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May 24, 1993


The opinion of the court was delivered by: BY THE COURT; EDWARD N. CAHN

 CAHN, C.J. May 24, 1993

 The plaintiffs, Dale B. Gouger and Carol Ann Gouger ["the Gougers"], initiated this suit against defendants Bear, Stearns & Co., Inc. ["Bear, Stearns"] and Ronald Diamond ["Diamond"]. Bear, Stearns is a registered securities broker-dealer and Diamond is one of its licensed brokers. The Gougers, who had opened an account at Bear, Stearns, claim that they sustained losses as a result of its improvident and excessive investments. The defendants have filed a motion to compel arbitration in accordance with Section 4 of the Federal Arbitration Act ["FAA"], 9 U.S.C. § 4, and the customer agreements that the parties executed. The Gougers, however, contend that the motion should be denied because the arbitration agreement was procured by fraud. After a review of the parties' briefs and consideration of the arguments made by their attorneys at the hearing held on May 14, 1993, this court concludes that the defendants' motion will be granted.

 The facts, insofar as they relate to the motion to compel arbitration, are undisputed. At Diamond's behest, Dale Gouger, a doctor who specializes in psychiatry, opened an account with Bear, Stearns in 1991. As part of that process, Dr. Gouger was required to execute a Customer Agreement. Approximately one year later he converted his account to a joint account with his wife, Carol. At that time, the Gougers signed another Customer Agreement. Both agreements specify that any disputes between the parties will be resolved through arbitration. Specifically, the clause states in pertinent part that

 ARBITRATION.. . . You agree and by maintaining an account for you Bear, Stearns agrees that controversies arising between you and Bear, Stearns concerning your accounts or this or any other agreement between you and Bear, Stearns whether entered into prior to, or subsequent to the date hereof, shall be determined by arbitration. Any arbitration under this agreement shall be held under the rules and auspices of the New York Stock Exchange, Inc., the American Stock Exchange, Inc. or the National Association of Securities Dealers, Inc. . . . The award of the arbitrators or of the majority of them shall be final and judgment upon the award rendered may be entered in any court, state or federal, having jurisdiction.

 The Customer Agreements also contain, separate from the arbitration clause, a choice of law provision. Specifically, it states that

 New York Law to Govern. This agreement shall be deemed to have been made in the State of New York and shall be construed, and the rights and liabilities of the parties determined in accordance with the law of the State of New York.

 Neither Diamond nor any other employee of Bear, Stearns explained to the Gougers the effect of these clauses. The Gougers invested a substantial sum of money into a personal account and an individual retirement account ["IRA"] at Bear, Stearns. *fn1" The Gougers contend that they suffered losses of approximately $ 180,000.00 and paid $ 200,000.00 in commissions to the defendants because the defendants churned *fn2" their account and made unsuitable investments. Despite the existence of the arbitration clause, the plaintiffs filed suit in this court. They seek inter alia, compensatory damages, punitive damages, attorneys fees, and costs. The defendants' Motion to Compel ensued.


 The Gougers urge that arbitration should not be compelled because the Customer Agreements that they executed were induced by misrepresentation and fraudulent non-disclosure. Specifically, they allege that Bear, Stearns did not explain the legal effect of the arbitration clause and the choice of law provision in the Customer Agreements. The "legal effect" that they refer to is that under New York law, arbitrators may not award punitive damages. See Garrity v. Lyle Stuart, Inc., 40 N.Y.2d 354, 353 N.E.2d 793, 794, 386 N.Y.S.2d 831 (N.Y. 1976) (cited in Barbier v. Shearson Lehman Hutton, Inc., 948 F.2d 117, 121, 122 (2d Cir. 1991); Fahnestock & Co., v. Waltman, 935 F.2d 512, 517-518 (2d Cir. 1991) (cert. denied U.S. , 116 L. Ed. 2d 331, 112 S. Ct. 380) (1991)).

 As a threshold matter, it must be determined whether the FAA governs the dispute in this case. The FAA does not cover all agreements to arbitrate. A federal district court must compel arbitration pursuant to 9 U.S.C. § 4 "only when [it] would have jurisdiction over a suit on the underlying dispute; hence, there must be diversity of citizenship or some other independent basis for federal jurisdiction before the order can issue." Moses H. Cone Memorial Hospital v. Mercury Construction Corp., 460 U.S. 1, 25 n.32, 74 L. Ed. 2d 765, 103 S. Ct. 927 (1983)). In this case, the court has subject matter jurisdiction because some of the claims are predicated on § 27 of the Securities Act of 1934, codified at 15 U.S.C. § 78aa. See 28 U.S.C. § 1331. Moreover, the parties are completely diverse, and the amount in controversy exceeds $ 50,000. See 28 U.S.C. § 1332. Accordingly, federal law must be used to determine whether the agreement to arbitrate shall be enforced. See Three Valleys Municipal Water District v. E.F. Hutton, 925 F.2d 1136, 1139 (9th Cir. 1991) (citing Moses H. Cone Memorial Hospital, 460 U.S. at 24). Indeed, both parties agree that the FAA is controlling. *fn3"

 Section 2 of the FAA, codified at 9 U.S.C. § 2 specifies that arbitration clauses in cases such as this "shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract." Furthermore, the "[Arbitration] Act leaves no place for discretion by a district court, but instead mandates that district courts shall direct the parties to proceed to arbitration on issues as to which an arbitration agreement has been signed." Dean Witter Reynolds Inc. v. Byrd, 470 U.S. 213, 218, 84 L. Ed. 2d 158, 105 S. Ct. 1238 (1985) (emphasis in the original) (construing 9 U.S.C. §§ 3,4). Accordingly, unless the Gougers demonstrate that the arbitration agreement is unenforceable, this matter must be stayed and the parties must proceed to arbitration.

 It is well-settled that a party to an agreement may avoid enforcement of an arbitration clause if it can be shown that the agreement to arbitrate was procured by fraud in the inducement. Mitsubishi Motors v. Soler Chrysler-Plymouth, 473 U.S. 614, 627, 87 L. Ed. 2d 444, 105 S. Ct. 3346 (1985); Southland Corp. v. Keating, 465 U.S. 1, 16 n.11, 79 L. Ed. 2d 1, 104 S. Ct. 852 (1984). If, however, the claim of fraud in the inducement pertains to the contract generally, the court is unable to adjudicate it. See Prima Paint Corp. v. Flood & Conklin Manufacturing Co., 388 U.S. 395, 404, 18 L. Ed. 2d 1270, 87 S. Ct. 1801 (U.S. 1967) ("a federal court may consider only issues relating to the making and performance of the agreement to arbitrate") (emphasis added). Limiting the court's scrutiny of fraud in the inducement claims to the agreement to arbitrate helps further the federal policy of favoring arbitration. Mercury Construction, 460 U.S. at 24. Additionally, such a policy does not leave the party ...

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