Wachovia Bank v. VCG Special Opportunities Master Fund, Ltd.

Wachovia Bank v. VCG Special Opportunities Master Fund, Ltd., --- F.3d ----, 2011 WL 5110122 (2d Cir. Oct. 28, 2011)
A hedge fund that entered into a credit default swap agreement with a bank affiliated with a capital markets servicer was not a customer of the servicer within the meaning of FINRA rules, such that the servicer must be compelled to arbitrate with the hedge fund, where the undisputed facts showed that (i) the hedge fund had no brokerage agreement with the servicer, (ii) the servicer had not recommended the credit default swap agreement, and that (iii) the parties to the agreement expressly disclaimed any sort of advisory, brokerage or other fiduciary relationship.
Procedural context:
Appeal from a judgment of the U.S. District Court for the Southern District of New York (the "District Court") dismissing a complaint that sought to enjoin a FINRA arbitration and directing the parties to proceed with arbitration.
Defendant VCG Special Opportunities Master Fund Ltd. ("VCG"), a hedge fund with more than $58 million in assets under management in 2007, entered into a credit default swap agreement (the "CDS Agreement") with plaintiff Wachovia Bank, N.A. ("Wachovia Bank" or "Bank") in 2007. A credit default swap, similar to a traditional insurance policy, obliges the credit protection seller to compensate the protection buyer in the event of loan default. The parties began negotiating after an employee of VCG's advisor contacted a business friend at Wachovia Capital Markets, LLC ("Wachovia Capital") in May 2007. Wachovia Capital, a member of the Financial Industry Regulatory Authority, Inc. ("FINRA"), is an affiliate of Wachovia Bank. Directors at Wachovia Capital, who had authority to negotiate credit default swaps on behalf of the Bank, negotiated the terms of part of the CDS Agreement with VCG. The Agreement contained a non-reliance clause, in which each party disclaimed any reliance on the other party, or on any of the other party's affiliates. In November 2007, following a dispute about the extent of VCG's obligation to provide collateral under the Agreement, VCG commenced litigation against Wachovia Bank and a FINRA arbitration against Wachovia Capital. The FINRA Code of Arbitration Procedures for Customer Disputes (the "FINRA Code") provides for arbitration of disputes between a FINRA member and its "customer[s]". Wachovia Bank and Wachovia Capital jointly commenced an action in the District Court seeking to enjoin the arbitration on the ground that VCG was not a customer of Wachovia Capital. The parties filed cross-motions for summary judgment, and the District Court granted VCG's motion. The District Court reasoned that the FINRA Code defined the term "customer" broadly, and that the role played by the directors of Wachovia Capital in negotiating the Agreement rendered VCG a customer of Wachovia Capital. The Second Circuit reversed. The Court found that the undisputed facts showed that VCG had no relationship with Wachovia Capital sufficient to render VCG a customer of Wachovia Capital. The Court found that there was no brokerage agreement between VCG and Wachovia Capital, and that VCG had agreed that Wachovia Capital had not recommended the CDS trade to VCG. The Court compared a parallel case between VCG and Citigroup Global Markets, Inc. (“CGMI”), in which VCG and CGMI had a brokerage agreement and CGMI had advised VCG. The Court also found significant that the parties had expressly disclaimed any sort of advisory, brokerage or other fiduciary relationship in the non-reliance clause of the Agreement. As a result of the undisputed facts about VCG’s dealings with Wachovia Capital, the court found no reason to inquire further into the meaning of the term “customer” in the FINRA Code.
Circuit Judges Kearse, Pooler, and Lynch

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