California Fina Group, Inc. v. Herrin

United States Court of Appeals
Fifth Circuit
F I L E D
UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT July 27, 2004

Charles R. Fulbruge III
Clerk
No. 03-10939

CALIFORNIA FINA GROUP, INC., d.b.a. FINACORP SECURITIES, INC.,

Plaintiff-Appellant,

versus

ROBERT L. HERRIN, JOSIE M. HERRIN, ERMA C. KUSIAN,
RICHARD J. WHITE, MAMIE M. WHITE, GARY L. CARPENTER,
RUSSELL J. FREY, BETTIE E. FREY, WALTER A. GRAMS,
NANCY BOSTON, EXECUTRIX OF THE ESTATE OF BESSIE GRAMS,
JOSE C. TAMEZ, ROSE A. MILLIGAN, and MARY P. ALBERT,

Defendants-Appellees.

Appeal from the United States District Court
For the Northern District of Texas

Before DeMOSS, STEWART, and PRADO, Circuit Judges.

DeMOSS, Circuit Judge:

Defendants-Appellees Robert L. Herrin, et al. (“Appellees”),

are a group of investors that purchased various investments from a

former independent registered representative for Plaintiff-

Appellant California Fina Group, Inc., d.b.a. Finacorp Securities,

Inc. (“Fina Group”). Appellees filed a claim with the National

Association of Securities Dealers, Inc. (“NASD”), seeking to

arbitrate their dispute with Fina Group. Fina Group filed a

declaratory action in district court seeking, inter alia, an order
stating they were not required to arbitrate because Appellees were

not “customers” of Fina Group. Appellees filed a motion to compel

arbitration. The district court ultimately granted Appellees’

motion to compel arbitration and dismissed Fina Group’s complaint.

Fina Group appealed. Because we find Appellees fall within the

term “customers” as used in Rule 10301(a) of the NASD Uniform Code

of Arbitration and their dispute arose from Fina Group’s business

or Gibson’s activities, such that Appellees could properly demand

arbitration, we AFFIRM the decision of the district court.

INTRODUCTION

Fina Group is a securities broker-dealer licensed and

qualified to transact business pursuant to the rules and

regulations of the NASD, the Securities and Exchange Commission

(“SEC”), and other necessary state, local, and federal government

agencies. On March 12, 1998, Fina Group and Darrell Todd Gibson

(“Gibson”) entered into an Independent Registered Representative

Agreement (the “Agreement”).

Pursuant to the Agreement, Fina Group agreed “to act as a

broker/dealer for the purchase and sale of various securities” and

Gibson was allowed to “place various buy and sell orders through

[Fina Group] in accordance with the terms of this Agreement.” The

Agreement expressly stated that “the relationship between [Fina

Group] and [Gibson] shall be that of a company and an independent

contractor.” The Agreement limited the type of securities Gibson

2
could sell to only those securities which Fina Group was authorized

to sell.1

Appellees, who are elderly persons with little or no

investment experience, allege they purchased the following

investments from Gibson during the time frame that he was an

independent registered representative for Fina Group:

(1) Financial Federated Title & Trust and American
Benefits Services, Inc. (“FFTT/ABS”) Viaticals;

(2) FFTT/ABS Viaticated Insurance Settlements;

(3) ETS Payphones, Inc.;

(4) Taormina Omne SRL Promissory Notes;

(5) Crown Meridian Bank, Ltd. Certificates of Deposit;

(6) Liberte Capital Group Viatical Settlements; and

(7) Chemical Trust Guaranteed Contract Agreements.2

Fina Group asserts it does not offer or sell these alleged

investments.

On December 12, 2002, Appellees filed a Statement of Claim

1
Addendum B to the Agreement indicates that the only outside
business interest disclosed by Gibson to Fina Group was Gibson’s
sale of fixed annuities through his Group 1 license as a licensed
Life & Disability Insurance Agent. The only other disclosures by
Gibson to Fina Group were that he held a Series 6 license, which
allows the representative to solicit and sell mutual funds,
variable annuities, and variable life insurance contracts, and a
Series 63 Blue Sky license, which is required before the
representative can sell securities in any state.
2
“A viatical settlement allows an individual with a life-
threatening illness – such as AIDS, heart disease, cancer or
Alzheimer’s disease – to sell their life insurance policy for
cash.” Frequently Asked Questions About Life Settlements, at
http://www.vspi.com/faq.htm.

3
with the NASD seeking to arbitrate a dispute between Fina Group and

themselves based on the alleged actions and omissions of Gibson.

Appellees alleged in the arbitration that Gibson sold fraudulent,

unsuitable, and unregistered investments. Appellees alleged that

Gibson recommended these investments while he worked for Fina

Group, that Fina Group failed to supervise him, and that Fina Group

was responsible for his actions. Appellees also alleged that they

knew Gibson was a licensed broker for Fina Group and they made

their investments based on his representations that he worked for

his firm, they assumed his firm was supervising him, and they

believed they were customers of his firm.

In response, Fina Group filed suit in the United States

District Court for the Northern District of Texas on March 6, 2003,

seeking: (1) a declaration that Fina Group did not have to

arbitrate the claims alleged by Appellees in the NASD arbitration;

and (2) an injunction to enjoin Appellees from pursuing the NASD

arbitration with Fina Group. Fina Group’s federal action was based

on the affidavit of Eduardo J. Prado, Fina Group’s President and

CEO. Prado’s affidavit established that Fina Group did not offer

or sell the investments alleged to have been purchased by

Appellees, that Fina Group did not receive any profit or benefit

from Appellees’ alleged investments, and that Fina Group did not

have a contract with any of Appellees with respect to their alleged

investments.

After answering Fina Group’s federal action, Appellees filed

4
a motion to compel arbitration pursuant to Section 4 of the Federal

Arbitration Act (“FAA”), 9 U.S.C. § 1 et seq. Appellees argued

that Fina Group was required to arbitrate the claims brought by

Appellees in the NASD arbitration, either: (1) based on NASD Rule

10301(a) or (2) as a purported third-party beneficiary of Gibson’s

Form U-4 application for registration with the NASD.

Rule 10301(a) of the NASD Uniform Code of Arbitration applies

to all NASD members, including Fina Group, and provides:

Any dispute, claim, or controversy eligible for
submission under the Rule 10100 Series [NASD
Administrative Provisions] between a customer and a
member and/or associated person arising in connection
with the business of such member or in connection with
the activities of such associated persons shall be
arbitrated under this Code, as provided by any duly
executed and enforceable written agreement or upon demand
of the customer.

NASD Rule 10301(a) (emphasis added).

The NASD Uniform Code of Arbitration does not define

“customer” or “associated person.” The NASD Conduct Rules define

“customer” as “any person who, in the regular course of such

member’s business, has cash or securities in the possession of such

member.” Id. 2270(b).3 However, several other NASD rules define

“customer” as any person other than a broker or dealer. Id.

0120(g); see also id. 6951(d); id. 4310(c)(6)(C) (relying on Rule

0120 definition); id. 4320(e)(4)(C) (same); id. 6800(e) (same).

3
The NASD Rules are available online at
http://cchwallstreet.com/NASD/NASD_Rules/.

5
The NASD By-Laws define “associated person” as “a natural person

who is registered or has applied for registration under the Rules

of the Association.” By-Laws of the NASD, art. I(dd).4

Fina Group does not dispute that Gibson was an “associated

person.” Fina Group contends that Appellees cannot be “customers”

of Fina Group (regardless of whether they were Gibson’s own

“customers”) because Fina Group has never sold the investments at

issue in this case. At a minimum, Fina Group requests a trial on

the issues the district court had originally identified as needing

resolution, i.e., whether Appellees can be considered “customers”

of Fina Group, and if so, whether the dispute between Appellees and

Fina Group arose in connection with the business of Fina Group.

Appellees allege that the term “customer” should be interpreted

broadly, such that they can be considered “customers” for purposes

of the Rule, and accordingly, that they are entitled to arbitrate

their claims.

Additionally, Gibson was required to submit a Form U-4,

Uniform Application for Securities Industry Registration or

Transfer, to register with the NASD to sell securities in the State

of Texas. Pursuant to his Form U-4, Gibson agreed:

[T]o arbitrate any dispute, claim or controversy that may
arise between me and my firm, or a customer, or any other
person, that is required to be arbitrated under the
rules, constitutions, or by-laws of the organizations
indicated in item 10 as may be amended from time to time

4
The NASD By-Laws are available online at
http://cchwallstreet.com/NASD/Organization/.

6
 and that any arbitration award rendered against me may be
entered as a judgement in any court of competent
jurisdiction.

Form U-4.

Appellees claim that Fina Group accepted the benefit of

Gibson’s Form U-4 and therefore is bound by its requirement that

Gibson arbitrate disputes with his customers. Appellees’ argument

related to Gibson’s Form U-4 is based on a third-party beneficiary

theory as well as on respondeat superior and agency theories. Fina

Group asserts that: (1) the district court never accepted

Appellees’ argument concerning the Form U-4 requirement of

arbitration; (2) the court was correct because Gibson was an

independent contractor so Fina Group cannot be obligated by his

Form U-4 agreement to arbitrate; and (3) there were no third-party

beneficiary issues.

On May 7, 2003, the district court initially denied Appellees’

motion to compel arbitration as to Fina Group. The district court

found that there was “no written arbitration agreement between the

parties.” The district court also found that the case should be

set for trial on an expedited schedule to determine whether

arbitration was mandated under NASD Rule 10301, stating that the

issue in determining whether arbitration was mandated would “seem

to be whether [Appellees] were customers of [Fina Group] and

whether the dispute between [Appellees] and [Fina Group] arises out

of or in connection with the business of [Fina Group].” On July 1,

7
2003, the district court also denied Appellees’ motion for

reconsideration of the denial of their motion to compel

arbitration.

Then, on August 7, 2003, the district court conducted a

telephone hearing between the parties. During this conference,

Appellees’ counsel refused to concede they were customers only of

Gibson, which prompted the judge to comment, “We’re going to have

a trial on arbitrability issues unless you’re willing to concede

that point.” Nevertheless, on August 8, 2003, the district court

issued an order granting Appellees’ motion to compel arbitration

and dismissed Fina Group’s complaint. See Cal. Fina Group, Inc. v.

Herrin, 278 F. Supp. 2d 808, 810 (N.D. Tex. 2003). The district

court held that Fina Group “is required to arbitrate disputes that

fall within Rule 10301(a) when no independent agreement to

arbitrate exists.” Id. at 809. The district court also held that

arbitration should be compelled based on factual findings that:

(1) the dispute arose between Appellees as “customers” of Gibson

and Gibson, an “associated person” of Fina Group; and

(2) regardless of whether the dispute arose in connection with Fina

Group’s business, the dispute arose in connection with the

activities of Gibson, the “associated person.” Id. at 809-10.5

Fina Group timely appealed.

5
The district court did not rely on Gibson’s Form U-4 when
compelling Fina Group to arbitration. Cal. Fina Group, Inc. v.
Herrin, 278 F. Supp. 2d 808, 809-10 (N.D. Tex. 2003).

8
 DISCUSSION

Whether the district court erred in granting Appellees’ motion to
compel arbitration with Fina Group.

This Court reviews de novo a district court’s interpretation

of an agreement to arbitrate and whether it binds the parties to

arbitrate. Bridas S.A.P.I.C. v. Gov’t of Turkmenistan, 345 F.3d

347, 353 (5th Cir. 2003). The district court’s factual findings

are subject to review only for clear error. Id.

In this case, there was no contract or independent agreement

to arbitrate between Fina Group and any Appellee; therefore, the

district court’s order compelling arbitration was based on Fina

Group’s membership in the NASD and its obligation to abide by the

NASD Uniform Code of Arbitration. Accordingly, arbitrability

pursuant to the NASD is a threshold “question whether the parties

have submitted a particular dispute to arbitration” and “is ‘an

issue for judicial determination.’” Howsam v. Dean Witter

Reynolds, Inc., 537 U.S. 79, 83 (2002) (citations omitted); see

also Will-Drill Res., Inc. v. Samson Res. Co., 352 F.3d 211, 214

(5th Cir. 2003) (explaining that arbitrability is an issue for the

court, not the arbitrator, to decide); Investors Capital Corp. v.

Brown, 145 F. Supp. 2d 1302, 1305 (M.D. Fla. 2001) (“In the context

of NASD arbitration, the issue of whether a would-be arbitration

claimant is a ‘customer’ entitled to invoke NASD Rule 10301 is a

threshold question going to the existence of an agreement to

9
arbitrate, and not to the agreement’s scope.”).6

The NASD Uniform Code of Arbitration requires certain claims

be submitted to arbitration, including “[a]ny dispute, claim, or

controversy . . . between a customer and a member and/or associated

person arising in connection with the business of such member or in

connection with the activities of such associated persons . . .

upon the demand of the customer.” NASD Rule 10301(a) (emphasis

added). Therefore, Appellees’ argument that arbitration is required

depends on their meeting the requirements of NASD Rule 10301(a):

(1) whether Appellees are “customers”; and (2) whether the dispute

arose “in connection with the business of such member or in

connection with the activities of such associated persons.”7 The

core issue in this case is whether Appellees are “customers” under

6
Contrary to Appellees’ assertion, the federal policy
favoring arbitration does not apply in a situation like this when
a court is determining whether an agreement to arbitrate exists.
Rather, it applies when a court is determining whether the dispute
in question falls within the scope of the arbitration agreement
already found to exist. Volt Info. Scis., Inc. v. Bd. of Trs. of
the Leland Stanford Jr. Univ., 489 U.S. 468, 475-76 (1989);
Fleetwood Enters., Inc. v. Gaskamp, 280 F.3d 1069, 1073-74 (5th
Cir. 2002); see also BMA Fin. Servs., Inc. v. Guin, 164 F. Supp. 2d
813, 818 (W.D. La. 2001) (“Thus, until this court determines that
the Defendant-Investors were ‘customers’ and are therefore entitled
to invoke arbitration pursuant to [Rule 10301(a)], this court may
not give the Defendant-Investors the benefit of the federal policy
favoring arbitration.”).
7
Appellees also claim arbitration is appropriate based on
several theories relating to Gibson’s Form U-4. These arguments
were not addressed by the district court, and we also do not reach
them here because we find arbitration appropriate pursuant to Rule
10301(a).

10
Rule 10301(a).

1. Whether Appellees are “customers” under Rule 10301(a).

The NASD Uniform Code of Arbitration does not define

“customer.” The NASD Conduct Rules define “customer” as “any

person who, in the regular course of such member’s business, has

cash or securities in the possession of such member.” Id. 2270(b).

According to this particular definition, Fina Group argues

Appellees cannot be considered “customers.” Fina Group maintains

the term “customer” should be interpreted narrowly when compelling

arbitration pursuant to NASD Rule 10301(a) so that NASD members are

required to arbitrate disputes only with their own customers, and

not with every customer of an independent representative.

According to Fina Group, this interpretation not only upholds the

reasonable expectations of NASD members, but also comports with

fundamental tenets for compelling arbitration. Considering Fina

Group’s reliance on the definition of “customer” in Rule 2270(b),

we note that this definition appears to relate specifically only to

paragraph (a) of Rule 2270, which explains what financial

disclosures member firms are required to make to their “bona fide

regular customer[s].” Id. 2270(b).

Rule 0120(g) of the NASD General Provisions, however, defines

“customer” negatively and simply states that “[t]he term ‘customer’

shall not include a broker or dealer.” Id. 0120(g). Thus,

Appellees argue that they satisfy the “customer” requirement of

11
Rule 10301(a), regardless of whether they maintained any formal

Fina Group accounts, because they were not brokers or dealers and,

additionally, they were Gibson’s, an “associated person’s,”

“customers.” Appellees maintain that Rule 0120(g) is the default

definition that applies to Rule 10301(a) because the NASD has

applied this broad definition in numerous other specific

circumstances. Id. 6951(d) (“‘Customer’ shall mean a person other

than a broker or dealer.”); id. 4310(c)(6)(C) (expressly relying on

Rule 0120 definition); id. 4320(e)(4)(C) (same); id. 6800(e)

(same). According to Appellees, this broad definition is also

consistent with the definition of “customer” commonly used by the

SEC. See 17 C.F.R. § 240.11Ac1-1(a)(26) (2004) (“The term customer

means any person that is not a registered broker-dealer.”);

17 C.F.R. § 240.15c3-2 (2004) (“For the purpose of this section

the term customer shall mean every person other than a broker or

dealer.”). Under the NASD Margin Requirements, Rule 2520(a)(3)

states that “[t]he term ‘customer’ means any person for whom

securities are purchased or sold or to whom securities are

purchased or sold.” NASD Rule 2520(a)(3); see also MONY Sec. Corp.

v. Bornstein, 250 F. Supp. 2d 1352, 1356 (M.D. Fla. 2003) (citing

this definition). Appellees argue they were “customers” under

these definitions because they undisputedly were not brokers or

dealers and they were sold securities. According to Appellees, the

term “customer” in Rule 10301(a) is simply a shorthand method of

12
distinguishing retail investors’ disputes from the industry

disputes covered under NASD Rule 10201 rather than Rule 10301.

See, e.g., Kidd v. Equitable Life Assurance Soc’y of the United

States, 32 F.3d 516, 519-20 (11th Cir. 1994) (discussing industry

disputes under the prior version of Rule 10201).

Fina Group argues that compelling arbitration in this case

does not further the purposes of the NASD arbitration forum because

the Appellees’ dispute does not arise from a relationship between

them and their securities firm. According to Fina Group, it never

anticipated having to arbitrate claims with individuals like

Appellees, with whom it had no relationship. Further, Fina Group

asserts Appellees can still bring their claims, but they are not

entitled to arbitration. Appellees argue nothing in the Rule

compels or even supports an interpretation that “customer” does not

refer to the “associated person’s” “customer.” By arguing that an

NASD-member firm must only arbitrate disputes “with its customers,”

Fina Group is rewriting the Rule by adding words to it.

This Court has never determined whether Rule 10301(a) requires

a NASD-member firm to arbitrate with claimants where the claimants

could only establish they were “customers” of the “associated

person.” However, when faced with a similar scenario, the Second

Circuit in John Hancock Life Insurance Co. v. Wilson, 254 F.3d 48

(2d Cir. 2001), drew the exact conclusion advanced by Appellees

here:

13
 John Hancock argues that the Investors must be customers
of John Hancock and not merely of an associated person.
In the district court’s view, “the term ‘customer’
plainly refers to either the member[’s] or the associated
person[’s] customer.” We agree with the district court.
There is nothing in the language of Rule 10301, or any
other provision of the NASD Code, that compels us (or
even suggests that we ought) to adopt John Hancock’s
narrow definition of the term “customer.” In fact, the
NASD Code defines “customer” broadly, excluding only “a
broker or dealer.” Rule 0120(g). The Investors are
neither.

Id. at 59 (alterations in original and citations omitted). The

district court below relied on John Hancock to conclude that the

dispute between the parties was arbitrable, because it arose

“between [Appellees] as customers and Gibson, an associated person

of [Fina Group].” Herrin, 278 F. Supp. 2d at 809. The court also

relied on Vestax Securities Corp. v. McWood, 280 F.3d 1078 (6th

Cir. 2002), where the Sixth Circuit followed the reasoning of John

Hancock to similarly reject the NASD-member firm Vestax’s argument

that “Rule 10301 requires that defendant-investors be direct

customers of Vestax.” Id. at 1082.

The instant situation is sufficiently analogous to that

presented in John Hancock, where an “associated person” of John

Hancock sold claimants fraudulent promissory notes, 254 F.3d at 51,

and in Vestax, where two “associated persons” recommended

securities to and made purchases on behalf of claimants, 280 F.3d

14
at 1080. We find the reasoning of our sister circuits persuasive.8

Thus, we agree with the district court and find that as presently

written, “customer” as used in Rule 10301(a) is plainly broad

enough to include persons who purchased securities from a

registered representative of an NASD-member firm, a.k.a. an

“associated person,” and who are not themselves brokers or dealers.

As such, Appellees fall within the “customer” group intended to

benefit from Rule 10301(a) and are eligible to demand arbitration

of their dispute with Fina Group pursuant to such Rule.

2. Whether Appellees’ dispute is connected to the member’s
business or the activities of an “associated person.”

The second requirement of Rule 10301(a) is that the dispute

must “aris[e] in connection with the business of such member or in

connection with the activities of such associated persons.” Here,

the dispute involves allegations of an “associated person” of Fina

Group recommending and selling fraudulent investments to Appellees

and of Fina Group’s negligent handling and supervision of its

“associated person.” As the district court correctly found,

regardless of whether the dispute arises from Fina Group’s

business, it is clear such dispute relates to the activities of

8
We do not find it significant that in John Hancock Life
Insurance Co. v. Wilson, 254 F.3d 48 (2d Cir. 2001), there is no
mention of whether John Hancock itself offered or sold the precise
securities sold to the claimants by the “associated person,” or
that in Vestax Securities Corp. v. McWood, 280 F.3d 1078 (6th Cir.
2002), it is unclear whether Vestax itself offered or sold the
securities which were purchased, through other firms, by the
“associated persons” for the claimants.

15
Gibson, and there is no question that Gibson was an “associated

person” of Fina Group. Here, the second requirement of Rule

10301(a) has been fully met because there is a connection between

the “customer’s” dispute and the “associated person’s” activities.

Thus, Appellees can properly compel arbitration.

CONCLUSION

Having carefully reviewed the record of this case and the

parties’ respective briefing and arguments, and for the reasons set

forth above, we conclude that the district court’s decisions to

grant Appellees’ motion to compel arbitration and to dismiss Fina

Group’s complaint were correct. Therefore, we AFFIRM.

AFFIRMED.

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