of the existence of the arbitration provision and its applicability to the underlying dispute. During that time, they filed and dismissed an arbitration claim,14 waited eight months, filed this lawsuit, and then waited another 11 months before renewing their request for arbitration after defendants answered the complaint, participated in mediation, propounded discovery, and filed a motion to compel. By the time the Leiths petitioned to return to arbitration, trial was only about four months away. 

We agree with defendants, and the trial court, that to allow the Leiths to compel arbitration under these circumstances would substantially undermine and impair the public policy of arbitration as a speedy and relatively inexpensive means of dispute resolution. . . .

Page 16 of the App. Opinion

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