Posts tagged with "FINRA Rule 12403"

Failure to Disclose Challenge to FINRA Arbitration Award Requires Court to Scrutinize FAA Statutory Grounds for Vacatur

Laurence Stone v. Bear, Stearns & Co., Inc., et al., 2012 WL 1946938 (E.D. Pa. May 29, 2012)

In a recent case before the Eastern District of Pennsylvania, Laurence Stone (“Stone”), a businessman and investor, filed a petition to vacate a Financial Industry Regulatory Authority (“FINRA”) Arbitration Award issued in July 2011. Bear, Stearns & Co and other named respondents filed a cross-petition to confirm the FINRA arbitration award. The court addressed several open questions of law concerning the judicial review of an arbitration award and denied the motion to vacate.

The underlying dispute in this case arose from Stone’s investments in a Bear Stearns hedge fund that held residential securities before that market collapsed in 2007. In April 2008, Stone filed a FINRA arbitration claim seeking damages of $7.6 million based on the allegation that Bear Sterns had fraudulently induced and misled him into investing in the fund. Pursuant to FINRA Rule 12403, FINRA generated and provided to the parties the following random lists of arbitrators: (1) a list of eight arbitrators from the FINRA non-public arbitrator roster; (2) a list of eight arbitrators from the FINRA public arbitrator roster; and (3) a list of eight public arbitrators from the FINRA chairperson roster. An arbitrator disclosure report (ADR) was provided for each individual. Using the ADR and publicly available information, the parties ranked and/or struck the arbitrators on the lists. Stone relied on his attorneys to conduct due diligence on the arbitration panel candidates and did no independent research on the arbitrators at that time. Based on parties’ input, FINRA appointed a panel of two public arbitrators and one non-public arbitrator to hear the case. The panel unanimously rejected all of Stone’s claims.

After the adverse decision, Stone conducted his own background investigation into each of the three arbitrators looking for evidence that would support vacatur of the judgment. Stone discovered that one of the arbitrator’s husband was a finance professor at a well-known business school and had close ties to the securities sector. The arbitrator had made full disclosure of her husband’s activities to FINRA; however, the ADR that FINRA provided to the parties only stated that the arbitrator’s “Family Member has a relationship with [the] University of Pennsylvania.” Stone alleged that this summarization constituted a failure to disclose on the part of the arbitrator and petitioned to vacate the arbitration award.

Failure to disclose is not a sufficient basis for vacating a FINRA arbitration award; it is relevant only to the extent that it can be linked to one of the statutory grounds for vacatur defined by the Federal Arbitration Act (“FAA”), 9 U.S.C. §§ 1-16. In his petition, Stone linked the arbitrator’s alleged failure to disclose her husband’s connections to three statutory bases for vacatur: evident partiality under FAA §10(a)(2), misbehavior under §10(a)(3), and exceeding powers under §10(a)(4).

Vacating an arbitration award pursuant to FAA §10(a)(2) requires “evident partiality or corruption in the arbitrators, or either of them.” The FAA does not provide an explicit definition of “evident partiality;” therefore, courts have struggled with its interpretation. “Evident partiality” can be defined either with respect to an “appearance of bias” standard or with respect to an “actual bias” standard. Under the appearance of bias standard, a court may vacate an arbitration award whenever an arbitrator fails to “disclose to the parties any dealings that might create an impression of possible bias.” Commonwealth Coatings Corp. v. Continental Casualty Co., 393 U.S. 145, 149 (1968). Under the actual bias standard, “the challenging party must show ‘a reasonable person would have to conclude that the arbitrator was partial’ to the other party to the arbitration.” Apperson v. Fleet Carrier Corp., 879 F.2d 1344, 1358 (6th Cir.1989). The court in the instant case adopted the actual bias standard, reiterating that in order to prevail on an evident partiality challenge, Stone “require[d] proof of circumstances powerfully suggestive of bias.” Kaplan v. First Options of Chicago, Inc., 19 F.3d 1503, 1523 n. 30 (3d Cir. 1994) (citations and internal quotations omitted). The court then concluded that Stone failed to show such circumstances.

Vacating an arbitration award pursuant to FAA §10(a)(3) requires the arbitrator to have engaged in “misbehavior by which the rights of any party have been prejudiced.” The Supreme Court pronounced in Hall Street Associates, L.L.C. v. Mattel, Inc. that the terms “misconduct” and “misbehavior” in section 10 of the FAA denote “extreme arbitral conduct.” 552 U.S. 576, 586 (2008). Federal courts may not vacate an arbitration award for “misbehavior” under FAA §10(a)(3) unless the arbitrator shows misconduct so severe that it denied the aggrieved party a fundamentally fair hearing. Therefore, the court found in Stone’s case that there was no “misbehavior” by the arbitrator that could fairly be characterized as “extreme arbitral conduct,” especially since the record reflects no scienter on the part of the arbitrator.

Vacating an arbitration award pursuant to FAA §10(a)(4) requires the arbitrators to have exceeded their powers. The Third Circuit delineated the categories of conduct that may suffice for a court to vacate an award as in excess of the arbitrators’ powers: “when [an arbitrator] [1] decides an issue not submitted to him, [2] grants relief in a form that cannot be rationally derived from the parties’ agreement and submissions, or [3] issues an award that is so completely irrational that it lacks support altogether.” Sutter v. Oxford Health Plans LLC, 675 F.3d 215, 219-220 (3d Cir. 2012). If an arbitrator makes a “good faith attempt” to comply with his or her mandate, “even serious errors of law or fact will not subject [the arbitrator’s] award to vacatur.” Id. at 220. The court found that none of the arbitration panel exceeded their powers by presiding over Stone’s dispute with Bear Stearns.

Courts afford the arbitrators’ decision extreme deference because, if a losing party could easily overturn an adverse arbitration award through judicial review, it would make little sense for parties to arbitrate a dispute in the first place. Based on its interpretation of the three cited sections of the FAA, the court denied Stone’s petition to vacate and granted the respondents’ cross–petition to confirm the FINRA arbitration award. Because resolving the dispute required the court to confront several open questions of law, the court denied the respondents’ request for attorneys’ fees and costs.

Should you have any questions relating to FINRA or arbitration issues, please do not hesitate to contact Attorney Joseph C. Maya in the firm’s Westport office in Fairfield County, Connecticut at 203-221-3100 or at JMaya@Mayalaw.com.

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