RBC Capital Markets Corp. v. Thomas Weisel Partners LLC, C.A. Nos. 4709-VCN, 4760-VCN (Del. Ch. Feb. 25, 2010) (Noble, V.C.)

In a joint memorandum opinion by Vice Chancellor Noble, the Court of Chancery confirmed that the threshold question of substantive arbitrability is reviewable by a court while the arbitration is pending unless the parties “clearly and unmistakably” submit the question to the arbitrator, and concluded that, the question whether rescission was an appropriate remedy in an arbitration proceeding was a matter for the arbitrator to decide in the first instance absent a sufficient basis to conclude the requested relief impermissibly expanded the scope of the parties’ consent to arbitration.

The plaintiffs, RBC Capital Markets Corp. (“RBC”) and Merrill Lynch, Pierce, Fenner & Smith, Inc.  (“Merrill”), and the defendant, Thomas Weisel Partners LLC, are registered broker-dealers and members of the Financial Industry Regulatory Authority, Inc. (“FINRA”), the private self-regulatory organization for securities dealers. Until February 2008, the defendant purchased auction rate securities (“ARS”) from the plaintiffs for resale to the defendant’s own customers. In February 2008, the ARS market collapsed due to the worldwide financial crisis that began in 2007, resulting in a series of “failed” auctions. Due to these failed auctions, ARS holders experienced a loss of liquidity in their positions. Both plaintiffs were the subject of regulatory investigations alleging violations of federal and state securities laws in connection with the ARS market collapse. Both plaintiffs settled these investigations by, among other things, agreeing to repurchase ARS at par from their retail customers. These settlements did not provide the same relief for institutional customers, like the defendant, or “downstream” purchasers, like the defendant’s customers.

The defendant commenced mandatory FINRA arbitration against both plaintiffs alleging substantially the same securities violations and seeking relief for damages, including rescission of ARS that the defendant owned and that its customers owned. The defendant argued rescission of ARS owned by its customers was a proper remedy because it would allow them to purchase other financial products from the defendant and increase the defendant’s trading fees. Merrill contested the defendant’s claim for rescission as improperly bootstrapping the claims of the defendant’s customers into the arbitration proceeding – these customers would themselves have no standing to force the plaintiffs into mandatory FINRA arbitration. The arbitrator rejected Merrill’s argument and scheduled an arbitration on the merits.

Both plaintiffs then filed separate actions with the Court seeking (1) to enjoin the defendant from proceeding with the FINRA arbitration to the extent it seeks to arbitrate its customers’ disputes; (2) to stay any arbitration proceeding until the Court determined the proper scope of the FINRA arbitration; (3) to declare that the plaintiffs are not required to arbitrate disputes relating to ARS owned by the defendant’s customers; and (4) general relief. The plaintiffs then filed motions for summary judgment and the defendant filed motions to dismiss or stay the complaints. The Court ruled upon all motions in this joint memorandum opinion.

The Court first explained the parties’ dispute is a matter of contractual interpretation of the proper scope of the FINRA arbitration rules to discern whether the plaintiffs had consented to arbitration of the defendant’s claims. Whether a particular claim falls under the scope of an arbitration provision is a matter of substantive arbitrability, as distinguished from procedural arbitrability. Procedural arbitrability disputes are those that “grow out of the dispute and bear on its final disposition,” such as time limits, notice, estoppel, and laches regarding an obligation to arbitrate. Courts generally defer to arbitrators on matters of procedural arbitrability, but not substantive arbitrability. The question of substantive arbitrability is a matter for judicial review even during a pending arbitration proceeding, unless the parties “clearly and unmistakably” submit the issue to the arbitrator. Here, the FINRA arbitration rules have been construed as leaving the issue of substantive arbitrability to the courts unless the parties provide otherwise.

The Court held the plaintiffs did not submit this dispute to the arbitrator “clearly and unmistakably” where they contested the issue to the arbitrator; immediately filed with the Court after the arbitrator’s decision; and only conceded to “some form” of future arbitration. The Court held, however, that the defendant’s claims were properly brought in arbitration because all parties are FINRA members and the defendant’s claims arise solely out of the parties’ business activities, as the FINRA rules provide.

The Court then considered the plaintiffs’ argument that, notwithstanding facial compliance with FINRA’s arbitration provisions, the defendant’s claim for rescission is inappropriate and tantamount to a question of substantive arbitrability, permitting the Court to intervene. Typically, questions of relief are not matters of substantive arbitrability. The plaintiffs did not simply argue the defendant was not entitled to rescission. Rather, the plaintiffs argued the request for rescission “dramatically expands the de facto scope of their respective consents to arbitrate to include the claims of [the defendant’s] customers and should not be permitted ‘merely through a contrived labeling of the parties to that arbitration.’”

While the Court expressed reservations about the propriety of rescission here, the Court nevertheless held that requesting rescission does not necessarily expand impermissibly the scope of the plaintiffs’ consent to arbitration. The Court reasoned rescission was not “obviously outside” the scope of the FINRA arbitration provisions. The Court explained that a party is not disqualified from seeking a remedy simply because a non-party may be “the more appropriate recipient.” The Court also noted the FINRA rules do not limit the types or amounts of remedy a party may request. The Court highlighted that rescission may itself even be appropriate for the ARS the defendant still holds.

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