Bass, Berry & Sims attorney Chris Lazarini discussed a court’s authority to compel arbitration where FINRA has declined to accept a case. In this case, following the Director of FINRA’s Office of Dispute Resolution determination that defendant was not compelled to arbitrate absent a court order directing it, the Court finds it has jurisdiction to review FINRA’s action and compels arbitration.

Chris provided the analysis for Securities Online Litigation Alert (SOLA). The full text of the analysis is below and used with permission from the publication. If you would like to receive additional content from the SOLA, please visit the SOLA website to sign up for the newsletter.

Morgan Stanley vs. Babu, No. 19-489 (D. Md., 3/23/20)

FINRA’s Dispute Resolution Director’s decision denying access to the arbitration forum is subject to judicial review.

In May 2018, two Morgan Stanley customers (the Newcombs) filed a FINRA arbitration against the firm, alleging a former Morgan Stanley broker (Pal) fraudulently induced them to transfer $4 million to a Wells Fargo account owned by DH Investments LLC, from which the funds were misappropriated. Morgan Stanley filed a third-party claim in the arbitration against Defendant Babu (also a Morgan Stanley customer), alleging he was the beneficial owner of the DH Investments LLC, and caused or allowed the alleged misappropriation of the Newcombs’ funds. Babu refused to submit to arbitration, and the Director of FINRA’s Office of Dispute Resolution determined he was not compelled to arbitrate absent a court order directing it.

Morgan Stanley filed this action seeking an order compelling Babu to arbitrate. Both parties filed various motions presenting three issues: (1) whether the Court has subject matter jurisdiction over the dispute, (2) whether Defendant was properly served, and (3) whether Defendant should be compelled to arbitrate. Babu argues the Court is without jurisdiction, because the decision of FINRA’s Director was not appealable or, if it was, the appeal should first have been to the SEC. The Court disagrees, finding no statutory or other authority precluding judicial review of the Director’s jurisdictional decision.

The Court recognizes that the Securities Exchange Act mandates SEC review of FINRA’s disciplinary actions, denials of registration or membership applications, and decisions limiting a person’s “access to services offered by FINRA or member thereof.” The Court says whether the jurisdictional decision limits Morgan Stanley’s access to FINRA’s services presents a “difficult question.” Arbitration is certainly a FINRA service, but SEC review is not required because the decision is less like a prohibition or limitation and more like a mandated result of the Arbitration Code and/or the arbitration clause in Morgan Stanley’s customer agreement.

The Court finds support in the Director’s letter denying jurisdiction absent a court order compelling it and also notes arbitrability is a gateway issue generally reserved for the courts. Finally, the Court states it would be absurd to require an appeal to the SEC when the Federal Arbitration Act gives a party the absolute right to seek an order compelling arbitration from a federal court.

The Court has less trouble finding Babu was properly served, noting service was made on Babu’s father (who accepted service) at the address Babu used as his official address with the Maryland and Florida bar associations and for receipt of his Morgan Stanley statements. The Court also finds no evidence of prejudice and no reason to quash service, because Babu had full notice of the claims and had briefed the issues. Finally, addressing arbitrability, the Court finds Morgan Stanley’s third party claims fall within the scope of Morgan Stanley’s broad arbitration clause, which covers “all claims or controversies . . . concerning any transaction involving MSSB . . . and you[.]”

(C. Lazarini) (EIC: One wonders on what basis the Director declined jurisdiction over the Member-Customer dispute. That Morgan Stanley might not have standing to claim liability or to extend the scope of the agreement to this dispute are arguable and arbitrable issues, not grounds for refusal to recognize the agreement that exists. If sensitivity to haling customers into FINRA arbitration is the concern, we’d only observe that the Claimant customer(s) will have a far more robust “day in court” with all intertwined parties in a single forum. Too often, FINRA policies invite fragmentation, rather than facilitating arbitration of the total dispute.)