NO. 92-539
IN THE SUPREME COURT OF THE STATE OF MONTANA
1993
LEROY E. MUESKE,
Plaintiff and Respondent,
PIPER, JAFFRAY & HOPWOOD, INCORPORATED,
JOHN LAWRENCE SCHTJLTZ, TERRAN FINANCIAL
GROUP, INC., TERRAN SECURITIES, INC.,
TERRAN PARTNERS 1. DANIEL E. HALLIGAN,
RONALD G. HEPPNER.AND MAURICE F. BOLGEN,
Defendants and Appellants.
APPEAL FROM: District Court of the Second Judicial District,
In and for the County of Silver Bow,
The Honorable James E. Purcell, Judge presiding.
COUNSEL OF RECORD:
For Appellant:
John G. Crist and James L. Jones, Dorsey & Whitney,
Billings, Montana
For Respondent:
Daniel R. Sweeney, Butte, Montana; A. Clifford
Edwards and Kevin M. Funyak, Edwards Law Firm,
Billings, Montana
Submitted on Briefs: March 18, 1993
Decided: AuquSt 27, 1993
Filed:
Justice Fred J. Weber delivered the Opinion of the Court.
Defendant, Piper, Jaffray & Hopwood, Incorporated (Piper,
Jaffray & Hopwood), appeals the Order of the District Court of the
Second Judicial District, Silver Bow County, which denied its
Motion to Compel Arbitration in an action brought by plaintiff
alleging negligence and violations of the Montana Securities Act in
relation to investments purchased through Piper, Jaffray & Hopwood.
We affirm.
Piper, Jaffray & Hopwood has raised several questions on
appeal including the correctness of the District Court's findings
of constructive fraud. admissions against interest of Piper,
Jaffray & Hopwood's employees and the plaintiff's intent to be
bound by a Margin Agreement. However, the District Court stated
that these factual findings made by the court are not the law of
the case. The sole issue before the District Court in the
evidentiary hearing was the validity of the arbitration clause
Piper, Jaffray & Hopwood sought to enforce. The sole issue for our
review is:
Does Piper, Jaffray & Hopwood's failure to comply with the
rules of the New York Stock Exchange and the National Association
of Securities Dealers render the predispute arbitration clause
within Piper, Jaffray & Hopwood's Margin Agreement invalid?
The following findings of fact of the District Court and
testimony presented provide the foundation for our review: Leroy
E. Mueske (Mueske) operated a dental practice in Butte, Montana.
He contacted defendant John Lawrence Schultz (Schultz) who was a
2
broker employed by Piper, Jaffray & Hopwood. On September 13,
1989, Mueske purchased one unit of Terran Partners I limited
partnership through Schultz.
On November 8, 1989, Schultz obtained Mueske's signature on a
"Margin AgreementN with Piper, Jaffray & Hopwood. The Margin
Agreement contained the following extensive provision with regard
to arbitration on the last page of the Margin Agreement just above
the signature line on which Mueske signed:
11. Customer Agrees to Arbitrate.
* Arbitration is final and binding on the
parties.
* The parties are waiving their right to seek
remedies in court, including the right to jury
trial.
* Pre-arbitration discovery is generally more
limited than and different from court
proceedings.
* The arbitrators* award is not required to
include factual findings or legal reasoning
and any partyls right to appeal or to seek
modification of rulings by the arbitrators is
strictly 1FmFted-
* The panel of arbitrators will typically
include a minority of arbitrators who were or
are affiliated with the securities industry.
I agree to arbitrate any disputes between PJH and
me. I specifically agree and recognize that all
controversies which may arise between PJH its
agents, representatives or employees and me
concerning any transaction, account or the
construction, performance or breach of this or any
other agreement between us, whether entered into
prior, on, or subsequent to the date hereof, shall
be determined by arbitration to the full extent
provided by law. Such arbitration shall be in
accordance with the rules then in effect, of the
Arbitration Committee of the New York Stock
Exchanae. Inc. or the National Association of
Securities Dealers, Inc. as I may elect. I
authorize PJH, if I do not make such election by
registered mail addressed to PJH at its main office
within 15 days after receipt of notification form
PJH requesting such election, to make such election
on my behalf. (Emphasis supplied.)
On December 26, 1989, again through Schultz, Mueske purchased
additional units of the Terran investments for $50,000, On August
23, 1990, the Securities Department of the State Auditor's office
sought a cease and desist order of all the named defendants in this
action, except Piper, Jaffray & Hopwood, based on fraud and
misrepresentation to the Terran investors.
Mueske contends that he lost his entire $75,000 investment in
the Terran investments. Mueske brought this action against Piper,
Jaffray & Hopwood concerning the Terran transactions. Piper,
Jaffray & Hopwood filed a Motion to Compel Arbitration based on the
above-outlined arbitration clause in the Margin Agreement.
After a hearing on Piper, Jaffray & Xopwood's motion, the
District Court concluded that the arbitration clause was severable
from the Margin Agreement as a whole based on incorporated choice
of law provisions relating solely to arbitration requiremehts and
procedures. In adjudicating the validity of the arbitration
clause, the court relied on the "doctrine of incorporation of
extrinsic documents" where reference is made within the contract to
such documents. The arbitration clause contains specific language,
which provides that arbitration shall be in accordance with the
rules then in effect of the New York Stock Exchange, Inc. (NYSE)
and the National Association of Securities Dealers, Inc. (NASD).
The rules of the NYSE and NASD were thus incorporated into the
contract.
The stipulation by Piper, Jaffray & Hopwood that it did not
fully comply with NASD Rules of Fair Practice, Art. 111, Sec. 21,
and NYSE Rule 537 is crucial to the District Court's conclusion
that the arbitration clause was invalid. The specific section of
NASD Section 21 with which Piper, Jaffray & Hopwood did not comply
provides :
Requirements When Using Predispute Arbitration Agreements
With Customers
(f) ...
(3) A copy of the aqreement containinq any
such clause shall be aiven to the customer who shall
acknowledqe receipt thereof on the aqreement or on a
separate document. (Emphasis supplied.)
NASD Manual--Rules of Fair Practice (CCH) a 2171, Art. 111, Sec.
21 (f)(3) (1991) . The District Court concluded that compliance with
the above rule was a condition precedent to a valid arbitration
clause, stating:
. . . [Piper, Jaffray & Hopwood] . . .
has G&?,ZC,
mandated obligations of disclosure regarding the use of
pre-dispute arbitration clauses. Failure to comply with
such rules is a failure to abide by the explicitly
incorporated terms of the agreement.
This Court finds that the May 10, 1989 changes in
the rules incorporated within the arbitration clause were
deliberate and purposeful actions of the Securities
Exchange Commission which require proper recognition from
the Court. .
. .
...
[Piper, Jaffray & Hopwood's] failure to adequately
correct its procedures and amend its account forms to
reflect the new disclosure requirements is a failure to
provide the Plaintiff with due and proper
notice/disclosure as determined by the Securities and
Exchange Commission as evidenced by the May 10, 1989
adoption of rule changes.
The District Court further noted that the burden of showing
satisfaction of the notice/disclosure requirements was on Piper,
Jaffray & Hopwood and that Piper, Jaffray & Hopwood had failed to
show that Mueske had received a copy of the agreement or that he
had acknowledged receipt of a copy of the agreement. The court
then stated that the requirements are not unduly burdensome, but
that even if they were, Piper, Jaffray & Hopwood nevertheless
designated the applicable rules and was bound by them.
Piper, Jaffray & Hopwood contends that the District Court
incorrectly concluded that the terms of the arbitration clause
clearly establish a choice of law election to be bound by the rules
of the NYSE or the NASD. They contend this was wrong for three
reasons: (1) Piper, Jaffray & Hopwood's minor variance from the
industry self-regulating rule did not prejudice Mueske, (2) the
arbitration clause is not a choice of law provision for the
purposes of determining what law governs the provision's
enforceability, and (3) nothing in the NASD rules mandates that the
clause is void if the rules are not followed.
First, we agree with the District Court that Piper, Jaffray &
Hopwood's noncompliance with the rules relating to disclosure and
notice is not a "minorw triviality. The District Court noted that
the changes in the NYSE and NASD rules, which were incorporated in
the Piper, Jaffray & Hopwood arbitration clause, resulted from
deliberate and purposeful actions of the Securities and Exchange
Commission (SEC) which require proper recognition from the court.
The key question is whether the arbitration clause is a choice of
law provision for the purposes of determining what law governs the
validity of the arbitration clause. We will uphold the District
Court's conclusions of law if they are correct. Steer, Inc. v.
Department of Revenue (l990), 245 Mont. 470, 474, 803 P.2d 601,
503.
Piper, Jaffray & Hopwood claims that the NASD rules control
only the arbitration process, not the validity of the clause
itself, As noted by Piper, Jaffray & Hopwood, the last paragraph
of the arbitration clause as reprinted above provides in the first
two sentences that the parties are to arbitrate all disputes to the
"full extent provided by law." As further noted by Piper, Jaffray
& Hopwood, no reference is made in the first two sentences to NYSE
or NASD rules--it is only further along in the clause (in the third
sentence) that it provides that any arbitration shall be in
accordance with the rules of the NASD or NYSE. Piper, Jaffray &
Hopwood admits that it did not strictly comply with all the
requirements of NASD Section 21. Mueske contends that it is
inconsistent for Piper, Jaffray & Kopwood to argue that the
arbitration clause should be found valid and strictly enforced
while at the same time argue that substantial compliance--not
strict compliance--with the requirements of NASD Section 21 is
sufficient.
The parties agree that the Federal Arbitration Act (FAA)
controls here. The FAA provides that an agreement to arbitrate is
valid except where grounds exist at law or in equity to revoke the
contract. 9 U.S.C. 2 (1988). A district court properly
adjudicates the validity of an arbitration agreement when a party
contests the validity of an arbitration clause within a contract,
but does not contest the validity of the contract as a whole.
Larsen v. Opie (19891, 237 Mont. 108, 111-12, 771 P.2d 977, 979-80
(citing Prima Paint Corp. v. Flood & Conklin Mfg. Co, (1967), 388
U.S. 395, 87 S.Ct. 1801, 18 L.Ed.2d 1270). Federal policy behind
the FAA is designed to ensure enforceability of private agreements
to arbitrate. Volt Information Sciences, Inc. v. Board of Trustees
(19895, 489 U.S. 468, 109 S.Ct. 1248, 103 L.Ed.2d 488. Allowing
enforcement of private agreements to arbitrate gives effect to the
contractual rights and expectations of the parties, without
ravaging the policies behind the FAA. Volt, 489 U.S. at 479, 109
S.Ct. at 1255-56, 103 L.Ed.2d at 500.
In Audit Services v. Frontier-West, Inc. (1992)' 252 Mont.
142, 148, 827 P.2d 1242, 1246, we said that "[a] state court may
rely on state contract law as long as it effectuates the policy
underlying federal labor legislationm and applies federal
substantive law. The same holds true for determining the validity
of an arbitration clause coming under the guidelines and
requirements of federal arbitration legislation.
Based on the language in volt, a district court's goal,
therefore, should be to give effect to the contractual rights and
expectations of the parties without running contrary to the
policies behind the FAA. Although the policy behind the FAA is to
encourage and enforce arbitration agreements, that extends only to
valid arbitration agreements. The court could find the agreement
invalid according to the law the parties have chosen to apply, so
long as the chosen law is not contrary to the FAA and the
legitimate rights and expectations of the parties. Here the
District Court determined that Piper, Jaffray & Hopwood's
arbitration clause was invalid by enforcing the provision of the
arbitration clause that provided for application of NASD and NYSE
rules as a choice of law provision.
The self-regulating securities industry, through the
Securities Industry Conference on Arbitration (SICA), developed
rules relating to arbitration and arbitrability for its own use,
pursuant to g 19(b) (1) of the Securities Exchange Act of 1934.
Order Aparovincr Proposed Rule Chancres bv NYSE, NASD and AMEX
Relatinq to the Arbitration Process and the Use of PredisBute
Arbitration Clauses, Exchange Act Release No. 34-26805 (19891, 54
Fed. Reg. 21144. SICA was formed in 1977 by the securities
industry in response to the SEC's request for a review of then-
existing arbitration procedures as an alternative to the
implementation of the SEC's own proposals to establish a system for
dispute resolution between broker/dealers and their customrs. I .
d,
54 Fed. Reg. at 21145. This resulted in a Uniform Code of
Arbitration. In September of 1987, after reviewing industry-
sponsored arbitration, the SEC advised SICA of its views regarding
the need for changes to the Uniform Code of Arbitration. I . 54
d,
Fed. Reg. at 21145. After that time, SICA and the SEC met
regularly to work out proposals in response to SEC concerns. Id.,
54 Fed. Reg. at 21145. NYSE Rule 637 and NASD Section 21 were
developed by the self-regulating organizations in response to SEC
concerns.
NYSE Rule 637 and NASD Section 21 are included in the rules
adopted by the SEC. They were specifically designed to improve
disclosure to customers in account opening agreements and to
restrict the content of the arbitration clauses. I . 54 Fed. Reg.
d,
at 21153. Notice of the proposed changes was given in Securities
Exchange Act releases and by publication in the Federal Register.
see, e.q., ProDosed Rule Chanqes bv NYSE, Exchange Act Release No.
34-26474 (1989j, 54 Fed. Reg. 3883. After reviewing the filings
and the comments received in response to notice, the SEC determined
that the proposed rule changes were consistent with the
requirements of the Securities Exchange Act. Exchange Act Release
No. 34-26805, 54 Fed. Reg. at 21155. One industry member commented
that the new rules should enhance investor confidence in the
system. I . 54 Fed. Reg. at 21155.
d, The SEC approved the NYSE and
NASD rules discussed above on May lo, 1989, and NYSE Rule 637 and
NASD Section 21 became effective September 13, 1989. I . 54 Fed.
d,
Reg. at 21155, n.61.
One of the most significant changes in the rules is the level
of disclosure and the emphasis on disclosure of arbitration clauses
in agreements such as Piper, Jaffray & Hopwood's Margin Agreement.
In its order approving the changes, the SEC stated:
The Commission welcomes the changes in SRO arbitration
heralded by these proposals, and the cooperative effort that
produced them. These rules represent several years of effort
by SICA. They represent the promise of the SROs to maintain
fair and efficient forums for the arbitration of disputes
between members and investors. The Commission believes that
the proposed rules appropriately balance the need to
strengthen investor confidence in the arbitration systems at
the SROs, both by improving the procedures for administering
the arbitrations and by creatinq clear obliqations reqardinq
the use by SRO members of predispute arbitration clauses, with
the need to maintain arbitration as a form of dispute
resolution that provides for equitable and efficient
administration of justice. (Emphasis supplied.)
Exchange Act Release No. 34-26805, 54 Fed, Reg, at 21155.
Congress established a self-regulatory scheme for the
securities industry. This scheme of self-regulation involves SEC
approval of rules developed by industry members. In approving the
new rules, the SEC stated that the rule changes of the NYSE and
NASD "dynamically advance the public interest in SRO arbitration
. .. [and] we conclude that these rules are designed to prevent
fraudulent and manipulative practices, promote just and equitable
principles of trade and in general, protect investors and the
public interest consistent with sections 6(b) (5) and 15A(b) (6) [of
the SEA]." I . 54 Fed. Reg. at 21155.
d,
The District Court's decision to include the NASD and NYSE
rules in the contract as a choice of law provision applicable to
the entire arbitration clause is reasonable. The SEC would not
approve the NYSE and NASD rules without the disclosure provision
requiring a signature for the arbitration agreement and requiring
that a copy be given to the investor. Exchange Act Release No. 34-
26805, 54 Fed. Reg. at 21144. The disclosure requirements of the
rules were intended to further the purpose of the FAA in enforcing
arbitration agreements, but only when the agreements are fully
disclosed to the investor.
As the drafter of the arbitration clause, Piper, Jaffray &
Hopwood should have specified therein if it had intended to submit
disputes to arbitration under the terms of the NASD and NYSE rules
but did not intend to have the determination of validity of the
arbitration agreement made by using the same rules. This is
particularly important where the NASD and NYSE rules include
sections which specify procedures for disclosure of arbitration
clauses to investors and where the SEC has stressed the importance
of the disclosure procedures and specifically required the industry
to include them.
"Arbitration clauses are creatures of contract and, therefore,
principles of contract interpretation are applicable." Frates v.
Edward D. Jones & Co. (1988), 233 Mont. 377, 382, 760 P.2d 748,
752. By not specifically stating in the arbitration clause the law
which will govern a determination of validity of the clause, Piper,
Jaffray & Hopwood has created an ambiguity. When ambiguities
exist, general rules of contract interpretation apply to determine
the intent of the parties.
Uncertain terms in a contract are to be construed against the
party causing the uncertainty. Section 28-3-206, MCA. see also
Rumph v. Dale Edwards, Inc. (1979), 183 Mont. 359, 600 P.2d 163,
169. Any ambiguity in the arbitration clause is thus to be
construed strictly against Piper, Jaffray & Hopwood as the drafter
of the contract. Frates, 760 P.2d at 752.
Further, the intention of the parties must be determined by
reading the instrument in full and not by isolating words and
phrases as Piper, Jaffray & Hopwood urges the Court to do here.
It is a well-established principle of contractual
construction that in interpreting a written instrument,
the court will not isolate certain phrases of the
instrument to garner the intent of the parties, but will
grasp the instrument by its four corners and in the light
of the entire instrument, ascertain the paramount and
guiding intent of the parties. Mere isolated tracts,
clauses and words will not be allowed to prevail over the
general language utilized in the instrument. . . .
Particular clauses of the agreement are subordinate to
the general intent of the contract. . . .
Rumph, 600 P.2d at 168 (citing 5 28-3-307, MCA).
Piper, Jaffray & Hopwood's arbitration clause incorporates the
rules of the NYSE and NASD as controlling law. The arbitration
clause does not include an exception for allowing other law to
govern determinations of validity. Applying the general rules of
contract interpretation set forth above, we conclude that those
rules, along with the public policy considerations expressed by the
SEC, direct that the validity of the arbitration clause be
determined according to the incorporated controlling law--the NYSE
and NASD rules--unless such rules contravene the substantive law of
the FAA.
We hold Piper, Jaffray & Hopwood's failure to comply with NYSE
and NASD rules renders the predispute arbitration clause within
Piper, Jaffray & Hopwood's Margin Agreement invalid.
Affirmed and remanded for further proceedings consistent with
this opinion.
We Concur: _ -4-
Justice K a r l a M. G r a y
Justice James C Nelson respectfully dissents.
.
The opinion of the Court states that when Piper, Jaffray &
Hopwood, Inc. (Piper) drafted the Margin Agreement at issue, which
included an arbitration clause, Piper included a choice of law
provision. ' This tqchoiceof lawm provision was the National
Association of Security Dealers (NASD) rules. The opinion of the
Court calls the NASD rules in this case "controlling law".
Although the Securities and Exchange Commission (SEC) has some
power over the NASD, the NASD is a private, independent, self-
regulating organization. The SEC did direct the NASD to implement
rules regarding arbitration. Essentially, the SEC allowed the NASD
to promulgate rules, rather than force rules on the group.
The new promulgated rules provided specific directions (Rule
21) for incorporating arbitration provisions into securities
agreements. A violation of Rule 21 could result in sanctions by
the NASD against the violating dealer.
Here, the Court held that a failure to comply with controlling
law incorporated into an arbitration agreement, such as an NASD
rule, renders a pre-dispute arbitration clause invalid. However,
if the NASD rule is "'controlling law", as held by the Court here,
then all of the NASD rules should control. The NASD rules provide
that a violation of Rule 21 can result in sanctions being issued
against the violating dealer. There is no provision for
' do not believe that the reference by the District Court or
I
by this Court to the provision at issue as being one of "choice of
law" is accurate in the context in which that concept is usually
understood.
invalidating the arbitration agreement in its entirety.
If there is some legal basis for the Court to determine that
a violation of a llchoice laww provision can result in a remedy
of
not provided for by that law, this legal basis should be clearly
articulated. If there is no legal basis for allowing this remedy,
one should not be artificially created.
For the foregoing reasons, I dissen
August 27, 1993
CERTIFICATE OF SERVICE
I hereby certify that the following order was sent by United States mail, prepaid, to the following
named:
John G. Crist and James L. Jones
Dorsey & Whitney
P.O. Box 7188
Billings, MT 59103
Daniel R. Sweeney
Attorney at Law
P.O. Box 3725
Butte, MT 59702
A. Clifford Edwards and Kevin M. Funyak
Edwards & Paoli
P.O. Box 20039
Billings, MT 59104
John L. McKeon
Attorney at Law
P.O. Box 879
Anaconda, MT 59711
Ronald G. Heppner
431 Grantsdale Rd.
Hamilton, MT 59840
William K. Van Canagan
Datsopoulos, MacDonald & Lind
201 W. Main, Ste. 201
Missoula. MT 59802
ED SMITH
CLERK OF THE SUPREME COURT
.
STATE-OF MONTANA