Berthel Fisher & Co. Financial Services v. Larmon

United States Court of Appeals
For the Eighth Circuit
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No. 11-2877
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Berthel Fisher & Company Financial Services, Inc.;
Thomas J. Berthel; Ronald O. Brendengen;
Shelley Rae Davenport; Frederick P. Fisher;
Richard M. Murphy; Leslie D. Smith; Daniel P.
Wegmann; and Thomas R. Biesheuvel
lllllllllllllllllllll Plaintiffs - Appellees
v.
Craig Larmon; Geneva OSWX XXII, LLC, a Delaware limited liability
corporation; Earl Holasek; OSWX XXXVI, LLC, a Delaware limited liability
corporation; Geneva FTCX I, LLC,a Delaware limited liability corporation;
Geneva BCCX XVIII, LLC, a Delaware limited liability corporation; Karen Lane;
Geneva OSWX IX, LLC, a Delaware limited liability company; Declaration of
Trust of Karen Lane dated April 24, 1996; Jack Hoopes; Lorna Hoopes; Geneva
OSWX XIX, LLC, a Delaware limited liability company; Patrick Jordan; Geneva
OSWX XXVII, LLC, a Delaware limited liability company; and Patrick J. Jordan
Trust dated April 6, 1990
lllllllllllllllllllll Defendants - Appellants
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Appeal from United States District Court
for the District of Minnesota - Minneapolis
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Submitted: June 12, 2012
Filed: October 1, 2012
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Before MURPHY, MELLOY, and COLLOTON, Circuit Judges.
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MELLOY, Circuit Judge.
This case comes to us on appeal from the district court's1 grant of the plaintiffs'
motion for a preliminary injunction and denial of the defendants' motion to compel
arbitration. Because we hold that the district court correctly concluded that the
defendants are not the plaintiffs' "customers" under the Financial Industry Regulatory
Authority's (FINRA) Code of Arbitration Procedure for Customer Disputes (FINRA
Code) we affirm the judgment of the district court.
I.
This case arises out of securities2 issued by a group of Minnesota limited
liability companies (collectively, Geneva) and purchased by defendants-appellants
(the Investors) in 2007 and 2008. Plaintiff-appellee Berthel Fisher & Company
Financial Services., Inc., et. al (collectively, Berthel), a licensed broker-dealer and
member of FINRA, served as managing broker-dealer for the offering. As managing
broker-dealer, Berthel assembled a group of FINRA-registered
broker-dealers—Selling Group Members, or SGMs—who in turn offered the
securities to their own customers, including the Investors.
1
The Honorable Ann D. Montgomery, United States District Judge for the
District of Minnesota.
2
The securities in question were tenancy-in-common interests in real estate
located in Minnesota and Texas.
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Although Geneva prepared the private placement memoranda (PPMs) to be
provided to prospective purchasers of the securities, Berthel reviewed at least two of
the PPMs, suggesting changes that Geneva adopted. Per the agreement between
Berthel and the SGMs, Berthel collected investor payments from the SGMs and
passed those payments along to Geneva. In addition, the contract between Berthel
and Geneva obligated Berthel and the SGMs to determine each investor's eligibility
to participate in the offering. Because of this, Berthel maintained a file on each
investor that included the investors' names, dates of birth, and contact information.
The securities did not perform as anticipated, leading the Investors to file
FINRA arbitration claims against Berthel. The Investors alleged that Berthel
performed insufficient due diligence on the offering, leading to critical omissions in
the PPMs. After preliminary proceedings before FINRA, Berthel filed suit in the
United States District Court for the District of Minnesota, seeking a declaratory
judgment that the Investors were not Berthel's "customers" under the FINRA Code
and that Berthel was therefore not obligated to arbitrate with the Investors. Further,
Berthel moved for a preliminary injunction enjoining the arbitrations, and the
Investors cross-moved to compel arbitration.
Relying on Fleet Boston Robertson Stephens, Inc. v. Innovex, Inc., 264 F.3d
770 (8th Cir. 2001), the district court held that the Investors did not qualify as
Berthel's customers under the FINRA Code and that the Investors' claims against
Berthel were therefore not arbitrable before FINRA. Accordingly, the court granted
Berthel's motion to enjoin the pending arbitrations and denied the Investors'
cross-motion to compel arbitration.
II.
"We have jurisdiction to review the denial of a motion to compel arbitration as
an interlocutory appeal within the scope of 28 U.S.C. § 1292(a)(1)." McNamara v.
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Yellow Transp., Inc., 570 F.3d 950, 954 (8th Cir. 2009). "We review de novo the
denial of a motion to compel arbitration." CD Partners, LLC v. Grizzle, 424 F.3d
795, 798 (8th Cir. 2005). Likewise, we review de novo the district court's legal
conclusions in granting a motion for a preliminary injunction. Sierra Club v. U.S.
Army Corps of Eng'rs, 645 F.3d 978, 989 (8th Cir. 2011). "When reviewing the
enforcement of an arbitration agreement, we determine only whether there is a valid
arbitration agreement and whether the dispute at issue falls within the terms of that
agreement." Franke v. Poly-America Med. & Dental Benefits Plan, 555 F.3d 656,
658 (8th Cir. 2009).
"[T]he first task of a court asked to compel arbitration of a dispute is to
determine whether the parties agreed to arbitrate that dispute." Mitsubishi Motors
Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 626 (1985). The Investors do
not allege that Berthel explicitly agreed to arbitrate; rather, they allege that they
qualify as Berthel's "customers" under the FINRA Code. The FINRA Code, which
Berthel has signed as a FINRA member, constitutes an agreement to arbitrate disputes
between Berthel and its customers. See In re Am. Exp. Fin. Advisors Secs. Litig.,
672 F.3d 113, 128 (2d Cir. 2011) ("Ameriprise does not dispute that, by virtue of its
membership in FINRA, it has consented to arbitrate with its customers."); MONY
Secs. Corp. v. Bornstein, 390 F.3d 1340, 1342 (11th Cir. 2004) (the predecessor to
the FINRA Code "itself constitutes the agreement" to arbitrate.). Rule 12200 of the
FINRA Code, which is the successor to National Association of Securities Dealers
Code of Arbitration Procedure Rule 10301,3 states:
3
Herbert J. Sims & Co., Inc. v. Roven, 548 F. Supp. 2d 759, 763 n.2 (N.D. Cal.
2008) ("Rule 12200 of the Code is an amended version of former Rule 10301 that
went into effect on April 16, 2007. The cases interpreting and applying Rule 10301
apply with equal force to Rule 12200, as the amendment did not effect any
substantive change to the rule.").
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Parties must arbitrate a dispute under the Code if:
• Arbitration under the Code is either:
(1) Required by a written agreement, or
(2) Requested by the customer;
• The dispute is between a customer and a member or associated
person of a member; and
• The dispute arises in connection with the business activities of the
member or the associated person, except disputes involving the
insurance business activities of a member that is also an insurance
company.
Here, the Investors have requested arbitration by filing claims with FINRA.
Further, the dispute "arises in connection with the business activities" of Berthel
because the Investors claim that Berthel failed to conduct adequate due diligence.
Accordingly, it is undisputed that the question of arbitrability in this case turns on
whether the Investors are Berthel's customers under the FINRA Code.
The FINRA Code defines "customer" in the negative, stating only that "[a]
customer shall not include a broker or dealer." FINRA Rule 12100(i). In Fleet
Boston, we rejected the argument that one may qualify as a customer merely be being
neither a broker nor a dealer. Fleet Boston, 264 F.3d at 772. Instead, we construed
"customer" to "refer[] to one involved in a business relationship with [a FINRA]
member that is related directly to investment or brokerage services." Id.
It is uncontested that the Investors had no contact with Berthel in the course of
investing in the securities at issue. The Investors argue, however, that they qualify
as Berthel's customers under Rule 12200 because Berthel
provided "investment or brokerage services" to the investors in three
ways. First, Berthel Fisher was responsible for conducting due diligence
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on the TIC interests. Second, Berthel Fisher was obligated to conduct
a reasonable-basis suitability analysis on the TIC interests. Third,
Berthel Fisher maintained customer files on the investors and was
responsible for protecting the investors' privacy.
The provision of these services in this case failed to transform the Investors
into Berthel's customers, because Berthel provided those services not to the Investors
but instead to the SGMs and Genevea. If the provision of these services formed any
customer relationships at all, it formed them between Berthel, Geneva, and the SGMs,
not between Berthel and the Investors.
According to the Investors, Vestax Securities Corp. v. McWood, 280 F.3d 1078
(6th Cir. 2002), establishes that a customer relationship is possible "even in the
absence of a direct transactional relationship with the firm." Id. at 1081. Citation to
Vestax, however, is misplaced. The investors in that case purchased securities from
associated persons of the firm. Id. at 1081–82. Arbitration was therefore required
because Rule 12200 requires arbitration when "[t]he dispute is between a customer
and a member or associated person of a member." Accordingly, that case stands for
the unremarkable proposition that customers of associated persons of a firm may
compel arbitration with the firm. It does not suggest that an investor who interacts
with neither the firm nor its associated persons may nevertheless qualify as a
customer of the firm. Neither party argues that the SGMs are associated persons of
Berthel; accordingly, Vestax is inapposite.
The Investors argue that Fleet Boston requires only "investment or brokerage
related services." But again, the provision of "investment or brokerage related
services" is only half of the picture—not only must the FINRA member firm provide
those services, but also must it provide those services to the customer either directly
or through its associated persons. In Fleet Boston, we observed that "[a]lthough other
cases interpreting the term 'customer' have in some ways taken a broad view of the
term, in all of these cases there existed some brokerage or investment relationship
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between the parties." Id. at 772 (emphasis added). Simply put, there is no
"relationship" between Berthel and the Investors as required by Fleet Boston.
Because Berthel did not provide "investment or brokerage related services" to the
Investors, the Investors are not Berthel's customers under FINRA Rule 12200. We
affirm the judgment of the district court.
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