The Contours of Arbitral Jurisdiction

THE CONTOURS OF ARBITRAL JURISDICTION*

A. Introduction

In A Tale of Two Cities Charles Dickens spins a story about love, sacrifice and redemption in London and Paris during the French Revolution. Two men are devoted to the same woman, the charming Lucie Manette. The suitor who eventually marries Lucie is a French exile named Charles Darnay, who is unjustly condemned to death in Paris for the crimes of his cruel uncle. The other, a drunken English lawyer named Sydney Carton, ultimately takes the place of his rival at the guillotine, thus finding moral nobility through an act far better than he had ever done before.

Controversies over arbitral jurisdictional rarely raise such interesting Dickensian narratives. However, a tale of not two, but three cases, each decided by the U.S. Supreme Court, might serve as a springboard from which to examine how jurisdictional functions are allocated between courts and arbitrators.

In Howsam v. Dean Witter Reynolds¹ a broker-customer dispute arose from alleged misrepresentations about the quality of an investment. The Court gave the arbitrators a green light to determine whether their power to hear the case was affected by time limits contained in the arbitration rules.

Pacificare Health Systems v. Book² involved a controversy between doctors and managed health-care organizations. Here the Court essentially allowed the arbitrators themselves to determine whether they could grant treble damages in a RICO (Racketeer Influenced and Corrupt Organizations Act) claim under an arbitration clause which explicitly denied them the power to award punitive damages.³

A plurality of the Court followed a similar line of reasoning in Green Tree Financial Corp v. Bazzle,⁴ which involved an attempt at class-action arbitration of disputes arising from consumer loan agreements. Once again, the Supreme Court punted the question to the arbitrator himself.

All cases address the vexed matter of which threshold preconditions for arbitration are to be determined by judges and which are for arbitrators. The issue is not only “who decides what,” but also “who decides who decides.”⁵ In the United States, this question may arise either when courts are asked to compel arbitration⁶ or when they are reviewing an award.⁷ Analysis usually implicates the twin doctrines referred to as “separability” (the validity of the arbitration clause is determined independently from that of the main agreement) and “compétence-compétence” (arbitrators have jurisdiction to determine their own jurisdiction, at least as a preliminary matter).⁸

B. Arbitration and Asset Management

Background: foxes, chickens and juries

Securities arbitration has been a particularly fruitful ground for jurisdictional conflict. The investor generally tells of a nest egg lost due to a financial adviser’s misconduct, with golden years of retirement now turned into a financially harsh old age due to unsuitable investments. The adviser, of course, usually replies that the customer was well aware of the risks and pushed hard for aggressive growth stocks.⁹

The jurisdictional tug-of-war in securities arbitration has been driven by several not-always-consistent themes. First, there exists a distrust of civil juries, composed of individuals who themselves may have had problems with financial institutions, and thus are likely to be sympathetic to the investor alleging mistakes by the broker and institutional adviser.¹⁰

Parallel to this distrust of the civil justice system there exists in many quarters an equally deep distrust of arbitrators, who have often been portrayed as foxes guarding the chickens, with a bias toward the financial service providers rather than the customers.

There is a third theme, however. Arbitrators may not always be objective in determining their jurisdiction, since their fees depend on their rulings on the scope of their power. Although a broker normally seeks to have the merits of a customer dispute decided by arbitrators (expected to be more “reasonable” than juries on liability and damages), the broker will not necessarily want arbitration of jurisdictional questions. In particular, with respect to time bars (arbitrations must be filed within a certain number of years after the alleged broker misbehavior) financial institutions generally want courts to determine jurisdiction. Arbitrators are paid if they accept jurisdiction, while judges are paid the same salary regardless of whether they hear a case—or so we would hope. By going to court on time-related eligibility questions, a financial institution thinks it is maximizing the chances that the arbitration will be barred. In most cases this would also mean that the claim is not allowed due to the statute of limitations.

For decades, the question of what jurisdictional determinations could be made by an arbitrator was moot, since the basic distrust of arbitrators (the foxes who would guard the chicken coop) generally meant there was no arbitration of securities transactions. Except in international cases,¹¹ courts traditionally refused to enforce arbitration clauses that implicated either the 1933 Securities Act or the 1934 Securities Exchange Act.¹² Interpreting these two pieces of legislation was considered too important for the private sector. Therefore, since most investment portfolios contain stocks and bonds, accusations of misfeasance by financial advisers generally ended up in court.

In 1989 the situation changed due to liberalization of limits on subject matter arbitrability by the U.S. Supreme Court.