Purchasers in Private Placements Are Not "Customers" of Managing Broker-Dealer:Eighth Circuit

There have been a number of recent cases addressing the issue of who is a "customer" for purposes of FINRA securities arbitration.  Typically, investors assert they are "customers" in order to pursue an arbitation against a securities firm, which the firm resists.  The applicable FINRA Rule 12200 allows a "customer" to bring arbitration proceedings against a FINRA member or an associated person if the dispute arises in connection with the business activities of the member or associated person.  A FINRA rule defines "customer" as "not includ[ing] a broker or dealer." 

In a recent case, Berthel Fisher & Co. v. Larmon (8th Cir. Oct. 1, 2012)( Download BerthelFisher.100112[1]), unhappy purchasers of securities issued in private placements sought to arbitrate claims against Berthel Fisher, which served as the managing broker-dealer for the offering.  As managing broker-dealer Berthel reviewed and suggested changes to at least two private placement memoranda.  It also was required, along with the selling brokers, to determine each investor's eligibility to participate in the offering and maintained customer files for this purpose.  The purchasers alleged that Berthel performed insufficient due diligence on the offering.  Although the investors had no contact with Berthel, they argued that they were "customers" because Berthel provided "investment or brokerage services" to them in three ways:  It was responsible for conducting due diligence on the offering, it was obligated to conduct a reasonable basis suitability analysis on the securities, and it maintained customer files on the investors.

The court, however, held that the investors were not "customers" of Berthel, because there was no "relationship" between the firm and the investors.  Assuming that the firm's services were "investment or brokerage," the  firm did not provide them to the customer either directly or through its associated persons.  Its contractual obligations were with the issuer and the selling brokers, not with the customers.