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Waterford Investment Services, Inc. v. Bosco, No. 11-2103

Decided: June 21, 2012

In this declaratory judgment action, the Fourth Circuit held that a securities brokerage firm was subject to arbitrate the claims of certain investors who alleged that their financial advisor, a person indirectly under the control of the firm, had committed misrepresentations and failed to perform “due diligence” in connection with several securities investments.

This litigation arose when members of the Bosco family (collectively “Investors”) filed arbitration claims against their financial advisor George Gilbert, Gilbert’s former investment firm Community Bankers Securities, LLC (“CBS”), and Gilbert’s current firm Waterford Investment Services, Inc (“Waterford”).  The claims were filed with the Financial Industry Regulatory Authority (“FINRA”), of which both CBS and Waterford were registered as members.  Waterford instituted the instant action by seeking a declaratory judgment in the U.S. District Court for the Eastern District of Virginia that it was not obligated to arbitrate the Investors’ FINRA claims and an injunction to prevent the arbitration proceedings from commencing.  The district court, adopting a magistrate’s report in full, concluded that Waterford must arbitrate the Investors’ claims because, pursuant to FINRA rules, Gilbert was an “associated person” of Waterford.

On appeal, the Fourth Circuit reviewed the district court’s ruling de novo.  The court first pointed out that under the FINRA Code of Arbitration Procedure for Customer Disputes, an investment customer can compel arbitration of a dispute with a FINRA member if the dispute “arises in connection with the business activities of the member or the associated person.”  According to the court, there was no question that the Investors were the customers of Gilbert; however, the dispositive issue was whether Gilbert was an “associated person” of Waterford during the period when the alleged improper advice was given.  At that time, Gilbert was employed by CBS—not Waterford—but both companies were owned by the same majority shareholder and were operated by a group of overlapping officers, directors, and employees.  In addition, the two companies shared office space and resources, and when CBS ceased its operations in 2009, many CBS representatives, including Gilbert, were transferred to Waterford.

After providing this background information, the court framed the issue as a novel one:  “[w]hether a person who is not in a contractual relationship with a member firm nevertheless can be an ‘associated person’ of that firm for purposes of FINRA arbitration.”  The court determined that the “associated person” definition did not require the exercise of actual control by the member firm over the person, but rather, all that was necessary was the firm’s “potential power to influence the person.”  Because of the extensive overlap in key personnel and office resources between CBS and Waterford, the court found that Waterford had the requisite power to control Gilbert’s business activities, thus making Gilbert a person associated with Waterford.  Therefore, the court rejected Waterford’s action for declaratory and injunctive relief, holding that Waterford was compelled to arbitrate the Investors’ claims.

Full Opinion

-John C. Bruton, III