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Court Finds No Basis for Triggering Mandatory Arbitration Under FINRA Rules

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  • Posted on: Jun 27 2019

Arbitration is an alternative form of dispute resolution where the parties voluntarily agree that a neutral, private person will resolve any legal disputes between them, instead of a judge or jury in a court of law. Rent-A-Ctr., W, Inc. v. Jackson, 561 U.S. 63, 67 (2010) (noting that “arbitration is a matter of contract”). In business and commercial transactions, arbitration is the preferred means of resolving disputes. It is encouraged and recognized as the public policy of the State of New York. Matter of Smith Barney Shearson v. Sacharow, 91 N.Y.2d 39, 49 (1997) (citations and quotation marks omitted). Id. Consequently, courts will interfere as little as possible with the agreement of consenting parties to submit their disputes to arbitration. Id. at 49-50. (citations omitted).

Since arbitration is a “creature of contract” (Louis Dreyfus Negoce S.A. v. Blystad Shipping & Trading Inc., 252 F.3d 218, 224 (2d Cir. 2001)), only signatories to a contract containing an arbitration agreement can be compelled to arbitrate. TBA Global, LLC v. Fidus Partners, LLC, 132 A.D.3d 195, 202 (1st Dept. 2015). Consequently, “a party cannot be required to submit to arbitration any dispute which he has not agreed so to submit.” AT&T Techs., Inc. v. Communications Workers of Am., 475 U.S. 643, 648 (1986) (quoting Steelworkers v. Warrior & Gulf Nav. Co., 363 U.S. 574, 582 (1960)).

Not surprisingly, whether the parties are bound by an arbitration agreement and whether they agreed to submit their dispute to arbitration are hotly contested questions. The person(s) who will resolve these questions is dependent upon the agreement at issue.

As a general matter, questions of arbitrability are decided by a court. However, the parties to an arbitration agreement can agree to delegate questions of arbitrability to an arbitrator. MetLife v. Buscek, 919 F.3d 184, 189 (2d Cir. 2019) (“In general, what is determinative for deciding whether the arbitrability of a dispute is to be resolved by the court or by the arbitrator is the arbitration agreement”).  When the parties agree to delegate the question of arbitrability to an arbitrator, the parties must clearly and unmistakably express their intent to do so. Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79, 83 (2002). In the absence of such a clear and unmistakable expression of intent, the presumption favors the courts deciding arbitrability. First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938 (1995).

Recently, the United States Supreme Court held that, when the parties have agreed to submit the question of the arbitrability to an arbitrator, the courts must respect and enforce that contractual agreement. Henry Schein Inc. v. Archer & White Sales, Inc., 139 S.Ct. 524 (2019). Consistent with this holding, the Second Circuit recently observed that “parties are free to enter into a binding contract by which either party can compel the other to have every aspect of a future dispute between them, including its arbitrability, determined by arbitrators.”  MetLife, 919 F.3d at 190, citing Rent-A-Ctr., , 561 U.S. at 66, 69 (finding that an arbitration agreement giving the arbitrators “exclusive authority to resolve any dispute relating to the interpretation, applicability, enforceability or formation of this contract” empowered the arbitrators to resolve arbitrability of an unconscionability claim).

The foregoing rules were intended to guard against “the risk of forcing parties to arbitrate a matter that they may well not have agreed to arbitrate.” Howsam, 537 U.S. at 83-84. “Were the courts to cede to arbitrators resolution of the arbitrability of the dispute (absent the clear and unmistakable agreement of the parties to that effect), this would incur an unacceptable risk that parties might be compelled to surrender their right to court adjudication, without their having consented.” MetLife, 919 F.3d at 190, citing First Options, 514 U.S. at 945. Accordingly, in the absence of an arbitration agreement that clearly and unmistakably provides for the issue of arbitrability to be decided by the arbitrator, the question whether the dispute is subject to an arbitration agreement “is typically an issue for judicial determination.” Id., quoting Granite Rock Co. v. Int’l Bhd. of Teamsters, 561 U.S. 287, 296 (2010) (internal citation and quotation marks omitted).

Recently, Justice Joel M. Cohen of the Supreme Court, New County, Commercial Division, addressed the foregoing principles in deciding to stay a FINRA arbitration. Lek Sec. Corp. v. Elek, 2019 N.Y. Slip Op. 31770(U) (Sup. Ct., N.Y. County June 14, 2019) (here).


[Ed. Note: The factual discussion below comes from the petition filed by Lek Securities Corporation (“LekUS”), Samuel Lek and Charles Lek.]

On March 22, 2019, Respondent, Istvan Elek (“Elek”), commenced an arbitration before FINRA against LekUS, Lek Holdings Limited, Charles Lek and Samuel Lek. Elek sought, among other things, compensatory damages, punitive damages and attorney’s fees in connection with his claim that LekUS improperly froze his account and deducted fees therefrom pursuant to a contractual right of indemnification.

The dispute arose in July 2014, when Elek opened a brokerage account with Lek Securities UK Limited (“LekUK”). Elek used the account to trade microcap securities. His relationship with LekUK was governed by LekUK’s Client Agreement Form and Terms of Business (“Terms of Business Agreement”). The Terms of Business Agreement contained an indemnity provision that required Elek to indemnify and hold LekUK harmless from any losses, claims or expenses incurred by virtue of LekUK’s performance of services on Elek’s behalf.

Between May 2015 and December 2016, Elek engaged in 11 microcap transactions with shares of Cannabis Science, Inc. (“CBIS”). Elek acquired his CBIS shares on his own and purchased the shares pursuant to stock purchase agreements that he prepared. He did not use LekUK or LekUS to negotiate these transactions.

Upon the deposit of the CBIS shares in his account at LekUK, Elek indicated that the shares were not registered with the Securities and Exchange Commission (“SEC”) and that he nevertheless wanted to sell his stock in the United States. LekUK then indicated to LekUS that LekUS could anticipate an order (from LekUK) to sell unregistered securities in the United States.

Once LekUS satisfied itself that the stock could be sold pursuant to a valid exemption from registration, LekUS deposited the stock in its account at Depository Trust & Clearing Corporation and credited the account of LekUK. Upon receiving the credit from LekUS, LekUK credited Elek’s account and the stock was reflected in his LekUK account statement.

On or about October 31, 2018, Elek contacted Charles Lek at LekUK and requested that his account be closed. Thereafter, on November 26, 2018, FINRA filed an enforcement action against LekUS and Samuel Lek (the “FINRA Action”). The FINRA Action alleged, in pertinent part, that LekUS failed to investigate suspicious activity with regard to CBIS trading, including (1) failing to investigate trades involving shares obtained from the conversion of debt instruments, which FINRA alleged did not contain stock conversion features; (2) failing to conduct an inquiry to determine whether the shares qualified for a resale exemption pursuant to SEC Rule 144; and (3) failing to determine whether the holding period relied on by the customer could relate back to the date the debt at issue was acquired.  

The FINRA Action related to transactions that occurred from July 17, 2015 to June 30, 2016, a time period in which Elek was actively trading CBIS shares through his account at LekUK. All of Elek’s trades allegedly fit the pattern of activity identified by FINRA as suspicious – i.e., they involved conversions of debt to CBIS stock and relied on SEC Rule 144 resale exemptions.

On November 26, 2018, Charles Lek notified Elek that LekUK intended to enforce the indemnity provision of the Terms of Business Agreement to cover LekUK’s anticipated expenses and obligations to LekUS stemming from the FINRA Action and from an allegation that Elek failed to abide by the Applicable Rules. Based on these indemnity claims, LekUK had frozen Elek’s account and notified Elek of its intent to deduct applicable costs and counsel fees.

Petitioners initiated the action, pursuant to CPLR § 7503(b) and the Federal Arbitration Act (9 U.S.C. § 1 et seq.), seeking to stay the FINRA arbitration that was commenced on March 22, 2019. Respondent cross-moved to compel arbitration.

The Court granted the motion to stay and denied the motion to compel arbitration.

The Court’s Decision

The Court held that on the facts, “the evidence clearly show[ed that the] dispute [was] not subject to mandatory FINRA arbitration.” Slip Op. at *2.

The Court found that “the record demonstrate[d] convincingly that the parties did not agree to arbitrate the claims asserted by Respondent.” Id. The Court explained that “[t]he only tether to FINRA arbitration is the assertion by Respondent that he is suing as a customer of LekUS, which is a member of FINRA. The record show[ed] that is not the case.” Id.  The Court went on to say that “Respondent’s customer relationship clearly was with Lek Securities UK Limited …, not with Petitioner Lek Securities Corporation …. Respondent’s attempt to shoehorn this into a customer dispute with Lek US is unavailing.” Id.


Lek is notable for its adherence to the proposition that the facts triggering mandatory arbitration before a FINRA arbitration panel must be clear and unmistakable. The fact that a broker-dealer is a FINRA member does not mean that there must be an arbitration before FINRA. The person against whom arbitration is sought to be compelled must be a “customer” within the meaning of FINRA’s Code of Arbitration Procedure for Customer Disputes.  Under FINRA Rule 12200, a customer is one who either purchases a good or service from a FINRA member or has an account with a FINRA member. Citigroup Glob. Market Inc. v. Abbar, 761 F.3d 268, 275 (2d Cir. 2014).  In Lek, Elek was not a customer of LekUS or the individual petitioners Charles Lek and Samuel Lek within the foregoing definition.

The Lek Court found Citigroup to be “directly on point.”  There, the defendant purchased, through his private banker, complex options from a Citigroup affiliate in the United Kingdom. Although Citigroup personnel in New York provided advice to their UK counterpart (e.g., supporting risk management and due diligence services), the securities were held in the United Kingdom by the U.K. affiliate. The defendant maintained complete oversight over the funds and assets held in the options. When the value of the options declined, the defendant commenced a FINRA arbitration against the U.S.-based Citigroup. The Second Circuit held that the defendant was not a customer of Citigroup and stayed the arbitration before FINRA. Id. at 275. In so holding, the court found that the defendant never held an account with Citigroup in New York, and the services it purchased were from the U.K. affiliate. Id. at 276.

Like the defendant in Citigroup, Elek opened his account with LekUK, not with LekUS. Slip Op. at *3. There was no evidence that Elek purchased any services from LekUS. Id. Instead, the record indicated “that the services performed by Lek US were on behalf of Lek UK, which paid for those services in a manner that was not based on transaction volume and thus not tied to Respondent’s trading.” Id.

Thus, as in Citigroup, Lek stands for the proposition that unless the evidence demonstrates that the parties clearly and unmistakably intended to arbitrate their dispute, the presence of a mandatory arbitration requirement will not necessarily send the parties to arbitration. In the FINRA world, this means that customers of a broker-dealer must be a “customer” of that firm – i.e., the person opened an account with the FINRA member; or the person purchased services from the FINRA member. As Lek teaches, in the absence of the foregoing, arbitration will not be triggered.  

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