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DAUGHERTY v. WASHINGTON SQUARE SECURITIES

July 9, 2003

JAMES A. DAUGHERTY, RITA DAUGHERTY, DONALD O. SOWERS THELMA J. SOWERS, ROBERT L. GROVES, TERRI J. GROVES, RONALD WATSON, GLENN B. CRABTREE, JANET A. CRABTREE, GOLDIE ALKIRE AND EDWARD E. CRABTREE, PLAINTIFFS,
v.
WASHINGTON SQUARE SECURITIES, INC., DEFENDANT.



The opinion of the court was delivered by: Joy Flowers Conti, District Judge

MEMORANDUM ORDER

Introduction

Plaintiffs James A. Daugherty, Rita Daugherty, Edward E. Crabtree, Janet A. Crabtree, Glen B. Crabtree, Robert L. Groves, Tern J. Groves, Donald 0. Sowers and Thelma J. Sowers*fn1 ("plaintiffs") brought this case seeking confirmation of an arbitration award issued on July 15, 2002, by a Panel of Arbitrators (the "Panel") of National Association of Securities Dealers Dispute Resolution, Inc. in Pittsburgh, Pennsylvania. Defendant Washington Square Securities, Inc. ("defendant" or "Washington Square"), a member of the National Association of Securities Dealers ("NASD"), answered and counterclaimed to vacate the arbitration award for two reasons. First, defendant claims that the Panel did not have jurisdiction over the parties' disputes because: (a) plaintiffs were not "customers" as defined under the rules of the NASD Code of Arbitration Procedure (the "NASD Code") and (b) the investments at issue were not "securities." Second, defendant asserts that the Panel exceeded its powers when it decided defendant's motion to dismiss four plaintiffs for lack of jurisdiction and acted in manifest disregard of the law in finding defendant had a duty to supervise its registered representative. This court disagrees with defendant, and it confirms the arbitration award because the NASD Code requires defendant to arbitrate these types of disputes and the Panel neither exceeded its powers nor manifestly disregarded the law.

Facts and Procedural History

Defendant is a licensed brokerage firm with its primary place of business in Minnesota. Plaintiffs, residents of West Virginia, are individual investors who purchased certain financial products, which were not registered under the securities laws. Plaintiffs purchased the financial products from David Henderson, one of Washington Square's stockbroker representatives. Mr. Henderson was a registered representative of defendant in North Carolina and was acting as a Washington Square investment advisor during the time that he dealt with plaintiffs. Plaintiffs claim that they invested money with Mr. Henderson, knowing and understanding him to be acting as a representative of defendant. Defendant denies it received any money from Mr. Henderson's sale of the financial products and insists that plaintiffs did not have accounts or customer agreements with it and did not purchase its products.

In 1998, Mr. Henderson sold each of the plaintiffs at least one of the following financial products: (1) U.S. Capital Funding, Inc. Promissory Notes, (2) U.S. Capital Funding, Inc. Corporate Funding Notes, (3) ETS Payphones Investments, (4) First Call Telephone Co. Investments, (5) Alpha Telcom Investments, (6) Ferris Productions Investments, (7) 21st Century Pay Communications Investments, and (8) Universe Arcade Equipment Lease Program Investments. These products defaulted and plaintiffs lost money. As a result, on October 4, 2000, plaintiffs filed a claim under the NASD Code alleging numerous common law, federal and state statutory claims against defendant.

On March 7, 2002, defendant objected to the Panel's jurisdiction over the claims of four of the eleven plaintiffs, raising arguments similar to the ones currently before this court.*fn2 Specifically, defendant claimed that the four plaintiffs were not its customers because they did not sign customer agreements and they dealt with Mr. Henderson in his individual capacity — not as its representative. Plaintiffs counter-argued that jurisdiction existed with respect to the four plaintiffs because defendant waived its jurisdictional challenge, plaintiffs were defendant's customers, and plaintiffs were covered under NASD Rule 10301(a). On May 6, 2002, the Panel heard defendant's jurisdictional challenge as to the four plaintiffs, determined it had jurisdiction over the four plaintiffs' claims, and continued the arbitration proceedings with respect to all eleven plaintiffs.

Following the Panel's decision on this jurisdictional challenge, defendant on May 9, 2002, commenced a case in the United States District Court for the District of Minnesota (the "Minnesota Proceeding") seeking to enjoin the arbitration proceeding with respect to plaintiffs Donald O. Sowers, Thelma J. Sowers, Glenn B. Crabtree and Goldie Alkire, the same four plaintiffs that defendant claimed the Panel should dismiss. On May 23, 2002, after argument and briefs, the court ruled orally in the preliminary injunction hearing that it would not issue an injunction and reserved the right to issue an opinion setting forth its reasoning.

Following the denial of the injunction, the parties returned to arbitration on May 29, 2002. On July 15, 2002, the Panel issued its decision. The Panel found for plaintiffs in the following amounts: James and Rita Daugherty — $131,600.00; Edward Crabtree — $10,620.00; Glen and Janet Crabtree — $88,400.00; Robert and Terri J. Groves — $24,000.00; Donald and Thelma Sowers — $75,000.00. On July 25, 2002, plaintiffs commenced the current case before this court to confirm the arbitration award. Defendant counterclaimed to vacate the arbitration award.

On August 9, 2002, the district court in the Minnesota Proceeding issued an opinion setting forth its reasons for denying defendant's injunction with respect to the four plaintiffs. In particular, the court concluded that defendant was not likely to succeed on the merits because the four plaintiffs' disputes were arbitrable; the four plaintiffs were customers under the NASD Code; and the disputes arose out of defendant's business. Washington Square Securities, Inc. v. Sowers, 218 F. Supp.2d 1108, 1117-1118 (D. Mm. 2002) (Rosenbaum, Chief Judge).*fn3 On March 4, 2003, the district court in the Minnesota Proceeding transferred that case to this court, and the two cases were consolidated.

Issues

The arguments regarding confirmation or vacation of the arbitration award raise the following legal questions: (1) whether the parties unambiguously agreed to permit the arbitrators to determine if they agreed to arbitrate their disputes, (2) if not, whether this court independently finds that the parties agreed to arbitrate their disputes, and (3) whether the Panel exceeded its powers or manifestly disregarded the law, thereby necessitating that the arbitration award be vacated.

Legal Standard

When parties move to confirm or vacate an arbitration award, "the court's function in confirming or vacating a commercial arbitration award is severely limited." Mutual Fire, Marine & Inland Ins. Co. v. Norad Reinsurance Co., 868 F.2d 52, 56 (3d Cir. 1989) (internal citation and quotations omitted). If the parties have clearly agreed to arbitrate, the courts will set aside arbitral verdicts only in "very unusual circumstances," First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 942 (1995), and there is a "strong presumption" in favor of the arbitration award, Mutual Fire, 868 F.2d at 56. See also 9 U.S.C. § § 9, 10 (setting forth the grounds for confirming and vacating arbitration awards under the Federal Arbitration Act).

The strong presumption in favor of arbitration, however, does not apply when courts are examining whether the parties agreed to submit their disputes to arbitration. First Options, 514 U.S. at 945 (reasoning that if courts applied the general presumption in favor of arbitration to the question of arbitrability, it "might too often force unwilling parties to arbitrate a matter they reasonably would have thought a judge, not an arbitrator, would decide"). Thus, courts must independently review legal questions regarding whether the parties agreed to submit their disputes to arbitration. Id. at ...


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