No proof of arbitration, business court says

An investor who claimed she was defrauded by an investment firm and its former stockbroker can pursue her lawsuit in court instead of in arbitration, an N.C. Business Court judge has ruled in a case that could have a major impact on business litigation.
In the April 13 order denying a motion to compel arbitration, Judge John R. Jolly Jr. held that the defendants – investment firm Morgan Keegan and broker Harold Blondeau – failed to prove that a written arbitration agreement existed between them and Martha Capps, an 84-year-old woman suffering from dementia.
Judge Jolly found the defendants produced questionable documentary evidence of the purported agreements, and testimony from the only two who could have witnessed the alleged signing of the agreements lacked credibility.
As a result, the case could be headed to a jury trial, something which has become virtually extinct for claims against investment firms, said the plaintiff’s attorneys, Gilbert File and Robert Zaytoun of Raleigh.
“This is one of the very few cases in the country in the last 20 years in which an investor has even had the opportunity to have a jury trial against an investment firm,” File told North Carolina Lawyers Weekly.
In a released statement, File said “the resulting legal precedent will require every trial judge in the state, and may persuade judges in other states, to deny mandatory arbitration when confronted with an investment firm’s sloppy recordkeeping.”
However, late last week, both the investment firm and broker filed notice of appeal.
“I think this precedent is extremely important to the brokerage industry,” said Raleigh attorney David Long, who represents the broker. “Arbitration provisions have historically been enforced. We’re asking Court of Appeals to reexamine this decision.”

‘Frankenstein’

The plaintiff’s son and guardian, Bruce Capps, filed the lawsuit in 2007, alleging that the broker had conspired with others to funnel millions of dollars into a charitable foundation they controlled and to misappropriate funds for their personal use, including the purchase of a $350,000 beach house in Morehead City’s historic district.
The lawsuit sought to hold the investment firm liable under a theory of vicarious liability.
According to the opinion, the broker had served as the plaintiff’s financial and investment adviser since 1988, shortly before she inherited millions of dollars in trust funds from an aunt.
When the broker switched firms, going from A.G. Edwards to Morgan Keegan in 1997, he advised the plaintiff to move her investment account to his new firm and her discretionary trust to the firm’s sister company, Regions Bank.
In the motion to compel, the defendants contended that, when she switched to Morgan Keegan in 1997, the plaintiff signed a written client agreement that contained a binding arbitration provision.
At the time the motion was filed, the plaintiff’s attorneys thought that overcoming that motion would be “like climbing Mount Everest,” Zaytoun said.
The initial plan was to challenge the arbitration agreement solely on grounds that it was procedurally and substantively “unconscionable,” relying on the state Supreme Court’s decision striking down an arbitration clause in Tillman v. Commercial Credit Loans, Inc., et al., 362 N.C. 93 (2008).
But, File said, “every investment firm that has an arbitration agreement uses language that is approved by the [U.S. Securities and Exchange Commission], and it would be hard for a judge to say that language approved by the SEC is unconscionable – even though we could say it was unconscionable to her, under these facts.”
However, while examining the documents purporting to be duplicates of the original written agreement, the attorneys discovered something amiss.
The documents had pages with different form numbers and other discrepancies.
“It was a Frankenstein,” File said. “We thought it raised more questions than answers.”
Through discovery and briefing, it was revealed that the investment firm had a practice in 1997 of scanning and saving only the signature pages of each client agreement, destroying the rest of the original agreements and then relying on “specimen” documents to prove the contents.
The “specimens” were kept in an unlocked file cabinet at the broker’s firm.
Before Judge Jolly, the plaintiff’s attorneys argued that those discrepancies meant the defendants had failed to prove what agreement the plaintiff had allegedly signed, or whether she had signed any agreement at all.
“We pressed in discovery: Produce her contracts. Ultimately, they didn’t produce the contracts. They produced specimen contracts that were inconsistent,” Zaytoun said, “and Judge Jolly picked up on that.”
The defendants, however, said that any differences between the signature pages and specimens were irrelevant because the arbitration provisions appeared on the same pages as the plaintiff’s alleged signature.
Jolly disagreed. Although specimen copies could be used as secondary evidence to prove the contents of lost contracts, the court found, the evidence submitted in this case was “so problematic as to be inconclusive.”
“[I]f a party wishes to rely upon such evidence, it must do better than what has been presented here,” Jolly wrote. “Morgan Keegan’s record keeping with regard to its Exhibit A, the contended client agreement, was sloppy and fragmented at best.”

Credibility questioned
The only two witnesses who could testify as to whether the agreements had been signed were the plaintiff and the broker, and Jolly found both to be “highly suspect.”
The plaintiff was suffering from dementia due to Alzheimer’s disease when she testified in 2008. Although she said the signatures were in her handwriting, she could not recall seeing or signing any document.
The broker, meanwhile, had pled guilty to investment advisory fraud in federal court, admitting that his scheme to defraud the plaintiff “was an abuse of his fiduciary relationship and position of trust,” Jolly wrote.
“His personal interest in this matter is obvious, and his testimony is unreliable,” the judge wrote.
The opinion also pointed out that it was undisputed that the plaintiff usually did not read documents given to her by the broker to sign, and that the broker generally did not explain the documents to her.
“Whether considered collectively or separately, the documentary evidence submitted by the defendants and the testimony of Capps and Blondeau is not persuasive on the threshold issue of whether there existed an arbitration agreement,” Jolly held.

Impact

Investors’ claims usually are decided by arbitrators through the Financial Industry Regulatory Authority, or FINRA.
The arbitrators are not required to give reasons for their decisions, investors have to share the cost of the arbitration proceeding and the decisions tend to favor the investment firms, according to research by File and Zaytoun.
In preparing for the case, the attorneys reviewed all of the FINRA arbitration awards involving Morgan Keegan and a consumer investor since 1997.
They discovered that out of $93,354,923 in actual damages claimed by investors, the arbitrators had awarded only $1,608,819, or 1.7 percent. That includes several zero-dollar decisions as well as no amount awarded in punitive damages.
“Morgan Keegan had a real interest in getting this case to arbitration,” Zaytoun said.
However, the case could end up helping other investors avoid arbitration if their original contracts have not been preserved or the brokerage firm has failed to show adequate maintenance of their “specimen documents,” the attorneys said.
In short, take another look at the documents.
“We did not go into this case thinking we would be where we’re at now, voiding this arbitration agreement,” Zaytoun said. “It comes down to Gil’s instincts that the papers he received from Morgan Keegan didn’t look right.
“You have to react to what comes to you.”

OPINION BRIEF

Case name: Capps v. Blondeau, et al.
Court: N.C. Business Court (Wake County Superior Court)
Judge: Hon. John R. Jolly Jr.
Date: April 13, 2010
Attorneys for plaintiff-Martha B. Capps (Bruce Capps, guardian): Gilbert W. File of Brownlee Law Firm (Raleigh); Robert E. Zaytoun and Lucy Inman of Zaytoun Law Firm (Raleigh)
Attorneys for defendant-Morgan Keegan: J. Anthony Penry and Neil A. Riemann of Penry Riemann (Raleigh)
Attorneys for defendant-Harold Blondeau: David W. Long of Poyner Spruill (Raleigh)
Issue: Whether, as a matter of North Carolina contract law, a written arbitration agreement existed between the plaintiff and defendant-brokerage firm, where the evidence consisted of “specimen” copies of the agreement and testimony from the plaintiff, who was suffering from dementia, and the defendant-broker, who pled guilty to investment advisory fraud related to the case?
Holding: No. Considered collectively or separately, the documentary evidence and witness testimony are not persuasive. The defendants have failed to meet their burden on the threshold issue of whether there existed an arbitration agreement. Thus, the defendants’ motion to stay judicial proceedings and compel arbitration is denied.
Noteworthy: The decision could impact claims of other investors whose original contracts have not been preserved or copied in their entirety, essentially voiding the mandatory binding arbitration provisions in those agreements.