Monday, February 13, 2012

Second Circuit Panel Rules that Hedge Fund Was Not a Customer of Broker and FINRA Member for Purposes of Arbitration

A Second Circuit panel has enjoined a hedge fund from proceeding with its FINRA arbitration against a registered broker-dealer and FINRA member with respect to a credit default swap agreement because the hedge fund was not a customer of the broker-dealer within the meaning of the FINRA Code. The panel found that the hedge fund had acknowledged in the agreement that the credit default swap was an arm's length transaction and that the firm had not provided the hedge fund with any agency, brokerage, advisory or fiduciary services with respect to the swap agreement. The hedge fund was alleging that the broker-dealer fraudulently induced the fund to enter into the swap agreement and had breached the FINRA Conduct Rules and its own fiduciary duties. Wachovia Bank, Wachovia Capital Markets LLC v. VCG Special Opportunities Master Fund, Ltd., CA-2, No. 10-1648-cv, Oct. 28, 2011)

The FINRA Code definition of customer states only that a customer must not include a broker or dealer, noted the appeals panel, and an online FINRA glossary, to which no reference is made in the FINRA Rules, describes a customer as a person or entity not acting in the capacity of an associated person or member that transacts business with any member firm and/or associated person. (FINRA Glossary of Arbitration Terms)

When the parties to relevant agreements and transactions have expressly disclaimed any sort of advisory, brokerage, or other fiduciary relationship, reasoned the panel, there is no need to grapple with the precise boundaries of the FINRA meaning of customer. In this action, there was no claim that the hedge fund had a brokerage agreement with the broker-dealer. Moreover, there was no factual issue as to whether the broker-dealer provided advice, recommendations, or other services to the hedge fund. On this record, the appeals court concluded that no rational fact finder could infer that the hedge fund was a customer of the broker-dealer for purpose of the FINRA arbitration.