September 16, 2019

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Is Your Investment Adviser’s Arbitration Clause Enforceable?

Many investment advisers, such as SEC registered Investment Adviser Fisher Investments, use a boilerplate JAMS commercial arbitration clause in their Account Agreements with customers that include a Delaware choice-of-law provision. Whether or not the Account Agreement is enforceable might depend upon the way the arbitrator utilizes the choice-of-law provision. 

For example, an arbitrator’s dismissal or preclusion of a claimant’s non-Delaware state securities law claims would leave the claimant with no recourse for the alleged violation of state model securities laws since the Delaware Securities Act provides no private cause of action relating to or arising from investment advice, including unlawful or unregistered investment advice.  Indeed, the clear language of the civil liabilities section within the Delaware Securities Act[1] provides a private cause of action only for wrongful conduct in offering, selling or purchasing a security:

(a) Any person who:

(1) Offers or sells a security.

(2) Offers, sells or purchases a security.[2]

Let’s assume the claimant is from Missouri and included Missouri securities law claims in his or her Statement of Claim.  Missouri has adopted the 2002 Uniform Securities Act, more specifically Section 509 pertaining to civil liabilities.  According to Official Comment 6 of the Uniform Securities Act, Section 509(f) “was adopted in order ‘to establish civil liability for individuals who willfully violate [sections] dealing with fraudulent practices pertaining to advisory activities.’”  This comment further states that Section 509(f) is not “intended to limit other state law claims for providing investment advice.”  Therefore, Missouri includes a private cause of action for fraudulent or deceptive activities involving investment advice, analyses, and reports.

Delaware, on the other hand, has not adopted the 2002 Uniform Securities Act. Instead, Delaware has adopted a version of its predecessor, the 1956 Uniform Securities Act.  Chapter 6 Section 7323 of the Delaware Annotated Code closely follows the language of Section 410 of the 1956 Uniform Securities Act for civil liabilities.  However, the 1956 Act, unlike the 2002 Act, limits private causes of action to activities relating to the offer and sale of securities, not investment advisory activities.  Furthermore, Delaware legislative history amending Section 7323 reveals that the legislature drafted Section 7323 after the model statute proposed by NASAA’s “3005 Working Group,” which deals exclusively with revised definitions of investment advisers, not private causes of action.  This legislative history also explicitly states that the purpose of the amendment to Section 7323 is to eliminate a private cause of action for violations of stop orders, while creating private causes of action for “violations of 7311(b) (which prohibits representations that the Commissioner has passed upon filings made with him pursuant to the Delaware Securities Act), 7312 (which requires the filing of sales and advertising literature) and 7306(d) (which requires that an issuer provide a prospectus to an offeree at or near the time of the offer).”  The Delaware legislature did not intend to include a private cause of action for fraudulent or deceptive investment advisory activities.  Therefore, an investor cannot seek remedy under Delaware law for fraudulent or deceptive investment advice.

As a result, using a Delaware choice-of-law provision to bar a Claimant from asserting any other state securities law claims against the investment adviser for its wrongful conduct under the Delaware choice-of-law provision within an Account Agreement likely violates public policy. 

For the purposes of our discussion here, let’s assume the customer living in Missouri entered into an ACCOUNT AGREEMENT with an investment adviser here in Missouri.  First, consider that “Missouri has a very strong policy in favor of providing a judicial forum for the claims of investors under the blue-sky laws.[3]” Moreover, with regard to a claim under the Investment Advisers Act, the Supreme Court has held that language in an arbitration agreement that effectively deprives a claimant of statutory remedies violates public policy and is unenforceable.[4]  Consistent with the Supreme Court’s approach, the Eighth Circuit has held that arbitration agreements encompassing federal statutory claims are only enforceable so long as the parties can effectively vindicate their statutory rights through arbitration.[5]

The significant implications of applying Delaware law is not limited to a Claimant’s securities law claims.  Consider, for example, state consumer fraud or unlawful merchandising claims.  The Delaware Consumer Fraud Act does not provide the substantial remedies provided by the Missouri Unlawful Merchandising Act.  And both Missouri and the Eighth Circuit have recognized that "the public policy involved in Chapter 407 [MMPA] is so strong that parties will not be allowed to waive its benefits."[6]

In DeOrnellas v. Aspen Square Management, Inc.[7], the plaintiffs argued in relevant part that the choice-of-law provision within the mandatory arbitration clause at issue—which required the arbitrator to apply federal or Massachusetts law—would operate to deny them the remedies afforded under a certain Michigan statute.[8]  In its opinion, the Eastern District of Michigan noted that “[i]f that were the inevitable result, the arbitration agreement likely would violate public policy and would be unenforceable.”[9]  The court relied upon and cited Mitsubishi Motors Corp. v. Soler Chrysler Plymouth, Inc., wherein the Supreme Court held that if a choice-of-law provision operated “as a prospective waiver of a party’s right to pursue statutory remedies…we would have little hesitation in condemning the agreement as against public policy.”[10] 

Federal district courts must apply the choice-of-law rules of the state in which they sit when jurisdiction is based on diversity of citizenship.[11]  Notably, Missouri has adopted Section 187 of the Restatement (Second) of Conflicts, which provides in pertinent part as follows:

[t]he law of the state chosen by the parties to govern their contractual rights and duties will be applied, unless either

(a) the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties' choice, or

 (b)   application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue…

With regard to subsection (b) above, Missouri clearly has a materially greater interest than Delaware in our hypothetical.  Specifically, the Claimant has resided in Missouri at all times relevant and has sustained all damages in Missouri.  Also, the execution of the ACCOUNT AGREEMENT occurred in Missouri.  Moreover, all of the marketing materials would have been mailed to the claimant in Missouri.  Finally, the Missouri Securities Act forbids the enforcement of a choice-of-law provision within an arbitration agreement that operates to waive a cause of action under the statute.  Specifically, the Missouri Securities Act contains the following provision:

A condition, stipulation, or provision binding a person purchasing or selling a security or receiving investment advice to waive compliance with this act or a rule adopted or order issued under this act is void.[12]

Indeed, the plain language of Section 409.5-509(l) indicates that an arbitrator’s use of a Delaware choice-of-law provision to circumvent Section 409.5-509 and preclude Missouri securities claims operates to void the entire arbitration clause under Missouri law, including the choice-of law provision.  Notably, Section 409.4-509(l) is not simply directed at arbitration clauses in violation of federal jurisprudence.

Moreover, as discussed above, “Missouri has a very strong policy in favor of providing a judicial forum for the claims of investors under the blue-sky laws.”[13]  Importantly, in Corcoran, the parties entered into an agreement in Missouri for the purchase and sale of securities.  Although the agreement was executed in Missouri, it provided in relevant part that “[t]his agreement and its enforcement shall be construed and governed by the laws of the state of New York.”[14]  The plaintiffs subsequently brought suit against the defendants under Missouri’s blue-sky laws and the defendants sought to apply New York law pursuant to the agreement.[15]  On appeal, the Missouri Court of Appeals found “the application of New York law to be contrary to [Missouri’s] fundamental policy regarding statutory protection of investors in securities transactions.”[16]  The court ultimately held that Missouri law applied despite the parties’ choice-of-law provision, and that compulsory arbitration clauses for such claims are unenforceable in Missouri.   

As to claims under the Missouri Merchandising Practices Act (“MMPA”), the language of the MMPA is very broad in scope, thus demonstrating “the [Missouri] legislature’s clear policy to protect consumers.”[17]  Both Missouri and the Eighth Circuit have recognized that "the public policy involved in Chapter 407 [MMPA] is so strong that parties will not be allowed to waive its benefits."[18]  In Huch, the Missouri Supreme Court clearly set forth the importance of the MMPA in protecting Missouri consumers:

. . . . Chapter 407 is designed to regulate the marketplace to the advantage of those traditionally thought to have unequal bargaining power as well as those who may fall victim to unfair business practices. Having enacted paternalistic legislation designed to protect those that could not otherwise protect themselves, the Missouri legislature would not want the protections of Chapter 407 to be waived by those deemed in need of protection. Furthermore, the very fact that this legislation is paternalistic in nature indicates that it is fundamental policy: "a fundamental policy may be embodied in a statute which ... is designed to protect a person against the oppressive use of superior bargaining power."

 * * *

The Missouri statutes in question, relating to merchandising and trade practices [MMPA], are obviously a declaration of state policy and are matters of Missouri's substantive law. To allow these laws to be ignored by waiver or by contract, adhesive or otherwise, renders the statutes useless and meaningless.[19]

 The Delaware Consumer Fraud Act lacks most of the benefits (substantial remedies) of the Missouri Unlawful Merchandising Act.  As such, the dismissal of a claimant’s Missouri consumer claims would seemingly violate Huch and Electrical and Magneto Service Co.

With regard to a customer’s federal securities claim, the Investment Advisers Act contains a provision nearly identical to the anti-waiver provision within the Missouri Securities Act:

Any condition, stipulation, or provision binding any person to waive compliance with any provision of this title or with any rule, regulation, or order thereunder shall be void.[20]

Accordingly, 15 U.S.C. § 80b-15(a) forbids the use of a choice-of-law provision to cAccount Agreementk a federally-registered investment advisor with immunity.  The United States Supreme Court has held that 15 U.S.C. § 80b-15(b) “fairly implies a right to specific and limited relief in federal court.”[21]  In addition, the plain language of Section 80b-15(a) mandates that if an arbitrator enforces the Delaware choice-of-law provision to preclude a customer’s federal securities claim under the Act—thereby waiving compliance by the adviser with the provisions of the Investment Advisers Act—the entire arbitration clause is voided under federal law, including the choice-of law provision. 

Importantly, Missouri courts have acknowledged that in some instances, where an arbitration clause is so prohibitive as to effectively deprive a party of his or her statutory rights, the arbitration agreement may be invalidated.[22]  Similarly, the Supreme Court has held that language in an arbitration clause that effectively deprives a claimant of statutory remedies violates public policy and is unenforceable.[23]  Consistent with Missouri’s and the Supreme Court’s approach, the Eighth Circuit has held that arbitration clauses encompassing federal statutory claims are only enforceable so long as the parties can effectively vindicate their statutory rights through arbitration.[24]

“The right to compel arbitration arises from the parties' contract and, as with other contractual rights, is subject to waiver.  Such waiver may be express or implied from the parties' conduct.”[25]  To establish waiver, the non-waiving party must show that the opposing party’s conduct resulted in prejudice to the non-waiving party.[26]  Courts find prejudice “where a party's actions deprive the non-waiving party of benefits of the arbitration agreement, such as the ‘efficient and low-cost resolution of disputes.’”[27]  The Missouri Court of Appeals recently made clear that “a failure by a party to proceed to arbitrate in the manner…provided in the arbitration provision is a waiver of the right to insist on arbitration as a defense to an action on the contract.[28]  More specifically a party’s refusal to abide by an arbitration forum’s rules or cooperate in the arbitration proceedings, thereby leaving the opposing party with no option other than to re-file in court, constitutes a waiver of that party’s right to enforce the underlying arbitration clause.[29] 

Importantly, the U.S. Supreme Court has recognized that “the existence of large arbitration costs could preclude a litigant…from effectively vindicating her federal statutory rights in the arbitral forum.”[30]  When evaluating arbitration costs, the Sixth Circuit Court of Appeals has held that “the court must evaluate the likely cost of arbitration not in absolute terms, but relative to the likely costs of litigation.”[31] 

The U.S. Supreme Court, in Lowe v. Securities and Exchange Comm’n, made clear the duties of investment advisers—such as Defendant Fisher Investments—under the Investment Advisers Act.  Specifically, in Lowe, the Supreme Court noted that “[t]he aim of the [Investment Advisers Act] is the protection of the investing public against fraud or manipulation on the part of advisers.”[32]  The Supreme Court acknowledged that:

Clients trust in investment advisers, if not for the protection of life and liberty, at least for the safekeeping and accumulation of property.  Bad investment advice may be a cover for stock-market manipulations designed to bilk the client for the benefit of the adviser; worse, it may lead to ruinous losses for the client.  To protect investors, the Government insists, it may require that investment advisers, like lawyers, evince the qualities of truth-speaking, honor, discretion, and fiduciary responsibility.[33]

 

            Moreover the Supreme Court in Lowe opined that:

[P]etitioners’ publications do not fit within the central purpose of the [Investment Advisers Act] because they do not offer individualized advice attuned to any specific portfolio or to any client’s particular needs.[34]

 

            In addition to the deprivation of constitutional and statutory rights, an arbitration clause within an otherwise binding Account Agreement might also be considered unconscionable and therefore unenforceable.  Importantly, this issue is directly within the state or federal courts’ jurisdiction and cannot be decided by the arbitrator.  Indeed, it is well-established that:

. . . . where a party specifically challenges arbitration provisions as unconscionable and hence invalid, whether the arbitration provisions are unconscionable is an issue for the court to determine, applying the relevant state contract law principles. This rule applies even where the agreement's express terms delegate that determination to the arbitrator. We hold that where, as here, an arbitration agreement delegates the question of the arbitration agreement's validity to the arbitrator, a dispute as to whether the agreement to arbitrate arbitrability is itself enforceable is nonetheless for the court to decide as a threshold matter.[35]

Whether the parties have a valid arbitration agreement at all, and whether the specific dispute falls within the scope of that agreement, are for the court, not the arbitrator, to decide.[36] 

The Eighth Circuit is clear that an agreement or any part of an agreement will be deemed unenforceable if the court finds the agreement or portion thereof to be unconscionable.[37]  The test for unconscionability is “whether one of the parties lacked a meaningful choice about whether to accept the provision in question and the challenged provision[[38]] or the contract unreasonably favors the other party to the contract.[[39]]”[40]  The two aspects—procedure and substance—should be considered together, “so that if there exists gross procedural unconscionability then not much be needed by way of substantive unconscionability and vice versa.”[41] 

            In determining whether an arbitration clause is procedurally unconscionable, courts must examine the contract formation process to determine whether the agreement constitutes a contract of adhesion.[42]  When evaluating the contract formation process, courts take into account the following pertinent factors, among others:

a.       Whether one party has a superior bargaining position;

 

b.      Whether the party with the inferior bargaining position had an opportunity in the ordinary course for negotiation, or whether the agreement was presented on a take-it-or-leave it basis;

 

c.       Whether the party with the superior bargaining position engaged in high-pressure sales tactics to coerce the inferior party into executing the agreement;

 

d.      Whether the terms of the arbitration clause are in easily readable, as opposed to being in fine print; and

 

e.       Whether the arbitration clause is set forth in a conspicuous manner, such as by being introduced with a boldfaced heading and containing all-uppercase font.[43]

 

In determining whether an arbitration clause is substantively unconscionable, courts consider the terms of the provision itself.[44]  Courts take into account “the totality of the circumstances on an objective basis, considering the reasonable expectations of the average person entering into such an agreement.”[45] In essence, courts look to whether the arbitration clause is “inherently unfair or oppressive.”[46]  

In sum, attorneys representing investment advisory customers who signed an Account Agreement that includes a Delaware choice-of-law provision should evaluate the enforceability of that agreement and the operation of its choice-of-law provision in order to provide effective and thorough representation. 

 

[1] 6 Del. C. § 7323.

[2] See 6 Del. C. § 7317(a).  (emphasis added).

[3] State ex rel. Geil v. Corcoran, 623 S.W.2d 555, 556 (Mo. App. E.D. 1981) (subsequently cited by the 8th Circuit Court of Appeals in Electrical and Magneto Service Co. v. AMBAC International Corp., 941 F.2d 660 (8th Cir. 1991)).

[4] Mitsubishi Motors Corp. v. Soler Chrysler Plymouth, Inc., 473 U.S. 614, 637, n. 19 (1985). 

[5] EEOC v. Woodmen of the World Life Ins. Society, 479 F.3d 561, 565 (8th Cir. 2006) (citing Green Tree Fin. Corp.-Ala. V. Randolph, 531 U.S. 79, 90 (2000)). 

[6] Huch, 290 S.W.3d at 725 (emphasis added) (citing Electrical and Magneto Service Co., 941 F.2d 660, 664 (8th Cir. 1991)).

[7] 295 F. Supp. 2d 753 (E.D. MI. 2003).

[8] Id. at 760. 

[9] Id. (emphasis added). 

[10] Id.

[12] See Mo. Rev. Stat. § 409.5-509(l).

[13] State ex rel. Geil v. Corcoran, 623 S.W.2d 555, 556 (Mo. App. E.D. 1981) (subsequently cited by the 8th Circuit Court of Appeals in Electrical and Magneto Service Co. v. AMBAC International Corp., 941 F.2d 660 (8th Cir. 1991)). 

[14] Id at 555. 

[15] Id. at 555-56.

[16] Id. at 556.

[17] Huch v. Charter Communications, 290 S.W.3d 721, 724-25 (Mo. 2009); See also Whitney v. Alltel Communications, Inc., 173 S.W.3d 300, 314 (Mo. App. W.D. 2005) (holding that an arbitration clause was substantively unconscionable because it had the effect of stripping consumers of “the protections afforded to them under the MMPA and unfairly allow[ed] companies…to insulate themselves from the consumer protection laws of this State [Missouri]”). 

[18] Huch, 290 S.W.3d at 725 (emphasis added) (citing Electrical and Magneto Service Co., 941 F.2d 660, 664 (8th Cir. 1991)).  

[19] Huch, 290 S.W.3d at 725-26 (citing Electrical and Magneto Service Co., 941 F.2d at 664).

[20] See 15 U.S.C. § 80b-15(a).

[21] Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979) (emphasis added). 

[22] Whitney v. Alltel Communications, Inc., 173 S.W.3d 300, 311 (Mo. App. W.D. 2005).

[23] Mitsubishi Motors Corp. v. Soler Chrysler Plymouth, Inc., 473 U.S. 614, 637, n. 19 (1985). 

[24] EEOC v. Woodmen of the World Life Ins. Society, 479 F.3d 561, 565 (8th Cir. 2006) (citing Green Tree Fin. Corp.-Ala. V. Randolph, 531 U.S. 79, 90 (2000)).

[25] Fisher Investments, Inc. v. Casper, 2009 WL 27338, at *3-4  (Cal. App. 4 Dist. Jan. 6, 2009). 

[26] See Boulds v. Dick Dean Economy Cars, Inc., 300 S.W.3d 614, 620 (Mo. App. E.D. 2010); Ritzel Communications, Inc. v. Mid-American Cellular Telephone Co., 989 F.2d 966, 969 (8th Cir. 1993). 

[27] Boulds, 300 S.W.3d at 620. 

[28] Id. at 619. 

[29] Id. at 621.

[30] Green Tree Fin. Corp.-Ala. V. Randolph, 531 U.S. 79, 90 (2000).

[31] Cooper v. MRM Investment Co., 367 F.3d 493, 511 (6th Cir. 2003).

[32] 472 U.S. 181, 219 (1985). 

[33] Id. at 229.

[34] Id. at 208.

[35] Jackson v. Rent-A-Center West, Inc., 581 F.3d 912, 918-19 (9th Cir. 2009) (emphasis added); See also Estate of Burford ex rel. Bruse v. Edward D. Jones & Co., L.P., 83 S.W.3d 589, 592 (Mo. App. W.D. 2002); Monex Deposit Co. v. Gilliam, 671 F.Supp.2d 1137, 1139-40 (C.D. Cal. 2009). 

[36] Express Scripts, Inc. v. Aegon Direct Marketing Services, Inc., 516 F.3d 695, 699-700 (8th Cir. 2007).

[37] See Cicle v. Chase Bank USA, 583 F.3d 549, 554 (8thCir. 2009). 

[38] Procedural unconscionability.

[39] Substantive unconscionability.

[40] Id. 

[41] Id.

[42] See Cicle, 583 F.3d at 554.

[43] See id. at 554-55.

[44] See Cicle 583 F.3d at 554. 

[45] Id. 

[46] Spurlock v. Life Ins. Co. of Va., 2000 WL 1785300, at *10 (M.D. Ala. Oct. 31, 2000).

 

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About this Author

David Cosgrove, Managing Partner, Financial and regulatory lawyer, Cosgrove Law Group
Managing Partner

Mr. Cosgrove represents financial professionals and entities throughout the nation.  He has obtained over $8 million in Awards and settlements for his adviser clients in U-5/tortious interference cases in just the last 7 years.  He also assists advisers and broker-dealers with regulatory inquiries, investigations, and audits.  Beyond the financial industry, he is an award winning trial attorney with a focus on commercial, defamation, and serious injury litigation.

Some of these results include:

  • Obtained over $3.3 million for an investment adviser and...
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