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State Appellate Court Affirms Judicial Determination of Arbitrability

by F. Peter Phillips
July 2012

Business Conflict Blog by Peter Phillips

F. Peter  Phillips

Amid the confusion of various holdings on arbitrability, and who decides arbitrability, and how parties decide who decides arbitrability, comes a lucid and calm opinion from the Superior Court of New Jersey Appellate Division in Merrill Lynch v. Cantone Research.

In 2009, four groups of investors filed complaints arising from their losses in connection with a Ponzi scheme perpetrated by Maxwell Baldwin Smith. Plaintiffs named Smith and certain broker-dealers with whom Smith had been a registered representative. Smith had received $8 million of claimants’ money and, instead of investing it as promised, deposited it in a Merrill Lynch account held in his and his wife’s names. One of the broker-dealers named in the investors’ complaint was Cantone Research, Inc.

The investors sought to hold Merrill Lynch liable, not because it employed Smith, but on a theory of negligent supervision of, and failure to police, the account established by Smith for his and his wife’s benefit. The claim was dismissed and the investors’ cross-motion to compel FINRA arbitration was denied on the ground that the investors were not customers of Merrill Lynch, and thus no duty was owed to them with respect to Smith’s account.

Cantone Research then filed a separate third-party arbitration claim with FINRA seeking contribution and indemnity from Merrill Lynch in the event that Cantone were found liable in the FINRA arbitrations that the investors had initiated against Cantone. Merrill Lynch filed complaints in New Jersey Superior Court seeking to enjoin Cantone from pursuing these third-party claims in FINRA arbitration.

The Motion Court held, and the Appellate Division affirmed, that no third-party claims could be pursued by Cantone against Merrill Lynch through a FINRA arbitration. The court assumed jurisdiction over Merrill Lynch’s motion in reliance on the Supreme Court’s 2002 decision in Howsam, holding that courts have jurisdiction to determine the threshold question of whether parties have agreed to arbitrate. Because there was no arbitration agreement between Merrill Lynch and Cantone, there was no contractual obligation for Merrill Lynch to arbitrate a dispute between them.

Moreover, affirmed the Appellate Division, FINRA’s regulations do not impose an independent obligation to arbitrate. Cantone’s claim against Merrill Lynch for indemnity and contribution was not one arising between a FINRA member and a customer. Nor was it a claim arising from business activities between a member and another member. Rather, it was a contingent claim, one that would arise only if Cantone were found liable to the original investors. Rather than an exchange-related dispute, this claim was a derivative one, resting on facts and legal theories that are independent of broker-dealer activities with each other.

Nothing prevented Cantone from asserting a claim in the Law Division of the Superior Court seeking contribution and indemnity. But an injunction prohibiting Cantone from asserting that claim in FINRA arbitration was appropriate in the absence of a showing of any basis whatsoever — either by agreement or by industry regulatory authority — to arbitrate third-party claims for indemnity.

Biography


F. Peter Phillips is a commercial arbitrator and mediator with substantial experience providing consultation on the management of business disputes to companies around the globe.

A cum laude graduate of Dartmouth College and a magna cum laude graduate of New York Law School, Mr. Phillips served for nearly ten years as Senior Vice President of the International Institute for Conflict Prevention and Resolution (CPR Institute). During that time, he earned a reputation as an author, teacher, industry liaison, and systems designer for the avoidance, management and resolution of complex and sophisticated business conflicts.

In 2008, Mr. Phillips formed Business Conflict Management LLC (BCM) in order to offer his direct services as a neutral and a consultant. Through BCM, Mr. Phillips also continues his career as a highly sought-after public speaker, facilitator and instructor.



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Website: www.BusinessConflictManagement.com

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