Posts tagged with "#taxlaw"

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 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 Initial Decision

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.

Stone’s Second Effort to Vacate

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 According to FAA §10(a)(2)

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 According to FAA §10(a)(3)

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 According to FAA §10(a)(4)

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.

The Final Decision

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

How to Survive an IRS Audit

Taxpayers in general have about a 1% chance of receiving an IRS audit each year.  You beat the odds and your tax return has been selected for an audit.  What does this mean and what do you do?

What is an IRS tax audit?

An IRS tax audit means that the IRS is examining your tax return carefully for the accuracy with intent to verify the correctness.  Your return may have been selected (i) based on the IRS’s computer program that scores returns based on certain red flags the IRS has identified (e.g., Schedule C filers, cash basis businesses, excessive deductions), (ii) based on information received from third-party documentation, such as Forms 1099 and W-2 that do not match the information reported on your return, or (iii) to address questionable treatment of an item and to study the behavior of similar taxpayers in that market segment in handling the tax issue.

It is helpful to understand the statute of limitation under which the IRS audit is conducted.  In most cases, the IRS has 3 years from the date the tax return is filed to assess any additional tax.  Typically, this means the IRS will issue an audit notice 12 to 18 months after the tax return is filed and have 1 to 2 years to complete the audit.  If the audit is not completed within the 3 year period and the IRS does not timely assess additional tax liability, the taxpayer is generally not liable for the additional tax.

However, if the taxpayer (is found to have) underreported income on the tax return by 25% or more, then the IRS has 6 years to audit and assess tax deficiency from the date the return is filed.  In the case of fraud, the IRS has unlimited time period to audit the tax return.

The Audit Process

The audit may be conducted by mail, in taxpayer’s place of business or preferably at its representative’s office (to minimize the IRS’s access to documents and information), or in the IRS offices.  The IRS will typically request information and documents to review, and may ask to interview the taxpayer.  The law requires you to retain records used to prepare your tax return, and generally you should keep them for three years from the date the tax return was filed.

During the audit process, taxpayers have certain rights:  (i) the right to professional and courteous treatment by the IRS employees, (ii) right to privacy and confidentiality about tax matters, (iii) right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided, (iv) a right to representation by oneself or an authorized representative, and (v) right to appeal.

The audit may conclude with: (i) no change to the return because all of the items under review were substantiated, (ii) taxpayer agreeing with the IRS’s proposed changes to the tax liability, or (iii) taxpayer disagreeing with the IRS’s proposed changes.

Protesting IRS Proposed Changes

If you agree with the IRS proposed changes, you can sign the examination report, and if money is owed, several payment options may be available.

If you disagree with the IRS findings based on the tax law, a conference with a manager may be requested for further review of the issue.  In the case that an agreement cannot be reached with the examiner’s supervisor, the examiner will forward your case for processing and you will receive a letter (known as a 30-day letter) notifying you of your right to appeal the proposed changes within 30 days.

A formal written protest within 30-days is usually required to appeal the case to the IRS Appeals division.  The IRS Appeals division is separate and independent of the IRS Examination division which conducts the audit, and is designed to settle most disputes without going to court.  If is important to respond timely to the 30-day letter if you want to appeal your case.

If you do not respond to the 30-day letter (or if you do not reach an agreement with the IRS Appeals Officer), the IRS will send you a letter (known as a 90-day letter), notifying you of your right to file a petition with the United States Tax Court within 90 days.  Alternatively, you may take your case to the United States Court of Federal Claims or the United States District Courts.

Taking your Case to Court

Generally, the Tax Court hears your case before any tax has been assessed and paid.  If you do not file your Tax Court petition on time, the proposed tax will be assessed, a bill will be sent to you and you have to pay your taxes or collection can proceed.

The District Court and the Court of Federal Claims hear tax cases only after you have paid the tax and filed a claim for a credit or refund with the IRS on Form 1040X.  Generally, you must file a claim for a credit or refund within 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.

If the IRS rejects your claim, you can file suit for a credit or refund in the District Court or in the Court of Federal Claims within 2 years from the date IRS rejects your claim.  You can also file suit for credit or refund if the IRS has not delivered a decision within 6 months since you filed a claim.

The IRS Appeals Office will normally consider any case petitioned to the United State Tax Court for settlement before the Tax Court hears the case.  You may be able to recover reasonable litigation or administrative expenses to defend your position with the IRS if you are the prevailing party, exhaust all administrative remedies within the IRS, your net worth is below certain limit and other requirements are met.

Potential Penalties

If you owe any additional taxes, you must pay interest on the additional tax, and interest is generally calculated from the due date of your return to the date of your payment.  Interest, however, may be suspended or abated under certain specific circumstances.

If you owe any additional taxes, various civil tax penalty provisions could apply, including the 20% accuracy related penalty on the total understatement of tax, failure to file penalty, failure to pay penalty, and civil fraud penalties equal to 75% of any federal tax due to fraud, plus interest on penalties.  Worst case, possible criminal charges (misdemeanors and felonies) could arise in applicable cases.

When faced with an IRS (or a state) audit, the goal is to limit the scope of the auditor’s review and limit your financial impact, and settle any disputes as early as possible during the examination or appeals process.  The first thing you should do is consult a tax counsel who can assist you, especially if you have complex or sensitive issues, since settlements of disputes often involve legal analysis of the tax law and an in-depth understanding of the tax procedure.  You should consult a tax counsel if you have potentially sensitive tax issues that might involve criminal tax matters.