TONETTI v. SHIRLEY

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Court of Appeal, Fourth District, Division 3, California.

Louis TONETTI, Plaintiff and Respondent, v. Stephen L. SHIRLEY and Kidder, Peabody & Company, Inc., Defendants and Appellants.

G000455.

Decided: February 19, 1985

Overton, Lyman & Prince, Peter Brown Dolan and William J. Coyne, Los Angeles, for defendants and appellants. Rick L. Lund & Associates, Costa Mesa, and Robert A. Curtis, Garden Grove, for plaintiff and respondent.

Stephen Shirley and Kidder, Peabody & Company, Inc. (collectively referred to as Kidder) appeal the trial court's order denying their petition to compel arbitration of a dispute between them and an employee.   They argue the trial court erred in refusing to enforce the arbitration provision contained in the contract of employment.

In March 1980, Louis Tonetti signed a New York Stock Exchange, Inc. Agreement (NYSE Agreement) and an American Stock Exchange, Inc. Application (AMEX Application) in connection with his employment as a stockbroker and investment analyst with Kidder.   Both agreements contained provisions requiring arbitration of any dispute arising out of Tonetti's employment or termination.1

In August 1982, a dispute arose between the parties regarding Kidder's allegedly defamatory statements and writings referring to Tonetti's qualifications and performance as a stock broker and investment analyst.   Tonetti filed suit against Kidder alleging libel, defamation, slander, and negligent and intentional infliction of emotional distress.   Kidder responded by filing a motion for order staying proceedings and a petition for order compelling arbitration.   The trial court denied both requests.   Kidder appeals.

I

 In Graham v. Scissor-Tail, Inc. (1981) 28 Cal.3d 807, 171 Cal.Rptr. 604, 623 P.2d 165, the California Supreme Court set forth guidelines for determining whether an arbitration provision constitutes an unenforceable contract of adhesion.   The court defined an adhesion contract as “ ‘a standardized contract, which, imposed and drafted by the party of superior bargaining strength, relegates to the subscribing party only the opportunity to adhere to the contract or reject it.’  [Citation.]”  (Id., at p. 817, 171 Cal.Rptr. 604, 623 P.2d 165.)   A contract of adhesion is fully enforceable unless (1) it does not fall within the reasonable expectations of the weaker or “adhering” party, or (2) it is unconscionable.  (Id., at pp. 819–820, 171 Cal.Rptr. 604, 623 P.2d 165.)   These guidelines were adopted because “certain ‘minimal levels of integrity’ [must] be achieved if the arrangement in question is to pass judicial muster.”  (Id., at p. 825, 171 Cal.Rptr. 604, 623 P.2d 165.)

The trial court in the present case found arbitration was not “appropriate” in light of Hope v. Superior Court (1981) 122 Cal.App.3d 147, 175 Cal.Rptr. 851.   In Hope, the court considered the validity of an arbitration provision in an employment contract between a securities brokerage firm and two of its account executives.   The court first held the employment contract was adhesive in nature due to the standardized employment application form and the requirement that an applicant must either adhere to the contract or reject it.  (Id., at p. 153, 175 Cal.Rptr. 851.)

Next, the court held the arbitration provisions were unconscionable.   The court reviewed the composition of the arbitral body as required by the New York Stock Exchange Rules and Constitution and concluded:  “The New York Stock Exchange, and thus its board of directors, performs a variety of quasi-public functions;  but insofar as the board of directors functions in disputes between member firms and their employees, it is presumptively biased in favor of management ․  This is not to say that members of the board of directors are in fact biased, or that they would necessarily exercise their authority in a consciously biased fashion;  it is to say that the structure of governance of the exchange is such that there exists a presumptive institutional bias in favor of member firms and members who constitute the electroal constituency of the board.”  (Id., at p. 154, 175 Cal.Rptr. 851)

Furthermore, the court noted:  “The presumption of bias does not disappear simply because the decisional power is delegated [to a panel of arbitrators].  Nor is the presumption dispelled by rules requiring the arbitrators to be persons not engaged in the securities business, or giving the nonmember one peremptory challenge, or granting the director of arbitration authority to disqualify an arbitrator.   Evenhandedness could be assured by a procedure which permits selection of arbitrators by the parties to the dispute or, failing that, through the auspices of some truly neutral party.   In the absence of such a procedure we must conclude, as in Scissor-Tail, that the arbitration procedures of the New York Stock Exchange fail to meet minimal levels of integrity.”  (Id., at p. 154–155, 175 Cal.Rptr. 851.)

Parr v. Superior Court (1983) 139 Cal.App.3d 440, 188 Cal.Rptr. 801 reached the opposite conclusion.   In Parr, the court applied the principles announced in Scissor-Tail and Hope and concluded an arbitration provision within an agreement between Merrill Lynch and a customer was enforceable.   Because there was no indication that the customer in Parr was anything but an experienced and sophisticated businessman, and arbitration provisions are common in the commercial context (Keating v. Superior Court (1982) 31 Cal.3d 584, 595, 183 Cal.Rptr. 360, 645 P.2d 1192, revd. in part on other grounds Southland Corp. v. Keating (1984) 465 U.S. 1, 104 S.Ct. 852, 79 L.Ed.2d 1), the court held the arbitration agreement was within the customer's reasonable expectations.  (Parr v. Superior Court at p. 445–446, 188 Cal.Rptr. 801.)   The customer's argument that he had no notice of the arbitration provision was rejected.  (Ibid.)

In concluding the provision was not unconscionable, the court held Merrill Lynch had effectively rebutted the presumption of institutional bias.  (Id., at pp. 446–447, 188 Cal.Rptr. 801.)   The court relied primarily on the Securities Exchange Commission's approval of the arbitration provision in reaching its conclusion.   Specifically, the court stated:  “The SEC is an agency of the federal government which bears as one of its most important duties the protection and enforcement of the public's interest in the area of securities.  [Citations.]  Without some basis for doing so, we are reluctant to find unconscionable procedures which have been approved by the SEC.”  (Id., at p. 447, 188 Cal.Rptr. 801.)

The court also noted the arbitration rules provided the customer with certain rights constituting the “minimum levels of integrity” required by Scissor-Tail.   Those rights were the same rights held not to be sufficient to rebut the presumption in Hope:  the right to a panel of arbitrators composed of a majority of members who are not from the securities industry, the right to peremptorily challenge one arbitrator, the right to a hearing and to present evidence, the right to counsel, and the right to a verbatim record.   (Ibid.)

Finally, the Parr court relied on the strong public policy favoring arbitration in deciding to enforce the provision.   Quoting Scissor-Tail, the court stated:  “[E]nforcement of an agreement to arbitrate should be denied ․ only in the clearest of cases, i.e., when the applicable procedures essentially preclude the possibility of a fair hearing.   In all other cases the matter should be permitted to proceed to arbitration.   If, in the course of arbitration proceedings, the resisting party is actually denied a fair opportunity to present his position, ample means for relief are available through a subsequent petition to vacate the award.  [Citations.]”  (Id., at p. 448, 188 Cal.Rptr. 801, emphasis deleted.)

II

 Here, as in Parr, Hope, and Scissor-Tail, we hold the agreements involved are contracts of adhesion.   The contracts are standardized in form, they were drafted by a large corporation of vastly superior bargaining strength, and they were imposed upon all persons desiring employment with Kidder as a stock broker or investment analyst.  (See Graham v. Scissor-Tail, supra, 28 Cal.3d at p. 817, 171 Cal.Rptr. 604, 623 P.2d 165.)

 For the reasons stated below, we also conclude Kidder has failed to rebut the presumption of institutional bias in favor of management as set forth in Hope.   Thus, the arbitration provisions are unenforceable.   Because of our conclusion, we need not address whether the arbitration provisions fell within the reasonable expectations of Tonetti.

According to our reading of the New York Stock Exchange (NYSE) Constitution and Rules of the Board of Directors,2 Tonetti is a “nonmember” of the NYSE.   Thus, Article VIII, Section 6 of the NYSE Constitution entitled “Non-member Controversies” applies here.   That section states:  “Any controversy between a non-member and a member, allied member, member firm or member corporation, arising out of the business of such member, allied member, member firm or member corporation ․ shall be submitted for arbitration as provided in the Rules of the Board of Directors.”

The Rules indicate that public controversies involving claims of more than $100,000 require an arbitration panel consisting of five arbitrators.  (Rule 607.)   At least three of the arbitrators must not be from the securities industry.  (Ibid.)  Controversies among members of the Exchange must be arbitrated by at least three but not more than five arbitrators where the amount in controversy exceeds $10,000.  (Rule 633.)   However, the rules do not specify the number of arbitrators required where the controversy is between a nonmember and a member, as in the present case.3

In upholding the enforceability of the arbitration provision in Parr, the court relied heavily on the requirement that a majority of the arbitrators were not allowed to be associated with the securities industry.   This provision, combined with the other rights provided the public customer in the Rules, convinced the court that Merrill Lynch had rebutted the presumption of unconscionability.   In addition, the court relied on the Securities Exchange Commission's approval of the arbitration provisions.

Here, however, Kidder has failed to sustain its burden of showing the NYSE Constitution and Rules are fair as applied to an employee of a member firm.   On their face, the Rules appear to be designed to protect public customers.   No evidence has been presented to indicate an employee is equally protected.   Employees, as nonmembers, appear to be entitled to one peremptory challenge, representation by counsel, the right to a hearing and to present evidence, and the right to a verbatim record.  (Rules 609, 614, 615, 621, 624.)   It is unclear from the Rules whether an employee is also entitled to a panel of arbitrators composed primarily of persons not associated with the securities industry.   Because we cannot determine from the record before us whether an employee is protected from the presumption of institutional bias in favor of management, Kidder did not meet its burden of establishing the fairness of the arbitration procedure in the trial court.   Consequently, we conclude the NYSE arbitration procedures “fail to meet the minimal levels of integrity” required by Scissor-Tail.   Thus, the presumption of institutional bias established in Hope has not been rebutted, and the arbitration provisions are unconscionable and unenforceable.

However, this conclusion does not mean the parties are precluded from resolving their dispute by arbitration.   In light of the strong public policy in favor of arbitration, we believe the parties are entitled to choose a different and acceptable forum for arbitration.   As stated in Scissor-Tail:  “The parties have indeed agreed to arbitrate, but in so doing they have named as sole and exclusive arbitrator an entity which we cannot permit to serve in that broad capacity.   In these circumstances we do not believe that the parties should now be precluded from attempting to agree on an arbitrator who is not subject to the disabilities we have discussed.”  (Graham v. Scissor-Tail, supra, 28 Cal.3d at p. 831, 171 Cal.Rptr. 604, 623 P.2d 165;  see also Richards v. Merrill Lynch, Pierce, Fenner & Smith, Inc. (1976) 64 Cal.App.3d 899, 906, 135 Cal.Rptr. 26.)

Therefore, on remand the trial court should give the parties a reasonable opportunity to agree on a suitable arbitrator.   If they are unable to agree, either party may petition the court to appoint a neutral arbitrator.  (See Code Civ.Proc., § 1281.6.)   If no arbitrator is agreed upon and neither party petitions for an appointed arbitrator, the matter should be resolved by the trial court.

The judgment is reversed and the cause is remanded to the trial court to proceed in accordance with this opinion.   The parties are to bear their own costs on appeal.

FOOTNOTES

1.   Paragraph (d) of the NYSE Agreement reads:  “Any controversy between me and any member or member organization arising out of my employment or the termination of my employment shall be settled by arbitration at the instance of any such party in accordance with the arbitration procedure prescribed in the Constitution and Rules then obtaining of the [New York Stock] Exchange.”Paragraph (10) of the AMEX Application provides:  “I agree that any controversy between me and any member or member organization of the American Stock Exchange, Inc. arising out of my employment or termination or my employment by and with such member or member organization or any successor thereto shall be settled by arbitration at the instance of any such party in accordance with the Constitution and Rules then obtaining of the American Stock Exchange Inc. or, if the employer be a member or member organization of the New York Stock Exchange, Inc. in accordance with the Constitution and Rules of that Exchange.”

2.   It is our understanding neither the NYSE Rules nor the Constitution were presented to the trial court.   The Rules were first presented to this court at oral argument.   We have obtained a copy of the Constitution by our own efforts.

3.   The Hope opinion indicates that nonmember controversies involving more than $100,000 are heard and determined by a panel of five arbitrators with a majority being persons not associated with the securities industry.   The opinion relied on the NYSE Constitution and Rules applicable in July 1981.  Article VIII, Section 6 of the Constitution was amended in November 1983.   Because there is now no reference to the number of arbitrators required for nonmember controversies in either the Constitution or the Rules, we assume the 1983 amendment deleted the provisions referred to in Hope.

WALLIN, Associate Justice.

TROTTER, P.J., and CROSBY, J., concur.

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