[*1]
Matter of Brean Capital LLC v NewOak Capital LLC
2014 NY Slip Op 51838(U) [46 Misc 3d 1203(A)]
Decided on December 22, 2014
Supreme Court, New York County
Kornreich, J.
Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431.
This opinion is uncorrected and will not be published in the printed Official Reports.


Decided on December 22, 2014
Supreme Court, New York County


In the Matter of the Application of Brean Capital, LLC, Petitioner, For an Order Staying Arbitration of a Certain Controversy

against

NewOak Capital LLC, Respondent.




651255/2014



Olshan Frome Wolosky LLP, for petitioner.



Pastore & Dailey, LLC, for respondent.


Shirley Werner Kornreich, J.

Petitioner Brean Capital, LLC (Brean) moves by order to show cause for an injunction staying a FINRA arbitration commenced against it by respondent NewOak Capital LLC (NewOak). Petitioner's motion is granted for the reasons that follow.



Procedural History & Factual Background



The facts recited, which are undisputed, are taken from the petition and the documentary evidence submitted by the parties.



The parties in this action, Brean and NewOak, each have similarly named non-party affiliates, one of which is a broker dealer and the other a financial advisory firm. The petitioner, Brean, is a broker dealer and a registered member of FINRA. Its affiliate advisory firm, non-party Brean Strategic Advisors, LLC (Brean S.A.), is not a FINRA member. The respondent, NewOak, is a financial advisory firm and is not a FINRA member. NewOak's broker dealer affiliate, non-party NewOak Capital Markets LLC (NewOak C.M.), is a FINRA member. Hence, in this action, FINRA-member Brean broker dealer is suing the NewOak advisory firm, which is not a FINRA member.



The parties and their affiliates are all involved in a FINRA arbitration (the Arbitration), which concerns four former NewOak employees (the Employees) who left the firm to work at [*2]non-party Brean S.A. in September 2013.[FN1] At NewOak, the Employees provided consulting services to banks and law firms on the valuation of structured financial products, for instance, in mortgage backed securities litigation. While at NewOak, the Employees signed FINRA arbitration agreements that apply, inter alia, to disputes over restrictive covenants in their employment contracts.[FN2]



Shortly thereafter, NewOak decided to commence a FINRA arbitration proceeding against: (1) the Employees for moving to Brean S.A.; (2) Brean S.A. for hiring the Employees; and (3) Brean for tortious interference. However, before commencing the Arbitration, on December 18, 2013, NewOak commenced a special proceeding under Article 75 for provisional orders in aid of arbitration. See NewOak Capital LLC v Brean Capital, LLC, Index No. 654351/2013. In that proceeding, NewOak moved by order to show cause for injunctive relief to enforce the Employees' restrictive covenants and to otherwise protect its trade secrets. On January 17, 2014, this court issued a temporary restraining order barring the Employees from soliciting business from NewOak's customers or providing Brean with NewOak's confidential information. See Index No. 654351/2013, Dkt. 14. After a hearing on February 6, 2014 [see Index No. 654351/2013, Dkt. 54 (2/6/14 Tr.)], this court granted NewOak's motion for a preliminary injunction. See Index No. 654351/2013, Dkt. 52. An order setting forth the full scope of the injunction was entered on April 18, 2014. See Index No. 654351/2013, Dkt. 59.



Meantime, on January 23, 2014, NewOak and NewOak C.M. commenced the Arbitration by filing a Statement of Claim with FINRA. In a letter dated January 27, 2014,[FN3] FINRA notified Brean of the Arbitration and took the position that Brean is "required by FINRA rules to arbitrate this dispute." In a letter dated February 10, 2014, FINRA clarified that Brean S.A. was only being served on a voluntary basis and is not "required to arbitrate this dispute"; however, the Arbitration is mandatory for Brean and the Employees. By letter to FINRA dated March 5, 2014, counsel for Brean and Brean S.A., the Olshan law firm, entered an appearance in the [*3]Arbitration for both Brean entities and took the position that the arbitration commencement materials, which FINRA had indicated were sent on January 27, 2014, were never received. They further took the position that: (1) Brean S.A. did not consent to the Arbitration; and (2) Brean was not subject to arbitration claims asserted by NewOak (as opposed to the claims asserted by NewOak C.M.) because NewOak, unlike NewOak C.M., is not a FINRA member nor are Brean and NewOak parties to an arbitration agreement. Counsel for the NewOak entities, the Pasotre law firm, responded in a letter dated March 6, 2014, disputing Brean's claim that it was not served and maintained that the Brean entities are subject to arbitration of NewOak's claims.



FINRA sent the parties another letter, dated April 11, 2014, in which it did not discuss the parties' jurisdictional arguments. Rather, FINRA stated that "your case is ready for the appointment of arbitrators" and went on to set forth how the Arbitration would proceed. NewOak understood the letter to mean that FINRA determined that all of the parties are subject to arbitration, other than Brean S.A. (pursuant to FINRA's February 11, 2014 letter), which is not a party to this action.



Thus, on April 23, 2014, Brean commenced the instant special proceeding seeking a stay of the claims NewOak has asserted in the Arbitration against it. Brean does not challenge any other aspect of the Arbitration. As discussed below, the issue in this case is whether the NewOak advisory firm, a non-FINRA member, is entitled to compel FINRA arbitration against the Brean broker dealer, a FINRA member and an affiliate of the Brean advisory firm to which the former NewOak employees went.



Discussion



The parties' briefs are unclear about whether this action is governed by New York law or the Federal Arbitration Act (the FAA), 9 USC § 2.[FN4] However, the applicable federal and New York law is basically the same, namely a liberal public policy in favor of arbitration, the principle that a party cannot be forced to arbitrate unless they agreed to do so by contract, and that the existence of an agreement to arbitrate is a question for a court, not the arbitrator. See Belzberg v Verus Inves. Holdings Inc., 21 NY3d 626, 630 (2013);[FN5] In re Am. Express Fin. [*4]Advisors Secs. Lit., 672 F3d 113, 127-28 (2d Cir 2011). Where, as here, the existence of an agreement to arbitrate before FINRA (or, as it was formerly known, the NASD)[FN6] turns on the interpretation of FINRA's rules, such rules should be construed with the usual contractual interpretation principles. Citigroup Global Markets Inc. v Abbar, 761 F3d 268, 274 (2d Cir 2014) ("The arbitration rules of an industry self-regulatory organization such as FINRA are interpreted like contract terms; the organization's arbitration provision should thus be interpreted to give effect to the parties' intent as expressed by the plain language of the provision'"), quoting Wachovia Bank, N.A. v VCG Special Opportunities Master Fund, Ltd., 661 F3d 164, 171 (2d Cir 2011), quoting Bensadoun v Jobe-Riat, 316 F3d 171, 176 (2d Cir 2003).



NewOak commenced the Arbitration asserting that Brean is subject to FINRA arbitration based on FINRA Rule 13200(a). That rule mandates arbitration of disputes that arise "out of the business activities of a member or an associated person AND is between or among: Members; Members and Associated Persons; or Associated Persons involving members' or associated persons of FINRA.'" Hawkins v Toussaint Capital Partners, LLC, 2010 WL 2158332, at *4 (SDNY 2010) (bold and capitalization added). "A member' of FINRA is any broker or dealer admitted to FINRA membership, and an associated person' is a "natural person who is registered or has applied for registration under the Rules of FINRA,' or is A sole proprietor, partner, officer, director, or branch manager of a member, or other natural person occupying a similar status or performing similar functions, or a natural person engaged in the investment banking or securities business who is directly or indirectly controlling or controlled by a member, whether or not any such person is registered or exempt from registration with FINRA under the By-Laws or the Rules of FINRA." Rusciano, 2014 WL 1677133, at *3.



It is undisputed that NewOak is neither a FINRA member nor an Associated Person of NewOak C.M. Ergo, Rule 13200(a) is not a valid basis to compel Brean to participate in the Arbitration. After this reality was made clear in Brean's opening brief, NewOak asserted, for the first time, that Brean was subject to mandatory FINRA arbitration under FINRA Rule 12200. That rule requires arbitration when "[t]he dispute is between a customer and a member or associated person of a member; AND "[t]he dispute arises in connection with the business activities of the member or the associated person." Citigroup, 761 F3d at 274 (bold and capitalization added). Hence, to compel Brean to arbitrate before FINRA, NewOak must establish that it is a "customer" and that the dispute regarding the Employees arose in connection with Brean's business activities.[FN7]



The parties dispute whether NewOak is a "customer" of Brean. As a threshold matter, the court notes that the principle of resolving ambiguities in favor of arbitration does not apply when the ambiguity goes to the threshold issue of the existence of an agreement to arbitrate, not the scope of an arbitration clause. For this reason, an ambiguity in the language of a FINRA rule is not dispositive. See Citigroup, 761 F3d at 274, citing Applied Energetics, Inc. v NewOak Capital Markets, LLC, 645 F3d 522, 526 (2d Cir 2011) ("While doubts concerning the scope of an arbitration clause should be resolved in favor of arbitration, the presumption does not apply to disputes concerning whether an agreement to arbitrate has been made"), accord Granite Rock [*5]Co. v Int'l Bd. of Teamsters, 561 US 287, 302 (2010) (in FAA cases, the presumption in favor of arbitrability should only be applied "where a validly formed and enforceable arbitration agreement is ambiguous about whether it covers the dispute at hand").



As for whether NewOak is a customer of Brean, the answer is clearly no. "The FINRA Code does not define customer,' except to say that a customer shall not include a broker or dealer.'" Citigroup, 761 F3d at 274. In the Second Circuit, "customer" must "be construed in a manner consistent with the reasonable expectations of FINRA members." Id., quoting Wachovia, 661 F3d at 171. Generally, "[t]he purchase of a good or service from a FINRA member creates a customer relationship." Citigroup, 761 F3d at 275. NewOak, however, proffers the argument that, because the FINRA code states that a "customer shall not include a broker or dealer", it therefore follows that a "customer" is everyone who is not a broker or dealer.



This argument has been expressly rejected by the First Department. See Sinclair & Co. LLC v Pursuit Inv. Mgmt. LLC, 74 AD3d 650 (1st Dept 2010) ("We reject the "argu[ment] that by negative inference [the FINRA] definition means a " customer' " is everyone who is not a broker or dealer"), quoting Fleet Boston Robertson Stephens, Inc. v Innovex, Inc., 264 F3d 770, 772 (8th Cir 2001). This argument was also recently rejected by the Second Circuit. See Citigroup, 761 F3d at 275.[FN8] The First Department held that "the word customer' [means] one involved in a business relationship with [a FINRA] member that is related directly to securities investment or brokerage services." Sinclair, 74 AD3d at 650. Simply put, the services must be "sufficiently investment-related to make defendant its customer for purposes of the FINRA rule requiring arbitration." Id. Under this standard, NewOak is not a customer of Brean because — and this is undisputed — Brean did not provide such services to NewOak.



Indeed, it makes sense that a consultancy that did not purchase the services of a broker dealer cannot compel the broker dealer to arbitrate before FINRA, especially when the arbitration has nothing to do with investment services. Here, the Arbitration is about whether NewOak can hold Brean liable for the Employees jumping ship from one consulting company to another. The Employees are not broker dealers; they advise clients on structured financial product valuation, often in the context of providing litigation advice, as opposed to investment advice. This is not ordinarily within FINRA's purview. The only reason FINRA is involved is because of the close corporate relationship between the Brean and NewOak entities (for obvious synergistic purposes, i.e., overlap of clients who need broker dealer and consulting services) and the Employees' contractual arbitration agreement with NewOak. The Employees, however, have no broker dealer relationship with either Brean entity nor do they have a contractual relationship with the Brean broker dealer.



Thus, the Brean broker dealer's desire to avoid FINRA arbitration on its tortious interference liability — which may well exist and will be litigated in this court — is understandable. That being said, efficiency militates in favor of a single, global arbitration to resolve the parties' conflict. However, as arbitration cannot be compelled absent contractual consent, efficiency is not a factor the court may consider. Moreover, there are genuine reasons [*6]why a litigant would prefer this court over even the most capable FINRA arbitrator. Even the best adjudicators make mistakes. Yet, judicial mistakes are correctible on appeal while an arbitrator's are not. See Hackett v Milbank, Tweed, Hadley & McCloy, 86 NY2d 146, 155-56 (1995); Campbell v NYCTA, 32 AD3d 350, 351-52 (1st Dept 2006) ("as long as arbitrators act within their jurisdiction, their awards will not be set aside because they have erred in judgment either upon the facts or the law. In short, an arbitration award cannot be vacated if there exists any plausible basis for it") (citation and quotation marks omitted).



Finally, NewOak's reliance on McMahan Secs. Co. v Forum Capital Markets L.P., 35 F3d 82 (2d Cir 1994) is misplaced. In McMahan, the Second Circuit held that:



A person who is neither a member nor an associated person is nevertheless appropriately joined in the arbitration where that party plays an active role in the securities industry, is a signatory to a securities-industry arbitration agreement (or is an instrument of another party to the arbitration), and has voluntarily participated in the particular events giving rise to the controversy underlying the arbitration.



Id. at 88. McMahan, as Brean correctly observes, was partially abrogated by subsequent Second Circuit precedent on the issue of whether "Associated Persons" are limited to natural persons (as noted earlier, now this is the case, which is why the parties, which are LLCs, cannot be Associated Persons). See Burns v NY Life Ins. Co., 202 F3d 616 (2d Cir 2000). However, NewOak correctly avers that McMahan's interpretation of "certain other" parties — the so-called "Sufficient Immersion" test[FN9] — was not abrogated in Burns or any other case. Indeed, New York federal and state courts have applied McMahan's Sufficient Immersion test to the NASD rules after Burns was decided. See, e.g., Kozlowski v NY Life Ins. Co., 13 AD3d 1227 (4th Dept 2004); CDC Capital Inc. v Gershon, 282 AD2d 217 (1st Dept 2001); Brownstone Inv. Group, LLC v Levey, 514 FSupp2d 536, 554 (SDNY 2007).



Nonetheless, the Sufficient Immersion test is not a basis to compel Brean to submit to arbitration of NewOak's claims. Even if the Sufficient Immersion test applies to Brean, this has no bearing on whether NewOak can compel Brean to arbitrate. The Sufficient Immersion test is simply an interpretation of the meaning of "certain others" that are permitted to participate in the arbitration at the insistence of a Member or Associated Person. See generally Marciano v MONY Life Ins. Co., 470 FSupp2d 518, 528-33 (ED Pa 2007); see Brownstone, 514 FSupp2d at 554 ("The Second Circuit has defined the term certain other' as [quoting the Sufficient Immersion test in McMahan]") (emphasis added). Additionally, while "certain others" are permitted to participate in FINRA/NASD arbitrations, it is well settled that "certain others" cannot compel arbitration. See World Group Secs. v Ko, 2004 WL 1811145, at *6 (ND Cal 2004) ("even if [defendant] were a certain other' under [NASD] Rule 10201, he could not compel arbitration"), accord Burns, 202 F3d at 620 ("One who is a certain other' may participate in a NASD arbitration, but is not a party who can compel arbitration under the NASD Code"). Simply put, the Sufficient Immersion test merely implicates the scope of permissive arbitration; it is not an independent basis to compel arbitration not otherwise mandated by Rules 12200 and 13200. See Kozlowski, 13 AD3d at 1227; Marciano, 470 FSupp2d at 535. As [*7]discussed earlier, NewOak cannot compel FINRA arbitration against Brean because NewOak is not a Member or Associated Person (under Rule 13200) nor is NewOak a customer of Brean (under Rule 12200). Accordingly, it is



ORDERED that Brean Capital, LLC's petition is granted, and the Clerk is directed to enter judgment staying the claims asserted by NewOak Capital LLC against Brean Capital, LLC in FINRA Arbitration No. 14-00212 (but not any other portion of that arbitration, the validity of which is not before the court).



Dated: December 22, 2014ENTER:



__________________________

J.S.C.

Footnotes


Footnote 1: Three of the Employees left on Friday, September 20, 2013. The fourth, their supervisor, left the next business day, on Monday, September 23, 2013. Brean S.A. was formed as a Delaware LLC on September 20, 2013, the day three of the Employees left NewOak. Brean S.A. allegedly is owned and controlled by the owners of Brean, and shares office space and resources with Brean.



Footnote 2: Such restrictive covenants prohibit the solicitation of clients, recruitment of employees, and disclosure of confidential information.

Footnote 3: NewOak's citation to the exhibits submitted with its opposition papers do not correspond to the documents e-filed on the NYSCEF system. For instance, the January 27, 2014 letter is cited in NewOak's brief as Exhibit E, but on the NYSCEF system, it is Exhibit F (Dkt. 18) and labeled as the February 10, 2014 letter. Exhibit E (Dkt. 17) is this court's April 18, 2014 injunction order.The February 10, 2014 letter is filed as Exhibit B (Dkt. 14), but is labeled as "Answer to the FINRA Statement of Claim." The court will not belabor the point, but other exhibits were also misfiled. NewOak's counsel is directed to promptly submit an affirmation to clarify which exhibits were filed under which docket entries and to correct the inaccuracies in the Affirmation of Joseph M. Pastore III, dated May 20, 2014 (Dkt. 12), regarding which documents correspond to which exhibit letters.

Footnote 4: This court has held that "arbitration in the securities industry is governed by the FAA." See GFI Brokers LLC v Bellard, 2013 WL 3771275, at *2 (Sup Ct, NY County 2013), accord Fletcher v Kidder, Peabody & Co., 81 NY2d 623, 630 (1993); see also Salvano v Merrill Lynch, Pierce, Fenner & Smith, Inc., 85 NY2d 173, 180 (1995) ("Under settled law, the arbitration of disputes concerning employment in the securities industry and the enforceability of the arbitration clause are governed by the [FAA]").



Footnote 5: The major proposition Belzberg stands for — that a nonsignatory to an agreement to arbitrate may be bound by such agreement when the nonsignatory receives a "direct" benefit from the agreement [id. at 631] — is inapplicable here. Brean may well receive indirect benefits from the Employees working for Brean S.A., but such benefits are insufficient under Belzberg to compel Brean to participate in the Arbitration. See Cammarata v InfoExchange, Inc., 2014 NY Slip Op 07774, at *1 (1st Dept Nov. 13, 2014) (no direct benefit where party "may have exploit[ed] the contractual relation of the parties, but not the agreement itself") (emphasis added), quoting Belzberg, 21 NY3d at 631.



Footnote 6: See Rusciano v Oppenheimer & Co., 2014 WL 1677133, at *2 (SDNY 2014).

Footnote 7: The court will not address whether the dispute arose in connection with Brean's business activities because, as set forth herein, NewOak is clearly not a customer of Brean.

Footnote 8: This argument, along with the notion that ambiguities in the FINRA rules are to be resolved in favor of arbitration, were once supported by the Second Circuit. See John Hancock Life Ins. Co. v Wilson, 254 F3d 48, 57-60 (2d Cir 2001). The Second Circuit has since rejected these holdings. See Citigroup, 761 F3d at 274-75.

Footnote 9: In McMahan, 35 F3d at 88, the court found an entity subject to arbitration because it was "sufficiently immersed in the underlying controversy for it to be considered a a certain other[]' party under § 8(a)."