Perpetual Securities, Inc. v. Julie Tang and Hua Yu Chen

Citations: 290 F.3d 132; 2002 U.S. App. LEXIS 9426; 2002 WL 927457Docket: 01-7901

Court: Court of Appeals for the Second Circuit; May 9, 2002; Federal Appellate Court

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Perpetual Securities, Inc. (Perpetual) appeals a judgment from the U.S. District Court for the Southern District of New York that denied its petition to vacate an arbitration award, confirmed the award in favor of respondents Julie Tang and Hua Yu Chen, and imposed Rule 11 sanctions against Perpetual in the form of attorney's fees and costs. The district court found it lacked jurisdiction to vacate the arbitration award due to Perpetual not presenting an independent federal jurisdictional basis, but ruled it had jurisdiction to confirm the award under the Federal Arbitration Act. The court sanctioned Perpetual for presenting arguments contrary to established Circuit precedent.

The appellate court agrees that the district court lacked jurisdiction to vacate the award but disagrees with its assumption of jurisdiction to confirm it. It also finds the imposition of Rule 11 sanctions against Perpetual improper. The appellate court vacates the district court's order and remands the case for dismissal due to lack of subject matter jurisdiction and for reconsideration of the sanctions issue. The underlying arbitration involved a claim against Perpetual for unauthorized trading, which was brought by Tang and Chen under agreements that mandated arbitration through the NASD. Perpetual's defenses of res judicata and collateral estoppel, based on a previous NASD investigation that found no grounds for disciplinary action against its employee, were rejected by the arbitration panel. The panel ultimately ordered Perpetual to pay damages and fees totaling $29,205.

Perpetual filed a petition in the U.S. District Court for the Southern District of New York to vacate an arbitration award. The appellees countered with a motion to dismiss Perpetual's petition, seek confirmation of the award, and impose sanctions under Fed. R. Civ. P. 11. The district court determined it lacked jurisdiction to vacate the arbitration award due to Perpetual's failure to establish an independent basis for subject matter jurisdiction but confirmed the award and imposed Rule 11 sanctions in the form of attorney's fees and costs. 

An appeal followed, and the appellate court confirmed its jurisdiction under 9 U.S.C. § 16(a)(1)(D) to hear appeals from orders confirming or denying arbitration awards. Although the district court lacked jurisdiction, the appellate court had the authority to correct this error. 

Federal courts operate under limited jurisdiction, as defined by Congress under Article III of the Constitution, which allows for federal question jurisdiction and diversity jurisdiction. Individual parties cannot create subject matter jurisdiction; it must exist independently before a case can be heard. The Federal Arbitration Act, while regulating arbitration agreements, does not itself confer federal jurisdiction. In this case, Perpetual's complaint cited 28 U.S.C. § 1331 for federal question jurisdiction, but the amount in controversy did not meet the diversity jurisdiction threshold of $75,000 under 28 U.S.C. § 1332. Thus, the court required a federal question for jurisdiction to be valid.

Federal question jurisdiction arises when a well-pleaded complaint demonstrates that either federal law creates the cause of action or the plaintiff's claim hinges on a significant question of federal law. Courts must carefully differentiate between substantial federal questions and those that lack merit. Merely invoking a federal issue does not guarantee federal jurisdiction; the court must assess whether the claim is sufficiently credible to warrant intervention. 

In the case at hand, Perpetual claims violations of its due process rights under the Fifth and Fourteenth Amendments due to the NASD's compulsory arbitration requirements. For this claim to hold weight, Perpetual must establish that NASD's actions constitute state action, as private conduct does not engage the Fourteenth Amendment’s protections. Although Perpetual can argue that NASD is a state actor, the entity is fundamentally a private corporation, not funded or mandated by government action, nor does it have government-appointed members. Previous rulings indicate that extensive state regulation of a private entity does not transform its actions into state actions. Thus, NASD is determined to be a private actor, negating the constitutional claims related to due process.

The court referenced previous cases to establish that NASD is not a state actor and that its compulsory arbitration requirement does not constitute state action. The SEC's approval of the arbitration clause alone does not implicate state liability, as highlighted in Desiderio, where the court determined that NASD's status as a private entity precludes it from being treated as a state actor. Perpetual's argument that NASD should be considered a state actor was unsupported and improperly relied on the distinguishable case of Lebron, which involved a government-created corporation with significant governmental control. 

Perpetual proposed a new test for state action, suggesting that the government would need to regulate NASD if it did not exist. The court rejected this proposal, reiterating the established legal standards that require a close nexus between the state and the entity’s actions, coercive power, or the exercise of powers traditionally exclusive to the state. The court maintained that the Supreme Court's precedent does not support Perpetual's claims and affirmed that the district court correctly ruled that Perpetual's due process argument lacked merit, as NASD's actions did not involve state action. Consequently, Perpetual's attempt to vacate the arbitration award was dismissed for lack of jurisdiction.

An allegation that an arbitration panel manifestly disregarded federal law can establish federal question jurisdiction. However, Perpetual's claims that the arbitration panel disregarded principles of collateral estoppel and res judicata are unfounded. The NASD Regulation's decision not to take action against Yue Chen does not impact the arbitration panel's decision regarding financial liability, as that issue was never adjudicated by NASD Regulation. Collateral estoppel, which prevents relitigation of decided issues, is inapplicable because the financial liability of Perpetual and Yue Chen was not determined by NASD. Res judicata, or claim preclusion, also does not apply for three reasons: NASD did not have jurisdiction over the arbitration panel's issues; appellees were not parties to the NASD investigation; and the matters decided were entirely different.

Furthermore, Perpetual's argument regarding the tort law principle of respondeat superior posits that the panel could not find Perpetual liable without first finding Yue Chen liable. However, there is no indication that respondeat superior is a federal law issue requiring federal court resolution. Additionally, the arbitrators may have based their decision on negligent supervision rather than respondeat superior. The district court correctly concluded it lacked jurisdiction to vacate the arbitration award but mistakenly held that section 9 of the FAA granted it jurisdiction to confirm the award, as the FAA does not confer federal question jurisdiction on district courts.

Independent federal question jurisdiction is necessary for claims under the Federal Arbitration Act (FAA) when confirming arbitration awards. In several cases, such as Smiga v. Dean Witter Reynolds and Kallen v. District 1199, it was determined that jurisdiction exists only if there is an independent basis, such as diversity of parties or the amount in controversy. The excerpt confirms that Section 9 of the FAA does not independently grant federal subject matter jurisdiction, aligning with decisions from other Circuits. Consequently, since there was no independent jurisdictional basis, the district court lacked the authority to confirm the arbitration award, leading to the vacating of that part of its judgment.

Despite the lack of jurisdiction over the main action, the district court retained the authority to address collateral issues, including the imposition of Rule 11 sanctions. The district court, referencing Willy v. Coastal Corp. and Cooter & Gell v. Hartmarx Corp., noted that sanctions can be applied even without jurisdiction over the main case, as they relate to abuse of the judicial process. The court has broad discretion in sanctioning under Rule 11, which is reviewed for abuse of discretion. The district court found that the actions of Perpetual constituted vexatious economic coercion, warranting an award of reasonable attorney's fees and costs. Rule 11 allows for sanctions if a party violates its provisions regarding frivolous claims after proper notice and opportunity to respond.

A motion for sanctions under Rule 11 must be made separately from other motions and specify the alleged misconduct violating subdivision (b). It must be served but not presented to the court unless the challenged claim is not withdrawn or corrected within 21 days. These procedural safeguards aim to limit sanctions and provide opportunities for correction. The appellees failed to comply with this requirement by including their sanctions request in a memorandum rather than filing it separately, and they did not serve it on Perpetual prior to filing. Consequently, Perpetual was deprived of the 21-day "safe harbor" period to amend its claims. The district court's imposition of sanctions against Perpetual was deemed an abuse of discretion due to this procedural violation. The judgment of the district court was partially vacated and remanded for reconsideration of the sanctions issue, allowing for the possibility of reassessment under proper procedural guidelines. The court noted that, unlike in a previous case (Hadges), there was no indication that Perpetual would have corrected its claims had it been given the opportunity. The district court is instructed to dismiss the case for lack of subject matter jurisdiction but may reconsider sanctions in line with Rule 11's requirements. The parties will bear their own costs. Additionally, it is noted that a district court may award sanctions without a party's motion, but must allow a response opportunity, and cannot impose monetary sanctions on its own initiative. The court also highlighted the importance of adhering to strict procedural rules, even when attempting to facilitate resolution outside of court.