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LEHMAN BROS. v. CERTIFIED REPORTING CO.

September 5, 1996

Lehman Brothers, Inc., plaintiff
v.
Certified Reporting Company, James K Arthur, Aquarius Travel Agency, John J Henely as trustee, John J Henely, Ltd., Fred M Parker, Louise Parker, Leonard S Bird, Jr., Jacob J Ivezich, and Donna Ivezich, defendants.



The opinion of the court was delivered by: CASTILLO

 Defendants are investors *fn1" who originally sought to arbitrate before the New York Stock Exchange ("NYSE") their claims against plaintiff Lehman Brothers. Investors alleged in their arbitration Statement of Claim ("Arbitration Claim") that Lehman disseminated false and misleading information inducing them to purchase grossly overvalued stock. In response, Lehman brought this action in federal district court. Lehman's complaint requests preliminary and permanent *fn2" injunctive relief barring Investors from arbitrating certain of their claims, namely those involving stock that Investors bought from other brokerage firms. Lehman seeks a declaratory judgment to the same effect.

 The parties have now filed cross-motions for summary judgment. They submitted a joint statement of facts, stipulating that no genuine issue of material fact prevents this Court from rendering judgment as a matter of law.

 Lehman and Investors also agree that the legal standard governing arbitrability in this case is NYSE Arbitration Rule 600(a), which provides:

 
Any dispute, claim, or controversy between a customer or a non-member and a member . . . arising in connection with the business of such member . . . shall be arbitrated under the Constitution and Rules of the New York Stock Exchange, Inc. as provided by any duly executed and enforceable written agreement or upon the demand of a customer or non-member.

 2 N.Y.S.E. Guide (CCH) P 2600 (Nov. 1995). Lehman acknowledges that it is a member of the NYSE. Joint Statement Pursuant to Local General Rule 12(M)(3)("Jt. St.") P A.1. In dispute is whether Investors are "customer[s] or non-member[s]," and whether Investors' claims arose in connection with Lehman's business. Resolving those issues requires this Court to decide whether Rule 600(a) permits arbitration when the parties lack a direct transactional relationship. For the reasons discussed below, the Court finds that it does. *fn3"

 RELEVANT FACTS

 To determine arbitrability, a court must look to "whether the party seeking arbitration has made a claim which on its face is governed by the contract." Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Hovey, 726 F.2d 1286, 1289 (8th Cir. 1984); see also Spear, Leeds & Kellogg v. Central Life Ass. Co., 85 F.3d 21, 28 (2d Cir. 1996) (relying on claimant's allegations in analyzing arbitrability); Paine, Webber, Jackson & Curtis v. Chase Manhattan Bank, 728 F.2d 577, 578 n.1 (2d Cir. 1984) (same). Consequently, the facts as stated in Investors' Arbitration Claim are critical to the Court's ruling. Their importance is magnified by the fact that the parties' joint statement of facts sheds little light on the legal issues involved in this case. *fn4"

 Investors allege in their Arbitration Claim that they purchased stock in Great American Communications Company ("GACC") based on the misrepresentations of Lehman and Mr. Paul Warehall, then a Lehman Chicago office employee. Compl., Ex. A, at 1. GACC was the product of a 1987 merger that left it mired in debt. In 1989, GACC sought to reduce its indebtedness by hiring Lehman to market and sell its stock. Id. PP 3-4. Lehman became GACC's primary market maker. Id. P 15.

 Shortly after GACC retained Lehman, the firm allegedly began to engage in conduct designed to artificially support and manipulate the stock price. Id. PP 5, 15. Lehman misrepresented to Investors GACC's financial fitness, performance, and prospects, selling the stock at inflated prices. Through the head of its over-the-counter trading department, Lehman presented over-enthusiastic recommendations to its brokers and implemented a broker incentive program to facilitate quick stock sales. Id. PP 6, 10, 15. The firm also allegedly directed one of its employees, Paul Warehall, to solicit Investors to buy GACC stock using a sales script containing false and misleading statements. Warehall misrepresented to Investors both the stock's value and its investment risk, claiming that GACC was and would remain profitable. Id. PP 13, 18.

 From 1989 to 1991, Investors purchased GACC stock based on these alleged misstatements. Id. PP 42-59. While some Investors bought the stock directly from Lehman, all executed at least one GACC transaction through other brokerage firms. Id.

 The GACC stock turned out to be a poor investment. Its market price plummeted from $ 12 per share to $ 0.40 per share in the span of three years. Id. PP 14, 27. When GACC's market price dipped to $ 3.00 per share, Lehman allegedly continued to recommend the stock and support its price by falsely stating that the share price would skyrocket when institutional short sellers were forced to "cover their positions." Id. P 19. This, however, never occurred, and by the second quarter of 1992, GACC was trading for just $ 0.40 per share. Id. P 27.

 These allegations are the genesis of several causes of action: (1) breach of fiduciary duty; (2) breach of the implied covenant of good faith and fair dealing; (3) common law fraud; (4) negligent misrepresentation; and (5) breach of fiduciary duties arising under ERISA. Investors seek up to $ 5 million in damages in each count for Lehman's actions.

 All Investors claim that they bought GACC stock in reliance on Lehman and Warehall's misrepresentations. But not every GACC purchase was executed through Lehman's brokerage office. See Jt. St. PP 12-21. Lehman challenges arbitration only as to the claims based on transactions with other brokers. Compl. P 1.

 DISCUSSION

 Resolving arbitrability is a matter entrusted to the courts. AT&T Tech., Inc. v. Communications Workers, 475 U.S. 643, 649, 89 L. Ed. 2d 648, 106 S. Ct. 1415 (1986); Spear, Leeds & Kellogg v. Central Life Ass. Co., 85 F.3d 21, 25 (2d Cir. 1996). This determination is the product of a straightforward analysis. First, the court must ascertain whether the parties have an agreement to arbitrate. If the answer is affirmative, the next task is to decide whether the scope of the agreement covers the dispute at hand. Spear, Leeds, 85 F.3d at 25-26; Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Hovey, 726 F.2d 1286, 1288 (8th Cir. 1984). Keeping in mind that arbitration is, at bottom, a matter of contract, judges must take care to ensure that they do not force the parties to arbitrate a dispute against their will. AT&T Tech., Inc., 475 U.S. at 648; Painewebber Inc. v. Elahi, 87 F.3d 589, 594 (1st Cir. 1996). To do so would undermine the parties' reasonable expectations, in violation of the most basic principles of contract law. See Spear, Leeds, 85 F.3d at 28.

 I. The Parties Have an Arbitration Agreement

 At first blush, it appears that Investors have no agreement with Lehman at all in relation to their stock purchases from other firms. And absent this privity, it would seem that the requisite contract to arbitrate is missing. But the New York Stock Exchange provides those who have disputes with its members an alternative route to arbitration: the NYSE Constitution and Arbitration Rules. NYSE Arbitration Rule 600(a), in particular, calls for arbitration simply "upon the demand" of a customer or NYSE non-member. *fn5" The Rule does not contemplate a contract as a precondition to arbitration because the rule supplies the contract. Spear, Leeds, 85 F.3d at 27. Courts have consistently held that Rule 600(a) alone is sufficient to compel NYSE member firms to arbitrate their disputes. Id. at 26; Hovey, 726 F.2d at 1289; Coenen v. R.W. Pressprich, 453 F.2d 1209, 1211-12 (2d Cir.), cert. denied, 406 U.S. 949, 32 L. Ed. 2d 337, 92 S. Ct. 2045 (1972).

 Lehman stipulated in the parties' joint fact statement that it is a NYSE member. Jt. St. P A.1. When it became a member, Lehman pledged to obey the Exchange's Constitution and Rules, including the Rule 600(a) procedures for resolving disputes. See Coenen, 453 F.2d at 1211-12 (since member signed pledge to obey NYSE Rules, court had "no doubt" that member had agreed to arbitrate). Far from transgressing the parties' reasonable expectations, this interpretation enforces the promise that Lehman made when it chose to receive the benefits and abide the dictates of the NYSE.

 That exchange rules create an enforceable arbitration contract has been made clear by the Second and Seventh Circuits. In Spear, Leeds & Kellogg v. Central Life Assurance Co., 85 F.3d 21 (2d Cir. 1996), three life insurance companies sought to arbitrate their claims against Spear, Leeds, a NYSE member, alleging that the firm had provided its client with information used to defraud the insurers. Although the insurers had never contracted to arbitrate or even conducted business with Spear, Leeds, the court held that such a "transactional nexus" was not necessary to compel arbitration. Id. at 25-29. The NYSE arbitration rules provided the requisite arbitration agreement. Id. at 26.

  Likewise, in Geldermann, Inc. v. CFTC, 836 F.2d 310, 319 (7th Cir. 1987), cert. denied, 488 U.S. 816, 102 L. Ed. 2d 33, 109 S. Ct. 54 (1988), the court held that by virtue of its status as a member of the Chicago Board of Trade, Geldermann consented to resolving claims against it under the Board's arbitration rules. This holding was based on parallel decisions regarding NYSE and NASD arbitration proceedings in other Circuits. Paine, Webber, Jackson & Curtis v. Chase Manhattan Bank, 728 F.2d 577, 580 (2d Cir. 1984); see also Patten Sec. Corp., Inc. v. Diamond Greyhound & Genetics, Inc., 819 F.2d 400, 405 (3d Cir. 1987) (NASD member "must be willing to live up to the responsibilities of such ...


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