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Reading Health System v. Bear Stearns & Co.

United States Court of Appeals, Third Circuit

August 7, 2018

READING HEALTH SYSTEM
v.
BEAR STEARNS & CO., n/k/a J.P. MORGAN SECURITIES LLC, Appellant

          Argued on October 10, 2017

          On Appeal from the United States District Court for the Eastern District of Pennsylvania (D. C. Civil Action No. 5-15-cv-01412) District Judge: Honorable Lawrence F. Stengel

          Jonathan K. Youngwood, Esq. (ARGUED) Simpson Thacher & Bartlett LLP Counsel for Appellant

          Mark A. Strauss, Esq. (ARGUED) Thomas W. Elrod, Esq., Peter S. Linden, Esq. Kirby McInerney LLP Counsel for Appellee

          Robert C. Port, Esq. Gaslowitz Frankel LLC Counsel for Amicus Appellee Public Investors Arbitration Bar Association

          Before: SHWARTZ and ROTH, Circuit Judges and [*] PAPPERT, District Judge.

          OPINION

          ROTH, CIRCUIT JUDGE.

         INTRODUCTION

         In this case, we address an emerging trend in the brokerage industry. Ordinarily, broker-dealers, as members of the Financial Industry Regulatory Authority (FINRA), [1] are required by FINRA Rule 12200 to arbitrate all claims brought against them by a customer. Seeking to avoid this obligation to arbitrate, broker-dealers have begun inserting forum-selection clauses in their customer agreements, without mentioning the customer's right to arbitrate. This practice, which has been condoned by several of our sister circuits, deprives investors of the benefits associated with using FINRA's arbitral forum to resolve brokerage-related disputes.

         This case concerns such a forum-selection clause. Over the course of several years, Bear Stearns & Co., now known as J.P. Morgan Securities LLC (hereinafter J.P. Morgan), a broker-dealer and FINRA member, executed several broker-dealer agreements with Reading Health System. The agreements were executed in connection with four separate offerings of auction rate securities (ARS), through which Reading issued more than $500 million in debt.[2] Two of those contracts included forum-selection clauses providing that "all actions and proceedings arising out of" the agreements or underlying ARS transactions had to be filed in the District Court for the Southern District of New York.

         After the ARS market collapsed, Reading filed a statement of claim with FINRA, alleging that J.P. Morgan engaged in unlawful conduct in connection with the ARS offerings and demanding that those claims be resolved through FINRA arbitration. J.P. Morgan refused to arbitrate, however, contending that Reading had waived its right to arbitrate by agreeing to the forum-selection clauses. To resolve this standoff, Reading filed a declaratory judgment action to compel FINRA arbitration in the District Court for the Eastern District of Pennsylvania. In response, J.P. Morgan moved to transfer the action to New York, based on the forum-selection clauses in some (but not all) of the broker-dealer agreements. The District Court denied the motion to transfer the action and ordered J.P. Morgan to submit to FINRA arbitration. We will affirm both rulings.

         BACKGROUND

         I. Factual Background

         Reading is a not-for-profit health system located in Berks County, Pennsylvania. Reading issued ARSs on four occasions in 2001, 2003, 2005, and 2007, offering a total of more than $500 million in debt to finance capital projects relating to the Reading Hospital and Medical Center Project. J.P. Morgan served as the underwriter and broker-dealer for each offering. The parties executed separate broker-dealer agreements in connection with each of the four ARS offerings.

         Over time, the ARS offerings did not go as planned for Reading. Reading claims that J.P. Morgan and other broker-dealers artificially propped up the ARS market through undisclosed support bidding that created a false appearance of market demand for ARSs. Allegedly, when the broker-dealers stopped propping up the market in early 2008, the ARS market collapsed. As a result, Reading filed various state law claims against J.P. Morgan relating to the ARS offerings and demanded that those claims be arbitrated before FINRA.

         This appeal does not require us to examine the propriety of J.P. Morgan's handling of the ARS offerings or to apportion fault for the collapse of the ARS market. Rather, we are asked to resolve only the parties' threshold disputes regarding the proper venue in which to adjudicate Reading's action to compel arbitration and the venue for Reading's substantive claims against J.P. Morgan.

         To do so, we must examine the four broker-dealer agreements. Each of the agreements included a New York choice-of-law clause.[3] Both the 2001 and 2002 broker-dealer agreements were executed by J.P. Morgan and Bankers Trust (as auction agent); Reading did not sign either agreement.[4] Neither agreement includes a forum-selection clause. The 2005 broker-dealer agreement was executed by Reading Health, J.P. Morgan, and Deutsche Bank Trust Company Americas.[5] The 2007 agreement was executed by the same three parties, as well as the Berks County Municipal Authority.[6] Both the 2005 and 2007 agreements contain a forum-selection clause that provides, in relevant part, as follows:

The parties agree that all actions and proceedings arising out of this Broker-Dealer Agreement or any of the transactions contemplated hereby shall be brought in the United States District Court in the County of New York and that, in connection with any such action or proceeding, submit to the jurisdiction of, and venue in, such court.[7]

         J.P. Morgan asserts that the forum-selection clauses in these agreements required Reading to file both its declaratory action to compel arbitration and its substantive claims in the District Court for the Southern District of New York.

         II. Procedural Background

         In February 2014, Reading filed a statement of claim with FINRA, asserting claims against J.P. Morgan relating to the ARS offerings and demanding that J.P. Morgan arbitrate those claims in FINRA's arbitral forum.[8] That demand was made pursuant to FINRA Rule 12200, which requires a FINRA member, such as J.P. Morgan, to arbitrate any dispute with a customer, such as Reading, at the customer's request. J.P. Morgan refused to arbitrate. In J.P. Morgan's view, the forum-selection clauses in the 2005 and 2007 broker-dealer agreements constituted a waiver of Reading's right to arbitrate under FINRA Rule 12200.[9]

         In March 2015, Reading filed a single-count declaratory judgment action in the District Court for Eastern District of Pennsylvania.[10] The following day, Reading moved to compel arbitration of the claims it had filed with FINRA, arguing that it was entitled to arbitrate those claims pursuant to FINRA Rule 12200. Invoking the forum- selection clauses in the 2005 and 2007 broker-dealer agreements, J.P. Morgan filed two motions: a motion to transfer the declaratory judgment action to the Southern District of New York and, in the event transfer was denied, a cross-motion to enjoin the FINRA arbitration.

         In February 2016, the District Court issued a single order (i) denying J.P. Morgan's motion to transfer, (ii) granting Reading's motion to compel, and (iii) denying J.P. Morgan's cross-motion to enjoin.[11] The court declined to transfer the declaratory judgment action to New York because, in its view, the forum-selection clauses did not designate the forum in which Reading should seek to compel arbitration. The court then required J.P. Morgan to submit to arbitration because it concluded that FINRA Rule 12200 granted Reading the right to arbitrate; this right was not overridden by the forum-selection clauses.

         After we dismissed J.P. Morgan's initial appeal on jurisdictional grounds, the District Court granted J.P. Morgan's motion to certify the following question for interlocutory review:

[W]hether the United States Supreme Court decision in Atlantic Marine Construction Company, Inc. v. United States District Court for the Western District of Texas, 134 S.Ct. 568 (2013), requires a district court to enforce a forum selection clause by transferring a declaratory action seeking to compel arbitration, even if the district court determines that the forum selection clause does not cover the underlying arbitration that the plaintiff seeks to compel.[12]

         We then granted J.P. Morgan's petition for permission to appeal under 28 U.S.C. § 1292(b).

         III. Regulatory Background

         Reading bases its right to arbitrate its disputes with J.P. Morgan on FINRA's compulsory arbitration rule.

         FINRA is an independent, self-regulatory organization (SRO) established pursuant to Section 15A of the Securities Exchange Act, which "created a system of supervised self-regulation in the securities industry."[13] FINRA is authorized to "exercise comprehensive oversight over 'all securities firms that do business with the public, '"[14] including J.P. Morgan and other broker-dealers that participated in the now-defunct ARS market. In its capacity as a securities regulator, FINRA has promulgated various rules governing the brokerage industry, many of which are designed to protect investors who conduct business with FINRA-regulated firms.[15] The Securities and Exchange Commission (SEC), which is statutorily authorized to oversee FINRA, must approve all such rules.[16] A FINRA member agrees to comply with all of FINRA's rules and is thus bound to adhere to FINRA's Code and its relevant arbitration provisions.[17]

         FINRA's authority includes regulatory oversight over securities arbitration.[18] Indeed, "[t]he SEC has long viewed the option of securities arbitration for investors as an important component of its investor protection mandate" and, since its inception, "has urged the SROs it regulates to provide an alternative dispute resolution forum for customers."[19] In furtherance of that mandate, FINRA now hosts the largest arbitration forum in the United States for resolving such disputes, [20] which, according to FINRA and amicus, provides investors with a "fair, efficient and economical alternative to litigation."[21] To ensure that customers can benefit from arbitration, FINRA has promulgated numerous arbitration-related rules, [22] including FINRA Rule 12200, which requires FINRA members to submit customer disputes to FINRA arbitration whenever a customer demands arbitration.[23] Given the compulsory nature of the Rule, courts have held that, even in the absence of a written arbitration agreement, Rule 12200 constitutes a binding arbitration agreement between a FINRA member and customer.[24]

         A customer can initiate FINRA arbitration and invoke its arbitration rights under Rule 12200 by filing a "statement of claim" with the FINRA Director.[25] Although Reading properly invoked its right to arbitrate by filing its statement of claim with FINRA, J.P. Morgan contends that it had no duty to arbitrate because Reading waived its rights under Rule 12200 by agreeing to the forum-selection clauses. It is against this backdrop that we consider the merits of the District Court's order.

         DISCUSSION[26]

         In this appeal, we must answer two questions: (i) whether J.P. Morgan, as a FINRA member, is obligated to resolve Reading's substantive claims through FINRA arbitration; and (ii) which court decides that question of arbitrability. To answer those questions we must resolve the inherent tension between Reading's right to arbitrate its claims pursuant to FINRA Rule 12200 and J.P. Morgan's purported contractual right to litigate those same claims pursuant to the forum-selection clauses in the broker-dealer agreements. Complicating this inquiry, the parties do not agree which of these questions must be resolved first; each side argues that the District Court lacked authority to resolve one of the two disputes at issue.

         We agree with J.P. Morgan that the transfer dispute, as a threshold question of venue, was properly resolved before the arbitrability dispute. We thus begin by discussing whether the District Court was required to transfer Reading's declaratory judgment action to the District Court for the Southern District of New York.

         I. The District Court Properly Resolved the Transfer Dispute Before the Arbitrability Dispute

         When Reading filed its single-count, declaratory judgment action in the District Court, the only merits issue before the court was whether FINRA Rule 12200 required J.P. Morgan to submit to FINRA arbitration. However, once J.P. Morgan moved to transfer that action, the District Court was presented with a threshold issue regarding the propriety of the venue in which Reading filed its action to compel arbitration-namely, whether the declaratory judgment action should be transferred to New York in light of the forum-selection clauses. The parties spill much ink on which of these two issues should be resolved first. In J.P. Morgan's view, the transfer dispute must be resolved first and, since the District Court was required to transfer the action, it lacked authority to resolve the arbitrability dispute. By contrast, Reading argues that the Federal Arbitration Act (FAA) required the District Court to enforce FINRA Rule 12200 by compelling arbitration and, therefore, the court was divested of its discretion to transfer. The District Court declined to transfer the case before turning to the question of arbitrability. We agree that threshold disputes over venue and jurisdiction should be resolved before merits disputes. Thus, we conclude that the District Court's sequence of decision-making was not only permissible, but also preferable.

         In In re: Howmedica Osteonics Corp, we endorsed the view that district courts have "discretion to address convenience-based venue issues" in the first instance and that they "should suspend concerns about other threshold issues" while doing so.[27] That view is supported by the principle that federal courts have flexibility to choose among alternate "grounds for denying audience to a case on the merits."[28] For instance, the Supreme Court has upheld the authority of a district court to dismiss an action under the doctrine of forum non conveniens, without first determining whether the action should be dismissed on jurisdictional grounds.[29] The Court granted such leeway to district courts because a forum non conveniens dismissal-much like the parties' dispute over transfer[30]-is a "nonmerits issue" that "does not entail any assumption by the court of substantive law-declaring power."[31] Venue disputes involve only a threshold determination "that the merits should [or should not] be adjudicated elsewhere."[32] By contrast, resolving a dispute over arbitrability requires a district court to apply its law-declaring power regarding the parties' right to arbitrate. This determination may be frustrated if the threshold issue of venue is not decided first.

         Moreover, resolving merits disputes at the outset, without first ensuring that venue is proper, would in certain cases nullify the very right afforded by the forum-section clause-i.e., the right to resolve the merits in a contractually designated forum.[33] In addition, ensuring venue is proper before turning to the merits promotes finality interests and judicial economy by ensuring the facial validity of any subsequent order compelling (or denying) arbitration.[34] Such concerns are alleviated, however, by resolving threshold challenges to venue before secondary disputes over arbitrability.

         The District Court, confronted with a plaintiff seeking to compel arbitration and a defendant moving to transfer the action to compel arbitration based on a forum-selection clause, properly addressed the transfer question before the question of arbitrability. We will turn then to the propriety of the denial of the motion to transfer.

         II. The District Court Properly Declined to Transfer Reading's Action to Compel Arbitration

         A. The Supreme Court's decision in Atlantic Marine does not require transfer.

         J.P. Morgan moved to transfer Reading's declaratory judgment action, arguing that the Supreme Court's transfer framework announced in Atlantic Marine required the District Court to enforce the forum-selection clause by transferring the action to the Southern District of New York. The court disagreed that the forum-selection clause required transfer because, in its view, the clause does "not establish the judicial forum" in which Reading "must compel arbitration."[35] In response to that ruling, J.P. Morgan asked us to determine, on interlocutory review, whether Atlantic Marine requires a district court to enforce a forum-selection clause by transferring a declaratory judgment action to compel arbitration, even if the district court concludes that the clause does not encompass the underlying arbitration.[36] In other words, the question instructs us to assume that even if Reading's declaratory judgment action and statement of claim filed with FINRA fall outside the scope of the forum-selection clause, nevertheless Atlantic Marine required transfer.

         Absent a forum-selection clause, a district court ordinarily assesses whether to transfer a case to another federal district by considering the factors set out in 28 U.S.C. § 1404(a), including "various public-interest considerations" and the private interests of the parties to the litigation.[37] In Atlantic Marine, however, the Supreme Court explained that the presence of a forum-selection clause alters the traditional analysis in several respects.[38] Most significantly, a court considering a "motion to transfer based on a forum-selection clause should not consider arguments about the parties' private interests," since forum-selection provisions "represent[] the parties' agreement as to the most proper forum."[39] As a result, when a court is confronted with a valid forum-selection clause that covers the dispute, it must consider only the public-interest factors and "deem the private-interest factors to weigh entirely in favor the preselected forum."[40] For these reasons, the Atlantic Marine Court held that when a party invokes a forum-selection clause to transfer an action under § 1404(a), "a district court should transfer the case unless extraordinary circumstances unrelated to the convenience of the parties clearly disfavor transfer."[41]

         Focusing on these words, J.P. Morgan contends that the District Court had to transfer this action because no extraordinary circumstances are present. But a central premise of J.P. Morgan's reliance on Atlantic Marine-and the requirement that district courts honor the parties' contractual choice of forum in all but extraordinary circumstances-is that Reading's action to compel arbitration falls within the scope of the forum-selection clauses. Nothing in Atlantic Marine disturbs the long-standing body of law clarifying that a court need not transfer an action based on a forum-selection clause if the clause is invalid (i.e., an enforceability challenge) or if it does not cover the action or claims that the defendant is seeking to transfer (i.e., a scope challenge).[42] Rather, the transfer framework announced in Atlantic Marine presupposes the existence of an action that falls within the scope of a valid forum-selection clause.[43] This conclusion answers the question we certified for interlocutory review:

[Does] . . . Atlantic Marine . . . require[] a district court to enforce a forum selection clause by transferring a declaratory action seeking to compel arbitration, even if the district court determines that the forum selection clause does not cover ...

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