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KOSTANTACOS v. GREENWOOD

November 21, 1994

MELVIN C. NIELSEN and PETER C. KOSTANTACOS, Plaintiffs,
v.
DANIEL B. GREENWOOD, JAMES B. KNOLL, CARL GORYCHKA, CARL F. WANGAARD, WILLIAM E. DOTTERWEICH, DONALD K. McKAY, WILLIAM W. ROBERTSON, GREGORY J. ZIOLS, KIDDER, PEABODY & CO., PIPER, JAFFRAY & HOPWOOD, INCORPORATED, SPECIALTY EQUIPMENT COMPANIES, INC., SPE ACQUISITION, INC., and GENERAL ELECTRIC CAPITAL CORPORATION, Defendants.



The opinion of the court was delivered by: REBECCA R. PALLMEYER

REPORT AND RECOMMENDATION

 Plaintiffs Melvin C. Nielsen and Peter C. Kostantacos filed this security fraud action on behalf of a purported class of wronged investors. The complaint, filed on October 11, 1991, seeks relief against a number of Defendants, including Defendant Piper, Jaffray & Hopwood, Inc. (hereinafter, "PJH"), one of two underwriters of the securities offering at issue. Defendant PJH moved to compel arbitration of Plaintiffs' claims against PJH. In a Report and Recommendation dated February 26, 1993, this court recommended that the District Court grant that motion. On August 27, 1993, District Judge George Lindberg affirmed that recommendation and ordered Plaintiffs to arbitrate their claims.

 Plaintiff Kostantacos now moves to vacate that order. Kostantacos argues that recent amendments to the National Association of Securities Dealers (hereinafter, "NASD") Code of Arbitration Procedure are applicable to this case and bar arbitration of class action securities claims, such as this one. The amendments at issue took effect on October 28, 1992, several months after the filing of PJH's motion to compel arbitration but well prior to this court's order. For the reasons set forth below, Kostantacos' motion should be granted.

 FACTUAL BACKGROUND

 Plaintiffs Melvin Nielsen and Peter Kostantacos filed this securities fraud class action against several Defendants, including the issuer of $ 150 million in debentures; a subsidiary of the issuer; officers and directors of the issuer; the lender; and two underwriters, one of whom is the moving party here, Defendant PJH. *fn1" On January 6, 1992, Defendant PJH filed its motion to compel arbitration of Plaintiffs' claims pursuant to the arbitration provisions that appeared in brokerage service agreements between Plaintiffs and PJH. Specifically, the "Fiduciary Cash Account Agreements" signed by Plaintiffs provided:

 
We specifically agree and recognize that all controversies which may arise between Piper, Jaffray and Hopwood Incorporated. . . and me, concerning any transaction, account or the construction, performance or breach of this or any other agreement between us, whether entered into prior, on, or subsequent to the date hereof, shall be determined by arbitration to the fullest extent provided by law. Such arbitration shall be in accordance with the rules then in effect, of the Arbitration Committee of the New York Stock Exchange or the National Association of Securities Dealers, Inc. as I may elect. . . . I understand that I am not obligated to arbitrate disputes under the federal securities laws to the extent such claims are held not to be arbitrable as a matter of law.

 (Fiduciary Cash Account Agreement, Exs. A and B to Defendant PJH's Motion to Stay Proceedings and to Compel Arbitration, filed January 6, 1992, at P 14.) In addition to the arbitration clause, the agreements specifically address the effect of changes in statutes or regulations that may occur:

 
Whenever any statute shall be enacted, or any regulation made under any statute or by any exchange, board or market, which shall be applicable to and affect in any manner or be inconsistent with any of the provisions hereof, the provisions of this agreement so affected shall be deemed modified or superseded, as the case may be, by such statute or regulation and all other provisions of this agreement and the provisions as so modified shall in all respects continue and be in full force and effect.

 Id. P9. *fn2"

 On February 26, 1993, this court recommended that PJH's motion to compel arbitration be granted. On August 27, 1993, the District Court adopted that recommendation and entered its order granting PJH's motion.

 Plaintiff Kostantacos argues that a recent rule change requires that the court vacate its earlier order. Plaintiff explains that he has now learned that two days before PJH presented its motion, the Securities Industry Conference on Arbitration (hereinafter, "SICA") had adopted a change in the NASD Code of Arbitration Procedure. *fn3" The Code governs the arbitration of "any dispute, claim or controversy" between members of the NASD and customers, and is "deemed a part of and incorporated by reference in every agreement to arbitrate under the rules of the [NASD]." NASD Manual -- Rules of Fair Practice (CCH) PP 3701, 3742 (1994). As amended, Section 12(d)(3) of Part III of the Code provides:

 
No member or associated person shall seek to enforce any agreement to arbitrate against a customer who has initiated in court a putative class action or is a member of a putative or certified class with respect to any claims encompassed by the class action unless and until: (A) the class certification is denied; (B) the class is decertified; (C) the customer is excluded from the class by the court; or (D) the customer elects not to participate in the putative or certified class action or, if applicable, has complied with any conditions for withdrawing from the class prescribed by the court.

 Id. P3712(d)(3).

 This new rule became effective upon approval by the Securities and Exchange Commission (hereinafter, "SEC") on October 28, 1992. *fn4" On that date, the SEC issued a Release in which it approved the NASD rule change and stated: "This rule change is effective upon the date of Commission approval for all open arbitrations and for arbitration filings made on or after that date. . . . Accordingly, neither member firms nor their associated persons may use an existing arbitration agreement to compel a customer to arbitrate a claim that is encompassed by a class action." (Order Approving Proposed Rule Change Relating to the Exclusion of Class Actions from Arbitration Proceedings, Securities and Exchange Commission Release No. 34-31371, 57 Fed. Reg. 42659 (October 28, 1992).) The Release further stated:

 
The proposed rule change will ensure that class actions and claims of individual class members are not eligible for arbitration at the NASD, regardless of any previously existing agreement to arbitrate. . . . Moreover, paragraph (d) (3) clearly prohibits NASD members from enforcing ...

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