products are deposited with ENSI, who send them to the investment company providing the product. The investment company then pays ENSI a percentage of each sale. Nicholas Aff. P 6. Between January 1, 1993 and January 1, 1997 Essex sold $ 11.3 billion in financial products. During this period, approximately 16% of Essex's total revenue, or $ 1.8 billion, can be attributed to ENSI. Nicholas Aff. PP 9, 11.
As registered representatives of ENSI, Harrell and Young signed a Uniform Application for Securities Industry Registration ("Form U-4"). Harrell Decl. P 7; Young Decl. P 7. The Form U-4 states that the representative agrees to "arbitrate any dispute, claim or controversy that may arise between me and my firm, or a customer, or any other person, that is required to be arbitrated under the rules, constitutions, or by-laws [of NASD]." Stechman Aff., Ex. 1.
Essentially, Essex's claims are all related to one marketing strategy and two sets of documents, which they claim were wrongfully appropriated and used by Independent with the assistance of Harrell and Young. The first set of documents are called "Essex Black Pieces," which consist of charts, graphs, tables and text providing financial information and analysis concerning investment and historical trends in the securities industry. These documents are called Black Pieces because of their distinctive black background. They are used as sales tools by representatives selling Essex products. Essex owns the copyrights to these Black Pieces, but these documents are created by ENSI.
The other set of documents relevant to this litigation are a series of informational publications called "Your Money Matters." These publications are distributed to prospective customers by Essex sales representatives. Particularly relevant here, is a document entitled "Your Money Matters - Investment Pyramid," which ranks various forms of securities according to risk and potential for financial return. As with the Black Pieces, Essex owns the copyrights to the "Your Money Matters" informational publications, but ENSI created these documents.
Finally, Essex's system of presenting financial products to potential customers -- called "hybrid program marketing" -- is central to this action. According to Essex, most companies in the bank insurance and investment industry market their products through full-time employees, or by providing marketing support to branch bank employees who sell financial products on a part-time basis. Conversely, through hybrid program marketing, Essex utilizes both full-time employees of the bank or marketing company and part-time employees of the branch bank. Accompanying this program is a hybrid methodology, encompassing employee training and compensation, marketing and sales materials, techniques and strategies, and a system for implementing and sustaining the hybrid program. Essex contends that the hybrid program methodology is a valuable trade secret which Defendant Harrell agreed to maintain in strict confidence.
Compl. PP 15, 25.
As stated earlier, both Harrell and Young are now employed by Independent. At Independent, Harrell and Young are involved in the marketing of variable annuities, and are therefore required to have securities licenses. Since Independent is not a member of NASD, Harrell and Young were licensed through Liberty Securities Corp. ("Liberty"), a NASD member wholly-owned by the entity that wholly-owns Independent.
Form U-4, the agreement signed by Harrell and Young when employed by Essex, is a contract. Consequently, § 9 of the Federal Arbitration Act ("FAA") governs the interpretation of the arbitration provision contained in this agreement. See Thomas James Associates, Inc. v. Jameson, 102 F.3d 60, 65 (2d Cir. 1996). Pursuant to § 3 of the FAA, a district court must stay proceedings if satisfied that the parties have agreed in writing to arbitrate an issue in the litigation. See McMahan Securities Co. L.P. v. Forum Capital Markets L.P., 35 F.3d 82, 85 (2d Cir. 1994) [hereinafter McMahan ].
The FAA embodies a strong federal policy favoring arbitration. See Thomas James Associates, 102 F.3d at 65. Consistent with this policy, all doubts as to the scope of issues eligible for arbitration must be resolved in favor of arbitrability. See McMahan, 35 F.3d at 86 (citing Moses H. Cone Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24-25, 103 S. Ct. 927, 941, 74 L. Ed. 2d 765 (1983). Arbitration is preferred "unless it may be said with positive assurance that the arbitration clause is not susceptible of an interpretation that covers the asserted dispute." Thomas James Associates, 102 F.3d at 65 (quoting David L. Threlkeld & Co. v. Metallgesellschaft, 923 F.2d 245, 250 (2d Cir.), cert. dismissed, 501 U.S. 1267, 112 S. Ct. 17, 115 L. Ed. 2d 1094 (1991)). Of course, this preference for arbitration is tempered by the Supreme Court's admonition that "the FAA does not require parties to arbitrate when they have not agreed" to resolve their dispute in that fashion. Volt Info. Sciences Inc. v. Board of Trustees, 489 U.S. 468, 478, 109 S. Ct. 1248, 1255, 103 L. Ed. 2d 488 (1989).
The arbitrability of this dispute turns on whether the relevant NASD requirements have been satisfied. Those requirements are found in Rule 10101 of the NASD Code of Arbitration Procedure ("NASD Code").
Rule 10101 sets forth the "matters eligible for submission" to arbitration. First, only disputes between or among members, associated persons or certain "others" may be arbitrated. Second, a party can arbitrate only those issues either "arising out of or in connection with the business of any member of the Association . . . with the exception of disputes involving the insurance business of any member which is also an insurance company." If both NASD Code requirements are satisfied, the Court must compel arbitration.
A. Are the Parties Subject to Arbitration?
Essex contends that compelling arbitration would be improper since neither it nor Independent, as corporate entities, fall within the NASD Code's definition of an "associated person." Rather, according to Essex, the definition of an "associated person" requires that the party be a human being. Indeed, the NASD By-Laws limit the term "associated person" to natural persons.
The analysis, however, does not end with the NASD By-Laws. As Independent points out, several courts have read § 3(a)(21) of the 1934 Securities Exchange Act ("1934 SEA") as providing a superceding definition of an "associated person."
See, e.g., Cular v. Metropolitan Life Insurance Co., 961 F. Supp. 550, 556 (S.D.N.Y. 1997); Chisolm v. Kidder, Peabody Asset Management, Inc., 810 F. Supp. 479, 481 n.2 (S.D.N.Y. 1992); but see Gaghich v. Prudential Insurance Co. of America, 1997 U.S. Dist. LEXIS 3129, 1997 WL 128269 (W.D.N.Y. March 10, 1997) (holding that NASD definition of associated person should govern whenever NASD By-Laws and rules are applied).
The 1934 SEA defines an associated person as one "directly or indirectly controlling, controlled by, or under common control with such member [of NASD]. . . ." 15 U.S.C. § 78c(a)(21). The NASD was established pursuant to, and derives its authority from, the Securities Exchange Act. Logically, then, the 1934 SEA should govern when there is a conflict between this Act and the NASD By-Laws. After all, it would be an anomalous result if a creature of the SEA could foreclose certain parties from arbitrating a securities-related dispute, even though arbitration would be possible under the SEA definition.
ENSI is a wholly-owned subsidiary of Essex. Essex, therefore, as one who "directly or indirectly controls" ENSI, a NASD-member, is an associated person. Similarly, Independent falls within the 1934 SEA definition of an associated person because it is "under common control" with Liberty, a NASD-member wholly-owned by the entity that wholly owns Independent. See McCowan v. Sears, Roebuck and Co., 908 F.2d 1099, 1107 (2d Cir. 1990) (compelling arbitration where claims were brought against brokerage firm and its non-NASD member "controlling person," on the basis of arbitration agreement between plaintiffs and brokerage firm, notwithstanding fact that no judgement was sought against the brokerage firm). Thus, as associated persons, Essex and Independent are both subject to the arbitration provision in the Form U-4 signed by Harrell and Young.
B. Are the Claims Subject to Arbitration?
Rule 10101 permits "arbitration of any dispute, claim, or controversy arising out of or in connection with the business of any member of the Association."
Consequently, Essex's claims are subject to arbitration if this Court concludes that they arise out of or are connected with the business of ENSI.
1. Essex Black Pieces and "Your Money Matters" Publications
The Plaintiff's amended complaint advances nine claims. Seven of those claims directly involve the alleged misappropriation and wrongful use of Essex Black Pieces and "Your Money Matters" publications.
Claims one and two assert that Independent and Young infringed on the copyrights Essex owns in the Black Pieces. Compl. PP 42-46. According to the amended complaint, in or about June 1994 Independent obtained copies of Essex marketing materials. Compl. P 17. These materials included the Black Pieces and "Your Money Matters" publications. Id. Essex further alleges that after obtaining these materials, Independent copied and distributed them to their sales representatives for use in selling financial products. Id. Young allegedly turned these materials over to Independent knowing that they would be copied and distributed. Compl. P 46.
Claim five asserts that Harrell and Young violated their duty of fidelity by taking confidential business information and property belonging to Essex and delivering them to Independent. Compl. P 52. The property wrongfully delivered to Independent included Essex Black Pieces.
Claim six asserts that Independent received confidential business information by wrongfully inducing Harrell to breach his confidentiality agreement with Essex. Compl. PP 54-55. This claim is supported in part by the allegation that Independent copied and distributed Essex Black Pieces to its sales representatives under the name "Independent Ideas." Compl. P 55.
Claim seven asserts that Independent received confidential business information by wrongfully inducing and conspiring with Harrell and Young to violate duties of fidelity owed to Essex. Compl.P P 57-58. Again, part of the information allegedly received, as a result of the wrongful inducement and conspiracy, was obtained from the Essex Black Pieces. Compl. P 58.
Claim eight alleges that Independent falsely represented the origin of certain documents and misrepresented some of the services they provided. Compl. P 60. According to the amended complaint, the false representation occurred when Independent distributed, without authorization, Black Pieces and "Your Money Matters" publications bearing the Essex name and logo. Compl. P P 17-18.
Claim nine alleges that Independent violated Essex's trademarks and engaged in unfair competition. Compl. P 62. These allegations largely rest on the assertion that Independent illegally altered copies of Essex's "Your Money Matters - Investment Pyramid." Compl. PP 40, 17-18.
The above claims all directly involved the alleged misappropriation and wrongful use of Essex marketing materials and arise out of or are connected with the business of ENSI. True, Essex owns the copyrights and trademarks to the marketing materials at issue. Yet, there is no dispute that the marketing materials owned by Essex, most notably the Black Pieces and "Your Money Matters - Investment Pyramid," were created by ENSI. The following words appear on the bottom of these documents: "The information contained herein is prepared for your use by Essex National Securities, Inc., member of NASD-SIPC." Harrell Decl., Ex. A; Compl., Ex. 2.
Certainly, ENSI's creation of Essex marketing materials is a central aspect of ENSI's business. The predominant focus of this business is facilitating the sale of NASD-registered products by Essex employees. That is, ENSI licenses Essex employees to sell these products, monitors compliance by these employees of NASD rules, processes the sales of these employees, and receives a percentage of the sale when consummated. Nicholas Aff. P 6.
Quite obviously, the success of a sales program strongly correlates to a compelling marketing strategy. As explained, ENSI developed the Essex marketing materials which facilitated the sale of NASD-registered products. The seven claims previously described all relate to the misappropriation and wrongful use of these marketing materials by the Defendants. Since the predominant focus of ENSI's business is facilitating the sale of NASD-related products, and the claims under consideration all relate to marketing materials created by ENSI to enhance such sales, I conclude that claims one, two and five through nine all arise out of or are connected with the business of ENSI. See McMahan, 35 F.3d at 88 (allegations that defendants purloined integral components of NASD-member's brokerage activities arose out of and were connected with that NASD member's business).
2. Hybrid Program Marketing and Methodology
The two remaining claims, three and four, substantially relate to the Defendants alleged misappropriation and use of confidential information concerning Essex's hybrid program marketing and methodology (the "hybrid program"). Compl. PP 48, 50. Determining whether Rule 10101's requirements are satisfied with respect to these claims is a closer question. Nevertheless, this Court cannot say "with positive assurance that the arbitration clause is not susceptible of an interpretation that covers the asserted dispute[s]." Thomas James Associates, 102 F.3d at 65 (quoting David L. Threlkeld & Co. v. Metallgesellschaft, 923 F.2d 245, 250 (2d Cir.), cert. dismissed, 501 U.S. 1267, 112 S. Ct. 17, 115 L. Ed. 2d 1094 (1991).
ENSI provides the requisite securities licensing for the salespersons who are the lifeblood of the hybrid program. Nicolas Aff. P 6. Moreover, many of the Essex employees involved in the hybrid program are supervised by ENSI. Nicolas Aff. P 6; Compl. P 15. Unquestionably, without the personnel licensed and supervised by ENSI, Essex's hybrid program could not function. Thus, ENSI's relationship with the hybrid program is significant.
The Plaintiff concedes that "a portion of Essex's business that has been injured has some relation to the business of ENSI." A significant part of Essex's success in the bank insurance and investment industry is due to the hybrid program. Compl. P 15. It follows, therefore, that the misrepresentation and wrongful use of hybrid program information would cause significant harm to Essex, and by extension, ENSI. Consequently, the behavior alleged in claims three and four, if true, adversely impact ENSI's business. Given this causal relationship, and considering the Supreme Court directive that "any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration," this Court concludes that claims three and four arise out of or are connected with the business of ENSI. Moses H. Cone, 460 U.S. at 24-25, 103 S. Ct. 941.
Accordingly, all nine of the Plaintiff's claims are subject to arbitration. Earlier, the Court concluded that all of the parties were subject to arbitration, since Essex and Independent fell within the definition of an "associated person." Consequently, both of the requirements articulated by NASD Code Rule 10101 are satisfied.
For the foregoing reasons, the Defendants motion to stay these proceedings and compel arbitration pursuant to the Federal Arbitration Act is GRANTED.
Dated: February 23, 1998
New York, New York
Harold Baer, Jr.