The Supreme Court, in a victory for the nation's securities firms, yesterday let stand a ruling allowing brokers to demand that small investors give up the right to sue as a condition of opening accounts.
The court refused to review a decision invalidating Massachusetts regulations that barred securities brokers from requiring customers to submit disputes over the handling of their accounts to binding arbitration. The regulations also required the firms to inform customers about the legal effect of signing such agreements, relinquishing their right to go to court and obtain a jury trial.
The federal appeals court in Boston said the Massachusetts regulations were preempted by a federal law designed to promote the use of arbitration.
Mandatory arbitration agreements have become an increasingly popular tool among securities firms, as well as many other businesses, as a means of avoiding the expense of litigation -- and the risk of large jury verdicts -- when customers claim that their securities transactions were not properly executed or their brokers provided them with bad investment advice. The use of such arbitration agreements has vastly expanded since the Supreme Court ruled in 1987 that the agreements, after being signed by the customer, were enforceable.
After Massachusetts adopted the regulations in response to that decision, the Securities Industry Association -- the trade group representing securities dealers -- and 10 brokerage firms filed suit challenging the rules. They argued that it was preempted by the Federal Arbitration Act, which provides that arbitration agreements are generally enforceable.
The federal appeals court in Boston agreed, saying that in passing the arbitration law, "Congress barred the states from making determinations about arbitration contracts that the states remained free to make about, say, used car sales."
Massachusetts, supported by 30 others states, sought Supreme Court review of the case, Connolly v. Securities Industry Association. While the federal law requires states to honor arbitration agreements, the states argued, it should not be interpreted to prevent them from seeking to ensure that consumers are not coerced into entering such contracts.
"If left undisturbed, the ruling threatens to undermine seriously the legitimate interests of the states in assuring that contractual arbitration is truly a matter of consent, not coercion," the states said in a friend-of-the-court brief.
The Justice Department, in response to a request from the justices to express its views on the case, concluded that the Massachusetts regulations were precluded by the federal law and recommended that the court not review the appeals court ruling.
"Federal law simply guarantees that arbitration agreements not be singled out for special treatment," Solicitor General Kenneth W. Starr told the court. "That is precisely what Massachusetts attempted to do here."
Starr said the decision "will not effectively undermine state and federal regulatory efforts to police securities arbitration provisions." He pointed out that the Securities and Exchange Commission and the Commodities Futures Trading Commission had both recently approved rules requiring brokers to disclose the effects of signing arbitration clauses.
In other action yesterday, the court ordered further lower court review in an important international banking case. The case will decide whether U.S. banks must use their general assets to repay Eurodollar deposits made at a foreign branch when the foreign government freezes branch assets.
The case, Citibank v. Wells Fargo Asia Ltd., involved a dispute over $1 million deposited by Wells Fargo with Citibank's branch in Manila. Citibank refused to give Wells Fargo the money after the Philippine government barred the bank from making the payment out of its Philippine assets.
The court, in an 8-1 decision written by Justice Anthony M. Kennedy, said the federal appeals court in New York erred when it ordered Citibank to pay the money on the grounds that Citibank and Wells Fargo had agreed that the debt was to be collected in New York -- and thus was not affected by the actions of the Philippine government.
Kennedy said the appeals court had exceeded its authority in reversing the factual determinations of the trial court, which found that the two banks had not explicitly agreed on where the debt could be collected. Kennedy ordered the case sent back to the appeals court to determine whether -- in the absence of any such agreement between the banks over where the debt was to be collected -- Citibank is obligated to repay the funds.