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No Broker-Customer Relationship Absent a Direct Connection to Investment-Related Services Provided by the Brokerage Firm

Jennifer Tomsen
Greenberg Traurig, LLP - Houston Office

Terry R. Weiss
Greenberg Traurig, LLP - Atlanta Office

August 16, 2013

Previously published on August 14, 2013

A Utah federal district court is the latest to join the chorus of opinions holding that a would-be arbitration claimant cannot proceed with a FINRA arbitration because the investor was not the brokerage firm’s customer.  Orchard Securities LLC v. Pavel.1   A host of district and appellate courts have agreed with brokerage firms that a non-customer may not compel brokerage firms into FINRA arbitration under FINRA Rule 12200 because the investors did not obtain goods or services from the firm they seek to compel into arbitration. 2

In Orchard Securities, the Utah district court determined that the Pavels could not compel FINRA member firm Orchard Securities LLC (“Orchard”) to arbitrate.  The Pavels had purchased tenant-in-common interests (“TICs”) as part of an offering for which Orchard was the managing broker-dealer.  Under FINRA Rule 12200, member firms must arbitrate claims arising out of the firms’ business and brought by their customers.  The FINRA Rules do not define “customer” other than to describe it nebulously as “not includ[ing] a broker or dealer.”  FINRA Rule 12100.

Orchard asked the district court to enjoin the arbitration, arguing that under Rule 12200, the Pavels were not its customers so could not compel Orchard to arbitrate.  District Judge Robert Shelby soundly rejected the Pavels’ argument that they were customers under the FINRA rule merely because they were not brokers or dealers.  The court identified more than a dozen cases declining to adopt such an expansive interpretation of Rule 12200.  See, e.g., Raymond James Financial Servs., Inc. v. Cary, 709 F.3d 382, 386-87 (4th Cir. 2013); Morgan Keegan & Co. v. McPoland, 829 F. Supp. 2d 1031, 1035 (W.D. Wash. 2011); Zarecor v. Morgan Keegan & Co., Inc., 2011 WL 5592861 at *5 (E.D. Ark. July 29, 2011).

The Pavels nevertheless urged that they were Orchard’s customers because of Orchard’s involvement in the offering.  The Pavels argued that Orchard, as managing broker-dealer, had enlisted another broker-dealer to sell the TICs directly to its customers.  Orchard’s name and logo appeared on the front and back covers of the marketing brochure the Pavels received for the offering.  Orchard received compensation for its participation in the offering, and the Pavels were told to mail their signed offering documentation directly to Orchard.

The court found that these connections were “too remote and insignificant” to establish a direct customer relationship between the Pavels and Orchard.  Orchard Securities, 2013 WL 4010228 at *5.  Orchard’s logo was featured on the brochure’s cover, but the brochure’s text referred to the offering’s sponsor.  While Orchard received a fee based on total sales of the offering, it did not sell interests to its own customers and paid all commissions to the soliciting broker-dealers.  Although Orchard served as a “clearinghouse” for documentation, the soliciting broker-dealer was required to review and sign off on investors’ paperwork.

The court viewed the facts suggesting a lack of customer relationship as dispositive.  The Pavels did not maintain an account with Orchard, enter into any contract with Orchard, or directly purchase any investments, products or services from Orchard.  The tangential links between Orchard and the Pavels “[did] nothing to change the fact that Orchard Securities provided the Pavels with no investment or brokerage services.”  Id. at *4.3

This decision is consistent with the prevailing view that such investment or brokerage services are necessary for a customer relationship.  It reflects the common concern that interpreting the FINRA customer rule too broadly, as excluding only brokers and dealers, would produce “absurd” results.  Id. at *3 (citing UBS Securities, LLC v. Voegeli, 684 F. Supp. 2d 351, 356 (S.D.N.Y. 2010)).

The court found the facts before it similar to those in Berthel Fisher & Co. Financial Services, Inc. v. Larmon, 2011 WL 3294682 (D. Minn. Aug. 1, 2011), aff’d 695 F.3d 749 (8th Cir. 2012).  Like Orchard, Berthel Fisher was the managing broker-dealer in a private offering but did not participate in drafting the offering materials or have any contract with investors in the offering.  The court echoed the concern expressed in Berthel that “[t]o expand the definition of ‘customer” to include individuals with no direct business or investment relationship with a firm ... would frustrate the reasonable expectations of FINRA members.”  Orchard Securities at *3 (citing Berthel at *1).

The purported customers here had no contract or agreement with Orchard.  They had no brokerage account with Orchard at any time.  They bought the offering through a different broker-dealer, on the recommendation of that firm’s representative.  They had no direct, substantive interaction with Orchard, but merely mailed Orchard their paperwork.  They bought no goods or services directly from Orchard.  Accordingly, Orchard had no reasonable expectation that the Pavels could force it to arbitrate their claims.  The court concluded that forcing Orchard to submit to arbitration it had not agreed to constituted irreparable harm and granted the injunction.4

1 No. 2:13-cv-00389, 2013 WL 4010228 (D. Utah Aug. 6, 2013).

2  See, e.g., Wachovia Bank National Assoc. v. VCG Special Opportunities Master Fund, Ltd., 661 F.3d 164 (2d Cir. 2011); Raymond James Fin. Servs., Inc. v. Cary, 709 F.3d 382 (4th Cir. 2013); Morgan Keegan & Co., Inc. v. Silverman, 706 F.3d 562 (4th Cir. 2013); Vestax Securities Corp. v. McWood, 280 F.3d 1078 (6th Cir. 2002); Berthel Fisher & Co. Financial Services, Inc. v. Larmon, 695 F.3d 749 (8th Cir. 2012); Fleet Boston Robertson Stephens, Inc. v. Innovex, Inc., 264 F.3d 770 (8th Cir. 2001); Morgan Keegan & Co., Inc. v. Agresti, 2012 WL 4505897 (D. N.J. Sept. 28, 2012); Morgan Keegan & Co., Inc. v. Shadburn, 829 F. Supp. 2d 1141 (M.D. Ala. 2011); Morgan Keegan & Co., Inc. v. McPoland, 829 F. Supp. 2d 1031 (W.D. Wash. 2011); Morgan Keegan v. Johnson, 2011 WL 7789796 (E.D. Va. Dec. 22, 2011); Morgan Keegan &  Co., Inc. v. Drzayick, 2011 WL 5403031 (D. Idaho Nov. 8, 2011); Morgan Keegan & Co., Inc. v. Jindra, 2011 WL 5869586 (W.D. Wash. Nov. 22, 2011); Proshares Trust v. Schnall, 695 F. Supp. 2d 76 (S.D.N.Y. 2010); Charles Schwab & Co., Inc. v. Reaves, 2010 WL 447370 (D. Ariz. Feb. 4, 2010); Interactive Brokers, LLC v. Duran, 2009 WL 393827 (N.D. Ill. Feb. 17, 2009); Herbert J. Sims & Co. v. Roven, 548 F. Supp. 2d 759 (N.D. Cal. 2008); Goldman Sachs & Co. v. Becker, 2007 WL 1982790 (N.D. Cal. July 2, 2007); TradeRight Corp. v. Minakhi, 2007 WL 704528 (N.D. Ill. Mar. 5, 2007).

3  Another decision reflecting these same principles in a different context was released in May in the Southern District of New York.  In SunTrust Banks, Inc. v. Turnberry Capital Management, LP, Turnberry had purchased Trust certificates, issued by SunTrust, through its broker Raymond James Financial.  - F. Supp. 2d --, 2013 WL 2128340 (S.D.N.Y. May 17, 2013).  Although Turnberry relied on documents SunTrust prepared and argued SunTrust knew the certificates were for purchase by Turnberry, the court refused to compel SunTrust to arbitrate because the bank had not given Turnberry any services or advice.  Id. at *6-7.  The court rejected Turnberry’s attempt to interject “foreseeable reliance” into the analysis, as well as its argument that Raymond James’ role as broker could be ignored because it was merely a conduit that took on no risk.  Id. at *7-8.

4  The court did require a $5,000 bond, noting, however, “some difficulty identifying any specific financial damages flowing to the Pavels” if the injunction was wrongfully granted.  Id. at *6.


The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.

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