United States District Court, S.D. New York
March 19, 2004.
SANDS BROTHERS & CO., LTD., Plaintiff, -v- CINDI ETTINGER, Defendant
The opinion of the court was delivered by: DENISE COTE, District Judge
OPINION AND ORDER
Sands Brothers & Co., Ltd. ("Sands"), a Delaware corporation with its
principal place of business in New York, filed this action against Cindi
Ettinger ("Ettinger"), a citizen of Pennsylvania, on October 6, 2003.
Sands has moved for a declaratory judgment pursuant to 28 U.S.C. § 2201
that it has no legal obligation to arbitrate any claims arising out of
Ettinger's dealings with Bluestone Capital Corp. ("Bluestone") or its
subsidiary, Shochet Securities, Inc. ("Shochet"),*fn1 who were
Ettinger's brokers before Sands purchased Bluestone. For the
reasons described below, the motion is granted in part.
The following facts are undisputed or as shown by Ettinger. In January
2000, Ettinger, an artist, opened an IRA account at GKN Securities Corp.
("GKN"). A broker at GKN, Robert Nosel ("Nosel"), was assigned to handle
her account. Following several telephone conversations during which
Ettinger told Nosel that she wanted to invest conservatively, Nosel sent
her a letter dated January 24, 2000 outlining his investment strategy for
her account. In the letter, Nosel stated that he had "taken into account
your expressed conservatism when tailoring this portfolio." Included
among Nosel's recommendations were speculative equity mutual funds.
Neither Nosel nor his associate reviewed with Ettinger the risks
associated with the proposed asset allocation plan. On January 28,
Ettinger invested $256,519.00 in accordance with the recommended asset
allocation plan devised by Nosel.
Ettinger's account moved with Nosel to Shochet in December 2000, and to
Bluestone in August 2001.*fn2 On November 7, 2001, Sands and Bluestone
executed a Purchase Agreement whereby Sands acquired certain of
Bluestone's accounts and assets in exchange for $1,075,000 in cash. One
of the accounts purchased by Sands
was that of Ettinger.*fn3
The Purchase Agreement provided, inter alia, that Sands would be
permitted, but not required, to offer to hire "some or all" of Bluestone's
personnel other than the co-chairmen; that Bluestone would transfer all
rights in Shochet's trademarks and copyrights to Sands; and that, upon
Sands' request, Bluestone would assign to Sands all of Bluestone's
properties other than its headquarters in New York and specified other
properties. Section 8 of the Purchase Agreement also released Sands from
any of Bluestone's "liabilities, expenses, debts or obligations . . .
contingent or absolute, known or unknown, including . . . any Litigation
Liabilities." The clause defined "litigation liabilities" as any "debts,
obligations or liabilities arising from or relating to pending,
threatened and unasserted claims (including, without limitation, customer
complaints), litigation, legal actions, counterclaims, suits or
arbitration. . . ."
In a March 28, 2002 letter from Sands to Ettinger for the purpose of
updating Ettinger's file and account information, Sands introduced itself
as having had "successfully acquired" Shochet. The letter asked Ettinger
to update her file and account information by completing and returning
the enclosed forms. Sands closed the letter by stating that it "look[ed]
forward to continuing our long-standing relationship with you."
According to Ettinger, she filled out the forms, checking off boxes
indicating "low-risk exposure," "preservation of capital" and "long term
growth" as investment objectives, and returned them to Sands. A broker at
Sands who had taken over Ettinger's account after Nosel's departure
called her in April and introduced himself. Sands and Ettinger had no
By October 2002, Ettinger's IRA account had declined 53%, from $292,148
to $138,287. Ettinger showed her account statements to one of her brokers
at UBS PaineWebber ("PaineWebber"), another brokerage house with which
she maintained investment accounts. The PaineWebber broker reviewed the
Sands account statements and informed Ettinger that she was invested in
speculative equity mutual funds. Ettinger immediately transferred the
speculative mutual fund investments from Sands to PaineWebber. In
December, she liquidated those investments, paying approximately $4,000
in sales charges.
On July 24, 2003, Ettinger initiated an arbitration proceeding against
Sands before the NASD. Ettinger charged Sands with fraud and
"unsuitability with respect to the sale of speculative equity mutual
funds" in her IRA account, as well as claims for breach of contract and
lack of supervision. On October 6, Sands filed this action. In its first
cause of action, Sands seeks a declaration that it is not a successor in
interest to either Bluestone or Shochet. In its second cause of action,
it requests a stay of the arbitration until there is a determination on
its first cause of action.
On October 6, Sands requested that the Court issue an ex parte stay of
the arbitration. The Court refused to issue an ex parte order, and
scheduled a conference for October 10. At the October 10 conference,
Sands requested an opportunity to supplement its motion papers. This
motion ensued. The parties do not contest the following facts: (1)
Sands, as a member of NASD, is bound by the NASD Code of Arbitration
Procedure ("NASD Code"); (2) Ettinger was a Sands customer from November
1, 2001, the date of the Purchase Agreement with Bluestone, to the date
in October 2002 on which she transferred her IRA account to PaineWebber;
and (3) the dispute between Sands and Ettinger is subject to the Federal
Arbitration Act ("FAA"), 9 U.S.C. § 1-14 (1988).
Sands contends that it has no legal obligation to arbitrate Ettinger's
claim against it because Ettinger was not its "customer" for purposes of
the NASD Code for any period before it acquired Bluestone on November 7,
2001, and because it is not a "successor in interest" to Bluestone. As a
threshold matter, it should be noted the question of arbitrability is for
the Court. "Unless the parties clearly and unmistakably provide
otherwise, the question of whether the parties agreed to arbitrate is to
be decided by the court, not the arbitrator." John Hancock Life Ins. Co.
v. Wilson, 254 F.3d 48, 53 (2d Cir. 2001) (citation omitted); see
Bensadoun v. Jobe-Riat, 316 F.3d 171, 175 (2d Cir.
2003). "[O]ne party's membership in [the NASD], is insufficient, in and
of itself, to evidence the parties' clear and unmistakable intent to
submit the `arbitrability' question to the arbitrators." John Hancock,
254 F.3d at 57. Since Ettinger has pointed to no agreement between her
and Sands that would place the issue of arbitrability before the
arbitrator, this Court will decide the issue of arbitration.
There is a strong federal policy favoring arbitration. See Howsam v.
Dean Witter Reynolds, Inc., 537 U.S. 79, 83 (2002) (citing Moses H. Cone
Mem'l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983)).
"[Q]uestions of arbitrability must be addressed with a healthy regard for
the federal policy favoring arbitration." Gilmer v. Interstate/Johnson
Lane Corp., 500 U.S. 20, 26 (1991) (citation omitted). "[A]ny doubts
concerning the scope of arbitrable issues should be resolved in favor of
arbitration." Moses H. Cone, 460 U.S. at 24-25.
Whether or not there is a motion to compel arbitration, any disputed
issues of fact concerning the existence of a binding agreement to
arbitrate are decided under the standard that applies to a motion for
summary judgment. Bensadoun, 316 F.3d at 175. If material issues of fact
are in dispute, the matter is properly left for trial. Id. (citing
9 U.S.C. § 4).
1. Ettinger's Status as a Customer
Rule 10301(c) of the NASD Code provides that "[a]ny dispute, claim, or
controversy . . . between a customer and a member and/or
associated person arising in connection with the activities of such
associated persons" must be submitted to arbitration "upon the demand of
the customer." The NASD Code "defines `customer' broadly, excluding only
`a broker or dealer.'" John Hancock, 254 F.3d at 59. If any ambiguity
exists in the meaning of "customer" as used in Rule 10301, "the term
should be construed in favor of arbitration." Bensadoun, 316 F.3d at
The Second Circuit has recently noted that "`customer status . . . must
be determined as of the time of the events providing the basis for the
allegation of fraud,' so that allegations against a
predecessor-in-interest did not give rise to a duty to arbitrate on the
part of the successor." Bensadoun. 316 F.3d at 177 (quoting Wheat, First
Securities, Inc. v. Green. 993 F.2d 814, 820 (11th Cir. 1993)). An
investor is a "customer" of a brokerage house, and able to compel the
brokerage house to arbitrate, only for conduct that falls within the
scope of the specific account between the investor and the brokerage
house. Id. at 178 (the investor "would be unable to rely on the existence
of his personal account to demand arbitration on issues relating to a
different account outside the scope of [the investor's] customer
relationship with [the NASD member]").
Ettinger cannot, under the theory that she was once a Sands customer,
compel Sands to arbitrate her losses stemming from activity in her
account before the account was acquired by Sands. To the extent that
Nosel engaged in misconduct with respect to her account while at GKN,
Shochet, or Bluestone, Ettinger cannot
require Sands to arbitrate that claim under the theory that she became a
"customer" of Sands thereafter.
To the extent, however, that Sands seeks a declaration that it is not
required to arbitrate claims associated with the period during which
Ettinger was Sands' customer, its motion is denied. Sands is required to
arbitrate any claims by Ettinger regarding the management of her IRA
account from the date she became a Sands customer, that is, November 7,
2001, to the time her IRA account was transferred to PaineWebber. It is
for the arbitrator to decide to what extent, if any, Sands is liable to
Ettinger for its handling of her account from November 7, 2001 to the
date in October 2002 when Ettinger transferred her account to
2. Successor in Interest Liability
Sands also seeks a declaratory judgment that it is not required to
arbitrate Ettinger's claims for conduct that occurred while she had an
account with either Shochet or Bluestone because it is not a successor in
interest to their liabilities. Ettinger does not oppose this prong of
Under New York common law,*fn4 a purchase of assets does not render
the purchaser liable for the torts of its predecessor unless (1) it
expressly assumed the predecessor's tort liability, (2) there was a
de facto merger of seller and purchaser, (3) the
purchasing corporation was a mere continuation of the selling
corporation, or (4) the transaction is entered into fraudulently to
escape such obligations. Cargo Partner AG v. Albatrans, Inc., 352 F.3d 41,
45 (2d Cir. 2003) (citing Schumacher v. Richards Shear Co., 59 N.Y.2d 239,
244-45 (N.Y. 1983)). Because Sands expressly rejected any of Bluestone's
liabilities, and there is no allegation or evidence that the parties
entered into the Purchase Agreement for fraudulent purposes, only the
second and third factor are at issue here.*fn5
A de facto merger occurs when a transaction is a merger in substance if
not in form. Cargo Partner, 352 F.3d at 46. To find that a de facto
merger has occurred, there must be: "(1) a continuity of the selling
corporation, evidenced by the same management, personnel, assets and
physical location; (2) a continuity of stockholders, accomplished by paying
for the acquired corporation with shares of stock; (3) a dissolution of
the selling corporation; and (4) the assumption of liabilities by the
purchaser." Id. (citation omitted) (emphasis supplied). The "continuity of
ownership" is an essential aspect of the doctrine of de facto merger.
There was no de facto merger of Sands with Bluestone. There was no
continuity of ownership between the two companies. Sands paid Bluestone
in cash for the purchase of certain of its assets, including the customer
accounts. Bluestone owners did not
receive any stock in Sands. In addition, under the terms of the Purchase
Agreement, Sands did not acquire Bluestone's liabilities. Moreover, the
Purchase Agreement prohibited Bluestone's co-chairmen from working at
Sands, and Sands was not required to hire Bluestone's employees.
In sum, Sands is not a successor in interest to Bluestone's
liabilities. The transaction between the two parties does not satisfy any
of the exceptions to the general rule that a successor business entity is
not liable for the torts of its predecessor.
For the reasons stated above, Sands' motion for a declaratory judgment
is granted in part. Sands has no obligation to arbitrate Ettinger's
claims for the period before November 1, 2001. The parties shall advise
the Court by April 2, 2004 whether there is any reason not to enter a
final judgment in this action based on the rulings contained herein.