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SCONE INVS., L.P. v. AMERICAN THIRD MKT. CORP.

January 26, 1998

SCONE INVESTMENTS, L.P., and STANLEY COHEN, Plaintiffs, against AMERICAN THIRD MARKET CORPORATION, ISRAEL A. ENGLANDER, ROSEHOUSE LTD., CHRISTOPHER CARAJOHN, RICHARD PRICHARD-JONES, TELLERSTOCK, INC., THOMAS N. TELEGADES, INVESTOR RELATIONS, INC., PETER C. TOSTO and STANDARD BANK INVESTMENT CORPORATION (JERSEY) LIMITED, Defendants.


The opinion of the court was delivered by: SCHEINDLIN

 SHIRA A. SCHEINDLIN, U.S.D.J.:

 Plaintiffs bring this action against all defendants alleging (1) violations of § 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b)) and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission, (2) common law fraud, and (3) bad faith and negligence. Plaintiffs also assert a claim against defendants Israel A. Englander ("Englander"), Christopher Carajohn ("Carajohn"), Richard Prichard-Jones ("Prichard-Jones"), Thomas N. Telegades ("Telegades") and Peter C. Tosto ("Tosto") alleging that, as "control persons," they violated §§ 10(b) and 20(a) of the Securities Exchange Act of 1934 (15 U.S.C. § 78j(b)) and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission. Defendants American Third Market Corp. ("ATM") and Englander (collectively "movants") move to dismiss the Complaint as against them pursuant to Fed. R. Civ. P. 9(a), 9(b) and 12(b)(6). They also move in the alternative to compel arbitration of the claims against them and stay the action until the arbitration is completed pursuant to the Federal Arbitration Act. 9 U.S.C. §§ 3 and 4. For the reasons set forth below, the motion to compel arbitration is granted. Therefore, the parties are directed to arbitration, and I will not address the motion to dismiss.

 I. Background

 Plaintiffs claim that in 1995 defendants Carajohn, Prichard-Jones and Rosehouse Ltd. combined and conspired with defendants Tellerstock, Inc., Investor Relations, Inc., Telegades and Tosto to devise and implement an unlawful scheme to manipulate the market prices of thinly traded "penny stock" securities through brokers such as defendants ATM and its officer, Englander. *fn1" See Plaintiffs' Memorandum of Law in Opposition to Motion to Dismiss or Stay the Action ("Plaintiffs' Memo") at 1. The alleged scheme involved manipulative trading of these securities, principally among Rosehouse, Ltd., an entity owned by Carajohn and Prichard-Jones, Tellerstock, Inc., owned by Telegades, and Investor Relations, Inc., owned by Tosto, in order to manufacture market activity and manipulate the price for the pecuniary benefit of the defendants and to the detriment of other investors. See Complaint at PP 5-11, 18, 21-25.

 In February 1996, plaintiff Stanley Cohen ("Cohen") authorized Carajohn to execute securities transactions for his account, as well as the account of plaintiff Scone Investments, L.P. ("Scone"), on a non-discretionary approval basis. See Complaint at P 26. Each trade made by Carajohn for plaintiffs' accounts was to be confirmed by Cohen upon transfer into plaintiffs' depository accounts with Spear, Leeds & Kellogg ("Spear Leeds"). Id. Carajohn was not a registered representative in accordance with the federal securities laws and was not authorized or permitted to effectuate securities transactions for third parties. Id. at P 27.

 On May 14, 1996, Carajohn opened an account with ATM to buy and sell securities on behalf of plaintiffs. See Complaint at P 31; Memorandum of Law of Defendants in Support of Motion to Dismiss the Complaint or Stay the Action Against Them ("Defendants' Memo") at 3. As part of this process, he executed account documents with ATM, in Cohen's name, which purported to authorize him to trade on Scone's account at ATM. See Complaint at P 31. These documents included a standard customer agreement with a clause providing for arbitration of all disputes. See Affidavit of Israel A. Englander ("Englander Aff.") at Ex. 2. Cohen claims that he never authorized Carajohn to execute any account documents on plaintiffs' behalf at ATM. See Complaint at P 31; Plaintiffs' Memo at 2-3.

 Carajohn effectuated securities transactions for plaintiffs' accounts through ATM as broker from May 14 through June 26, 1996. See Plaintiffs' Memo at 10; Complaint at PP 28, 33. Cohen authorized the transfers from ATM into plaintiffs' depository accounts at Spear Leeds. See Complaint at P 30 (Cohen approved purchases of MENW shares); Complaint at PP 33, 37 (Cohen accepted the BNN trades for plaintiffs' accounts); Complaint at P 50 (Cohen authorized transfer from ATM into his depository account at Spear Leeds of 1.5 million MKTB shares). However, Cohen claims that he was fraudulently induced by the defendants to accept the transactions. See Complaint at P 59. During July and August, 1996, the market price of these securities declined and plaintiffs were unable to sell their stock for an amount approximating the purchase price. See Complaint at PP 41, 51. Plaintiffs are seeking damages in the amount of $ 2.5 million to compensate them for their resulting losses. Id.

 II. Discussion

 A. Arbitration

 The Federal Arbitration Act provides that agreements to arbitrate "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. Therefore, a district court must stay proceedings if it finds a valid arbitration agreement, 9 U.S.C. § 3; and may compel arbitration when a party does not abide by that agreement. 9 U.S.C. § 4. If the "making of the arbitration agreement" is in issue, the court "shall proceed summarily to the trial thereof." Id.

 The Supreme Court has consistently held that the Federal Arbitration Act "establishes a 'federal policy favoring arbitration'." Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 226, 96 L. Ed. 2d 185, 107 S. Ct. 2332 (1987) (quoting Moses H. Cone Mem'l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24, 74 L. Ed. 2d 765, 103 S. Ct. 927 (1983)); see also Southland Corp. v. Keating, 465 U.S. 1, 10, 79 L. Ed. 2d 1, 104 S. Ct. 852 (1984). Accordingly, federal policy requires that federal courts rigorously enforce agreements to arbitrate. See Shearson/American Express, Inc., 482 U.S. at 226 (citing Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213, 221, 84 L. Ed. 2d 158, 105 S. Ct. 1238 (1985)). Moreover, any doubts regarding the existence of an arbitration clause ought to be resolved in favor of coverage. See AT&T Technologies, Inc. v. Communications Workers, 475 U.S. 643, 650, 89 L. Ed. 2d 648, 106 S. Ct. 1415 (1986).

 Whether an arbitration agreement exists between the parties is an issue for judicial determination. See AT&T Technologies Inc., 475 U.S. at 649; Corallo v. Merrick Cent. Carburetor, Inc., 733 F.2d 248, 252 (2d Cir. 1984). In determining the arbitrability of a particular dispute, a court must decide (1) whether the parties agreed to arbitrate in writing and (2) if so, whether the scope of the agreement encompasses the claims being asserted. See Progressive Casualty Ins. Co. v. C.A. Reaseguradora Nacional De Venezuela, 991 F.2d 42, 45 (2d Cir. 1993). A federal court may only consider issues relating to the making and performance of the arbitration agreement itself, not general contract claims. See Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 404, 18 L. Ed. 2d 1270, 87 S. Ct. 1801 (1967).

 The Federal Arbitration Act requires that the arbitration agreement be in writing. 9 U.S.C. § 3. However, a party may be bound by an agreement to arbitrate even absent a signature to that agreement. See Genesco, Inc. v. T. Kakiuchi & Co., Ltd., 815 F.2d 840, 846 (2d Cir. 1987); McAllister Bros., Inc. v. A & S Transp. Co., 621 F.2d 519, 524 (2d Cir. 1980). In the absence of a signed agreement, a court must ...


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