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KAYNE v. PAINEWEBBER INC.

January 19, 1989

BERNARD J. KAYNE, Plaintiff,
v.
PAINEWEBBER INCORPORATED, and THOMAS W. FORSBERG, Defendants



The opinion of the court was delivered by: DUFF

 HONORABLE BRIAN BARNETT DUFF, UNITED STATES DISTRICT JUDGE

 PaineWebber subsequently moved to dismiss the original complaint pursuant to Rules 12(b)(1) and 12(b)(6) of the Federal Rules of Civil Procedure. This court granted the motion on the securities claims on the grounds that unauthorized trading alone does not violate § 10(b) or Rule 10b-5, and that Forsberg's fraudulent acts -- i.e., the false post-purchase assurances that he would cancel the transactions -- were not "in connection with" the purchase of the securities as required by the statute and the rule. Kayne v. PaineWebber, 86 C 6646, Minute Order (January 12, 1988). The court denied the motion on the RICO and state law claims. Id.

 PaineWebber then moved to compel plaintiff to submit these claims against it to arbitration, pursuant to the Federal Arbitration Act, 9 U.S.C. § 1 et seq. The motion was predicated on an arbitration clause ("the Arbitration Clause") in plaintiff's Customer Agreement with PaineWebber. The clause provided that:

 
Any controversy between us arising out of or relating to this contract, breach thereof, or any account(s) maintained with you (except any claim for relief by a public customer for which a remedy may exist pursuant to an express or implied right of action under the federal securities laws) shall be settled by arbitration. . . .

 The court granted the motion, thereby removing PaineWebber from the lawsuit. Kayne v. PaineWebber, 684 F. Supp. 978 (1988).

 On June 1, 1988, plaintiff filed an amended two-count complaint against PaineWebber under § 10(b) and Rule 10b-5. The amended complaint deletes the allegations of unauthorized trading in the Mineral's stock, but adds substantially to the allegations concerning Forsberg's unauthorized purchases of Ventrex stock. The allegations of the new complaint (and relevant exhibits) are as follows.

 On July 22, 1985, plaintiff opened a margined securities account at PaineWebber with Forsberg as plaintiff's account executive. The account was a non-discretionary one, so that before Forsberg could purchase securities for plaintiff, he had to obtain plaintiff's permission. If plaintiff received a report of an executed order that he did not authorize, he had to immediately notify PaineWebber in writing or the report was conclusive.

 Later that year, Forsberg devised and implemented a plan in which he purchased a large amount of Ventrex stock for his own account, and then, in order to raise the value of his stock, made unauthorized purchases of Ventrex stock for the accounts of many of his clients. Two of these purchases, 20,000 shares on August 13, and 50,000 shares on September 11, were credited to plaintiff's account.

 When plaintiff received the reports of these transactions, he immediately notified Forsberg that he had not authorized them, and insisted that they be reversed. Forsberg initially assured him that they would be, but when time passed and nothing was done, plaintiff told Forsberg that he was going to report the transactions to Forsberg's superiors. At this point, Forsberg threatened that if plaintiff did so Forsberg would recommend to his other clients that they sell the stock of another company in which plaintiff had a substantial investment.

 In time, plaintiff did report the unauthorized transactions to PaineWebber. After repeated demands that the transactions be cancelled, the Ventrex stock was finally sold from his account at a loss of more than $ 50,000.

 Plaintiff states his § 10(b) and Rule 10b-5 claims in two counts. Count I alleges fraud in Forsberg's failure to disclose that the unauthorized purchases were for the purpose of manipulating the price of the Ventrex stock. Count II alleges fraud in Forsberg's failure to notify plaintiff that the purchases were being made at all, and in Forsberg's subsequent representations that he would immediately reverse the transactions. Plaintiff seeks to hold PaineWebber responsible for the fraud as a controlling person pursuant to § 20(a) of the Securities Exchange Act, 15 U.S.C. §§ 77(o) and 77t(a). PaineWebber has moved to dismiss the amended complaint, or in the alternative, to compel arbitration.

 DISCUSSION

 The first issue this court faces, one not discussed by the parties, is the proper order in which to proceed. PaineWebber asks the court to first rule on the motion to dismiss and then, if that motion is denied, to turn to the motion to compel arbitration. In its earlier ruling, however, this court explained that arbitrators are as qualified as courts to rule on the sufficiency of pleadings, and that a defendant "generally may not 'forum-shop' by first asking a court to examine the merits of [the] claims and then, if displeased with the result, demanding that the court send them to an arbitrator." Kayne v. PaineWebber, 684 F. Supp. 978, 981. Thus, the court will first address the motion to compel arbitration.

 The Motion to Compel Arbitration

 The question of whether a claim brought in federal court is subject to arbitration is, first and foremost, a matter of contract law. See Shearson American Express, Inc. v. McMahon, 482 U.S. 220, 107 S. Ct. 2332, 2337, 96 L. Ed. 2d 185 (1987); Giles v. Blunt, Ellis & Leowi, Inc., 845 F.2d 131 (7th Cir. 1988). With McMahon's ruling that § 10(b) and Rule 10b-5 claims are arbitrable, it is now settled that the Arbitration Clause in plaintiff's agreement with PaineWebber requires this court to compel arbitration here unless the clause specifically excludes it. See Dickinson v. Heinold Securities, Inc., 661 F.2d 638, 643 (7th Cir. 1981).

 The Arbitration Clause provides for the arbitration of all controversies arising between plaintiff and PaineWebber, with the exception of those delineated in a parenthetical ("the Exception Clause"). The Exception Clause excepts from arbitration "any claim for relief by a public customer for which a remedy may exist pursuant to an express or implied right of action under the federal securities laws." Since § 10(b) and Rule 10b-5 claims are implied rights of action under the federal securities laws, plaintiff reasons that PaineWebber cannot force him to arbitrate these claims. PaineWebber contends, however, that the Exception Clause must be read in its historical and legal setting.

 In Wilko v. Swan, 346 U.S. 427, 98 L. Ed. 168, 74 S. Ct. 182 (1953), the Supreme Court held that a predispute agreement to arbitrate claims arising under § 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l(2), could not be enforced. Section § 10(b) comes from the Securities Exchange Act of 1934, and hence did not fall within the expres ruling of Wilko, but the Securities Exchange Commission ("SEC") interpreted Wilko as applying to § 10(b) claims, and subsequently promulgated a rule making it unlawful "for a broker or dealer to enter into an agreemeent with any public customer which purports to bind the customer to the arbitration of future disputes between them arising out of the federal securities laws, or to have in effect such an agreement, pursuant to which it effects transactions with or for a ...


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