Nonsignatory Third Party Is Liable To Arbitrate Securities Case

Key Points:

• Non-parties to an arbitration agreement may force a party to arbitrate claims.
• Equitable estoppel prevents a party from avoiding an arbitration clause.
• A principal may rely on the agent's arbitration agreement to compel arbitration of claims.

Can a broker-dealer sued as a third party in a securities case arbitrate the claims against it even if it was not a party to the main litigants' arbitration agreement? According to the New Jersey Appellate Division, the answer is "yes."

In Hirsch v. Securities America, Inc., 2012 N.J.Super. Unpub. LEXIS 896 (April 23, 2012), all of the investors' claims in an arbitration action against their broker, as well as litigation against the accountants that referred them to the broker, should be handled in one arbitration. In allowing the broker-dealer, Securities America, Inc. (SAI), to arbitrate, the court held that arbitrability of claims against a nonsignatory to an arbitration agreement may be established through the principle of equitable estoppel.

The plaintiffs, Michael and Robyn Hirsch, had consulted their accounting firm, now known as EisnerAmper, which referred them to investment advisor, Marc Scudillo of Amper Financial Services (AFS), a related financial planning firm. Scudillo and EisnerAmper were co-owners of AFS. Scudillo was also a registered broker with SAI. From 2004 to 2008, on Scudillo's alleged recommendation, the Hirsches made $550,000 in purchases of securitized notes issued by Medical Capital Companies (MedCap), a group of Anaheim, California-based entities dealing in medical receivables financing.

During that period, the Hirsches and SAI, through Scudillo, signed customer agreements. Those documents included provisions stating that the parties were "giving up their right to sue each other in court" and that all "controversies that may arise between us … shall be determined by arbitration."

MedCap began defaulting on the notes in 2008, and the U.S. Securities and Exchange Commission in July of 2009 filed an enforcement action against the company in California federal court, alleging securities fraud. According to the SEC, MedCap had raised about $2.2 billion in investments and had misappropriated millions. The court appointed a permanent receiver for MedCap.

The Hirsches lost $550,000. In September 2010, the court – along with Hirsch LLP, a family partnership formed for business dealings – filed an arbitration action with the Financial Industry Regulatory Authority against SAI and Scudillo.

Two months later, they filed a Law Division complaint against EisnerAmper and AFS, claiming, among other things, that the firms breached their fiduciary duty. Neither SAI nor Scudillo were named.

EisnerAmper and AFS filed a third-party complaint against SAI seeking contribution and indemnification. SAI, in turn, filed a motion that sought to compel arbitration, stay the suit pending arbitration and consolidate the suit with the Hirsches' arbitration action.

SAI argued that the arbitration clause should be broadly construed to include EisnerAmper's and AFS's third-party claims, even though they were not parties to the customer agreements between the Hirsches, SAI and Scudillo. The Hirsches, acknowledging some factual similarities between their arbitration action and the suit, countered that the two presented different issues and that, either way, no arbitration agreement existed between them and AFS or EisnerAmper.

Nevertheless, last June 24, 2010, the Monmouth County Superior Court granted SAI's motion, finding that the Hirsches were "attempting to circumvent the policy favoring arbitration" by failing to name SAI in the suit. It said the principle of agency warranted arbitration, pointing to Scudillo's status as an AFS principal.

The Appellate Division said the reasons for arbitrability go beyond agency because EisnerAmper, not AFS, was named a defendant in the Hirsch suit and Scudillo was not a direct representative of the former. The court cited EPIX Holdings Corp. v. Marsh & McLennan Cos. Inc., 410 N.J. Super. 453 (App. Div. 2009), where the Appellate Division held that the relationship between the claim and the contract, combined with the relationship between the signatory and nonsignatory party, can be "a sufficient basis to invoke estoppel." The Hirsches agreed to arbitrate any controversy "concerning any account, order, or transaction," and both the SAI arbitration and the Law Division suit stemmed from the same transactions, the panel said.

The court noted that the legal and factual issues concerning the plaintiffs' transactions were intertwined and should be resolved in one proceeding. The court found that the purchase of the securities notes formed the basis for the Law Division action, as well as the arbitration claim filed before the Financial Industry Regulatory Authority.

Further, the court stated that the relationship among Scudillo, AFS and EisnerAmper also "militate[d] in favor of estoppel," commenting that the Hirsches' complaint went "to great lengths to link defendants and Scudillo together." Finally, the court opined that compelled arbitration also accorded "with the equitable underpinnings of the entire controversy doctrine," which applies to arbitration proceedings the same way it applies to litigation.

*Denis is a shareholder in our Philadelphia, Pennsylvania, office who can be reached at 215.575.2779 or dcdice@mdwcg.com.

Defense Digest, Vol. 18. No. 3, September 2012