MEMORANDUM OPINION AND ORDER
Edward C. Jana and his elderly mother Lucille Jana made several investments through Merrill Lynch, Pierce, Fenner & Smith, Inc. ("Merrill Lynch"). The Janas invested in a series of limited partnerships that eventually resulted in substantial financial loss and a dispute with Merrill Lynch over who was to bear that loss. Pursuant to customer agreements with Merrill Lynch, the Janas sought to arbitrate the dispute before the National Association of Securities Dealers, Inc. ("NASD"). They filed a Statement of Claim and Demand for Arbitration with NASD on June 25, 1992. On February 26, 1993, Merrill Lynch filed this action seeking injunctive relief with respect to elements of the Janas' requested arbitration.
Before the Court are two related motions. Merrill Lynch has filed a Motion for Injunctive Relief based upon their Complaint and the Janas have filed a Motion to Dismiss Complaint and to Compel Arbitration.
FACTUAL AND PROCEDURAL BACKGROUND
In 1983 and 1986 respectively, Lucille Jana and her son Edward C. Jana opened accounts with the Naperville, Illinois office of Merrill Lynch. In opening their accounts, the Janas signed similar customer agreements, each of which stated, in part: (1) that the agreements were governed by the laws of the State of New York and, (2) that any controversy between the contracting parties would be conducted pursuant to the provisions of either the Constitution and Rules of the Board of Governors of the New York Stock Exchange, Inc. (the "NYSE Rules") or the Code of Arbitration Procedure of the National Association of Securities Dealers, Inc. (the "NASD Code"), at the Janas' election.
As a result of the dispute leading to this case, the Janas filed a Statement of Claim and Demand for Arbitration before NASD on June 25, 1992 and thereby decided that this controversy would be governed by the NASD Code. In their Statement of Claim, the Janas alleged that they had been fraudulently misled by their Merrill Lynch account executive, Mr. Paul E. Waigand, with respect to the nature of six limited partnership investments in which, at Waigand's direction, they invested. In their Statement of Claim the Janas sought to impose joint and several liability on Merrill Lynch and Waigand for losses resulting from the investments. Additionally, the Janas made a demand for an award of punitive damages.
On July 23, 1992, Merrill Lynch filed suit in the Supreme Court of the State of New York, seeking an order barring arbitration of several of the Janas claims and of their request for punitive damages. On November 30, 1992, the Honorable Edith Miller dismissed Merrill Lynch's petition for lack of personal jurisdiction over the Janas. After Judge Miller's decision NASD ordered Merrill Lynch and Waigand to file Answers and Submission Agreements in the arbitration. Merrill Lynch filed this action on February 26, 1993 and, on May 27, 1993, this Court entered an agreed order staying the arbitration proceedings pending resolution of the issues now presented.
The parties agree that, pursuant to the original customer agreements signed by the Janas, this case is governed by the law of the State of New York to the extent that it is not preempted by the Federal Arbitration Act ("FAA"), 9 U.S.C. § 1 et seq.1
Also pursuant to their customer agreements, the Janas had the right to elect whether to arbitrate their dispute with Merrill Lynch under the Constitution and Rules of the Board of Governors of the New York Stock Exchange, Inc. or under the Code of Arbitration Procedure of the National Association of Securities Dealers, Inc. Having chosen to arbitrate this case with NASD, the Janas have chosen that the case be governed by the NASD Code as well. In its Complaint seeking injunctive relief, Merrill Lynch seeks to enjoin two separate elements of the Janas' arbitration claim: certain compensatory claims that it argued to be ineligible for arbitration and the Janas request for punitive damages. Merrill Lynch first argues that Section 15 of the NASD Code prevents the arbitration panel from hearing certain ineligible claims made by the Janas (the "eligibility issue"). Next, Merrill Lynch argues that New York law bars the arbitration panel from imposing punitive damages (the "punitive damages issue"). The Court addresses these elements separately.
With respect to the eligibility issue, Section 15 of the NASD Code is central to the resolution of both motions now before the Court. Section 15 says:
No dispute, claim, or controversy shall be eligible for submission to arbitration under this Code where six (6) years shall have elapsed from the occurrence or event giving rise to the act or dispute, claim or controversy. This Section shall not extend applicable statutes of limitations, nor shall it apply to any case which is directed to arbitration by a court of competent jurisdiction.
It is apparent that the Janas' Statement of Claim, with respect to two of the Janas' limited partnership investments, was made more than six years after the date of investment.
In its Motion for Injunctive Relief Merrill Lynch contends that Section 15 of the NASD Code renders ineligible two of the Janas' claims for compensatory damages. In rebuttal, the Janas contend that any such issue should be decided by the NASD arbitration panel and not this Court. This argument is the crux of the Janas' Motion to Dismiss.
In support of their Motion to Dismiss Merrill Lynch's Section 15 claims, the Janas assert that, under New York law, the application of the NASD Code, and thus Section 15, should be decided by the arbitrators, not the Court. Under the New York Court of Appeals case County of Rockland v. Primiano Const. Co., 51 N.Y.2d 1, 409 N.E.2d 951, 431 N.Y.S.2d 478 (N.Y. 1980), this argument depends on whether Section 15 is to be construed as a "condition precedent to arbitration" or as a "procedural stipulation."
According to the New York Court of Appeals, on motions to stay or to compel arbitration there are three threshold questions to be resolved by the courts: (1) whether the parties made a valid agreement to arbitrate; (2) if made, whether such an agreement was complied with; and (3) if the agreement was made and complied with, whether a claim under the agreement would have been barred by a statute of limitations if brought in state court. Id. at 953.
When, as here, the second of these questions is at issue, Courts must distinguish between "conditions precedent to arbitration" and "procedural stipulations" laid down by the parties "to be observed in the conduct of the arbitration proceeding itself." Id. at 954. The former are "preconditions to access to the arbitral forum" to be determined by the courts; the latter are rules governing the arbitration itself and thus are to be interpreted by the arbitrator "as incidental to the conduct of the arbitration proceedings." Id. Such a distinction, and the forum in which it is to be interpreted, makes sense. The Courts are to determine what issues are eligible for arbitration; the arbitration panel is to determine how that arbitration will proceed. When there is disagreement over whether a given rule is a precondition or a procedural rule, the courts must analyze the substance of the rule and the function it is perceived to play and then determine into which category the rule falls. See id.
With respect to Section 15, the Seventh Circuit has given the district courts clear guidance in interpreting New York State law. Notwithstanding the Primiano court's inclusion of "limitations of time within which the demand for arbitration must be made" as an example of a "procedural stipulation", the Seventh Circuit has clearly stated that Section 15's time limitation is to be considered an "eligibility requirement", or a condition precedent. See PaineWebber Inc. v. Farnam, 870 F.2d 1286 (7th Cir. 1989) (contrasting Section 15, an eligibility requirement, with a statute of limitations, a procedural rule); see also Edward D. Jones & Co. v. Sorrells, 957 F.2d 509 (7th Cir. 1992) (relying on Farnam in concluding that Section 15 was an eligibility requirement). Under Farnam and Sorrells, Section 15 goes to the very power" or subject matter jurisdiction, of NASD to arbitrate a claim. See Sorrells, 957 F.2d at 512. Under that Section NASD may not process, i.e. has no jurisdiction over, any claim submitted for arbitration more than six years after the "event in dispute." Sorrells, 957 F.2d at 512 (citing Farnam, 870 F.2d at 1292).
Despite the clear Seventh Circuit authority on this issue, the Janas claim that the decisions in Farnam and Sorrells should be ignored as wrongly decided. The Court disagrees.
Since the Seventh Circuit's decision in Sorrells, two New York State Courts have endorsed either the Sorrells or Farnam decision. See Merrill Lynch, Pierce, Fenner & Smith, Inc. v. DeChaine, 600 N.Y.S.2d 459 (N.Y. App. Div. 1993) (stating that Section 603 of the New York Stock Exchange Arbitration Rules, which is identical in wording to NASD Code Section 15, is not a statute of limitations but an eligibility requirement); Prudential Bache Sec. v. Archard, 179 A.D.2d 652, 579 N.Y.S.2d 890 (N.Y. App. Div. 1993), appeal denied, 587 N.Y.S.2d 906 (N.Y. 1992) (citing Farnam and Primiano for statement that the commencement of arbitration proceedings after six years is time barred by NASD Code Section 15). Although all the federal courts are not in consensus on this issue, the Sorrells and Farnam decisions have been endorsed by the Third and Sixth Circuits. See PaineWebber Inc. v. Hofmann, 984 F.2d 1372, 1379 (3d Cir. 1993) (citing Sorrells and stating that Section 15 can only be read as a substantive limit on the claims that can be submitted to arbitration); PaineWebber Inc. v. Hartmann, 921 F.2d 507, 513-514 (3d Cir. 1990) (citing Farnam and concluding that the district court did not commit clear error in interpreting NYSE Arbitration Rule 603 like Section 15); Roney & Co. v. Kassab, 981 F.2d 894, 897 (6th Cir. 1992) (adopting the positions of the Third and Seventh Circuits). But see FSC Sec. Corp. v. Freel, 811 F. Supp. 439, 442 (D.Minn. 1993) (relying on a Fourth Circuit case, Miller v. Prudential Bache Sec., Inc., 884 F.2d 128 (4th Cir. 1989), cert. denied, 497 U.S. 1004 (1990)).
In the face of this support of Farnam and Sorrells, the Janas cite several cases distinguishable on the grounds that they are statute of limitations, waiver, or other non-section 15 or NYSE Rule 603 cases.
The Janas point to an anomalous case in support their current position: Merrill Lynch, Pierce, Fenner & Smith Inc. v. Noonan, 93 Civ. 3770, 1992 WL 196741 (S.D.N.Y. Aug. 3, 1992). This case fails to distinguish, cite or even address any authority directly on point. Instead, the case relies on Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114 (2d Cir. 1991). Although Wagoner broadly states that: "any limitations defense--whether stemming from the arbitration agreement, arbitration association rule, or state statue--is an issue to be addressed by the arbitrators", 944 F.2d at 121, the case does not directly address the issues here at hand. To the extent the case conflicts with Farnam and Sorrells, the Court rejects it as unpersuasive.
Accordingly, the Court finds that under Section 15 of the NASD Code, the arbitration panel has no jurisdiction over any claim not submitted to arbitration within six years of the "event or occurrence" leading to the dispute. The Court now turns to determining what constitutes an "event or occurrence" for the purposes of the case at hand. The case of Edward D. Jones & Co. v. Sorrells, 957 F.2d 509 (7th Cir. 1992) is directly on point.
In Sorrells, the Seventh Circuit implicitly held that, for the purpose of NASD Code Section 15, an "event or occurrence" is the date of investment. The Court stated:
More than six years elapsed from the date the Sorrells made the last of the ten investments which gave rise to their claims . . . Thus, the Sorrells' arbitration claims were not timely filed under Section 15.
Sorrells, 957 F.2d at 512. According to Merrill Lynch two of the limited partnership investments complained of by the Janas were invested in more than six years before their claims were submitted to arbitration. The two investments were made on April 4, 1985 and April 15, 1986.
Since the claims regarding these investments were submitted to NASD on June 25, 1986, they are both untimely.
The Janas contend that the date of investment should not be used for measuring timeliness because Merrill Lynch and Waigand "fraudulently concealed" the nature of the investment and the harm incurred. Similarly, the Janas argue that the six year time requirement should be tolled due to this fraudulent concealment. These arguments are rejected by Sorrells and Farnam. In Sorrells, the Seventh Circuit, quoting Farnam, states:
In PaineWebber [Farnam]. . . we explicitly held that Section 15 which defines which claims "shall be eligible for submission for arbitration" (emphasis added), is an eligibility requirement and not a statute of limitations and thus cannot be tolled.