FINRA Arbitration Clause Did Not Apply to Trade Secret Misappropriation Claims
By Rina Wang, summer associate, and Timothy B. Nelson
The California Court of Appeal recently addressed the issue of the interpretation of arbitration clauses in the context of claims for misappropriation of trade secrets in the case of Valentine Capital Asset Management, Inc. v. Agahi, 174 Cal.App.4th 606 (1st Dist. 2009).
In Valentine, respondent John Valentine was the founder and president of Valentine Capital Asset Management, Inc. (“VCAM”) and Valentine Wealth Management, Inc. (“VWM”), neither of which was a member of the Financial Industry Regulatory Authority (“FINRA”). John Valentine was subject to FINRA rules and regulations through his affiliation with FINRA member Geneos Wealth Management, Inc., but not through his affiliation with VCAM and VWM. Appellants Agahi, Luippold and Ortale worked as employees of VCAM and VWM. In their capacity as employees of VCAM and VWM, Agahi, Luippold and Ortale were given business leads, and they were responsible for following up on the leads, developing a client relationship, and providing services to those clients. Agahi resigned from VCAM and VWM to form a competing firm, which added Luippold and Ortale as employees. The competing firm was also not a member of FINRA. The three defendants allegedly brought VCAM and VWM client databases with them to the competing firm. Valentine allegedly discovered that Agahi had e-mailed VCAM and VWM’s client database to Ortale, and that files and e-mails had been deleted from Agahi’s work computer prior to his departure. Valentine also allegedly discovered that Agahi was attempting to persuade clients of the Valentine companies to move their assets to Agahi and his competing firm. Valentine sued Agahi, Luippold and Ortale for misappropriation of trade secrets, intentional interference with contractual relations, intentional interference with prospective economic advantage, trade libel, slander, and common law and statutory unfair competition.
Agahi, Luippold and Ortale moved to compel arbitration, arguing that the dispute was subject to mandatory arbitration under FINRA’s arbitration clause because all of the parties were members of FINRA. Valentine opposed the motion, contending that the defendants had waived their right to arbitrate and that the disputes in the litigation were not subject to FINRA arbitration. The trial court denied the motion to compel arbitration, finding that FINRA was inapplicable because the parties’ dispute did not arise out of their business activities as FINRA members.
The Court of Appeal affirmed. The court first explained that written arbitration provisions in interstate commercial transactions are enforceable under the FAA. Thus, the FAA applied to determine the scope of arbitration provisions in contracts with FINRA-member firms. Before engaging in activities as a registered representative for a FINRA-member firm, all registered representatives of broker-dealers, investment advisors, and securities issuers must sign a “Uniform Application for Securities Industry Registration or Transfer,” also known as Form U-4. See McManus v. CIBC World Markets Corp., 109 Cal. App. 4th 76, 88 n. 3 (2003). Form U-4 contains an arbitration provision. Valentine and the defendants signed this form, thereby agreeing to arbitrate every dispute required to be arbitrated under FINRA rules. Arbitration of a dispute between associated persons is required under FINRA Rule 13200 only “if the dispute arises out of the business activities of a member or an associated person . . . .”
The Valentine court found that the phrase “business activities of . . . an associated person” is limiting and cannot include the activities of every possible business enterprise in which an individual “associated person” might be engaged. Valentine, 174 Cal.App.4th at 615. According to the Valentine court, this language, when reasonably read, must require arbitration of disputes only if they arise out of the business activities of an individual as an associated person of a FINRA member. Id.at 616.
The court held that there was no allegation that any of the parties were acting for any FINRA-member firm or as an associated person. No relation was alleged between any FINRA-member firm and the work performed for Valentine. The Court further determined that none of the purported wrongdoing was alleged to have occurred in the course of the parties’ duties as associated persons with a FINRA-member firm. Rather, it allegedly occurred with investment advisory firms that were not members of FINRA. The disputes thus related to defendants, but not to their business activities as associated persons of a FINRA member.
Although Valentine is based on the distinction between “broad” and “narrow” arbitration clauses, the court reached its conclusion based on the language of the pleadings. The plaintiff pled multiple causes of action alleging misconduct by various defendants. When the court ruled on the motion to compel arbitration, the legal characterization of the parties in the Complaint controlled the ruling.
The Valentine decision makes it clear that when prosecuting or defending a claim for misappropriation of trade secrets, one must be mindful of what forum is appropriate, arbitration or litigation. Furthermore, the Valentine decision also provides an example of the importance of pleading causes of action properly based upon the forum. Because Valentine pled his causes of action in a way that made it clear they were not based on the defendants’ business activities as associated persons of a FINRA member, Valentine was able to avoid FINRA arbitration.
