Arbitration Agreements Mandating Arbitration Before the NASD May Be Unenforceable

Keller v. ING Financial Partners, Inc., No. 2011-193026 (S.C. App. Jan. 9, 2013) is an interesting unpublished opinion out of the state of South Carolina whose reasoning, if followed in other jurisdictions, could have a rather profound effect on client/broker-dealer arbitration agreements entered into prior to July 2007. In that case, the circuit court's denied ING Financial Partners’ motion to compel arbitration. The circuit court found the arbitration agreement between the parties designated the National Association of Securities Dealers (NASD) as an exclusive arbitral forum, the NASD was unavailable to arbitrate because it no longer existed, and the court could not substitute the Financial Industry Regulatory Authority (FINRA) for NASD.

The court noted that the Federal Arbitration Act (FAA) does not confer an absolute right to compel arbitration, but only a right to obtain an order directing that "arbitration proceed in the manner provided for in [the parties'] agreement." Volt Info. Scis., Inc. v. Bd. of Trs. of Leland Stanford Junior Univ., 489 U.S. 468, 469 (1989) (emphasis added). The agreement at issue stated "any dispute between you and me arising out of this agreement shall be submitted to arbitration conducted under the then applicable provisions of the code of arbitration procedure of NASD." The NASD's rules indicated that conducting arbitration "under the then applicable provisions of the code of arbitration procedure of NASD" mandated arbitration before the NASD itself. But the NASD was no longer available to arbitrate because in July 2007 FINRA was created through the consolidation of the NASD and the member regulation, enforcement and arbitration functions of the New York Stock Exchange (NYSE).

The court of appeals found that it could not rewrite the parties' agreement to substitute FINRA for NASD. The court noted that neither Iowa state (the law that applied) nor the Eighth Circuit Court of Appeals had decided whether a court may substitute an arbitral forum when a designated forum had become unavailable to arbitrate. Among federal circuit courts, the court noted that a split existed on the issue. In the absence of any controlling law, the court opted to follow Grant v. Magnolia Manor-Greenwood, Inc., 383 S.C. 125, 678 S.E.2d 435 (2009). There, the South Carolina Supreme Court saw "great merit in the Second Circuit's view that Section 5 [of the FAA] does not apply in cases where a specifically designated arbitrator becomes unavailable" to arbitrate. Id. at 131, 678 S.E.2d at 438 (approving of In re Salomon Inc., 68 F.3d 554 (2d Cir. 1995)).

In Salomon, the Second Circuit held that Section 5 of the FAA permits substitution only "when there is 'a lapse in time in the naming of the' arbitrator or in the filling of a vacancy on a panel of arbitrators, or some other mechanical breakdown in the arbitrator selection process." See Salomon, 68 F.3d at 560 (emphasis added). The court noted that the case before it did not present a breakdown in the process of selecting an arbitrator because the arbitral forum simply did not exist. Regardless of any similarities between NASD's and FINRA's procedural rules, the court of appeals found that it could not impose upon the parties the power of an arbitral forum that they did not agree to submit to. As a result, the court of appeals found that the trial court properly denied Appellants' motion to compel arbitration.