Rodriguez de Quijas v. Shearson/American Express Inc.

Rodriguez de Quijas v. Shearson/American Express Inc., 490 U.S. 477 (1989), is a United States Supreme Court decision holding that investors’ claims under the Securities Act of 1933 can be resolved through arbitration under the Federal Arbitration Act. The case arose from suits by Texas investors against their brokerage house. By a 5–4 margin the Court affirmed the Fifth Circuit Court of Appeals and ruled that their claims under the Securities Act of 1933, which regulates trading in the primary market, must be arbitrated as stipulated in their customer agreements.

The decision overruled the 1953 Wilko v. Swan decision. Justice Anthony Kennedy's majority opinion found that arbitration procedures offered more adequate protection for investors than they had when that case was decided. John Paul Stevens's short dissent criticized the majority for taking it upon itself to overturn a precedent that, he argued, Congress had purposely left intact during a major overhaul of the securities laws in the mid-1970s. Both opinions criticized the Fifth Circuit for disregarding Wilko, emphasizing that only the Supreme Court may overrule its own precedents.

Many courts besides the Fifth Circuit had chosen to disregard Wilko after the Supreme Court's own decision in Shearson/American Express Inc. v. McMahon that claims under the Securities Exchange Act of 1934, which applies to the secondary market, were also arbitrable if a contract so provided cast serious doubt on the logic of the older case. As a result of Rodriguez de Quijas, many more securities fraud claims were heard in arbitration instead of the courts, an intended outcome that has supporters and critics and led to long-term changes in how the securities industry conducts arbitration. The decision was the last in the Mitsubishi trilogy, which expanded the use of arbitration from contractual disputes to statutory claims during the 1980s.

Underlying dispute

In the early 1980s several small first-time investors in Brownsville, Texas, opened accounts with Shearson/American Express agent Jon Grady Deaton. They included minors, widows, and terminally ill people; some could not understand English. Their investments with him totaled about $400,000 ($ in ).

They later alleged that Deaton had mismanaged some of the money and churned the accounts, making trades solely to generate commissions for himself. They brought suit in federal court for the Southern District of Texas alleging securities fraud under the applicable state and federal laws. Shearson moved to compel arbitration, as the plaintiffs' customer agreements committed them to using that method of dispute resolution. The court granted the motion for all claims except those under the Securities Act of 1933 (the 1933 Act), which regulates trading in the primary market and was still considered non-arbitrable.Rodriguez de Quijas et al v. Shearson/American Express, Inc. et al (hereafter Rodriguez de Quijas I), 845 F. 2d 1296 (5th Cir., 1989)

Shearson appealed to the Fifth Circuit Court of Appeals, asking that the 1933 Act claims be arbitrated as well. In 1953 the Supreme Court had explicitly held otherwise in Wilko v. Swan.Wilko v. Swan, . But in 1987, it had held in Shearson/American Express Inc. v. McMahon that claims under the similar Securities Exchange Act of 1934 (the "1934 Act"), which regulates the secondary market where the vast majority of securities are traded, were arbitrable,Shearson/American Express Inc. v. McMahon, overruling several appeals court precedents that had extended the Wilko holding to the 1934 Act.

McMahons logic, Shearson argued, meant that Wilko was no longer applicable even if the Supreme Court had not yet overruled it. In the two years since that case, many district court judges had taken it upon themselves to overrule it,Staiman v. Merrill Lynch, 673 F.Supp. 1009 (C.D.Cal., 1987); Rosenblum v. Drexel Burnham Lambert, 700 F.Supp. 874 (E.D.La., 1987) and Aronson v. Dean Witter Reynolds, 675 F.Supp. 1324 (S.D.Fla., 1987) and while no appeals court had yet upheld those decisions, the Fifth Circuit, in Noble v. Drexel Burnham Lambert, had expressed doubts as to its continuing viability.Noble v. Drexel Burnham Lambert, 823 F. 2d 849, 850n3 (5th Cir., 1987). "McMahon undercuts every aspect of [Wilko]; a formal overruling of Wilko appears inevitable—or, perhaps, superfluous." The plaintiffs argued that Wilko was still good law because it reflected congressional intent to protect investors by guaranteeing them recourse to the courts. Even if it were not, they allowed, the contract still did not clearly establish the parties' intent to arbitrate all claims.

Appeals court

Judges William Homer Thornberry, Jerre Stockton Williams and W. Eugene Davis were empaneled to hear the case. They heard oral arguments in the case and handed down its decision in May 1988. Unanimously, in a decision written by Williams, they found for Shearson and held Wilko inapplicable.

Williams considered the case in light of McMahon and other recent arbitration jurisprudence. While in that case Wilko'''s protections had not been before the Court, the similarities between the 1933 and 1934 acts was close enough that it was hard to see why a holding that applied to one would not also apply to the other. "The reasoning in McMahon completely undermined Wilko ... As McMahon makes clear, the Supreme Court no longer considers arbitration inadequate to protect substantive rights," wrote Williams.Rodriguez I, at 1298.

The plaintiffs argued, as Justice Harry Blackmun had in his McMahon dissent, that since Congress had implied a stated attempt to leave Wilkos holding alone during a 1975 revamp of securities laws, it had given its assent and wished 1933 Act claims to be nonarbitrable while 1934 Act claims were. "We find it implausible that Congress intended to prohibit arbitration of Securities Act claims but intended to allow courts to determine the arbitrability of Exchange Act claims," he wrote. While there were, indeed, fine distinctions between the two statutes, "... McMahon, which binds us here, turns solely on the adequacy of arbitration to resolve securities disputes." Since circuit precedent held that the similarities between the two were more significant for interpretation purposes than the differences, "'[w]e thus follow the reasoning of the Supreme Court in McMahon and our own decision in Noble which lead directly to the obsolescence of Wilko and the arbitrability of Securities Act § 12(2) claims." And because McMahon had been handed down before they filed suit, the plaintiffs could not argue that they did not intend to arbitrate a 1933 Act claim since the possibility that they might have to already existed.Rodriguez I, at 1299.

Supreme Court

A request for an en banc rehearing of the case was denied a month later. The plaintiffs petitioned the Supreme Court for certiorari. It was granted in November.. Oral arguments were heard in March of 1989.

Oral arguments

Denis Downey, who had represented the plaintiffs from the district court onwards, argued for them. Theodore Krebsbach, who had argued McMahon before the Court, argued again for Shearson. Downey was permitted a short time for rebuttal after Krebsbach finished.

Petitioners

"In the petitioners' view," Downey told the justices, "the Federal Arbitration Act has been read much too broadly." It had been intended, as its language indicated, to put arbitration agreements on an equal footing with other contracts, but courts had more recently been reading it as superseding all other statutes when the two conflicted. "We do not see an elevated federal policy in the Federal Arbitration Act."

Adopting that view, he admitted, would require the Court to reconsider many of its recent decisions on the subject of arbitration. "Our purpose here is, rather than in the absolute sense, to try to create a better comparative balance," Downey said. "We see the Federal Arbitration Act as involving federal policies of considerably less importance than that of the 1933 Securities Act."

The justices asked him to distinguish the two acts. Downey answered that the 1934 Act might have been meant to protect sellers less. He added that the 1933 Act's legislative history was relevant to the present case. "[It] would seem to show that Congress realized that it was important that private enforcement would be used to effectuate the goals [of the act]."

One justice wanted to know about the adhesion issue. Could it be used to defeat the contracts even if they were held arbitrable? It hadn't been discussed in the lower courts, "and that's a major problem in this whole arbitration area," Downey claimed, since it could only have been brought up if the contract was challenged as fraudulently induced. "[D]istrict courts really don't get to review these things until after arbitration," he commented. Leaving such issues to the enforcement stage needlessly delayed dispute resolution, since it was necessary sometimes to rearbitrate the case. "I think if there's a fundamental claim like that, the district court ought to decide it up front."

Downey returned to Wilko and how it was applicable to the facts of the case. "[W]e think it's very clear, based on 36 years of what legal commentators said and based on every decision of this Court with the exception of McMahon, that Wilko said that the waiver of the choices in Section 22 amounted to an attempted waiver of the provision." It was not always possible, he added, to appeal an arbitrators' decision.

In conclusion, Downey told the justices, "our basic position is also that this is the worst possible choice we're being given." He believed any arbitrators would favor the industry, and that the Securities and Exchange Commission (SEC) could not be trusted to look out for the interests of small investors in arbitration. "[T]he Court should give some consideration to protecting the unsophisticated investor." He felt it was ironic to be in this position:

Shearson

Krebsbach began by assuring the justices that arbitration could vindicate the petitioners' rights as well as a trial. The SEC, he said, had already suggested Wilko should be overruled in its McMahon amicus curiae brief. The justices wanted to know if, as they suggested, their claims should still be litigated even if the Court overruled Wilko because they had signed their agreements before McMahon. He believed they could be arbitrated since it would not be found prejudicial.

Sandra Day O'Connor asked Krebsbach where the cases would be arbitrated. "It would take place usually in the venue closest to where the plaintiff resides" notwithstanding the absence of contractual language to that effect. "That has been the practice for as long as I can recall."

Krebsbach returned to his argument. "[T]he Court has articulated time and time again over the past 15 years that a plaintiff does not waive substantive rights in arbitration," he said. "There is nothing in the Securities Act of 1933, any more than there is in the Exchange Act of 1934, which expresses a Congressional intent to prohibit arbitration of Securities Act claims." While the anti-waiver provisions could have been read that way, McMahon rendered them both moot.

Petitioners were wrong to claim that a sentence in a report on the 1975 amendments indicated Congressional support of Wilko. "Congress never said in this single sentence in 1975 what it thought that the Wilko law was" and McMahon had already rejected that argument. Nor had Congress, in securities law amendments since McMahon, enacted any affecting arbitration.

Krebsbach touted at length the changes to securities arbitration rules since McMahon. Arbitrators would have to disclose more about their background, and those who were recently retired from the industry would no longer be considered members of the public. A transcript of the proceedings would also be required. He conceded, however, that none of these rules would apply to the plaintiffs' case.