October 05, 2015 Practice Points

Federal Court Defers Brokerage Case to Panel for Initial Decision

By Christopher King

In December 2014, a federal court stayed a lawsuit and sent the parties to a FINRA arbitration, even though it recognized that some of the parties’ claims might need to come back to the court for resolution. Christensen v. Nauman, 73 F. Supp. 3d 405 (S.D.N.Y. 2014).

KCCI was a FINRA-registered brokerage firm owned by the plaintiff, Christensen, and two of the defendants, Nauman and Gollner. Between 2008 and 2014, Nauman and Gollner made several decisions on behalf of KCCI without holding shareholder meetings or providing notice to Christensen. Those decisions included multiple million-dollar payouts to the defendants and the firm’s CFO, issuing new shares in KCCI and thereby diluting Christensen’s 40 percent stake, and selling the firm without paying any of the proceeds to Christensen.

When Christensen learned of the sale, he filed suit in the Southern District of New York seeking, inter alia, repayment of money to KCCI by the other shareholders and a declaration that he was entitled to 40 percent of the proceeds from any sale of KCCI. The defendants moved to dismiss the complaint in favor of arbitration. They argued that, although section 13205 of the FINRA Code of Arbitration Procedure (the Code) prohibits the arbitration of shareholder derivative claims, Christensen’s complaint contained numerous direct claims. Christensen counter-argued that without discovery he could not know the underlying facts and determine which claims were direct and which were derivative.

The court held that the “matter should proceed in the first instance to arbitration, with the direction to the arbitration panel to resolve only those claims that, following development of a factual record, it finds direct in nature….” Christensen at 415. The court had three basic reasons for its decision. First, the complaint contained direct claims that were required to be resolved in arbitration. Second, the development of a factual record in the arbitration would allow the panel to decide which claims were derivative and needed to be brought in court. Third, to allow the potentially derivative claims to be litigated at the same time that the direct claims were being arbitrated would not be efficient and thus would thwart a major goal of arbitration.

The court also held that the proceedings should be stayed and not dismissed, because some of the claims might need to be determined by the court at a later date. The court also noted that the dismissal of a case is appealable whereas a stay is not. Thus, to dismiss the case would potentially lead to an appeal that would prolong the litigation and delay the arbitration process.

The Christensen decision recognizes that efficiency is a primary goal of arbitration, and it promotes that goal. Instead of permitting parallel proceedings to take place in arbitration and court, the court gave the arbitration panel the ability to develop the factual record and determine which claims should be arbitrated. If necessary, any remaining claims could be brought to court at a later time.

Keywords: alternative dispute resolution, adr, litigation, FINRA, direct claims, derivative claims, dismiss, stay, efficiency

Christopher King is a 2016 J.D. candidate at DePaul University College of Law in Chicago, Illinois.

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