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NILSEN v. PRUDENTIAL-BACHE SECURITIES
April 1, 1991
TERJE NILSEN, PLAINTIFF,
PRUDENTIAL-BACHE SECURITIES, DEFENDANT.
The opinion of the court was delivered by: Mukasey, District Judge.
Plaintiff Terje Nilsen, a resident of Monaco, charges that
defendant Prudential-Bache Securities, Inc., a "futures
commission merchant," lied about and then "churned" his
commodity option trading account, and thereby committed fraud
in violation of sections 4b and 4o of the Commodity Exchange
Act, as amended ("CEA"), 7 U.S.C. § 6b, 6o (1990). Nilsen has
also brought state law claims for negligence and breach of
contract. Essentially, Nilsen alleges that a broker employed by
defendant misrepresented the degree of risk to which his
account would be subject and then ran the account solely to
generate commissions. More specifically, the complaint alleges
that during an eight-month period in which plaintiff suffered
total trading losses of approximately $2.4 million, defendant
earned over $3.2 million in commissions, "mark-ups" or profits
from trades executed on both the Chicago Mercantile Exchange
and the London Interbank Market.
Defendant has moved for an order (i) to compel arbitration and
stay this action, pursuant to § 4 of the Federal Arbitration
Act, 9 U.S.C. § 1 et seq., with respect to all claims arising
out of transactions which were not executed on, or subject to
the rules of, a contract market designated as such under the
CEA, and (ii) to dismiss all non-arbitrable claims in their
entirety, pursuant to Fed.R.Civ.P. 12(b)(1), 12(b)(6), and
9(b). For the reasons set forth below, the parties will submit
to arbitration all claims not arising from transactions
executed on the Chicago Mercantile Exchange. With respect to
claims arising out of transactions that were executed on the
Chicago Mercantile Exchange, defendant's motion to dismiss is
granted in part and denied in part.
The following facts are based on plaintiff's complaint.*fn1
On August 31, 1988,
plaintiff established a commodity trading account with the
Monte Carlo office of Prudential-Bache. Before opening the
account, Nilsen allegedly told a Prudential-Bache broker, Lien
Tah Nguyn, that his investment objectives were preservation of
capital and avoidance of excessive risk. Nguyn allegedly
assured plaintiff that the account would be both closely
scrutinized, and managed so as to realize these investment
objectives. Complaint ¶ 6. According to plaintiff, Nguyn
warranted that his account would be handled with "the care and
supervision accorded to fiduciary accounts." Complaint ¶ 12.
The account agreement Nilsen signed to open the account
contained the following arbitration clause in paragraph 14:
. . .Any controversy arising out of or relating to my
account, to transactions with or for me or to this Agreement or
the breach thereof, and whether executed or to be executed
within or outside of the United States, except for any
controversy arising out of or relating to transactions in
commodities or contracts related thereto executed on or subject
to the rules of a contract market designated as such under the
Commodity Exchange Act, as amended, shall be settled by
arbitration in accordance with the rules then obtaining of
either the American Arbitration Association or the Board of
Governors of the New York Stock Exchange as I may elect. . . .
Hurley Affidavit, Exh. B. (emphasis added).
After the account was opened, extensive trading was conducted
in futures contracts for U.S. Treasury Bills, British Pounds,
Swiss Francs, German Marks, Canadian Dollars, Australian
Dollars, and Japanese Yen, on both the International Monetary
Market of the Chicago Mercantile Exchange and on the London
Interbank Market. Complaint ¶ 7. The complaint alleges that the
trading activity in the account bears many of the "earmarks of
churning" including "a large amount of day trading, in and out
movements in the market, reestablishment of previous positions,
retention of losses and trades lacking any apparent rhyme or
reason." Complaint ¶ 8. The annualized commissions to average
monthly equity ratio allegedly exceeded 80%, while monthly
commission to equity ratios sometimes exceeded 100%. Complaint
¶ 9. From mid-September, 1988 to mid-May, 1989, a total of
3,200 currency future trades were executed, Complaint ¶ 6, and
between October 1988 and March 1989, the average total number
of foreign currency contracts traded for plaintiff's account
ranged from approximately 5,000 per month to 12,000 per month.
Complaint ¶ 10. During the eight months in which plaintiff's
account was active, plaintiff allegedly suffered net total
trading losses of approximately $2.4 million, while defendant
earned over $3.2 million in total commissions, "mark-ups" or
profits. Complaint ¶ 6.
Throughout the trading, the broker employed by defendant "was
in complete control of the account" because "[p]laintiff lacked
any useful experience or sophistication in futures trading, and
was entirely dependent on the broker's recommendations."
Complaint ¶ 11. It is alleged that plaintiff was "urged to stay
out of the way and allow the broker to trade without
distraction or interruption" and that plaintiff suffered his
greatest losses while away "on a skiing vacation and largely
incommunicado." Id. Throughout, plaintiff "was actively
misled by his broker as to the state of his account." Complaint
¶ 14. Specifically, in January, 1989, the broker allegedly
misled plaintiff as to his equity position so as to induce him
to contribute an additional $1 million, whereupon the broker
"embarked upon an orgy of trading" during a period when
plaintiff "was conveniently away on holiday." Complaint ¶ 15.
Plaintiff filed this action on May 9, 1990. Plaintiff's first
claim for relief alleges that defendant, through its broker,
churned plaintiff's account by intentionally engaging in
excessive trading for the primary
purpose of generating commissions. Complaint ¶¶ 17-20.
Plaintiff's second claim for relief, entitled "fraud and
misrepresentation," alleges that defendant, through its broker,
intentionally misrepresented that plaintiff's account would be
maintained in a "prudent reasonable manner and with a minimum
of risk" in order to induce plaintiff to open the account and
make additional contributions. Complaint ¶¶ 21-27. Plaintiff's
third claim for relief, entitled "fraudulent concealment,"
alleges that "Pru-Bache knowingly concealed information
concerning the volume and nature of the trading in plaintiff's
account which it knew to be excessive and in violation of
plaintiff's stated objectives," and that "Pru-Bache also
knowingly concealed the true extent of losses resulting from
the unauthorized, excessive trading, actively misleading the
plaintiff as to the lack of success which defendant's trading
strategy has produced, resulting in a continuing fraud upon the
plaintiff." Complaint ¶¶ 28-32. Plaintiff's fourth claim alleges
that defendant was negligent in handling the account. Complaint
¶¶ 33-35. The fifth claim, entitled "unauthorized trading,"
alleges that defendant's broker did not obtain prior
authorization for either the type or level of trading engaged
in. Complaint ¶¶ 36-41. The sixth claim, entitled "breach of
contract," alleges that defendant breached a purported
contractual obligation to operate plaintiff's account
"prudently" and in accordance with "expressed conservative
investment goals." Complaint ¶¶ 42-46. The sole jurisdictional
allegation in the complaint is that the action arises under §§
4b and 4o of the CEA, 7 U.S.C. § 6b, 6o.
Defendant has moved to compel arbitration with respect to all
arbitrable claims — namely, all claims which do not arise from
transactions executed on the Chicago Mercantile Exchange. With
respect to all non-arbitrable claims — which do arise from
transactions executed on the Chicago Mercantile Exchange —
defendant has moved to dismiss pursuant to Fed.R.Civ.P. 9(b),
12(b)(1) and 12(b)(6).
The Federal Arbitration Act reflects a legislative recognition
of "`the desirability of arbitration as an alternative to the
complications of litigation.'" Genesco, Inc. v. T. Kakiuchi &
Co., 815 F.2d 840, 844 (2d Cir. 1987) (quoting Wilko v.
Swan, 346 U.S. 427, 431, 74 S.Ct. 182, 184, 98 L.Ed. 168
(1953)). The Act was "designed to allow parties to avoid the
`costliness and delays of litigation,' and to place arbitration
agreements `upon the same footing as other contracts.'" Id.
(citations omitted). Section 2 provides that written agreements
to arbitrate controversies arising out of any contract
involving commerce "shall be valid, irrevocable, and
enforceable, save upon such grounds as exist at law or in
equity for the revocation of any contract." 9 U.S.C. § 2.
Section 3 provides for a stay of proceedings where the court is
satisfied that the issue before it is arbitrable under the
agreement, and § 4 directs a court to order parties to proceed
to arbitration where there has been a "failure, neglect, or
refusal" of any party to abide by an agreement to arbitrate.
9 U.S.C. § 3, 4; Genesco, 815 F.2d at 844.
When some claims before the court are arbitrable and others are
not, a court has no discretion to hear the arbitrable claims,
notwithstanding that those claims are based on facts common to
the non-arbitrable claims. In Dean Witter Reynolds, Inc. v.
Byrd, 470 U.S. 213, 217, 105 S.Ct. 1238, 1240, 84 L.Ed.2d 158
(1985), the Supreme Court held that the Act "requires district
courts to compel arbitration of pendent arbitrable claims when
one of the parties files a motion to compel, even where the
result would be the possible inefficient maintenance of
separate proceedings in separate forums." On the other hand, if
a court determines that some, but not all, of the claims before
it are arbitrable, it can then determine whether to stay the
balance of the proceedings pending arbitration. Genesco, 815
F.2d at 844.
As with any motion to compel arbitration, the initial task is
to determine the scope of the arbitration clause. Mitsubishi
Motors Corp. v. Soler Chrysler-Plymouth,
Inc., 473 U.S. 614, 626, 105 S.Ct. 3346, 3353, 87 L.Ed.2d 444
(1985). Under federal law, the substantive law governing
agreements to arbitrate, the contract is interpreted according
to "generally accepted principles of contract law." Genesco,
815 F.2d at 845. However, in determining what the parties have
agreed to arbitrate, "as a matter of federal law, any doubts
concerning the scope of arbitrable issues should be resolved in
favor of arbitration." Moses H. Cone Memorial Hosp. v. Mercury
Constr. Corp., 460 U.S. 1, 24-25, 103 S.Ct. 927, 941, 74
L.Ed.2d 765 (1983).
The arbitration clause at issue in this case provides for
arbitration of any controversy relating to plaintiff's account
"except for any controversy arising out of or relating to
transactions in commodities or contracts related thereto
executed on or subject to the rules of a contract market
designated as such under the Commodity Exchange Act.. . ."
(emphasis added). By its terms, the exclusion from arbitration
does not depend on the nature of the transaction, but upon
where the transaction is executed. Simply put, all
controversies that arise out of or relate to transactions in
either commodities or commodities contracts are subject to
arbitration unless those transactions were either executed on a
contract market so designated under the CEA, or executed
subject to the rules of such a contract market.
A "contract market" within the meaning of the CEA is limited to
a board of trade so designated by the Commodity Futures Trading
Commission (CFTC). 17 C.F.R. § 1.3 (1990). Only United States
exchanges are eligible for such designation. 17 C.F.R. § 33.4.
Therefore, only trades occurring on a market located within the
United States could have been executed on a contract market or
be subject to the rules of a contract market. See also Mormels
v. Girofinance, S.A., 544 F. Supp. 815, 817 (S.D.N.Y. 1982)
(Weinfeld, J.) (alleged acts of commodities fraud involving
foreign residents and transactions occurring almost entirely
outside United States not subject to CEA).
The complaint alleges that the trades that generated this
controversy took place on both the London Interbank Market and
the International Monetary Market of the Chicago Mercantile
Exchange. Complaint ¶¶ 7, 9, 13. Purported exclusions from broad
arbitration clauses such as this one must be interpreted
narrowly, see AT & T Technologies, Inc. v. Communications
Workers of Am., 475 U.S. 643, 650, 106 S.Ct. 1415, 1419, 89
L.Ed.2d 648 (1986); David L. Threlkeld & Co. v.
Metallgesellschaft Ltd., 923 F.2d 245, 250-51 (2d Cir. 1991),
so the account agreement signed by plaintiff requires that all
controversies relating to plaintiff's account be subject to
arbitration unless the controversy arises out of or relates to
transactions that were executed on the Chicago Mercantile
Plaintiff tortures the exclusionary language in the arbitration
clause to argue that his dispute with defendant is not subject
to arbitration. The relevant part of the clause reads as
except for any controversy arising out of or relating to
transactions in commodities or contracts related thereto
executed on or subject to the rules of a contract market
designated as such under the Commodity Exchange Act
Plaintiff reads the exclusion to encompass two types of
controversies: (1) all controversies arising out of or relating
to any "transaction in commodities" whether or not executed
on or subject to the rules of a contract market, and (2) all
controversies arising out of or relating to transactions in
"contracts related [to commodities] executed on or subject to
the rules of a contract market." Plaintiff then argues that his
dispute is not subject to arbitration because it arises out of
or relates to a "transaction in commodities."