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Olde Discount Corp. v. Tupman

filed: July 30, 1993.


On Appeal from the United States District Court for the District of Delaware. (D.C. Civil No. 92-00498).

Before: Greenberg, Nygaard, and Rosenn, Circuit Judges.

Author: Greenberg

GREENBERG, Circuit Judge.

This case presents a novel question of the relationship between a contracting party's right to enforcement of an arbitration agreement under the Federal Arbitration Act, 9 U.S.C. §§ 1-16 (FAA), and a state's interest in pursuing a remedy of rescission in an administrative proceeding. The district court enjoined the Delaware securities commissioner from seeking rescission on behalf of two investors who had entered into a predispute arbitration agreement. We will affirm the district court's order. Judge Greenberg votes to affirm on the grounds that the FAA preempts Delaware's rescission remedy in these circumstances and this opinion reflects the reasons why he has reached this Conclusion. Judge Rosenn votes to affirm on the ground that the rescission remedy is barred by reason of contract law as set forth in his separate Concurring opinion. Judge Nygaard Dissents on this issue for the reasons set forth in his separate opinion. We unanimously hold that this claim, i.e., that a state statute is preempted to the extent it authorizes relief in conflict with rights secured by the FAA, necessarily falls within an exception to the abstention doctrine of Younger v. Harris, 401 U.S. 37, 91 S. Ct. 746, 27 L. Ed. 2d 669 (1971).


Appellee Olde Discount Corporation, a securities broker-dealer, is a Michigan corporation with its principal place of business in Detroit and numerous offices throughout the United States. Olde Discount is registered in Delaware as a broker-dealer and has an office in Wilmington. Appellants Eugene and Carol Engelhardt are former customers of Olde Discount. The Engelhardts, then Michigan residents, opened a brokerage account with Olde Discount's Detroit office in 1983. When they moved to Wilmington in 1986, the Engelhardts transferred their account to its Wilmington office.

Olde Discount is primarily, as its name implies, a discount broker. It also makes a market in a few selected stocks; at the times relevant to this action, Second National Federal Savings Bank (SNFS) was among those stocks. Allegedly at the instance of Olde Discount's Wilmington office manager, Michael Donohoe, the Engelhardts purchased 5,000 shares of SNFS stock on May 15, 1990. On May 25, 1990, the Engelhardts signed an account agreement with Olde Discount that required them "to submit any and all controversies or claims arising out of the relationship established by this agreement to arbitration to be conducted according to the rules and procedures of the New York Stock Exchange, Inc. (NYSE) or of the National Association of Securities Dealers, Inc. (NASD) . . . ." Investors Account Agreement, P 18, J.A. at 53. Also on May 25, 1990, the Engelhardts provided Olde Discount with a "customer preference profile" that expressed their interest in "aggressive" investments for the purposes of "growth" and "speculation." J.A. at 48. On June 6, 1990, the Engelhardts purchased an additional 5,000 shares of SNFS. Thus, by early June 1990, the Engelhardts had purchased 10,000 shares of SNFS. These purchases cost the Engelhardts over $50,000.

The price of SNFS stock declined steadily during the summer and fall of 1990, as the bank suspended its dividend and came under the scrutiny of federal regulators because it failed to fulfill capital requirements. The Engelhardts, apparently because of their bad experience with this investment, terminated their Olde Discount brokerage account and removed their SNFS shares from Olde Discount on September 6, 1990. By then the Engelhardts' SNFS stock had declined in value to approximately $32,500.

Nearly a year later, in July 1991, the Engelhardts first contacted the Division of Securities of the Delaware Department of Justice with a complaint about their purchase of SNFS stock from Olde Discount. The Division, primarily through appellant Michael Tupman, a Delaware Deputy Attorney General responsible for securities law enforcement, investigated the Engelhardts' complaint. In early June 1992, after the Division substantially had completed its investigation, it sent Olde Discount a draft "Notice of Intent to Suspend or Revoke Broker-Dealer Registration." The draft Notice of Intent alleged that Olde Discount and its agent Donohoe had engaged in fraudulent and unethical practices in connection with the sales of SNFS stock to the Engelhardts, in violation of Del. Code Ann. tit. 6, §§ 7303(2) and 7316(a) (1974 & Supp. 1992).

In particular, the Notice asserted that Donohoe repeatedly had urged the Engelhardts to invest in SNFS and had made false statements of material fact about the stock. Further, the Notice alleged that Olde Discount had not kept the Engelhardts advised of information that could have been pertinent to their decision whether to hold or sell the stock. The Notice indicated that the Delaware securities commissioner sought the remedies of suspension or revocation of Olde Discount's broker-dealer registration and imposition of fines; and, central to the preemption question in this case, that the commissioner would seek rescission of the SNFS stock transactions between Olde Discount and the Engelhardts, as authorized by Del. Code Ann. tit. 6, § 7325(b). The Notice, however, did not suggest that either Olde Discount or Donohoe had violated any duty to customers other than the Engelhardts; the Notice thus proposed individual relief for the Engelhardts only.

During the summer of 1992, the Division of Securities and Olde Discount tried to negotiate a settlement of the proposed charges. Ultimately Olde Discount, desiring to bring the settlement negotiations to fruition, offered to pay $15,000 to the Delaware Investors Protection Fund and to pay $20,375 to the Engelhardts.*fn1 The proposed payment to the Engelhardts represented the difference between the total price they had paid for the SNFS stock, and its value of approximately $32,500 on September 6, 1990, when the Engelhardts had closed their brokerage account with Olde Discount.

The appellants do not dispute that Tupman agreed in principle to accept $15,000 in partial settlement of the Division's proposed charges. Nevertheless, Tupman insisted that Olde Discount also must rescind the Engelhardts' SNFS purchases. This demand was not acceptable to Olde Discount, which apparently had consistently maintained that the securities commissioner could not properly pursue a rescission, because Olde had a contractual right to arbitrate the Engelhardts' claims. Tupman, however, viewed Olde Discount's claims of its contractual right to arbitration and of the federal preemption of Delaware's rescission remedy as "baffling." See Tupman's August 7, 1992 letter to Olde Discount, J.A. at 111. He consequently would not abandon the demand that it rescind the SNFS sales to the Engelhardts.

Olde Discount determined to pursue its right to arbitration, and served the Engelhardts with a demand to arbitrate on August 5, 1992. Shortly thereafter, on August 17, 1992, Tupman issued the Notice of Intent in substantially the same form as the June 1992 draft, i.e., including the demand for rescission of the Engelhardts' SNFS transactions. Notice of Intent, P 43, J.A. at 139. The Notice provided that Olde Discount would be entitled to a hearing before the Delaware securities commissioner if it made a written request within 30 days. However, if Olde Discount did not request a hearing, the allegations would be deemed admitted and the commissioner would issue a final order of suspension, revocation, rescission, fine and/or costs.

On August 25, 1992, Olde Discount commenced this action against Tupman, Delaware Securities Commissioner Richard W. Hubbard, and the Engelhardts. The complaint's four counts alleged that: (1) the rescission remedy of Del. Code Ann. tit. 6, § 7325(b), as applied by the defendants, circumvents Olde Discount's rights under the FAA and thus violates the Supremacy Clause; (2) the application of Del. Code Ann. tit. 6, § 7325(b), to Olde Discount's transactions with the Engelhardts in SNFS stock would constitute an ex post facto punishment in violation of the Due Process Clause;*fn2 (3) Tupman and Hubbard had violated 42 U.S.C. § 1983 by employing the Delaware securities laws in a manner that impaired Olde Discount's federal constitutional and statutory rights; and (4) Tupman's actions constituted a common law abuse of process. Olde Discount sought an injunction, a declaratory judgment, compensatory damages, and punitive damages.

Olde Discount most immediately was concerned with preserving its federal right to arbitration of the Engelhardt dispute. It therefore vigorously pressed for a preliminary injunction to halt further proceedings before the Delaware Division of Securities. After expedited briefing and argument, the district court, by order dated September 16, 1992, accompanied by a comprehensive memorandum opinion, partially granted Olde Discount's motion for preliminary relief, enjoining "the Securities Commissioner[] [from pursuing] a rescission action under [Del. Code Ann. tit. 6, § 7325(b)] on behalf of defendants Engelhardt, individual investors who are parties to a predispute arbitration agreement with plaintiff, which agreement is enforceable under the Federal Arbitration Act, 9 U.S.C. § 2." In its opinion, the district court determined that the FAA preempted the Delaware rescission remedy. Furthermore, the district court declined to abstain under Younger from issuing injunctive relief. Tupman, Hubbard, and the Engelhardts jointly appealed from the September 16, 1992 order, contending that the district court "erred as a matter of law" both in declining to abstain under Younger and in holding that the rescission remedy was preempted.


Before turning to the merits of the preemption and abstention issues, we must resolve a challenge to our jurisdiction raised by Olde Discount. It argues that the appeal is from an interlocutory order "directing arbitration to proceed," which is specifically nonappealable under 9 U.S.C. § 16(b)(2). However, contrary to Olde Discount's characterization, the district court's order in this case is not an order "directing arbitration to proceed." Rather, the district court directed the Delaware securities commissioner not to pursue a remedy of rescission in the administrative proceedings. Thus, the order falls within the usual rule of 28 U.S.C. § 1292(a)(1), which permits immediate appeals from "interlocutory orders

Our review of a determination regarding preliminary injunctive relief is limited to examining whether the district court abused its discretion, committed an obvious error in applying the law, made a clear mistake in considering the proof, or improperly applied the law to the facts. Kreimer v. Bureau of Police of Morristown, 958 F.2d 1242, 1250 n.9 (3d Cir. 1992); Philadelphia Marine Trade Ass'n v. Local 1291, Int'l Longshoremen's Ass'n, 909 F.2d 754, 756 (3d Cir. 1990), cert. denied, 498 U.S. 1083, 111 S. Ct. 953, 112 L. Ed. 2d 1041 (1991). This standard requires a plenary review here, as the appellants contend that the district court erred as a matter of law in entering the injunction. We also exercise plenary review over the abstention question because we are resolving that issue by making a legal determination. General Glass Indus. Corp. v. Monsour Medical Found., 973 F.2d 197, 200 (3d Cir. 1992); Gwynedd Properties, Inc. v. Lower Gwynedd Township, 970 F.2d 1195, 1199 (3d Cir. 1992).


The Supremacy Clause allows Congress to preempt state legislation if it so intends.*fn3 See United States Dep't of Treasury v. Fabe, 124 L. Ed. 2d 449, 61 U.S.L.W. 4579, 113 S. Ct. 2202 (U.S. June 11, 1993). The development of the law of federal preemption has defined three ways of discerning a congressional intent to preempt state law: express or explicit preemption, implied preemption, or "actual conflict" preemption. The Supreme Court thus has differentiated among the three types of preemption:

Congress explicitly may define the extent to which its enactments pre-empt state law

Schneidewind v. ANR Pipeline Co., 485 U.S. 293, 299-300, 108 S. Ct. 1145, 1150-51, 99 L. Ed. 2d 316 (1988) (citations omitted).

The preemption claim before us is that the FAA demands enforcement of an agreement to arbitrate which cannot be abrogated by a state agency's pursuit of an administrative remedy that would duplicate the remedy sought in an arbitration. Section 2 of the FAA, 9 U.S.C. § 2, directs the enforcement of arbitration agreements as broadly as Congress' powers under the Commerce Clause permit:

A written provision in . . . a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction, or the refusal to perform the whole or any part thereof, or an agreement in writing to submit to arbitration an existing controversy arising out of such a contract, transaction, or refusal, shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.

Olde Discount contends that the FAA's directive compels enforcement of the arbitration clause of the Engelhardts' account agreement. Thus, if the Delaware securities commissioner pursues rescission in the administrative proceeding, Olde Discount's federal right to arbitration would be impaired, as the merits of the claim that the arbitration agreement reserves for an arbitral forum will be resolved administratively.

Yet it is clear that the FAA does not explicitly preempt any particular remedy that might be sought in state administrative proceedings. Nor does the FAA entirely occupy the field of securities regulation so as to give rise to implied preemption; to the contrary, both the Securities Act of 1933 and the Securities Exchange Act of 1934 specifically preserve the traditional rights of the states to regulate securities transactions within their own jurisdictions. See, e.g., 1933 Act, 15 U.S.C. § 77r ("nothing in this subchapter shall affect the jurisdiction of the securities commission . . . of any State or Territory . . . over any security or any person"); 1934 Act, 15 U.S.C. § 78bb(a) ("nothing in this chapter shall affect the jurisdiction of the securities commission . . . of any State over any security or any person insofar as it does not conflict with the provisions of this chapter"). In fact the FAA is not concerned in particular with securities regulation, as 9 U.S.C. § 2 deals generally with contracts involving commerce. Therefore, to preserve its right to a meaningful arbitral forum Olde Discount relies on the third type of preemption, "actual conflict" preemption.

There can be "actual conflict" preemption in two circumstances, either where it is impossible to comply with the conflicting demands of federal and state statutes, or where the state law is an "obstacle" to the fulfillment of the congressional purposes embodied in the federal law. See, e.g., Florida Lime & Avocado Growers, Inc. v. Paul, 373 U.S. 132, 83 S. Ct. 1210, 10 L. Ed. 2d 248 (1963) (holding federal regulation concerning maturity of avocados did not preempt California regulation, where it was not impossible for growers to comply with both regulations); Hines v. Davidowitz, 312 U.S. 52, 67, 61 S. Ct. 399, 404, 85 L. Ed. 581 (1941) (holding federal Alien Registration Act preempted Pennsylvania Alien Registration Act because state law "stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress"); Pennsylvania Medical Soc'y v. Marconis, 942 F.2d 842, 848 (3d Cir. 1991) (holding Pennsylvania statute governing limited aspects of Medicare billing not preempted by federal Medicare Act because state statute did not create obstacle to fulfillment of Congress' objectives). As our analysis of the interaction between the Delaware administrative rescission remedy and Olde Discount's arbitration agreement with the Engelhardts will make clear, both factors indicating conflict preemption, conflicting statutory demands and an obstacle to Congress' purposes, are present in this case.

The context of this preemption claim, i.e., the preservation of a federal right to an arbitral forum, is critical. At one time other substantive and procedural rights of parties were thought to outweigh a right to arbitration. See Wilko v. Swan, 346 U.S. 427, 74 S. Ct. 182, 98 L. Ed. 168 (1953) (stating Securities Act of 1933 precluded waiver of judicial forum, rendering arbitration agreement invalid). But that time is no more. See Rodriguez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477, 109 S. Ct. 1917, 104 L. Ed. 2d 526 (1989) (overruling Wilko v. Swan). The Supreme Court unstintingly has promoted a favorable climate for arbitration through vigorous enforcement of the FAA over the last 20 years. The gradual erosion of the principles of Wilko v. Swan began with the 1974 decision of Scherk v. Alberto-Culver Co., 417 U.S. 506, 94 S. Ct. 2449, 41 L. Ed. 2d 270, which held that a claim under the Securities Exchange Act of 1934 would be arbitrable in the distinctive context of an international business transaction. The international character of the dispute was also an important consideration in Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, 473 U.S. 614, 105 S. Ct. 3346, 87 L. Ed. 2d 444 ...

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