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JI SHEUNN JAMES CHANG AND CHIN-LAN CHANG v. ALLISON S. LIN AND MERRILL LYNCH (07/30/87)

decided: July 30, 1987.

JI SHEUNN JAMES CHANG AND CHIN-LAN CHANG, PLAINTIFFS-APPELLANTS, CROSS-APPELLEES,
v.
ALLISON S. LIN AND MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., DEFENDANTS-APPELLEES, MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., DEFENDANT-APPELLEE, CROSS-APPELLANT



Appeal and cross-appeal from an order of the United States District Court for the Western District of New York (John T. Curtin, Chief Judge) compelling arbitration of plaintiffs' state law claims and staying litigation of plaintiffs' federal securities claims pending the outcome of arbitration. Affirmed in part, reversed in part, and remanded.

Author: Winter

OAKES and WINTER, Circuit Judges, and BONSAL, Senior District Judge.*fn*

WINTER, Circuit Judge:

The plaintiffs commenced this action in September 1984 against the brokerage firm of Merrill Lynch, Pierce, Fenner & Smith, Inc. and Allison Lin, a former employee of Merrill Lynch. The plaintiffs' principal allegation is that Lin mismanaged their securities account by engaging in "churning," the excessive trading in securities for the purpose of generating commissions. They further contend that Merrill Lynch failed properly to supervise Lin's handling of their account. The complaint alleges that the defendants' actions violated the Securities Act of 1933, 15 U.S.C. § 77a et seq. (1982) ("'33 Act"); the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (1982) ("'34 Act"); the rules of the Securities Exchange Commission; and New York common law.

Merrill Lynch moved to compel arbitration of the plaintiffs' claims under the '34 Act, based on the arbitration clause of the customer agreement between the plaintiffs and Merrill Lynch. The plaintiffs cross-moved to bar or stay any such arbitration.

On October 27, 1986, the district court entered an order compelling arbitration of the plaintiffs' state law claims and staying litigation of their federal securities claims pending the outcome of that arbitration. The plaintiffs contend on appeal that they should not be required to arbitrate their state claims or to defer litigation of their federal claims. The defendants maintain on cross-appeal that the district court should have compelled arbitration of the claims brought under the '34 Act.

Discussion

I

The plaintiffs first contend that they should not be required to arbitrate their state law claims because the findings in the arbitration proceeding might be given collateral estoppel effect in any subsequent litigation of federal claims. A similar argument was rejected by the Supreme Court in Dean Witter Reynolds Inc. v. Byrd, 470 U.S. 213, 221-23, 84 L. Ed. 2d 158, 105 S. Ct. 1238 (1985). The Court noted that under general collateral estoppel principles "it is far from certain that arbitration proceedings will have any preclusive effect on the litigation of nonarbitrable federal claims." Id. at 222. Furthermore, the Court recognized that lower federal tribunals faced with arbitrators' decisions on related state claims "may directly and effectively protect federal interests by determining the preclusive effect to be given to an arbitration proceeding." Id. at 223.*fn1 Accordingly, given the ability of federal courts to fashion preclusion rules that protect federal interests, the Court held that "neither a stay of the arbitration proceedings, nor a refusal to compel arbitration of state claims, is required in order to assure that a precedent arbitration does not impede a subsequent federal-court action." Id. We likewise hold that the district court was not required in the instant case to refrain from ordering arbitration of the plaintiffs' state law claims.

II

Plaintiffs have alleged violations of both the Securities Act of 1933, 15 U.S.C. § 77a et seq. (1982), and the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (1982). In their cross-appeal, defendants contend that the district court erred in denying their motion to compel arbitration of their claims under the '34 Act. In denying this motion, the district court relied on our decision in McMahon v. Shearson/American Express, Inc., 788 F.2d 94, 96-98 (2d Cir. 1986), which held that claims under Section 10(b) of the '34 Act and under Rule 10b-5 were not arbitrable. Since the argument of this appeal, however, the Supreme Court reversed our decision in McMahon and held that claims under the '34 Act may be subject to arbitration. Shearson/American Express, Inc. v. McMahon, 482 U.S. 220, 107 S. Ct. 2332, 96 L. Ed. 2d 185 (1987). Accordingly, we reverse the order of the district court insofar as it denied defendants' motion to compel arbitration of the plaintiffs' '34 Act claims.*fn2

III

Based on Wilko v. Swan, 346 U.S. 427, 98 L. Ed. 168, 74 S. Ct. 182 (1953), the parties agreed in the district court that plaintiffs' claims under the '33 Act were nonarbitrable. Although the Supreme Court in McMahon questioned the rationale underlying Wilko, the Court nevertheless did not overrule that decision, and it continues to govern us. We must therefore address plaintiffs' contention that the district court erred in staying their '33 Act claims pending the arbitration of their state law claims.

A plaintiff has the right to litigate a '33 Act claim in a federal court notwithstanding any arbitration agreement with the defendant. See Wilko. This right is substantially diminished if such claims must lay dormant until other claims arising out of the same series of events have been arbitrated. Evidence supporting the federal claims may become stale or unavailable prior to the conclusion of the arbitration. Moreover, delay generally works to the advantage of defendants who may well be inclined to prolong the arbitration unnecessarily in the hope that plaintiffs ultimately will be forced to abandon their nonarbitrable claims. If nonarbitrable federal claims are stayed pending the arbitration of other federal or state claims, plaintiffs alleging fraud in securities transactions face the unhappy ...


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