Morgan Keegan & Company, Inc. v. Louise Silverman

Filing

PUBLISHED AUTHORED OPINION filed. Originating case number: 8:11-cv-02533-JFM. Paper copies to all parties and the district court/agency. [999035783]. [12-1208]

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PUBLISHED

UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
MORGAN KEEGAN & COMPANY,
INC.,
Plaintiff-Appellee,
v.
LOUISE SILVERMAN; LOUISE
SILVERMAN TRUST; MAX SILVERMAN,
Defendants-Appellants.




No. 12-1208



Appeal from the United States District Court
for the District of Maryland, at Greenbelt.
J. Frederick Motz, Senior District Judge.
(8:11-cv-02533-JFM)
Argued: December 4, 2012
Decided: February 4, 2013
Before NIEMEYER, KEENAN, and DIAZ, Circuit Judges.

Affirmed by published opinion. Judge Keenan wrote the opinion, in which Judge Niemeyer and Judge Diaz joined.

COUNSEL
ARGUED: Adam J. Gana, NAPOLI BERN RIPKA SHKOLNIK LLP, New York, New York, for Appellants. George C.
Freeman, III, BARRASSO, USDIN, KUPPERMAN, FREE-

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MAN & SARVER, LLC, New Orleans, Louisiana, for Appellee. ON BRIEF: Thomas C. Costello, COSTELLO LAW
GROUP, Baltimore, Maryland, for Appellants. Priscilla A.
Donovan, DONOVAN AND RAINIE LLC, Baltimore, Maryland; Larry E. Mobley, David N. Luder, BARRASSO,
USDIN, KUPPERMAN, FREEMAN & SARVER, LLC, New
Orleans, Louisiana, for Appellee.

OPINION
BARBARA MILANO KEENAN, Circuit Judge:
In this case, we consider whether the district court erred in
holding that Morgan Keegan & Company, Inc. (Morgan Keegan), a member of the Financial Industry Regulatory Authority (FINRA), is not subject to FINRA arbitration proceedings
initiated by Louise Silverman, Max Silverman, and the Louise
Silverman Trust (collectively, the defendants). In their
FINRA arbitration claim, the defendants asserted that Morgan
Keegan engaged in misconduct relating to the valuation and
marketing of certain bond funds purchased by the defendants
through their brokerage firm, Legg Mason Investor Services,
LLC (Legg Mason).1
Morgan Keegan filed an action in the district court seeking
to enjoin the arbitration proceedings on the ground that under
the controlling FINRA Rule, the defendants were not "customers" of Morgan Keegan entitled to compel arbitration of
their dispute. The district court agreed with Morgan Keegan’s
position, permanently enjoining the arbitration proceedings.
Upon our review, we affirm the district court’s judgment
because the defendants were not "customers" of Morgan Keegan, within the meaning of the disputed FINRA Rule, and,
1

Legg Mason is also a FINRA member. See FINRA, List of Members, http://www.finra.org/AboutFINRA/MemberFirms/ListOf Members/
P012923.

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therefore, were not entitled to invoke the mandatory arbitration provision contained in that Rule.
I.
A.
FINRA is a registered, self-regulatory organization authorized under the Securities Exchange Act of 1934.2 See 15
U.S.C. §§ 78c(a)(26), 78s(b). FINRA has the authority to
create and enforce rules for its members to provide "regulatory oversight of all securities firms that do business with the
public." Securities and Exchange Commission Release No.
34-56145, 72 Fed. Reg. 42169, 42170 (July 26, 2007). At
issue in this appeal is the portion of the FINRA Rules, known
as the "Customer Code," which establishes the conditions for
an arbitration proceeding between FINRA "members" and
their "customers" before a FINRA arbitration panel (FINRA
arbitration).3 The Code of Arbitration Procedure contained in
the FINRA Rules (the FINRA Code or the Code) provides in
Rule 12200 that parties must arbitrate a dispute if the following conditions are met:
•

Arbitration under the Code is either:
(1) Required by written agreement, or

2

FINRA was created in 2007 by a consolidation of the National Association of Securities Dealers, Inc. (NASD) and the regulatory arm of the
New York Stock Exchange Regulatory, Inc. Securities and Exchange
Commission Release No. 34-56145, 72 Fed. Reg. 42169, 42170 (July 26,
2007).
3
The FINRA Rules include distinct subparts: the "Industry Code,"
which governs "arbitrations between or among industry parties only," and
the "Customer Code," applicable in this case, which governs arbitrations
between "investors and brokers and/or brokerage firms." See FINRA,
Arbitration & Mediation, Code of Arbitration Procedure,
http://www.finra.org/arbitrationandmediation/arbitration/rules/codeof
arbitrationprocedure/.

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(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.

Thus, in the absence of a separate arbitration agreement, a
party can compel a FINRA member to participate in FINRA
arbitration if: (1) the party is a "customer" of the FINRA
member; and (2) there is a dispute between the "customer"
and the FINRA member, or the member’s associated person,
arising in connection with the business activities of the
FINRA member or a member’s associated person.
B.
Morgan Keegan, a member of FINRA, engages in business
services that include the brokerage and dealing of securities,
as well as providing investment advice. Morgan Keegan was
the principal distributor and underwriter of certain bond
funds, known as the Regions Morgan Keegan Funds (the
funds), which were traded on the New York Stock Exchange.
The defendants did not invest in the funds during their initial public offering, which occurred before the end of 2006.
Instead, in 2007, the defendants purchased shares of the funds
from a third party, through the defendants’ securities broker
at Legg Mason, a firm unaffiliated with Morgan Keegan.
In late 2007, the defendants suffered financial losses when
the value of the funds dropped dramatically. The defendants
asserted that their losses resulted, in part, because Morgan
Keegan failed to disclose critical information about the high-

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risk nature of the funds and falsely inflated the funds’ asset
values. To resolve this claim and other related claims, the
defendants initiated FINRA arbitration proceedings against
Morgan Keegan, asserting that they were entitled to do so
under Rule 12200 as "customers" of Morgan Keegan.4
Although the defendants acknowledged that they never
held a brokerage account with Morgan Keegan, they nonetheless claimed a customer relationship with Morgan Keegan as
a result of their brokerage dealings with Legg Mason, another
FINRA member. The defendants contended that employees of
Morgan Keegan encouraged the Legg Mason broker to purchase the funds and that, in executing these purchases, the
Legg Mason broker relied on Morgan Keegan’s marketing
materials describing the funds. The defendants, however, did
not receive or review personally the information that their
broker obtained from Morgan Keegan.
Morgan Keegan filed suit in the district court seeking,
among other things, an injunction prohibiting the defendants
from pursuing their FINRA arbitration claim. Morgan Keegan
alleged that it was not required to submit to arbitration under
Rule 12200, because the defendants were not Morgan Keegan’s "customers" asserting a dispute arising from its business
activities.
The district court granted Morgan Keegan’s request for a
preliminary injunction. Morgan Keegan & Co., Inc. v. Louise
Silverman Trust, No. JFM-11-2533, 2012 U.S. Dist. LEXIS
3870 (D. Md. Jan. 12, 2012). In addressing the issue whether
Morgan Keegan was likely to succeed on the merits, the district court determined that the defendants did not qualify as
4

The defendants asserted claims of fraud, negligent misrepresentation,
negligence, failure of supervision, vicarious liability, and violations of
both the Tennessee Securities Act of 1980, Tenn. Code § 48-2-122(a), and
the Tennessee Consumer Protection Act of 1977, Tenn. Code § 47-18-101,
et seq.

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"customers," within the meaning of that term in Rule 12200,
because there was "no evidence of any relationship at all
between the parties or representatives of the parties."5 Id. at
*13. The district court ultimately entered final judgment on
the same basis, permanently enjoining the defendants from
pursuing their FINRA arbitration claim. The defendants
timely filed the present appeal.
II.
On appeal, the defendants argue that the district court erred
in enjoining the arbitration proceedings because, under Rule
12200, the defendants were "customers" of Morgan Keegan
engaged in a dispute arising from Morgan Keegan’s conduct
of its business activities. We review this question de novo.6
5

In evaluating Morgan Keegan’s request for a preliminary injunction,
the district court applied the factors set forth in Winter v. Natural
Resources Defense Council, Inc., 555 U.S. 7 (2008), and, in addition to
evaluating the likelihood of success on the merits, held that the harm Morgan Keegan would suffer in the absence of an injunction would be irreparable, that the balance of equities favored Morgan Keegan, and that, to the
extent the public interest was impacted in this case, that factor also
weighed in Morgan Keegan’s favor. Louise Silverman Trust, 2012 U.S.
Dist. LEXIS 3870, at *14-21.
6
We recognize that the defendants, relying on Washington Square
Securities, Inc. v. Aune, 385 F.3d 432 (4th Cir. 2004), contend that the federal policy favoring arbitration is applicable to the question whether they
are "customers" of Morgan Keegan. See AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740 (2011) (discussing presumption). However, their
argument is foreclosed by our recent decision in UBS Financial Services,
Inc. v. Carilion Clinic, No. 12-2066, ___ F.3d ___, (4th Cir. Jan. 23,
2013). There, we distinguished Washington Square and explained that the
question whether an entity "requesting arbitration is a customer [under
Rule 12200] must be resolved to determine the existence of a contract to
arbitrate, not the scope of an arbitration agreement." Carilion Clinic, slip
op. 7-8 n.2. Accordingly, pursuant to our holding in Carilion Clinic, we
address the present question regarding a customer relationship as a matter
of contract law, without considering the federal presumption in favor of
arbitration. Id.

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UBS Fin. Servs., Inc. v. Carilion Clinic, No. 12-2066, ___
F.3d ___, slip op. at 7-8 n.2 (4th Cir. Jan. 23, 2013).
In asserting that they have a customer relationship with
Morgan Keegan, the defendants primarily contend that the
FINRA Code provides a complete definition of the term "customer," by stating in Rule 12100(i) that, unless otherwise
defined in the Code, a "customer shall not include a broker or
dealer." According to the defendants, this broad definition of
"customer" applies to Rule 12200, because that Rule does not
provide an alternate definition of the term, in contrast to two
other FINRA rules, which define the term in a more specific
manner applicable only to those rules. See FINRA Rules
2261, 4210(a)(3). Therefore, the defendants contend that they
are "customers" of Morgan Keegan under the description of
the term provided in Rule 12100(i), because the defendants
are not brokers or dealers.
The defendants further assert that the scope of the term
"customer" is limited only by the language of Rule 12200,
which requires that arbitrable disputes arise from "the business activities of the [FINRA] member." The defendants contend that the term "business activities" necessarily includes
conduct by a FINRA member that violates FINRA’s Rules,
such as Morgan Keegan’s alleged misconduct in manipulating
the value of funds and in negligently marketing those funds.
Thus, the defendants maintain that because their financial
losses are traceable to Morgan Keegan’s alleged misconduct,
the defendants qualify as "customers" of Morgan Keegan,
within the meaning of Rule 12200, and are entitled to pursue
their FINRA arbitration claim against Morgan Keegan. We
disagree with the defendants’ arguments.
After the parties presented oral argument in this case, we
issued an opinion in UBS Financial Services, Inc. v. Carilion
Clinic, which addressed the meaning of the term "customer"
as used in Rule 12200. In that case, we considered whether an
issuer of bonds was a "customer" of two FINRA members,

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who had entered into agreements with the bond issuer to assist
in the structuring and financing of those bonds. Carilion
Clinic, slip op. at 2-5. The FINRA members asserted that the
bond issuer was not a "customer" under Rule 12200, because
the issuer did not have a brokerage or investment relationship
with the members. Id. at 6-7. Although we rejected this narrow view of the term advocated by the FINRA members, we
nevertheless declined to adopt the broad scope of the term
"customer" advanced by the defendants in the present case.
We began our analysis in Carilion Clinic by addressing the
language in Rule 12100(i) that describes the term "customer."
Id. at 8-9. Contrary to the defendants’ position here, we
observed that Rule 12100(i) does not provide a comprehensive definition of the term, but simply limits the scope of the
term by stating, "[A] customer shall not include a broker or
dealer." Id.
We also observed that the meaning of the term "customer"
is informed by the context of Rule 12200, which requires that
arbitrable disputes arise in connection with the FINRA member’s "business activities." Id. at 9. Thus, we determined that
an entity requesting arbitration "must be a customer with
respect to a FINRA member’s business activities." Id.
To determine the scope of such related business activities,
we examined relevant language in the FINRA Rules and in
FINRA’s mission statement. Id. at 9-10. We observed that
Rule 12100(r)7 suggests that "business activities" involve the
7

FINRA Rule 12100(r) provides:
The term "person associated with a member" means:
(1) A natural person who is registered or has applied for registration under the Rules of FINRA; or
(2) A sole proprietor, partner, officer, director, or branch manager of a member, or other natural person occupying a similar
status or performing similar functions, or a natural person

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"investment banking or securities business," and that such
entities are the subject of FINRA’s regulatory mission. Carilion Clinic, at 9-10 (citing Restated Certificate of Incorporation of Financial Industry Regulatory Authority, Inc. § 3 (July
2, 2010)). Therefore, we concluded from these sources that
the term "business activities" under Rule 12200 refers to
investment banking and the securities business. Id.
We also considered the ordinary meaning of the term "customer" as being "one that purchases a commodity or service."
Id. at 10 (citing Merriam-Webster’s Collegiate Dictionary
308 (11th ed. 2007)). Relying on this definition, as well as the
other sources stated above, we concluded that the term "customer" in Rule 12200 refers to an entity that is "not a broker
or dealer, who purchases commodities or services from a
FINRA member in the course of the member’s business activities," namely, "the activities of investment banking and the
securities business." Id. We further observed that this definition comports with the decisions of other courts that have
addressed the meaning of the term "customer" under Rule
12200. Id. (citing UBS Fin. Servs., Inc. v. W. Va. Univ.
Hosps., Inc., 660 F.3d 643, 648-53 (2d Cir. 2011); UBS Fin.
Servs. Inc. v. City of Pasadena, No. CV 12-05019-RGK
(JCx), 2012 WL 3132949, at *4-5 (C.D. Cal. July 31, 2012);
J.P. Morgan Sec. Inc. v. La. Citizens Prop. Ins. Corp., 712 F.
Supp. 2d 70, 77-79 (S.D.N.Y. 2010)).
In applying this definition to the facts presented in Carilion
Clinic, we determined that the relationship between the bond
issuer and the FINRA members was multifaceted. Carilion
Clinic, at 14. Under the parties’ numerous agreements, the
engaged in the investment banking or securities business who is
directly or indirectly controlling or controlled by a member,
whether or not any such person is registered or exempt from registration with FINRA under the By-Laws or the Rules of FINRA.
(Emphasis added.)

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FINRA members offered financial advice, served as underwriters, worked as lead broker-dealers of the issuer’s bond
auctions, acted as the issuer’s agents in many respects, and
rendered other services related to the securities business. Id.
In exchange for these services, the FINRA members earned
compensation in the form of fees and discounts. Id. Therefore,
we had ample bases on which to conclude that the bond issuer
had purchased services from the two FINRA members involving their investment banking and securities business activities
and, thus, that the issuer was a "customer" within the meaning
of Rule 12200. Id. at 18-19.
The facts in the current case, however, differ significantly
from the facts presented in Carilion Clinic. Here, the defendants did not have a contractual relationship with Morgan
Keegan, and did not purchase from Morgan Keegan services
or commodities, related to investment banking or the securities business. Instead, the defendants purchased shares of the
funds from a third party, through the defendants’ brokerage
firm, Legg Mason, which was not an "associated person" of
Morgan Keegan.
The defendants did not achieve "customer" status with
Morgan Keegan as a result of either their Legg Mason broker’s interaction with representatives of Morgan Keegan, or
that broker’s review of Morgan Keegan’s written materials
describing the funds. While this conduct may have related to
Morgan Keegan’s securities business, such contact between
Morgan Keegan and Legg Mason did not transform the defendants, who merely purchased shares of the funds through
Legg Mason, into the role of a "customer" of Morgan Keegan.
See Bensadoun v. Jobe-Riat, 316 F.3d 171, 177 (2d Cir. 2003)
(considering the NASD Rules and requiring a business relationship with a NASD broker for an investor to qualify as a
"customer," noting that otherwise, "every purchaser of shares
in a mutual fund . . . would arguably be ‘customers’ of every
investment institution with which those funds did business").

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We find equally untenable the defendants’ argument that
they have a customer relationship with Morgan Keegan based
on Morgan Keegan’s alleged violation of the FINRA Rules
and the "connection" between that alleged violation and the
defendants’ financial losses. The defendants cannot satisfy the
common understanding of the term "customer," namely, of
"one who purchases a commodity or service," by alleging
merely a remote association with alleged misconduct falling
within the general ambit of FINRA’s regulatory interests.8
Accordingly, we hold that, under the facts presented, the
defendants were not "customers" of Morgan Keegan as contemplated by Rule 12200, because the defendants did not purchase commodities or services from Morgan Keegan in the
course of its business activities regulated by FINRA. See Carilion Clinic, at 14.
III.
In sum, we conclude that the defendants were not "customers" of Morgan Keegan under Rule 12200 and, therefore,
were not entitled to initiate arbitration proceedings under the
mandatory arbitration provision contained in that Rule.
Accordingly, we affirm the district court’s judgment permanently enjoining the defendants from pursuing their FINRA
arbitration claim against Morgan Keegan.
AFFIRMED

8

We also are not persuaded by the defendants’ reliance on the requirement imposed by FINRA’s predecessor organizations that "all disputes
arising out of the business activities of a member [ ] be arbitrated." This
argument fails in light of the plain language of Rule 12200 requiring a
customer relationship. We likewise reject the defendants’ reliance on a letter issued by the Director of FINRA in a separate FINRA proceeding. That
document is not relevant to the present case and is not entitled to any deference by this Court.