Opinion
Civil Action No. 02-7689
December 9, 2002
MEMORANDUM AND ORDER
Defendants move pursuant to the Federal Arbitration Act ("FAA"), 9 U.S.C. § 1-16, to compel arbitration and stay an action brought against them by Plaintiff. Plaintiff's complaint alleges violations of Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j(b), and SEC Rule 10b-5, 17 C.F.R. § 240.10-b5, the Pennsylvania Securities Act of 1972, 70 Pa.Cons.Stat. § 1-401, and the Pennsylvania Unfair Trade Practices and Consumer Protection Act, 73 Pa.Cons.Stat. § 201-1 et seq. The complaint also alleges claims for fraud, negligence, and breach of fiduciary duty. Defendants removed the action to federal court on October 3, 2002. Defendants' Motion to Compel Arbitration and to Stay Proceedings will be granted.
I. BACKGROUND
Plaintiff William Ritch, Jr. ("Ritch") contacted Wentworth Eaton ("Eaton") a registered representative of the securities broker-dealer Merrill Lynch, Pierce, Fenner and Smith Incorporated ("Merrill Lynch") to open an investment account in late 1999. As a result of their discussions, Ritch subsequently signed a Cash Management Account application ("Application") with Merrill Lynch on January 2, 2000 and a Client Relationship Agreement ("Agreement") on February 1, 2000. Under the Agreement, Ritch opened three accounts with Merrill Lynch. Both the Application and Agreement contained arbitration provisions. See (Exs. Attached to Pl.'s Compl.). Ritch's investments, which included a number of technology stocks, were initially valued at $222,678, but decreased in value to $66,762.39 by March 20, 2001. (Pl.'s Compl., ¶¶ 14-27).
The Cash Management Account application provides in relevant part that "all controversies which may arise between [the parties] including but not limited to those involving any transaction or the construction, performance, or breach of this or any other agreement between [the parties] whether entered into prior, on or subsequent to the date hereof shall be determined by arbitration." (Ex. Attached to Pl.'s Compl.). The Application also describes many of the practical consequences of arbitration and appear in bold type, in contrast to most of the other terms. See id. The Agreement contains an arbitration provision materially the same as the Application. See id.
During the time that Ritch remained a client of Merrill Lynch, he alleges that Eaton misrepresented his expertise as a financial advisor, falsely stated that higher risk technology securities were good investments for Ritch's needs, and indicated that returns on the investments would be substantial. Ritch maintains that the arbitration provisions in the Application and Agreement were part of a larger fraudulent scheme undertaken by Merrill Lynch to sell unsuitable securities that the company advertised as good investments. See (Pl.'s Compl., ¶ 39 et seq.). After seeing the funds in his Merrill Lynch accounts diminish, Ritch transferred the remainder to a new broker and later filed a complaint against Eaton and Merrill Lynch in the Court of Common Pleas of Lehigh County, Pennsylvania on September 18, 2002. Defendants then removed the action to federal court on October 3, 2002, leading to the motion to compel arbitration now before us.
II. DISCUSSION
The Federal Arbitration Act of 1947, 9 U.S.C. § 1-16, establishes by statute a policy favoring arbitration as an alternative to litigation. See Perry v. Thomas, 482 U.S. 483 (1987); Shearson/American Express, Inc. v. McMahon, 482 U.S. 220 (1987); E.I. DuPont de Nemours and Co. v. Rhone Poulenc Fiber and Resin Intermediates, S.A.S., 269 F.3d 187, 194 (3d Cir. 2001). The FAA authorizes a federal court to issue an order compelling arbitration if there has been a "failure, neglect, or refusal" to comply with the arbitration agreement. 9 U.S.C. § 4. "Arbitration agreements `shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.'" Shearson, 482 U.S. at 226 (quoting 9 U.S.C. § 2). Plaintiff Ritch does not dispute that he executed the Application and Agreement containing the arbitration provisions, but does claim that state law doctrines of unconscionability and fraud apply to invalidate his agreement to arbitrate. We first consider whether the arbitration provisions are unconscionable, and second, whether the arbitration provisions are unenforceable as part of a fraudulent scheme, an exception to arbitration established by Moseley v. Electronic Missile Facilities, Inc., 374 U.S. 167, 171 (1963).
A. Whether the Arbitration Provisions are Unconscionable
Unconscionability is a "defensive contractual remedy which serves to relieve a party from an unfair contract or from an unfair portion of a contract." Germantown Mfg. Co. v. Rawlinson, 491 A.2d 138, 145 (Pa.Super.Ct. 1985) (citation omitted). Courts determine whether a given provision is unconscionable by using a two-part test. First, "one of the parties to the contract must have lacked a meaningful choice about whether to accept the provision in question." Ferguson v. Lakeland Mut. Ins. Co., 596 A.2d 883, 885 (Pa.Super.Ct. 1991), appeal denied, 611 A.2d 712 (Pa. 1992). Second, "the challenged provision must unreasonably favor the other party to the contract." Id. (citation omitted). Ritch first characterizes the agreements as part of a contract of adhesion, and second, argues that terms of the provisions are so unfair as to be unconscionable.
1. The arbitration provisions do not amount to a contract of adhesion
Ritch's position that the arbitration provisions of the Application and the Agreement amount to a contract of adhesion finds little support. The overwhelming majority of cases suggest that the inclusion of arbitration provisions, such as the ones presently disputed, does not create an adhesion contract. See e.g. Seus v. John Nuveen Co., Inc., 146 F.3d 175, 184 (3d Cir. 1998); R.J. O'Brien Assoc., Inc. v. Pipkin, 64 F.3d 257, 261 (7th Cir. 1995); Dillard v. Merrill Lynch. Pierce. Fenner Smith, Inc., 961 F.2d 1148, 1155 (5th Cir. 1992);Adams v. Merrill Lynch. Pierce. Fenner Smith, Inc., 888 F.2d 696, 700 (10th Cir. 1989).
In Adams v. Merrill Lynch, Pierce, Fenner Smith, The Tenth Circuit reviewed the district court's order compelling arbitration of claims brought by investors against the broker-dealer alleging violation of securities laws, as well as breach of contract, fraud, and negligent management. 888 F.2d 696, 697 (10th Cir. 1989). Upholding the district court's order, the court reviewed the language of the arbitration provision at issue, which is materially the same as the provision in the present dispute. Id. Given the nearly identical terms combined with the similarity between the claims brought by Ritch to those brought by the plaintiff in Adams, we find the opinion particularly relevant to the dispute now before us.
Similarly, in Dillard v. Merrill Lynch, Pierce, Fenner Smith, Inc., the Fifth Circuit affirmed the district court's order compelling arbitration in yet another investor's claim against the securities broker-dealer. 961 F.2d 1148, 1161 (5th Cir. 1992). The court noted that adhesion contracts are not automatically void because a party must also establish unfairness as a second prerequisite to unconscionability of a contract. 961 F.2d at 1154. By way of explanation, the court quoted the Ninth Circuit's opinion in Cohen v. Wedbush, Noble, Cooke, Inc.: "The strong federal policy favoring arbitration, coupled with the extensive regulatory oversight performed by the SEC in this area, compel the conclusion that agreements to arbitrate disputes in accordance with SEC-approved procedures are not unconscionable as a matter of law." 841 F.2d 282, 286 (9th Cir. 1988).
Although Defendants have not cited binding precedent directly on point, we agree with their assertion that no contract of adhesion exists in the present case. We note that the Third Circuit's decision in Seus did not involve a dispute between an investor and a brokerage firm; it concerned a former employee's claims against her employer under Title VII and the ADEA. 146 F.3d at 177. The employee plaintiff had signed a Uniform Application for Securities Industry Registration that contained arbitration and compliance clauses, and the employer sought to enforce the clauses. The district court granted the motion to compel arbitration, and the Third Circuit affirmed. 146 F.3d at 177. The Seus court held that the specific arbitration clause was not unconscionable, based on the Supreme Court case Gilmer v. Interstate/Johnson Lane Corp., 500 U.S. 20, 111 S.Ct. 1647, 114 L.Ed.2d 26 (1991) (involving an ADEA claim governed by the arbitration provision of a registration agreement between an employee of a brokerage and the New York Stock Exchange). But the Seus court also upheld the district court's order compelling arbitration primarily because the plaintiff did not assert any unfairness, the second part of the test for unconscionability. See 146 F.3d at 184. The Seus opinion arguably stands for the general proposition that arbitration provisions on their own do not create adhesion contracts. That view, along with the more specific precedent from other circuits leads us to find that Ritch did not enter a contract of adhesion with Defendants.
We are not persuaded to reach a different conclusion by Kloss v. Edward D. Jones Co., a case cited by Ritch in which an investor, a 95-year-old widow, alleged violations of state securities laws, breach of contract, fraud, and negligence. 54 P.3d 1, 4 (Mont. 2002). Unlike the arbitration provision in that case, the terms that Ritch agreed to state that controversies will be arbitrated by commonly accepted securities entities, including the New York Stock Exchange, Inc., the American Stock Exchange, Inc., the National Association of Securities Dealers, Inc., or the Municipal Securities Rulemaking Board, according to the entities' rules then in force. (Ex. Attached to Pl.'s Compl.). Further, the investor may select which of the listed organizations will conduct the arbitration. Id. Likewise, we are not persuaded by Circuit City Stores, Inc. v. Adams, 279 F.3d 889 (9th Cir. 2002), which involved an employment dispute and not the claim of an investor, whose dealings with a broker would be subject to SEC rulemaking and regulatory oversight.
Accordingly, we find that the Application and Agreement between Ritch and Merrill Lynch are not contracts of adhesion.
2. The arbitration provisions do not contain terms unreasonably favorable to Defendants
Even assuming that the arbitration provisions created an adhesion contract, our decision would remain unchanged because the provisions are not unfair and do not unreasonably favor Merrill Lynch. First, Ritch argues that the terms are unfair because it will cost him approximately ten times more to arbitrate the claim than the $97.50 filing fee required by the Court of Common Pleas of Lehigh County, Pennsylvania. The Supreme Court has found no merit in arguments focused on "potentially substantial" arbitration costs. See Green Tree Financial Corp. v. Randolph, 531 U.S. 79, 80, 121 S.Ct. 513, 148 L.Ed.2d 373 (2000). Regardless, the possibility of a $1425 filing fee for arbitration in Ritch's case, (Pl.'s Mem. of Law in Opp. to Defs.' Mot., n. 3), is not so prohibitive as to make the Application and Agreement unfair. Ritch invested a substantial amount of money with Merrill Lynch. In addition, other litigation costs will undoubtedly raise Ritch's costs above $97.50 if he pursued this matter in court, so his comparison appears somewhat inaccurate.
Second, Ritch argues that the terms are unfair because arbitration will not avail him of the same discovery procedures as a court action, and third, because under NYSE Rule 620 and NASD Rule 10323, arbitrators are not bound by the same rule of evidence as a court. Neither of these arguments addresses the sort of substantive unfairness that would be necessary to overcome the strong federal policy and presumption in favor of arbitration. See Shearson/American Express, Inc. v. McMahon, 482 U.S. 220 (1987); Harris v. Green Tree Financial Corp., 183 F.3d 173, 178 (3d Cir. 1999).
In Harris, the Third Circuit held that an arbitration agreement remained enforceable, even though it appeared in fine print boilerplate on the back of a standard agreement. 183 F.3d at 182. The Application and Agreement involved in this dispute are no more difficult to read than the terms in Harris. In addition, Ritch has the option of choosing among several approved securities organizations to arbitrate his claim, where by contrast the plaintiff in Harris was limited to approving the defendant's selection for an arbitrator. Id. at 183.
The Fifth Circuit has determined that arbitration provisions similar to the ones before us now. In Webb v. Investacorp, Inc., the court affirmed an order compelling arbitration before an NASD panel. 89 F.3d 252, 260 (5th Cir. 1996). In affirming the district court, the court rejected the plaintiffs' arguments that the arbitration provision was unconscionable because the defendants added it to prior oral agreements, because the clauses were in fine print, and because the terms forced the plaintiffs to relinquish their rights to a court proceeding. 89 F.3d 259. Ultimately, the court held that the provision was not unconscionableId.; see also Surman v. Merrill Lynch, Pierce, Fenner Smith, 733 F.2d 59 (8th Cir. 1984) (rejecting investors' argument that provisions requiring mandatory arbitration were unconscionable). The agreement that Ritch voluntarily signed likewise forces him to relinquish remedies he would otherwise have. But the Application and Agreement explicitly state that discovery through arbitration is more limited. See (Ex. Attached to Pl.'s Compl.). All of the arguments raised by Ritch do not assert that he is being completely deprived of a remedy. Instead, he takes issue with the means of redress to which he previously agreed.
Accordingly, we find that the terms of the Application and Agreement between Ritch and Merrill Lynch are not unfair or unreasonably favorable to Merrill Lynch.
B. Whether the Arbitration Provisions are Part of a Fraudulent Scheme
Ritch claims that Defendants fraudulently induced him into entering agreements with arbitration provisions. But as Merrill Lynch maintains, Ritch's complaint does not specifically allege that he was fraudulently induced into agreeing to the arbitration provisions. Rather, it only claims that Defendants induced Ritch into making agreements that contained arbitration provisions. According to the Supreme Court's decision in Prima Paint Corp. v. Flood Conklin Mfg. Co., a plaintiff's allegation of fraud in the inducement of a contract containing an arbitration provision is an issue "properly adjudicated in arbitration." 388 U.S. 395, 404, 87 S.Ct. 1801, 18 L.Ed.2d 1270 (1967);see also Merritt-Chapman Scott Corp. v. Pennsylvania Turnpike Com'n, 387 F.2d 768, 771 (3d Cir. 1967) (following Prima Paint and holding that a general attack on a contract for fraud is to be decided under the applicable arbitration provision, unless a plaintiff alleges fraud in the inducement of the arbitration provision itself); Garten v. Kurth, 265 F.3d 136, 143 (2d Cir. 2001) (affirming an order compelling arbitration in the absence of fraud related to the arbitration clause itself).
If we assume for the sake of argument that Ritch has properly alleged a claim of fraud in the inducement of the arbitration provisions, he nevertheless remains obligated to arbitrate his claims. Ritch attempts to avoid the general policy favoring arbitration by relying on Moseley v. Electronic Missile Facilities, Inc., in which the Court held that arbitration is not mandated where an arbitration clause is part of a fraudulent scheme. 374 U.S. 167, 171 (1963). In Moseley, a contractor and subcontractor entered into a contract containing a broad arbitration clause. As the Court explained, "[f]raud in the procurement of an arbitration contract, like fraud in the procurement of any contract, makes it void and unenforceable and [we agree] that this question of fraud is a judicial one, which must be determined by a court." Id. at 172, 83 S.Ct. 1815.
Subsequent to Moseley, the Supreme Court decided Prima Paint Corp. v. Flood Conklin Mfg. Co., 388 U.S. 395, 404, 87 S.Ct. 1801, 18 L.Ed.2d 1270 (1967). In Prima Paint, the Court considered "whether the federal court or an arbitrator is to resolve a claim of `fraud in the inducement,' under a contract governed by the United States Arbitration Act of 1925." Id. at 396-97, 87 S.Ct. 1801. The Court held that the issue should be decided by the arbitrator because under 9 U.S.C. § 4, courts may not adjudicate "claims of fraud in the inducement of the contract generally." Id. at 404, 87 S.Ct. 1801. Courts differ in their interpretations of the effect of Prima Paint on Moseley. See Campaniello Imports, Ltd. v. Saporiti Italia, S.p.A, 117 F.3d 655, 667 (2d Cir. 1997) (holding that the rule of Moseley was limited by Prima Paint to situations involving a substantial relationship between the fraud and the arbitration clause in particular); Richards v. Lloyd's of London, 135 F.3d 1289 (9th Cir. 1998) (distinguishing the exception of Moseley from the general rule favoring arbitration); Garten v. Kurth, 265 F.3d 136 (2d Cir. 2001) (distinguishing the exception of Moseley from the general rule favoring arbitration); Hayes Children Leasing Co. v. NCR Corp., 43 Cal.Rptr.2d 650, 653-54 (Cal.Ct.App. 1995) (recognizing that Prima Paint overruled the earlier case).
Nevertheless, all of the courts that have commented on the two cases appear to recognize that "the only way to reconcile Prima Paint withMoseley is to require some substantial relationship between the fraud or misrepresentation and the arbitration clause in particular." Garten, 265 F.3d at 143 (citing Campaniello, 117 F.3d at 667). In Campaniello in particular, the court rejected the argument that a substantial relationship existed simply because the arbitration clause required the parties to arbitrate in Italy, where, the plaintiff argued, the law was more favorable to the defendant. 117 F.3d at 667. Ritch has made a similar argument, claiming that the arbitration provisions are part of a fraudulent scheme because he believes the forum for arbitration will be more favorable to the defendants. But Ritch has not established with sufficient specificity the requisite substantial relationship between the alleged fraud and the arbitration provisions that would bring his claims within the scope of Moseley. We accordingly find that the arbitration provisions now at issue are not part of a fraudulent scheme.
III. CONCLUSION
Ritch entered into the Application and Agreement, both containing arbitration provisions, with Merrill Lynch. Neither document creates an unconscionable contract, nor are the arbitration provisions part of a fraudulent scheme. Therefore, we will grant Defendants' Motion to Compel Arbitration and to Stay Proceedings pursuant to 9 U.S.C. § 3 4. An appropriate order follows.
ORDER
AND NOW, this 9th day of December, 2002, upon consideration of Defendants' Motion to Compel Arbitration and to Stay Proceedings, filed October 15, 2002, Plaintiff's Response to Defendants' Motion, filed November 12, 2002, and Defendants' reply thereto, filed December 3, 2002, consistent with the foregoing memorandum, it is hereby ORDERED that Defendants' Motion to Compel Arbitration and to Stay Proceedings is GRANTED and that Plaintiff must submit all claims contained herein to arbitration. It is further ORDERED that all further proceedings in this court are stayed pending the outcome of arbitration.