CLARK v. PRUDENTIAL SECURITIES INC

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Court of Appeal, Fourth District, Division 1, California.

Steven D. CLARK et al., Plaintiffs and Respondents, v. PRUDENTIAL SECURITIES, INC., et al., Defendants and Appellants.

No. D022387.

Decided: November 30, 1995

Keesal, Young & Logan, Terry Ross, Robert D. Feighner and Stacey M. Garrett, Long Beach, for Defendants and Appellants. Edward D. Schmitt, San Diego, for Plaintiffs and Respondents.

Defendants Prudential Securities, Inc. et al.1 (together Prudential) appeal an order denying their motion to compel arbitration as to plaintiffs John W. Brown and Mary D. Brown on the Browns' claim for damages arising from securities investments.   Concluding the Browns did not make a sufficient factual showing of fraud in the inception of the parties' arbitration agreement, we reverse the order denying Prudential's motion to compel the Browns to arbitrate.2

I

INTRODUCTION

To make securities investments the Browns entered into an agreement with Prudential containing arbitration clauses.   When the Browns brought this lawsuit for damages, Prudential sought to compel arbitration.   In opposing Prudential's motion, the Browns asserted Prudential's fraud rendered unenforceable their agreement's arbitration clause.   The superior court agreed and denied Prudential's motion to compel the Browns to arbitrate.

II

FACTUAL BACKGROUND

The Browns entered into an agreement with Prudential to invest in securities.   The agreement contained a clause providing:  “Any controversy arising out of or relating to my account, to transactions with or for me or to this Agreement or the breach thereof ․ shall be settled by arbitration in accordance with the rules then obtaining of either [NASD, AMEX] or the Board of Governors of the New York Stock Exchange [NYSE] as I may elect.”

III

SUPERIOR COURT PROCEEDINGS

The Browns sued Prudential for damages in connection with their securities investments.   In June 1994 the Browns filed an unverified first amended complaint alleging Prudential fraudulently sold them high-risk speculative investments with high fees and commissions while portraying such investments as low-risk, conservative, high-income, and suitable for small or conservative investors.   The Browns' first amended complaint included a cause of action seeking a declaration their arbitration agreement with Prudential was void due to fraud in its inception.

On July 20, 1994, Prudential answered the Browns' first amended complaint, affirmatively alleging the parties' arbitration agreement precluded the Browns from pursuing this lawsuit.   Prudential also filed a motion to compel arbitration before NASD and to stay the superior court proceedings.

On August 25, 1994, the Browns filed opposition to Prudential's motion to compel arbitration.   The Browns asserted the motion should be denied because triable issues existed bearing on whether the arbitration clause was unenforceable due to fraud in the inception.

On September 2, 1994, the court made a telephonic ruling denying Prudential's motion to compel the Browns to arbitrate, deeming sufficient to defeat such motion the Browns' declarations alleging fraud in the inception based upon Prudential's misrepresentations made directly to the Browns about the agreement.

On September 9, 1994, after hearing, the court confirmed its telephonic ruling denying Prudential's motion to compel the Browns to arbitrate.

Prudential appeals.

IV

DISCUSSION

Prudential contends the court erred in denying its motion to compel arbitration as to the Browns, asserting their claim of fraud in the inception was insufficient to defeat the motion.   Independently reviewing the undisputed evidence, we conclude the superior court should have granted Prudential's motion to compel the Browns to arbitrate because the facts presented by the Browns were insufficient as a matter of law to establish the invalidity of the parties' arbitration agreement.

A

STANDARD OF REVIEW

 In California the issue of the validity of an arbitration agreement “is determined upon a petition to compel arbitration.”  (Strauch v. Eyring (1994) 30 Cal.App.4th 181, 185–186, 35 Cal.Rptr.2d 747.)  “A petition to compel arbitration is to be heard in the manner of a motion.  [Citation.]   Factual issues on motions are submitted on affidavits or declarations (or oral testimony in the court's discretion).  [Citations.]”  (Id. at p. 184, 35 Cal.Rptr.2d 747.)  “[I]f arbitration is to be denied based on a factual determination of fraud upon a petition to compel arbitration, there should be some evidentiary basis for that determination.”  (Id. at p. 186, 35 Cal.Rptr.2d 747.)

 Opposing Prudential's motion to compel arbitration, the Browns submitted evidentiary declarations to support their factual allegations of fraud.   Prudential did not present contrary evidence.   Hence, since there was no conflict in the evidence, we independently review the propriety of the order denying arbitration as to the Browns.  (Cf. Patterson v. ITT Consumer Financial Corp. (1993) 14 Cal.App.4th 1659, 1662–1663, 18 Cal.Rptr.2d 563;  Coopers & Lybrand v. Superior Court (1989) 212 Cal.App.3d 524, 529, 260 Cal.Rptr. 713;  Ford v. Shearson Lehman American Express, Inc. (1986) 180 Cal.App.3d 1011, 1027, 225 Cal.Rptr. 895.)

B

THE RECORD

The Browns' cause of action for declaratory relief alleged:  The Browns did not know they signed any arbitration agreements;  when asking the Browns to sign investment-related papers, Prudential did not tell them any dispute must be resolved by arbitration;  instead, “completely down playing any significance” to such papers, Prudential described the papers as “mere formalities” needed to begin the process of investing;  Prudential also stated or suggested the Browns need not read those papers;  the Browns relied upon fiduciary Prudential's advice about the significance of papers they signed;  the Browns would not have signed the papers had they known they would be obligated to submit disputes “to persons selected by self-regulatory organizations comprised of brokerage houses” or to waive jury trial;  and, knowing that the investments sold to the Browns would cause large losses and likely result in a dispute, Prudential intentionally misled the Browns into believing the papers had no significance.

The Browns submitted their declarations in opposition to Prudential's motion to compel arbitration.   According to John Brown's declaration, he received a high school diploma, took several math classes at the junior college level, was in the navy from 1942 to 1945, worked for 28 years as a bread delivery man and wholesaler for bakeries, retired in 1979, and was 73 years old.   John's declaration asserted:  “Although I have not had much experience with investing, prior to making my investments with Prudential, because I know little about what makes a good or bad investment, I always relied upon the advice of a stockbroker.   In all of my dealings with Prudential, I relied entirely upon the skill and expertise of my stockbroker, Michael Piscitelli.”   John also asserted Piscitelli presented him with various investment-connected forms for signature and “told me essentially that the forms were necessary to buy the investments but were of no importance otherwise and were not necessary to read and did not contain anything that I needed concern myself with.”   John further asserted he “believed” Piscitelli and “signed the forms without reading them, unaware that they contained an arbitration clause.   Piscitelli never mentioned arbitration to me nor did Piscitelli ever discuss with me what my options would be if I felt I had a legal claim against Prudential.”   Finally, John asserted:  “At the time that I signed the forms, I did not understand the meaning of arbitration as it is used in the forms submitted to me, nor did I read the terms of the arbitration clauses.   If Piscitelli had not told me the forms were of no importance, I would have read the forms and would not have wondered what the arbitration clause meant and would have asked Piscitelli the meaning of the clause.   If Piscitelli had told me that if I lost my money I was giving up a jury or judge trial in favor of a trial before a panel of persons selected by the securities industry, I would not have signed the forms.”

According to Mary Brown's declaration, she had a high school diploma, never studied financial matters or investments, worked as a grocery clerk for 15 years until marrying her husband in 1963, had been a housewife and mother since then, and was 72 years old.   Mary's declaration asserted:  “My husband and I have always made our investment decisions jointly.   Although we have not had much experience in investing, prior to making our investments with Prudential, we had always relied entirely upon our stockbrokers in making investments.   Consequently, in all of my dealings with Prudential, we both relied entirely upon the skill and expertise of our stockbroker, Michael Piscitelli.”   Mary also asserted Piscitelli presented her with various investment-connected forms for signature and “told us that the forms were necessary to buy the investments but were of no importance otherwise and were not necessary to read and did not contain anything that we needed concern ourselves with.”   Mary further asserted she “believed” Piscitelli and “signed the forms without reading them, unaware that they contained an arbitration clause.   Piscitelli never mentioned arbitration to us nor did Piscitelli ever discuss with us what our options would be if we felt I had a legal claim against Prudential over the investments.”   Finally, Mary asserted:  “At the time that I signed the forms, I did not understand the meaning of arbitration as it is used in the forms submitted to me, nor did I read the terms of the arbitration clauses.   If Piscitelli had not told me the forms were of no importance, I would have read the forms and would not have wondered what the arbitration clause meant and would have asked Piscitelli the meaning of the clause.   If Piscitelli had told me that if I lost my money I was giving up a jury or judge trial in favor of a trial before a panel of persons selected by the securities industry, I would not have signed the forms.”

Prudential did not present any evidence contravening the substance of the Browns' assertions of fraud in the inception of the arbitration agreement.

C

ANALYSIS

 The parties have proceeded on the theory this case is governed by the Federal Arbitration Act (9 U.S.C. § 1 et seq.) (the Act) as their agreement involved securities transactions in interstate commerce.  (Ford v. Shearson Lehman American Express, Inc., supra, 180 Cal.App.3d at p. 1017, 225 Cal.Rptr. 895.)  “Generally, under the Act, arbitration is strongly favored, and ‘any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration․’  [Citations.]”  (Rice v. Dean Witter Reynolds, Inc. (1991) 235 Cal.App.3d 1016, 1023, 1 Cal.Rptr.2d 265;  accord Macaulay v. Norlander (1992) 12 Cal.App.4th 1, 6, 15 Cal.Rptr.2d 204;  Rowland v. PaineWebber Inc. (1992) 4 Cal.App.4th 279, 284, 6 Cal.Rptr.2d 20.)   California also has a “strong public policy in favor of arbitration as a speedy and relatively inexpensive means of dispute resolution.”  (Ericksen, Arbuthnot, McCarthy, Kearney & Walsh, Inc. v. 100 Oak Street (1983) 35 Cal.3d 312, 322, 197 Cal.Rptr. 581, 673 P.2d 251;  Strauch v. Eyring, supra, 30 Cal.App.4th at p. 186, 35 Cal.Rptr.2d 747;  Macaulay v. Norlander, supra, 12 Cal.App.4th at p. 6, 15 Cal.Rptr.2d 204;  Rowland v. PaineWebber Inc., supra, 4 Cal.App.4th at p. 284, 6 Cal.Rptr.2d 20.)   The California Supreme Court has “warned against ‘procedural gamesmanship’ aimed at undermining the advantages of arbitration.  [Citation.]”  (Ericksen, Arbuthnot, McCarthy, Kearney & Walsh, Inc. v. 100 Oak Street, supra, 35 Cal.3d at p. 323, 197 Cal.Rptr. 581, 673 P.2d 251;  Rowland v. PaineWebber Inc., supra, 4 Cal.App.4th at p. 285, 6 Cal.Rptr.2d 20.)

 The Act “provides that a written arbitration provision in a contract involving commerce is valid and enforceable ‘save upon such grounds as exist at law or in equity for the revocation of any contract.’  (9 U.S.C. § 2).”  (Lynch v. Cruttenden & Co. (1993) 18 Cal.App.4th 802, 807, 22 Cal.Rptr.2d 636.)  “ ‘[S]tate law, whether of legislative or judicial origin, is applicable [to arbitration clauses] if that law arose to govern issues concerning the validity, revocability, and enforceability of contracts generally.’  [Citations.]”  (Rice v. Dean Witter Reynolds, Inc., supra, 235 Cal.App.3d at p. 1023, 1 Cal.Rptr.2d 265, italics in original.)   It is well established “that fraud may be a ground for the revocation of a contract.  [Citations.]”  (Lynch v. Cruttenden & Co., supra, 18 Cal.App.4th at p. 807, 22 Cal.Rptr.2d 636.)   The theory of “fraud in the inception” has emerged in California to “permit a litigant to avoid an arbitration agreement on the ground of fraud.”  (Rice v. Dean Witter Reynolds, Inc., supra, 235 Cal.App.3d at p. 1023, 1 Cal.Rptr.2d 265.) 3  The “fraud in the inception” theory “requires the litigant to show that the fraud went to the inception or execution of the agreement, so that the promisor did not in fact voluntarily assent to any part of the purported contract of which the arbitration clause is a part.”  (Ibid.)  The theory “assumes that the party seeking to avoid arbitration did not enter into any contract, and thus did not assent to the arbitration clause.”  (Id. at p. 1024, 1 Cal.Rptr.2d 265, italics in original.)  “Every California case which has addressed the issue has concluded that fraud in the inception is sufficient to avoid an arbitration clause, and that the court—not the arbitrator—must determine if such fraud exists.  [Citations.]”  (Id. at p. 1025, 1 Cal.Rptr.2d 265, fn. omitted.)

 The Browns' specific claim that they were defrauded into agreeing to arbitration “is a commonly raised issue in both state and federal cases dealing with challenges to arbitration agreements.”  (Rowland v. PaineWebber Inc., supra, 4 Cal.App.4th at p. 284, 6 Cal.Rptr.2d 20.) 4  Mindful of the strong policies favoring arbitration and judicial cautioning against procedural gamesmanship aimed at undermining the advantages of arbitration (id. at pp. 284–285, 6 Cal.Rptr.2d 20), we conclude the facts asserted in the Browns' declarations were insufficient to establish fraud in the inception of the parties' arbitration agreement.   Nowhere in their declarations do the Browns make factual assertions they were unfamiliar with the mechanisms for opening investment accounts or otherwise did not know they were entering into an agreement with Prudential.   On the contrary, careful reading of the Browns' declaration reveals they had investment experience before investing with Prudential.5  Further, the Browns acknowledge they knew they were opening an investment account at Prudential.  (Rice v. Dean Witter Reynolds, Inc., supra, 235 Cal.App.3d at pp. 1023–1024, 1 Cal.Rptr.2d 265.)   Hence, knowing they were signing documents necessary to open an investment account, the Browns could not have reasonably believed a representation those documents would not affect their legal rights.  (Cf. Lynch v. Cruttenden & Co., supra, 18 Cal.App.4th at p. 808, 22 Cal.Rptr.2d 636.)   Moreover, although the Browns' first amended complaint contained a conclusory allegation Prudential and its agents were “fiduciary investment experts,” the Browns' declarations make no factual assertions indicating their dealings with Prudential were other than in a business relationship at arm's length.6  Nor do the Browns' declarations contain factual assertions they were prevented from reading the documents before signing them.  (Id. at p. 806, 22 Cal.Rptr.2d 636;  Rowland v. PaineWebber Inc., supra, 4 Cal.App.4th at pp. 286–287, 6 Cal.Rptr.2d 20.) 7

Cases relied upon by the Browns are factually distinguishable as involving egregious elements not present here.   In Ford v. Shearson Lehman American Express, Inc., supra, 180 Cal.App.3d 1011, 225 Cal.Rptr. 895, the plaintiff was under the complete dominion and control of his psychotherapist/business adviser and others to the extent that any assent to the arbitration agreements was involuntary.  (Id. at pp. 1015, 1025–1026, 225 Cal.Rptr. 895.)   In Strotz v. Dean Witter Reynolds, Inc., supra, 223 Cal.App.3d 208, 272 Cal.Rptr. 680, the plaintiff was not given the opportunity to read the documents she signed, was under control of the defendant, and did not know what she was signing.  (Id. at pp. 211, 217, 272 Cal.Rptr. 680;  explained in Rowland v. PaineWebber Inc., supra, 4 Cal.App.4th at p. 287, 6 Cal.Rptr.2d 20.)   In Rice v. Dean Witter Reynolds, Inc., supra, 235 Cal.App.3d 1016, 1 Cal.Rptr.2d 265, the aged infirm plaintiff with no experience in securities investments was under the dominion and control of her son-in-law.  (Id. at pp. 1020, 1025, 1 Cal.Rptr.2d 265.)   Finally, in Lynch v. Cruttenden & Co., supra, 18 Cal.App.4th 802, 22 Cal.Rptr.2d 636, plaintiffs lacking any experience with stocks or securities investment accounts were under the control and dominion of a securities broker who had befriended them and specifically discouraged them from reading the documents they signed.  (Id. at pp. 805–806, 809, 22 Cal.Rptr.2d 636.)

This case is most closely analogous to Rowland v. PaineWebber Inc., supra, 4 Cal.App.4th 279, 6 Cal.Rptr.2d 20.   Although—unlike one plaintiff in Rowland—the Browns were not former stockbrokers or brokerage employees, neither were they helpless novices unfamiliar with the mechanisms for opening an investment account.  (Id. at p. 286, 6 Cal.Rptr.2d 20.)   Further, as discussed, the Browns made no factual showing they had anything other than an arm's length business relationship with Prudential.  (Ibid.)  Similar to the situation in Rowland, the record contains “no facts tending to show [the Browns] were under [Prudential's] dominion and control.”  (Id. at p. 287, 6 Cal.Rptr.2d 20.)   Moreover, like the plaintiffs in Rowland, the Browns did not present any facts indicating “they were in any way prevented from reading what it was their duty to read.”  (Ibid.)  Hence, as a matter of law, the Browns did not establish fraud in the inception of their arbitration agreement with Prudential.  (Id. at p. 285, 6 Cal.Rptr.2d 20.)

In sum, since the Browns did not establish the parties' arbitration agreement was unenforceable as resulting from fraud in the inception, on this record the superior court should have granted Prudential's motion to compel the Browns to arbitrate.

DISPOSITION

The order denying Appellants' motion to compel arbitration is reversed.   Appellants shall have costs on appeal.

FOOTNOTES

1.   Other defendants are Matthew Pavich, Bernard Wrightson, and Oliver B. Kiel, III.

2.   Prudential has also challenged an order designating the American Arbitration Association (AAA) instead of the National Association of Securities Dealers, Inc. (NASD) as the forum for arbitrating the claims of other plaintiffs, to wit, John Boyd, Steven D. Clark, Ann M. Clark, Wanda Crader, Carl Crader, Philip Wagner, and Patricia Wagner.   However, we do not address such challenge since at oral argument counsel advised us this case remains at issue only as to the Browns.   Neither do we address the matter of selection of an arbitration forum for the Browns.   Although prior to the hearing on Prudential's motion to compel arbitration the Browns' counsel advised Prudential he intended to oppose arbitration but if compelled to arbitrate would select NASD as the arbitration forum, the superior court did not reach the forum issue with respect to the Browns since it declined to compel the Browns to arbitrate.   Further, on appeal the parties have not discussed the issue of selecting a forum for arbitrating the Browns' claim.

3.   “ ‘In the usual case of fraud, where the promisor knows what he is signing but his consent is induced by fraud, mutual assent is present and a contract is formed, which, by reason of the fraud, is voidable.   In order to escape from its obligations the aggrieved party must rescind, by prompt notice and offer to restore the consideration received, if any.  [Citations.]’  [Citations.]”  (Ford v. Shearson Lehman American Express, Inc., supra, 180 Cal.App.3d 1011, 1028, 225 Cal.Rptr. 895, italics in original.)  “ ‘[T]he cases recognize the familiar distinction between fraud in the inducement ․ and fraud in the inception, factum, or execution.   If the fraud goes to the inception or execution of the agreement, so that the promisor is deceived as to the nature of his act, and actually does not know what he is signing, or does not intend to enter into a contract at all, mutual assent is lacking, and it is void.   In such a case it may be disregarded without the necessity of rescission.  [Citation.]’  [Citation.]”  (Ibid., italics in original;  cited with approval Rice v. Dean Witter Reynolds, Inc., supra, 235 Cal.App.3d at p. 1024, 1 Cal.Rptr.2d 265.)

4.   In Rowland v. PaineWebber Inc., supra, 4 Cal.App.4th 279, 6 Cal.Rptr.2d 20, the appellate court expressed concern about “unmeritorious allegations of fraud being presented for the sole purpose of avoiding the obligation to arbitrate.”  (Id. at p. 286, 6 Cal.Rptr.2d 20.)

5.   As noted, John Brown's declaration asserted that in making investments prior to investing with Prudential he “always relied upon the advice of a stockbroker.”   Similarly, Mary Brown's declaration asserted that “prior to making our investments with Prudential, we had always relied entirely upon our stockbrokers in making investments.”

6.   We note that “[i]n the context of adhesion contracts, the courts have held that the inclusion of an arbitration provision is not per se unconscionable, particularly in a commercial transaction.  [Citation.]”   (Strotz v. Dean Witter Reynolds, Inc. (1990) 223 Cal.App.3d 208, 216, 272 Cal.Rptr. 680, cited with approval Macaulay v. Norlander, supra, 12 Cal.App.4th at p. 6, 15 Cal.Rptr.2d 204;  see also Parr v. Superior Court (1983) 139 Cal.App.3d 440, 188 Cal.Rptr. 801.)

7.   California's strong public policy in favor of arbitration “is particularly applicable to cases where the parties agreeing to arbitration are of presumptively equal bargaining power.  [Citation.]”  (Rowland v. PaineWebber Inc., supra, 4 Cal.App.4th at p. 284, 6 Cal.Rptr.2d 20.)  “No law requires that parties dealing at arm's length have a duty to explain to each other the terms of a written contract, particularly where, as here, the language of the contract expressly and plainly provides for the arbitration of disputes arising out of the contractual relationship.  [Citation.]   Reliance on an alleged misrepresentation is not reasonable when plaintiff could have ascertained the truth through the exercise of reasonable diligence.  [Citation.]   Reasonable diligence requires the reading of a contract before signing it.   A party cannot use his own lack of diligence to avoid an arbitration agreement.  [Citation.]”  (Id. at p. 286, 6 Cal.Rptr.2d 20;  Cohen v. Wedbush, Noble, Cooke, Inc. (9th Cir.1988) 841 F.2d 282, 287–288.)   Hence, the Browns “were bound by the provisions of the client agreement regardless of whether they read it or were aware of the arbitration clause when they signed the document.  [Citation.]”  (Macaulay v. Norlander, supra, 12 Cal.App.4th at p. 6, 15 Cal.Rptr.2d 204;  Rowland v. PaineWebber Inc., supra, 4 Cal.App.4th at pp. 287–288, 6 Cal.Rptr.2d 20.)

KREMER, Presiding Justice.

HUFFMAN and NARES, JJ., concur.