Opinion
Civil Action No. SA-04-CA-0677 FB (NN).
August 31, 2005.
MEMORANDUM AND RECOMMENDATION OF THE UNITED STATES MAGISTRATE JUDGE
I. Introduction
The matter before the court is the Deutsche Bank defendants' motion to stay proceedings. After careful review of all relevant argument and authority, I recommend the District Court deny the motion for the reasons set forth below.
Docket Entry 8. The Deutsche Bank defendants are Deutsche Bank AG ("Deutsche Bank"), Deutsche Bank Securities, Inc., d/b/a Deutsche Bank Alex Brown and David Parse. For purposes of this Memorandum and Recommendation only, the Deutsche Banks defendants will be referred to collectively as "defendants."
I have jurisdiction to enter this Memorandum and Recommendation under 28 U.S.C. § 636(b) and the District Court's Order referring this matter to me for disposition by order, or to aid in its disposition by recommendation where my authority as a Magistrate Judge is statutorily constrained.
Docket Entry 15.
II. Statement of the Case
Plaintiffs seek damages for claims arising out of tax strategies developed and marketed by defendants. While promoted under various names, the tax strategy giving rise to the instant claims was marketed to plaintiffs as "COBRA" (Currency Options Bring Reward Alternatives). The primary aim of COBRA was to reduce or eliminate certain tax liabilities by artificially orchestrating capital losses. Plaintiffs allege that the various defendants acted together to obtain plaintiffs' participation in the COBRA strategy. Plaintiffs further allege defendants' purpose in marketing the strategy was to generate and split large fees among the various defendants.Defendant Deutsche Bank is a German corporation offering various financial products and services worldwide and is primarily involved in the financing of foreign trade. Plaintiffs allege that Deutsche Bank recruited defendants KMPG, L.L.P. (KPMG) and Interstar Capital Group, L.L.C. as "marketing participants" to assist them in recruiting plaintiffs for participation in COBRA.
As plaintiffs were recruited for participation in COBRA, they were reassured by defendants that the strategy employed a loophole in the tax code and was legal. Plaintiffs allege defendants advised "that the [capital] losses created by the Strategy were legitimate and in accordance with all applicable tax laws, rules, and regulations." Relying on the expertise and advice of defendants, plaintiffs began participation in the COBRA strategy in July of 2000.
Defendants claimed the strategy was not a "sham transaction" and provided an "independent" opinion letter as to the validity of the shelter from the law firm of Jenkens Gilchrist. Plaintiffs allege that the COBRA strategy was — at least in part — created, designed and implemented by Jenkens Gilchrist. Jenkens Gilchrist is not named as a party to this action.
For purposes of carrying out the COBRA strategy, plaintiffs formed the various limited liability companies named as parties to this suit.
Despite defendants' assurances that the strategy was legal, the IRS had previously taken the position that the shelters were in fact not valid. In December of 1999 and August of 2000, the IRS published notices stating that the purported losses generated by these strategies were not allowable for federal income tax purposes. Nonetheless, defendants continued to represent to plaintiffs that the strategy was legitimate. Plaintiffs subsequently utilized the COBRA strategy in their 2000, 2001 and 2002 tax returns.
In late 2001, the IRS offered an amnesty program for individuals and entities that had participated in these strategies. This program allowed individuals and entities to avoid penalties for the underpayment of taxes in exchange for disclosing their involvement in the strategies. Plaintiffs allege they did not participate in the amnesty program under advice from defendants, and as a consequence now face substantial additional liability.
In June of 2003, the IRS issued regulations which invalidated the COBRA strategy retroactively to 1999. In May of 2004, the IRS issued Notice 2004-46 which effectively offered a settlement to plaintiffs and other similarly situated taxpayers who had utilized these invalid tax shelters. Plaintiffs entered into a settlement with the IRS, obligating them to pay substantial back-taxes, interest and penalties.
Plaintiffs filed their original complaint in this court on July 30, 2004, and their first amended complaint on July 7, 2005. They assert the following claims:
FIRST CLAIM: Violations of RICO, 18 U.S.C. § 1962(c); asserted against all defendants.
SECOND CLAIM: Violations of RICO, 18 U.S.C. § 1962(d) by conspiring to violate 18 U.S.C. § 1962(c); asserted against all defendants.
THIRD CLAIM: Violations of 18 U.S.C. § 2 by seeking to and aiding and abetting a scheme to violate 18 U.S.C. § 1962(c); asserted against all defendants.
FOURTH CLAIM: Declaratory judgment and unjust enrichment; asserted against all defendants.
FIFTH CLAIM: Breach of contract and breach of the duty of good faith and fair dealing; asserted against the Deutsche defendants.
SIXTH CLAIM: Breach of fiduciary duty; asserted against all defendants.
SEVENTH CLAIM: Fraud; asserted against all defendants.
EIGHTH CLAIM: Negligent misrepresentation and professional malpractice; asserted against all defendants.
NINTH CLAIM: Breach of contract/professional malpractice; asserted against all defendants except for the Deutsche defendants.
TENTH CLAIM: Declaratory judgment; asserted against all defendants.
ELEVENTH CLAIM: Civil conspiracy; asserted against all defendants.
The Deutsche Bank defendants moved for a stay of these proceedings on November 22, 2004. The motion has been extensively briefed by the parties.
Docket Entry 8.
Docket Entries 9, 18, 20, 26-28, and 36-38.
III. Related Proceedings
This case is one of many filed across the United States in which plaintiffs seek recovery against defendants for faulty tax advise involving the structuring of capital losses. Significant to the pending motion, the individual plaintiffs in this proceeding are also members of various classes in Denney v. Jenkens Gilchrist, pending in the Southern District of New York. That court certified a class and approved a proposed settlement of claims asserted by the class members against Jenkens Gilchrist and some of the individual defendants on February 18, 2005. Plaintiffs are also members of putative litigation classes in Denney not yet certified.As will be discussed more fully below, defendants' current motion asks the Court to hold this case in abeyance pending resolution of the class certification issues in Denney. Not surprisingly, defendants in related cases have also sought a stay of proceedings pending resolution of the class questions in Denney. Those motions have had inconsistent outcomes. Several courts have granted the stay requests finding same to be a proper use of their discretionary authority. Others have concluded that defendants had not sufficiently supported their request and denied the stay of proceedings. More recently, several courts have dismissed plaintiffs' RICO claims altogether.
Chew v. KPMG, L.L.P., No. 3:04CV748 (S.D. Miss. Apr. 29, 2005) (denying defendants' motion for a mandatory stay pursuant to 9 U.S.C. § 3 and issuing discretionary stay pending resolution of controlling putative class action certification); Plyler v. BDO Seidman, L.L.P., No. 04-2146 (W.D. Tenn. Apr. 11, 2005) (staying action and deferring ruling on motion to compel arbitration until resolution of class issues in Denney ); Hansen v. KPMG, L.L.P., No. CV04-10525 (C.D. Cal. Mar. 28, 2005) (holding that limiting provision of arbitration agreement precludes present arbitration of matter and therefore staying proceedings for 180 days pending resolution of controlling putative class action certification).
King v. Deutsche Bank AG, No. CV 04-1029 (D.C. Or. May 9, 2005) (Deutsche Bank's motion to compel arbitration or stay proceedings denied pending resolution of Denney, finding that arbitration provision at issue did not compel a stay pending resolution of putative class action and that conditions for a discretionary stay were not satisfied); Armitage v. BDO Seidman, L.L.P., No. SA CV 04-1035 (C.D. Cal. Feb. 14, 2005) (holding that a stay is not justified where it is not certain that the matter will be resolved through Denney or by arbitration, and that defendants did not demonstrate sufficient prejudice to warrant a discretionary stay); RA Invs. I, L.L.C. v. Deutsche Bank AG, No. 3:04-CV-1565-G (N.D. Tex. Jan. 10, 2005) (denying motion to stay because uncertainty of Denney resolution would create a stay "of indefinite duration" and because movant did not present a sufficient case of hardship or inequity if required to proceed); Blythe v. Deutsche Bank AG, No. 04 Civ. 5867 (S.D.N.Y. Jan. 7, 2005) (denying motion to stay because Denney did not encompass, and therefore could not resolve, all of plaintiffs' claims, and because the time frame for the resolution of Denney is too uncertain; motion to compel arbitration also denied); Tice v. BDO Seidman L.L.P., No. SA CV04-599 (C.D. Cal. Dec. 31, 2004) (holding that a stay is not justified where it is not certain that the matter will be resolved through Denney or by arbitration, and that defendants did not demonstrate sufficient prejudice to warrant a discretionary stay); Barron v. Deutsche Bank AG, No. SA CV04-0401 (C.D. Cal. Dec. 31, 2004) (holding that a stay is not justified where it is not certain that the matter will be resolved through Denney or by arbitration, and that defendants did not demonstrate sufficient prejudice to warrant a discretionary stay).
See, Orders dismissing RICO claims with prejudice, Armitage, (C.D. Cal. July 28, 2005; Tice, (C.D. Cal. July 28, 2005); Barron, (C.D. Cal. July 25, 2005); RA Inv. I, L.L.C., 2005 WL 1356446, (N.D. Tex. June 6, 2005); and Order dismissing RICO claims without prejudice to plaintiffs filing amended complaint, Blythe, (S.D.N.Y. June 1, 2005). Cf. Jones v. Deutsche Bank AG, 2005 WL 1683614 (N.D. Cal. July 19, 2005) (defendants' motion to dismiss denied as to RICO claims and granted as to securities fraud claim).
IV. Analysis
Defendants premise their motion to stay proceedings on the statutory authority found in Section 3 of the Federal Arbitration Act, as well as the discretionary authority of the court to stay proceedings.Determination of defendants' motion begins with a review of the written agreements by which plaintiffs opened the Deutsche Bank Alex Brown brokerage accounts. All of those Account Agreements contain the following provision:
I agree to arbitrate with you any controversies which may arise, whether or not based on events occurring prior to the date of the agreement, including any controversy arising out of or relating to any account with you, to the construction, performance or breach of any agreement with you, or to the transactions with or through you, only before the New York Stock Exchange or the National Association of Securities Dealers Regulation, Inc., at my election.
Account Agreement, Appendix to Affidavit of Mike Stenglein, attached to Docket Entry 9. Plaintiffs allegedly entered into the account agreements with defendant Deutsche Bank Alex Brown in order to make foreign currency investments and related transfers as part of the COBRA strategy. See, Docket Entry 1, p. 23, ¶ 59; Docket Entry 9, p. 3, ¶ 5.
Defendants argue that in light of this agreement to arbitrate, Section 3 of the Federal Arbitration Act requires this Court to stay this proceeding.
Section 3 of the Federal Arbitration Act specifically provides:
If any suit or proceeding be brought in any of the courts of the United States upon any issue referable to arbitration under an agreement in writing for such arbitration, the court in which such suit is pending, upon being satisfied that the issue involved in such suit or proceeding is referable to arbitration under such an agreement, shall on application of one of the parties stay the trial of the action until such arbitration has been had in accordance with the terms of the agreement, providing the applicant for the stay is not in default in proceeding with such arbitration.
Defendants argue that the case before this Court is "referable to arbitration" as that term is contemplated by Section 3 Federal Arbitration Act, and that this Court must therefore stay proceedings.
Although the agreement to arbitrate expressed in the Account Agreements between plaintiffs and defendants appears clear, and the statutory entitlement to a stay as a result thereof compulsory, the parties also agreed to limit the enforceability of the agreement to arbitrate in those situations when class certification proceedings are pending. The relevant provision of the Account Agreement states as follows:
No person shall bring a putative or certified class action to arbitration, nor seek to enforce any pre-dispute arbitration agreement against any person who has initiated in court a putative class action; or who is a member of a putative class who has not opted out of the class with respect to any claims encompassed by the putative class action until (1) the class certification is denied; or (2) the class is decertified; or (3) the customer is excluded from the class by the court.
Account Agreement, Appendix to Affidavit of Mike Stenglein, attached to Docket Entry 9.
Notably, this provision mirrors the rules of the National Association of Securities Dealers and the New York Stock Exchange, the designated forums for arbitration under the Account Agreements, which specifically prohibit the arbitration of matters that are encompassed by putative or certified class actions.
The rules of the National Association of Securities Dealers provide that "any claim filed by a member or members of a putative or certified class action is also ineligible for arbitration at the Association if the claim is encompassed by a putative or certified class action filed in federal or state court. . . ." Docket Entry 18, p. 6 (citing NASD Rule 10301(2)). NASD rules provide that "[n]o member or associated person shall seek to enforce any agreement to arbitrate against a customer . . . who . . . is a member of a putative or certified class with respect to any claims encompassed by the class action. . . ." Docket Entry 18, p. 6 (citing NASD Rule 10301(3)). The rules of the New York Stock Exchange contain an identical provision precluding arbitration of matters encompassed by putative class action proceedings. See NYSE Arbitration Rule 600(d).
As discussed above, plaintiffs are members of putative litigation classes in Denney not yet certified. None of the plaintiffs have opted out of any of the classes. Thus, because plaintiffs are members of a class pursuing claims which remain in Denney, the Account Agreements prohibit defendants from compelling plaintiffs to arbitrate their claims at this time. Because defendants cannot presently compel arbitration, and further, because no determination has been made as to whether plaintiffs' claims are referable to arbitration, Section 3 of the Federal Arbitration Act does not compel this Court to issue the requested stay.
Docket Entry 18, p. 6.
Id.
Defendants also ask this Court to stay proceedings pursuant to its discretionary authority. This court possesses the "general discretionary power to stay proceedings before it in the control of its docket and in the interests of justice." The Supreme Court has noted that this discretion is "incidental to the power inherent in every court to control the disposition of the causes on its docket with economy of time and effort for itself, for counsel, and for litigants." In the exercise of this judgment, the court "must weigh competing interests and maintain an even balance." Ultimately, the burden is upon the party seeking the stay to "make out a clear case of hardship or inequity in being required to go forward, if there is even a fair possibility that the stay for which he prays will work damage to someone else." Lastly, when granting a stay pending resolution of another case, the court must consider the time expected for resolution of that case. The resultant stay must not be of immoderate or indefinite duration.
McKnight v. Blanchard, 667 F.2d 477, 479 (5th Cir. 1982).
Landis v. North American Co., 299 U.S. 248, 254 (1936); United States v. $9,041,598.68, 163 F.3d 238, 251 (5th Cir.), cert. denied, 527 U.S. 1023 (1999) ("Generally, the power to stay a pending matter derives from a trial court's wide discretion to control the course of litigation.").
Landis, 299 U.S. at 254-55.
In re Davis, 730 F.2d 176, 178 (5th Cir. 1984), quoting Landis, 299 U.S. at 255.
Wedgeworth v. Fibreboard Corp., 706 F.2d 541, 545 (5th Cir. 1983), citing McKnight, 667 F.2d at 479.
Wedgeworth, 706 F.2d at 545, quoting Landis, 299 U.S. at 257 ("The stay is immoderate and hence unlawful unless so framed in its inception that its force will be spent within reasonable limits, so far at least as they are susceptible of prevision and description.").
Here, defendants argue that absent a stay, they "will be forced to forego the economies of arbitration and incur the very burdens associated with litigation that arbitration is meant to avoid." They also claim that continued litigation costs "can constitute not merely ordinary hardship but irreparable harm when imposed upon a party seeking vindication of its right to compel arbitration. . . ." However, the ultimate enforceability of the arbitration provision in these Account Agreements remains undecided, and defendants concede they cannot presently compel arbitration so long as the plaintiffs are members of a putative class in Denney.
Docket Entry 26, p. 5, ¶ 7.
Id. See Buffler v. Elec. Computer Programming Inst., Inc., 466 F.2d 694 (6th Cir. 1972); Cendant Corp. v. Forbes, 72 F. Supp.2d 341 (S.D.N.Y. 1999); C.B.S. Employees Fed. Credit Union v. Donaldson, Lufkin Jenrette Sec. Corp., 716 F. Supp. 307 (W.D. Tenn. 1989).
Nonetheless, it is equally true that damage to plaintiffs, if any, caused by a stay of these proceedings will not be significant. As the Supreme Court stated in Landis, the movant for a stay must show hardship or inequity where "there is even a fair possibility that the stay for which he prays will work damage to someone else." Plaintiffs to this action are potential members of a litigation class involving the Deutsche defendants not yet certified and none have opted out. Those claims are proceeding in New York. Apparently, some of the claims brought by plaintiffs in the action pending in this Court were not brought as class claims in Denney and those are the most clearly affected by the stay defendants request. However, while a stay of this case may delay recovery to which plaintiffs might eventually be found entitled, their right to full restitution from defendants for the back taxes, penalties and interest which they owe the IRS, fees paid to defendants, as well as expenses related to this litigation remains intact regardless of the outcome of this case.
Landis, 299 U.S. at 255.
Plaintiffs' Second Amended Complaint in Denney, found at Docket Entry 18, Exh. A.
Nevertheless, the Supreme Court instructs that the movant seeking a stay of proceedings shoulders a heavy burden. Defendants here argue that they are irreparably harmed by being forced to litigate claims which the parties had mutually agreed to arbitrate. However, so long as the class claims in Denney proceed, defendants have no present right to compel arbitration of the dispute before this Court. Interestingly, defendants have proceeded to file motions to dismiss in the cases in which their stay request has been denied, and have been successful in the vast majority of the rulings I have been able to identify. Defendants can hardly claim that the denial of their motion to stay presents irreparable harm when the denial of those motions in most other jurisdictions has been followed so quickly by dismissal of plaintiffs' claims against them. Although the harm to plaintiffs resulting from imposition of stay is minimal, defendants have failed to make out a "clear case of hardship or inequity" in being required to go forward with this litigation so as to justify a stay.
Supra at note 13.
Landis, 299 U.S. at 255.
Defendants' motion must also be denied for the reason that they request a stay of uncertain duration. Specifically, defendants request that this case be stayed pending resolution of putative class claims in Denney. As noted above, the court in Denney certified a class and approved settlement of those claims asserted against Jenkens Gilchrist in February of this year. That ruling is on appeal. However, the plaintiffs have not been aggressive in their attempt to certify litigation classes in the Southern District of New York case and that court is currently awaiting briefing on the preliminary issue of whether the arbitration provisions of the account agreements are binding on non-signatories. When that court will return to consider class certification questions is entirely speculative. Defendants essentially ask for a stay of indefinite duration, and such a request, "in the absence of pressing need," constitutes an abuse of the court's discretion. The motion must accordingly be denied.
No. 05-1275. Oral argument on the appeal was scheduled for August 24, 2005.
Transcript of Hearing, August 4, 2005 (found at Docket Entry 230 in Denney, No. 03-CV-5460 (S.D.N.Y)).
Landis, 299 U.S. at 255.
V. Recommendation
For the above reasons, I recommend that the Court conclude that defendants have failed to justify their request for a stay, either pursuant to Section 3 of the Federal Arbitration Act or the discretionary authority of the court, and that their motion to stay be DENIED.
Instructions For Service and Notice of Right to Object/Appeal
The United States District Clerk shall serve a copy of this Memorandum and Recommendation on each and every party either (1) by certified mail, return receipt requested, or (2) by facsimile if authorization to do so is on file with the Clerk. According to 28 U.S.C. § 636(b)(1) and Federal Rule of Civil Procedure 72(b), any party who desires to object to this report must serve and file written objections to the Memorandum and Recommendation within 10 days after being served with a copy unless this time period is modified by the District Court. A party filing objections must specifically identify those findings, conclusions or recommendations to which objections are being made and the basis for such objections; the District Court need not consider frivolous, conclusive or general objections. Such party shall file the objections with the Clerk of the Court, and serve the objections on all other parties and the Magistrate Judge. A party's failure to file written objections to the proposed findings, conclusions and recommendations contained in this report shall bar the party from a de novo determination by the District Court. Additionally, any failure to file written objections to the proposed findings, conclusions and recommendations contained in this Memorandum and Recommendations within 10 days after being served with a copy shall bar the aggrieved party, except upon grounds of plain error, from attacking on appeal the unobjected-to proposed factual findings and legal conclusions accepted by the District Court.
See Thomas v. Arn, 474 U.S. 140, 149-52 (1985).
Douglass v. United Servs. Auto. Ass'n, 79 F.3d 1415, 1428-29 (5th Cir. 1996).