Washington Square Securities, Inc. v. Aune ( 2004 )

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
WASHINGTON SQUARE SECURITIES, 
INCORPORATED,
Plaintiff-Appellant,
v.
JAMES K. AUNE; VIRGINIA M.
NORMAN, individually and as the
executrix of the Estate of Howard  No. 03-1937
W. Norman and trustee of the
Howard and Virginia Norman
Charitable Trust; PATRICIA J.
WALKER; FRED W. MILTZ, Trust
Manager of the SAM Trust,
Defendants-Appellees.

Appeal from the United States District Court
for the Western District of North Carolina, at Charlotte.
Richard L. Voorhees, District Judge.
(CA-02-308-3-V; CA-02-309-3-V)
Argued: June 2, 2004
Decided: September 23, 2004
Before WILKINS, Chief Judge, LUTTIG, Circuit Judge,
and Louise W. FLANAGAN, United States District Judge
for the Eastern District of North Carolina,
sitting by designation.
Affirmed by published opinion. Judge Flanagan wrote the opinion, in
which Chief Judge Wilkins and Judge Luttig joined.
2 WASHINGTON SQUARE SECURITIES v. AUNE
COUNSEL
ARGUED: Burton W. Wiand, FOWLER WHITE BOGGS BANKER
P.A., Tampa, Florida, for Appellant. Joel Arnold Goodman, GOOD-
MAN & NEKVASIL, P.A., Clearwater, Florida, for Appellees. ON
BRIEF: Hala A. Sandridge, Elaine M. Rice, FOWLER WHITE
BOGGS BANKER P.A., Tampa, Florida, for Appellant.
OPINION
FLANAGAN, District Judge:
This appeal arises from the commencement of arbitration proceed-
ings by appellees James K. Aune and other investors (collectively
"the Investors") against appellant brokerage firm Washington Square
Securities, Inc. ("Washington Square"). Washington Square sought a
declaratory judgment in district court halting the arbitration. Applying
North Carolina contract and agency principles, the district court deter-
mined that Washington Square was bound to arbitrate by virtue of its
membership in the National Association of Securities Dealers, Inc.,
("NASD"), and dismissed the action. Albeit on different reasoning,
we affirm.
I.
Appellees invested in ETS Payphone Equipment, Inc., and World-
wide Growth Partners, Inc. Series B/Evergreen Security Ltd. ("ETS
and Evergreen") at various times from late 1997 through 1998. Dur-
ing that time, Richard White, the investment broker for each of these
transactions, was acting as an associated person of NASD member
Washington Square. As such, White was employed and authorized by
Washington Square to sell securities on its behalf, but White was free
to participate in other business opportunities unrelated to Washington
Square. Washington Square did not authorize or have knowledge of
the ETS and Evergreen investment transactions. As a result of their
investments in ETS and Evergreen, the Investors collectively sus-
tained losses in excess of $1,000,000.00.
WASHINGTON SQUARE SECURITIES v. AUNE 3
On March 13, 2002, the Investors filed an arbitration claim before
the NASD, seeking to hold Washington Square responsible for
White’s sale of allegedly fraudulent ETS and Evergreen investments,
on grounds that Washington Square acted through White as his
employer and otherwise failed to take adequate steps to supervise
White. The Investors sought damages against Washington Square
based upon North Carolina securities laws, breach of contract, com-
mon law fraud, breach of fiduciary duty, negligence, and gross negli-
gence.
Washington Square filed two separate actions1 in the Western Dis-
trict of North Carolina on July 26, 2002, seeking a declaratory judg-
ment that there was no valid agreement to arbitrate between
Washington Square and the Investors, and seeking injunctive relief
staying the arbitration before the NASD. Upon the Investors’ motion
to compel arbitration, the court dismissed Washington Square’s com-
plaint seeking declaratory judgment and denied Washington Square’s
motion for preliminary injunction.
In reaching its decision, the court first determined that there was
no presumption in favor of arbitration, given that Washington Square
and the Investors never entered into an agreement to arbitrate. None-
theless, based on the plain language of Rule 10301 of the NASD
Code, White’s representative agreement with Washington Square
("Form U-4"), and the circumstances surrounding the ETS investment
transaction, the court concluded that the Investors were entitled to
arbitrate under North Carolina law as third-party beneficiaries of the
NASD Code.
The district court declined to consider Washington Square’s extrin-
sic evidence bearing upon the meaning of the term "customer" in the
NASD arbitration provision, reasoning that consideration of such evi-
dence was unnecessary because "the language of the NASD Arbitra-
tion Code provisions is not ambiguous." J.A. 515. Moreover, the court
1
Washington Square filed one action against appellees James K. Aune,
Howard W. Norman, Virginia M. Norman, and Patricia J. Walker (3:02-
CV-308-V), and a second action against appellee Fred W. Miltz, Jr.
(3:02-CV-309-V). The district court issued a combined order dismissing
both cases.
4 WASHINGTON SQUARE SECURITIES v. AUNE
reasoned that the extrinsic evidence offered by Washington Square
was not dispositive of the meaning of the language in the NASD
Code.
As an alternative basis for its decision, the district court determined
that North Carolina’s agency principles were sufficient to compel
arbitration. Without allowing discovery, and based on allegations by
the Investors as to representations made by Mr. White at the time of
the ETS transactions, the court found "ample evidence" that Mr.
White acted with apparent authority from Washington Square. J.A. II.
514. Accordingly, the district court held that the Investors were enti-
tled to compel arbitration in their dispute with Washington Square.
II.
Washington Square raises several issues on appeal. In particular, it
contends that the district court erred by applying Rule 10301 of the
NASD Code without looking to additional language in Rule 10101,
which states the eligibility requirements for arbitrable disputes. Wash-
ington Square also argues that there exists a latent ambiguity in the
language of the NASD arbitration rules, and that the district court
should have resolved this ambiguity by resort to its extrinsic evidence
of the parties’ intent. Finally, Washington Square challenges the dis-
trict court’s denial of discovery on the issue of whether White was
acting as an agent of Washington Square. These are issues of first
impression in this Circuit, and, as the district court noted, federal
courts are divided over arbitrability of disputes between a NASD
member and investors who conduct transactions through an associated
person of the member. Compare John Hancock Life Ins. Co. v. Wil-
son, 254 F.3d 48, 59 (2nd Cir. 2001) (finding that the NASD Code
unambiguously requires arbitration in such circumstances), and
Vestax Secs. Corp. v. McWood, 280 F.3d 1078, 1082 (6th Cir. 2001)
(same), and California Fina Group, Inc. v. Herrin, __ F.3d __ 2004
WL 1663847 *6 (5th Cir. 2004) (same), with Investors Capital Corp.
v. Brown, 145 F. Supp. 2d 1302, 1308 (M.D. Fla. 2001) (holding that
investors’ status as "customer" under the NASD Code turns on the
factual issue of whether the investors attempted to have an "informal
business relationship" with the member).
WASHINGTON SQUARE SECURITIES v. AUNE 5
III.
A.
The court reviews de novo a district court’s determination that a
dispute is arbitrable. Cara’s Notions v. Hallmark Cards, 140 F.3d
566, 569 (4th Cir. 1998).
We address first the district court’s finding that no presumption in
favor of arbitration applied in this case because the Investors and
Washington Square never entered into an agreement to arbitrate.
Washington Square urges the court to follow the reasoning of the dis-
trict court on this point. We find Washington Square’s argument and
the reasoning of the district court unpersuasive.2
The obligation and entitlement to arbitrate "does not attach only to
one who has personally signed the written arbitration provision." Int’l
Paper Co. v. Schwabedissen Maschinen & Anlagen GMBH, 206 F.3d
411, 416 (4th Cir. 2000). Rather, "[w]ell-established common law
principles dictate that in an appropriate case a nonsignatory can
enforce, or be bound by, an arbitration provision within a contract
executed by other parties." Id. at 416-417.
The NASD Code of Arbitration Procedure, Rule 10301(a), pro-
vides:
Any dispute, claim or controversy eligible for submission
. . . between a customer and a member and/or associated
person arising in connection with the business of such mem-
ber or in connection with the activities of such associated
persons shall be arbitrated under this Code, as provided by
any duly executed and enforceable written agreement or
upon the demand of the customer.
2
Contrary to appellant’s argument, when affirming, we are not bound
to follow the reasoning of the district court in the absence of a cross
appeal by appellees. Ithaca Indus., Inc. v. Comm’r of Internal Revenue,
17 F.3d 684, 686 n.2 (4th Cir. 1994).
6 WASHINGTON SQUARE SECURITIES v. AUNE
J.A. II. 449. The NASD Code constitutes an "agreement in writing"
under the Federal Arbitration Act, 9 U.S.C. § 2, which binds Wash-
ington Square, as an NASD member, to submit an eligible dispute to
arbitration upon a customer’s demand. See Kidder, Peabody & Co.,
Inc. v. Zinsmeyer Trusts P’ship, 41 F.3d 861, 863-64 (2nd Cir. 1994).
Because this arbitration agreement binds Washington Square, the
remaining issue is whether the Investors are "customers" whose dis-
pute falls within its scope.
"[T]he examination of the scope of an arbitration agreement is pri-
marily a task of contract interpretation." Cara’s Notions, 140 F.3d at
569. "[A]s with any other contract, the parties’ intentions control."
Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, 473 U.S. 614,
626 (1985). Nevertheless, "in applying general state law principles of
contract interpretation to the interpretation of an arbitration agreement
within the scope of the [Federal Arbitration] Act, due regard must be
given to the federal policy favoring arbitration." Volt Info. Sciences,
Inc. v. Bd. of Trs. of Leland Stanford Jr. Univ., 489 U.S. 468, 475-76
(1989) (citing 9 U.S.C. § 2).
Pursuant to this policy, the parties’ intentions "are generously con-
strued as to issues of arbitrability," Mitsubishi, 473 U.S. at 626, and
any "ambiguities as to the scope of the arbitration clause itself" must
be "resolved in favor of arbitration." Volt, 489 U.S. at 476. "[T]here
is a presumption of arbitrability in the sense that ‘an order to arbitrate
the particular grievance should not be denied unless it may be said
with positive assurance that the arbitration clause is not susceptible of
an interpretation that covers the asserted dispute. Doubts should be
resolved in favor of coverage.’" AT&T Techs., Inc. v. Communica-
tions Workers of America, 475 U.S. 643, 650 (1986) (quoting United
Steelworkers v. Warrior & Gulf Navigation Co., 363 U.S. 574, 582-
83 (1960)). "In the absence of any express provision excluding a par-
ticular grievance from arbitration, . . . only the most forceful evidence
of a purpose to exclude the claim from arbitration can prevail, particu-
larly where, as here, . . . the arbitration clause [is] quite broad." War-
rior & Gulf, 363 U.S. at 584-85.
Applying these principles to the case at hand, we hold that the dis-
trict court did not err in compelling arbitration.
WASHINGTON SQUARE SECURITIES v. AUNE 7
B.
Turning first to the language of the NASD Code, we find Rule
10301 susceptible to a meaning which covers the Investors’ dispute.
The primary requirements for arbitrability under Rule 10301 are that
the dispute must (1) be "between a customer and a member and/or
associated person," and (2) arise "in connection with the business of
such member or in connection with the activities of such associated
persons." J.A. II. 449.
The language of the first clause, "between a customer and a mem-
ber and/or associated person," is ambiguous in two respects. The first
ambiguity results from the fact that the rule does not specify with
whom the customer must conduct business. That is, as written, the
rule leaves open the possibility that a dispute could arise between "a
[member’s] customer and a member" or between "[an associated per-
son’s] customer and a member." Under the latter interpretation, the
Investors’ dispute falls within the scope of the rule because it is undis-
puted that the Investors were customers of White, and that White was
an associated person of the member Washington Square.
The first clause is also ambiguous because, even assuming that the
dispute must arise between the member’s customer and the member,
it is not clear from the language of the rule what is required before
an investor is deemed a customer of a member. While the rule is sus-
ceptible to an interpretation under which only consumers with
accounts or "informal business relationships" with the member are
customers of the member, Investors Capital, 145 F. Supp. 2d at 1308,
the language of the Code does not exclude as "customers of members"
those investors who believed they were dealing with the member
through an associated person. See John Hancock, 254 F.3d at 59 (not-
ing that definition of "customer" in the Code, at Rule 0120(g),
excludes only "a broker or dealer"). Although the broader interpreta-
tion is not the only reasonable interpretation of the rule, much less the
one required by the plain language of the rule, it is nonetheless one
which encompasses the Investors’ dispute in this case. Accordingly,
because this clause is ambiguous in two separate respects which cover
the instant dispute, we must construe this clause in favor of arbitra-
tion.
8 WASHINGTON SQUARE SECURITIES v. AUNE
The relevant language from the second clause, "arising in connec-
tion with the business of such member or in connection with the activ-
ities of such associated persons," is also ambiguous. Assuming,
arguendo, that only the first half of this requirement ("arising in con-
nection with the business of the member") is applicable here, the
meaning of "in connection with the business" is nonetheless open to
multiple interpretations. "The business" of a member reasonably can
be interpreted either narrowly to extend only to the sale of its finan-
cial products, as Washington Square urges, or broadly to refer to
supervision over associated persons, as other courts have found. See
WMA Sec. Inc. v. Ruppert, 80 F. Supp. 2d 786, 790 (S.D. Ohio 1999)
(finding that where the investors’ claims "arise from [the member’s]
failure to supervise its registered representatives," the claims "are
therefore related . . . to [the member’s] business"); First Montauk Sec.
Corp. v. Four Mile Ranch Dev. Co., 65 F. Supp. 2d 1371, 1379 (S.D.
Fla. 1999) (same). Under the latter interpretation, the Investors’ dis-
pute falls within the scope of the clause, as their claims arise in con-
nection with Washington Square’s supervision of White.
Accordingly, because both the first and second clauses of Rule 10301
are susceptible to a meaning which covers the Investors’ dispute, Rule
10301 must be construed in favor of arbitration.
C.
Washington Square argues that Rule 10101 further limits the field
of arbitrable disputes, to the exclusion of the Investors’ instant dis-
pute. This argument is without merit, as the Rule is at best ambiguous
as to whether any additional limitations are imposed. Rule 10101,
which is incorporated by reference into Rule 10301, provides in rele-
vant part:
This Code of Arbitration Procedure is prescribed and
adopted . . . for the arbitration of any dispute, claim, or con-
troversy arising out of or in connection with the business of
any member of the Association, or arising out of the
employment . . . of associated person(s) with any member,
with the exception of disputes involving the insurance busi-
ness of any member which is also an insurance company:
***
WASHINGTON SQUARE SECURITIES v. AUNE 9
(c) between or among members or associated per-
sons and public customers, or others; . . . .
J.A. II. 447. Rule 10101 contains a requirement similar to that found
in Rule 10301 that the dispute arise "in connection with the business
of any member." As explained previously, this clause is susceptible
to an interpretation which encompasses the Investors’ dispute con-
cerning Washington Square’s supervision over its associated person,
White.
Furthermore, the limitation in subsection (c) of the Rule to disputes
"between or among members or associated persons and public cus-
tomers, or others" is of questionable applicability to the instant dis-
pute. Beginning with the clause "with the exception of disputes
involving the insurance business," the language in the Rule can rea-
sonably be read to apply only to insurance disputes rather than all
other disputes described in the Rule. See Kidd v. Equitable Life Assur-
ance Soc’y of the United States, 32 F.3d 516, 519 (11th Cir. 1994)
(finding that "the colon [in Rule 10101] modifies the clause immedi-
ately preceding it" thus making subsections (a)-(d) applicable only to
insurance business disputes). Thus, any further limitation provided by
subsection (c), assuming one is unambiguously stated therein, is not
necessarily applicable to the dispute at hand. Accordingly, we must
resolve these doubts as to whether Rule 10101 encompasses the
instant dispute in favor of coverage.
D.
Washington Square argues that any ambiguity in the term "cus-
tomer" in Rules 10101 and 10301 is a "latent ambiguity" that, under
North Carolina law, must be resolved by looking to extrinsic evidence
of the parties’ intent. See Root v. Allstate Ins. Co., 158 S.E.2d 829,
835 (N.C. 1968) (stating that "parol or extrinsic evidence may be
introduced to show what was in the minds of the parties at the time
of making the contract or executing the instrument, and to determine
the object for or on which it was designed to operate.").
Having already construed the ambiguity in the language of the
NASD Code in favor of arbitration pursuant to federal law, we ques-
tion whether other evidence of the parties’ intent is relevant. The
10 WASHINGTON SQUARE SECURITIES v. AUNE
Supreme Court directive to resolve doubts and ambiguities in favor
of arbitration appears to foreclose recourse to extrinsic evidence of
intent. Volt, 489 U.S. at 475-76; Moses H. Cone Mem’l Hosp. v. Mer-
cury Constr. Corp., 460 U.S. 1, 24-25 (1983). Finding doubts as to
the scope of the NASD Code arbitration provision, our inquiry should
be complete.
Nevertheless, the Supreme Court has also indicated that "forceful
evidence of a purpose to exclude the claim from arbitration" may help
to resolve ambiguity in an arbitration provision. See Warrior & Gulf,
363 U.S. at 585. Other Circuits, too, have recognized the relevance
of additional evidence of the parties’ intent, under limited circum-
stances. As the Fifth Circuit explained:
A finding that the scope of the arbitration clause is vague
does not automatically catapult the entire dispute into arbi-
tration. Rather, such a finding creates a presumption in favor
of arbitration. This presumption can be overcome with clear
evidence that the parties did not intend the claim to be arbi-
trable.
Harvey v. Joyce, 199 F.3d 790, 793 (5th Cir. 2000) (citing Moses H.
Cone, 460 U.S. at 24-25) (emphasis added); see also In re Dist. No.
1 - Pac. Coast Dist., Marine Eng’rs’ Ben. Ass’n (AFL-CIO), 723 F.2d
70, 77 (D.C. Cir. 1983) (noting that "compelling evidence that the par-
ties intended to exclude the subject matter from arbitration" could be
considered) (emphasis added); John Hancock, 254 F.3d at 61 (concur-
ring op.) (noting that, if available, extrinsic evidence "that, for exam-
ple, the drafters of NASD Rule 10301(a) intended that an investor
must be a customer of the member — and not just a customer of the
associated person of the member — in order to force the member to
arbitrate" is relevant).
In this case, we need not decide whether federal law prevents
recourse to extrinsic evidence of intent to resolve an ambiguity in an
arbitration provision, as we find that the extrinsic evidence offered by
Washington Square is neither "forceful" nor "clear" evidence of
NASD intent as to the scope of the NASD arbitration provision. War-
rior & Gulf, 363 U.S. at 585; Harvey, 199 F.3d at 793.
WASHINGTON SQUARE SECURITIES v. AUNE 11
Washington Square offers as extrinsic evidence of the parties’
intent a declaration by Philip J. Hoblin, Jr., a "Charter Member" of
the Securities Industry Conference on Arbitration,3 who stated in May
2002:
It was the intention of SICA, and its members, that the arbi-
tration process would be broad and encompass all claims
that could be brought against a broker-dealer by (i) another
broker-dealer; (ii) an associated person; or (iii) a customer
of the broker dealer. It was not our intention that either the
arbitration process or the Uniform Code of Arbitration Pro-
cedure would require mandatory arbitration of claims
brought against a broker-dealer by a person who was not a
customer of that broker-dealer.
J.A. I. 195 (emphasis added). In addition, Washington Square offers
a declaration of Thomas Wiltrakis, a former "Director of Arbitration
for the NASD," who also stated in May 2002 that it was the view of
the NASD (from 1979 to 1983) that "[i]f a person was not a customer
of a broker-dealer, the broker-dealer was not required to arbitrate
those claims." J.A. I. 199. In its brief, Washington Square also urges:
"The drafters did not specifically address arbitrability of disputes
brought by customers of registered representatives who were not cus-
tomers of broker-dealers because they never contemplated the arising
of this situation in broker-dealer arbitration. (JA1-196)." Corrected
Brief of Appellant, p. 18 (citation in original).
The evidence presented fails in several respects to clearly indicate
the intent of the NASD to exclude the instant dispute from the scope
of the arbitration agreement. First, declarations made in 2002 during
the course of litigation are much less reliable evidence of NASD
intent than contemporaneous statements, reports, or minutes of the
NASD at the time it adopted the arbitration provision. See Redd v.
Taylor, 153 S.E.2d 761, 767 (N.C. 1967) (considering oral declara-
tions of testator at time will was drafted); Root, 158 S.E.2d at 836
(considering "evidence of prior negotiations" to aid in resolving latent
3
The Securities Industry Conference on Arbitration [SICA] "was
formed in April of 1977 for the purpose of developing a uniform system
of arbitration for the securities industry, including [NASD]." J.A. I. 194.
12 WASHINGTON SQUARE SECURITIES v. AUNE
ambiguity in description of property in contract); Vestal v. Vestal, 271
S.E.2d 306, 309 (N.C. Ct. App. 1980) (citing Miller v. Green, 112
S.E. 417 (N.C. 1922) (relevant extrinsic evidence consists of "prelimi-
nary negotiations and surrounding circumstances")); see also Recon-
struction Fin. Corp. v. Sherwood Distilling Co., 200 F.2d 672, 676
(4th Cir. 1952) ("[T]he interpretation placed upon a contract by the
parties themselves, before a dispute has arisen, is entitled to the
greatest weight.") (emphasis added). Therefore, the declarations sub-
mitted here are not the "most forceful" or "compelling" evidence
bearing on the parties’ intent. Warrior & Gulf, 363 U.S. at 585; In re
Dist. No. 1, 723 F.2d at 77.
Second, the declarations do not indicate whether the NASD specifi-
cally intended to exclude disputes between a customer of a person
associated with the member and a member. Rather they only state that
the NASD did not intend to include "claims brought against a broker-
dealer by a person who was not a customer of that broker dealer." J.A.
I. 195. This falls short of clear evidence of an intention to affirma-
tively exclude the Investors’ particular type of dispute from arbitra-
tion. See Warrior & Gulf, 363 U.S. at 585; First Options of Chicago,
Inc. v. Kaplan, 514 U.S. 938, 944 (1995).
Third, even accepting that only a "customer of a broker-dealer" (as
opposed to a customer of an associated person) can arbitrate with a
broker-dealer, the declarations do not specify what is required before
an investor is a "customer of a broker-dealer." As noted earlier, noth-
ing in the language of the Code excludes from the class of "customers
of a member" those who believed they were dealing with the member
through an associated person. While Washington Square wishes to
limit "customers" of members to those who opened accounts with the
broker, or to those who had an informal business relationship with the
broker, neither the plain language of the rule nor the extrinsic evi-
dence of intent requires such an interpretation.
Finally, Washington Square undermines the force of its evidence
of intent by noting that the Code "drafters did not specifically address
arbitrability of disputes brought by customers of registered represen-
tatives who were not customers of broker-dealers because they never
contemplated the arising of this situation in broker-dealer arbitra-
tion." Corrected Br. of Appellant, p. 18 (emphasis added). If the
WASHINGTON SQUARE SECURITIES v. AUNE 13
drafters did not contemplate this situation in broker-dealer arbitration,
then it cannot follow that they unambiguously intended the provision
to be interpreted against arbitration in these circumstances.
For the foregoing reasons, even considering Washington Square’s
extrinsic evidence of intent, we do not find that it, in conjunction with
the language of the arbitration provision, clearly reveals the intent of
the parties to limit the scope of the provision to the exclusion of the
Investors’ dispute. Therefore, the Investors’ dispute is arbitrable.4
IV.
Finding the instant dispute arbitrable, we affirm the district court’s
order and judgment compelling arbitration, denying the injunction,
and dismissing the declaratory judgment action.
AFFIRMED
4
In so holding, we need not address the district court’s additional reli-
ance upon the language in the Form U-4 or the district court’s alternative
finding that North Carolina’s agency principles are sufficient to compel
arbitration without further discovery on this issue.