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May 12, 2003


The opinion of the court was delivered by: John A. Nordberg, Senior District Judge.


After a four-day hearing, a panel of NASD arbitrators found that Martin W. Smith committed fraud against Elizabeth Bartolini and ordered him to pay an award of more than a half million dollars including $100,000 in punitive damages. Smith filed this action seeking to vacate that award on to ground that the NASD arbitrators lacked jurisdiction to hear the dispute because Bartolini was not technically a "customer" under the Code of Arbitration Procedure and because the investment vehicle was not a "security." Bartolini filed a counter petition to confirm the award. See Federal Arbitration Act, 9 U.S.C. § 9, 10. Both sides have moved for summary judgment.


The essential facts are undisputed. In 1997, Elizabeth Bartolini's husband died of cancer, leaving her with approximately $400,000 in life insurance proceeds, which then constituted the bulk of her net worth. Soon after her husband's death, she went to Martin W. Smith for advice on how to invest the proceeds. Smith was married to Bartolini's deceased husband's sister.

Smith is a man who — as the business expression goes — wore several hats. In addition to being Bartolini's brother-in-law, he was president, 50% shareholder, and chairman of the board of World Securities, Inc. ("WSI"). At the same time, he was president of Investors Financial, Inc. ("IFI"). During the relevant time period, WSI was registered as an SEC broker-dealer while IFI was an SEC registered investment adviser. Both WSI and WI were Missouri corporations, both were located at the same address, and both used the same employees. However, for purposes of this case, they differed in one key respect — WSI was a member of NASD but IFI was not. As will be discussed below, this fact underlies Smith's central argument against arbitration.

When Bartolini approached Smith for investment advice, it is undisputed that she was emotionally fragile (due to the recent death of her husband) and was an inexperienced investor. It is also undisputed that Smith provided her investment advice, which she followed. Specifically, Smith advised Bartolini to put all her money into a single investment — World Capital Management, L.P. ("World Capital"), which operated a high-risk hedge fund that Smith created and managed. Both WSI and WI were involved in its operation. IFI was the general partner and WSI provided brokerage services.*fn1

Although Smith advised Bartolini to invest in World Capital, he advised her to do so indirectly through a complicated series of business entities. After consulting with attorneys for WSI, Smith established an irrevocable trust that was funded by the $300,000 of the life insurance proceeds. The trust in turn acquired all the outstanding stock of a shell corporation known as Jazzy Internet Services, Inc., a Nevada corporation ("Jazzy"), for a nominal amount and then made a loan to Jazzy for $300,000. Jazzy used the money to purchase a limited partnership interest in World Capital. In return, Jazzy executed a promissory note back to the trust. In short, as Smith describes the investment, it was "twice removed" in that Bartolini was a beneficiary of a trust that owned the shares of a corporation that became a limited partner of World Capital.

Bartolini's "twice removed" investment in World Capital eventually declined to virtually nothing. Smith was the trading manager for World Capital and he made the trading decisions that resulted in more than a thousand trades, eventually leading to the loss of around $20 million of investors' money. However, during this time, WSI made approximately $2.2 million in commissions from World Capital.

On November 26, 1999, Bartolini filed a statement of claim with the NASD alleging that the World Capital investment was unsuitable because it involved speculative and high volume trading. On February 2, 2000, Smith executed a Uniform Submission Agreement in which he agreed to "submit the present matter in controversy [to arbitration], as set forth in [Bartolini's] statement of claim" and "to abide by and perform any [arbitration] award(s) rendered pursuant to this Submission Agreement." In the arbitration, Smith and WSI raised the same arguments they are making here; namely, that the arbitrators had no jurisdiction. The arbitrators twice rejected this argument — first on September 15, 2000 and again later at the hearing. Before the arbitration hearing began, Smith and WSI did not — as they had a right to do — bring this issue to federal court for a ruling on whether the dispute was arbitrable. A four-day hearing was held beginning in late January 2001. Smith participated in the hearing through his attorney and raised various defenses and arguments.

On March 26, 2001, the arbitrators ordered WSI and Smith, jointly and severally, to pay Bartolini $401,111.95 in out-of-pocket losses, $100,000 in punitive damages, $75,000 in attorneys' fees, and $15,000 for witness and other fees for a total of $591,111.95. The arbitrators specifically concluded that Smith and WSI (i) "committed fraud while acting in a fiduciary capacity;" (ii) "obtained [Bartolini's] money under false pretenses;" and (iii) engaged in a "malicious and willful violation of trust and confidence placed in them by [Bartolini]." The panel awarded Bartolini $100,000 in punitive damages to "punish [Smith and WSI] and deter them [] from similar treatment of public customers." (Arb. Award at 4.)

Smith and WSI filed this action seeking to vacate the arbitration award. Subsequently, WSI settled with Bartolini and is no longer a part of this action. Bartolini filed a counter petition to confirm the arbitration award. The parties agreed to file simultaneous cross-motions for summary judgment. We have reviewed these briefs as well as the supporting exhibits and affidavits.


Smith argues that this dispute is not arbitrable under Section 10301 of the NASD Code of Arbitration Procedure because (i) Bartolini was not a "customer" and (ii) she did not purchase a "security." Neither argument has merit. See Sections I & II. Even if there were some doubt about whether this dispute were arbitrable based on the NASD Code, we would still find it arbitrable under the Uniform Submission Agreement executed by Smith. See Section III.

I. Was Bartolini A "Customer" Under NASD Section 10301?

Both sides agree that the general question of whether this dispute is arbitrable is governed by NASD Code Section ...

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