Securities Arbitration Awards: What Are Your Rights To Challenge the Outlandish Recovery? - DD 12/03

Defense Digest

Securities Arbitration Awards:  What Are Your Rights To Challenge the Outlandish Recovery?

Ever since the United States Supreme Court's decision in Shearson/American Express v. McMahon, 482 U.S. 220 (1987) (holding that claims pursuant to the federal securities acts are arbitrable), almost all disputes between a customer and a broker or broker-dealer must be arbitrated.  Indeed, upon the opening of a securities account, most customers are required to complete new account information  forms which contain arbitration clauses that require any dispute be litigated in the arbitration programs of either the National Association of Securities Dealers (NASD) or the New York Stock Exchange (NYSE). 

In the past, the NASD and NYSE arbitration forums were believed by many to be most favorable to the brokers and broker-dealers. However, the latest figures from the NASD reflect that in 2002 and 2003, customers have recovered some form of damages in roughly 55 percent of the NASD arbitrations.  Moreover, in 1999, customers recovered damages in 61 percent of the arbitrations before the NASD.  Hence, what was once viewed as a broker-friendly forum, has been tilting toward the public customer. 

Thus, if you are the unfortunate recipient of an unfavorable or "outlandish" securities arbitration award, what are your rights?  You might be surprised to learn that your ability to challenge the arbitration awards are limited, and such are rarely disturbed by the courts.

First, the process by which an unfavorable arbitration award is challenged starts by filing a Petition to Vacate the arbitration award in either a federal or state court of "competent" jurisdiction (generally where the arbitration took place.)  To the contrary, the prevailing claimants often file a Petition to Confirm the arbitration award, which if granted, reduces the award to a civil judgment, which may be used to enforce the payment. 

Second, a determination must be made as to the correct court for the filing of Petition to Vacate.  A determination must be made as to whether the petition may be filed in federal or state court.  As discussed below, there may be significant differences as to standards to be used to review the Petition to Vacate, depending on the jurisdiction and the applicable law.

For example, in Pennsylvania, the Pennsylvania Uniform Arbitration Act provides that arbitrations are considered to be either "statutory" or "common law" arbitrations.  42 Pa.C.S. § 7302.  If a matter is considered a "common law" arbitration, pursuant to 42 Pa.C.S. § 7341, the standard of review provides that the "arbitration proceeding is binding and may not be vacated or modified unless it is clearly shown that a party was denied a hearing or that fraud, misconduct, corruption or other irregularity caused the rendition of an unjust, inequitable or unconscionable award."  Hence, a "common law" arbitration under Pennsylvania law can only be vacated if it is proven that: (1) a party was denied a hearing; or (2) that fraud, misconduct, corruption, or other irregularity caused the rendition of an unjust, inequitable, or unconscionable award. 

If the applicable arbitration agreement provides that the arbitration is to be conducted pursuant to the Pennsylvania Uniform Arbitration Act, or a "similar statute," then the arbitration would be considered a "statutory" arbitration pursuant to 42 Pa.C.S. § 7302.  Under the "statutory" arbitration standard, the review of the arbitration award by the court would be broader.  In addition to factors to consider under a common law review, the court could consider whether, among other things, "there was evident partiality by an arbitrator appointed as a neutral or corruption or misconduct in any of the arbitrators prejudicing the rights of any party..." or if "the arbitrators exceeded their powers."  42 Pa.C.S. § 7314(a).  Hence, additional argument are available to the party seeking to overturn or vacate the unfavorable award. 

However, it must also be realized that the Pennsylvania Uniform Arbitration Act does state, "The fact that the relief awarded by the arbitrators was such that it could not or would not be granted by a court of law or equity is not a ground for vacating or refusing to confirm the award." 42 Pa.C.S. § 7314(a)(2).  As a result, a party cannot argue that there was a mistake of law by the arbitrators.  Pennsylvania courts routinely rule that "errors of law or the failure of the arbitrators to render awards that have some relationship to the evidence that the parties introduced are not a basis for judicial intervention." See, Vigilone v. F.F. Monroeville Associates, 43 Pa. D. & C. 4th 292 (Allegheny CCP 1999) citing,  Chevernak, Keane & Co, Inc. v. Hotel Rittenhouse Associates Inc. , 328 Pa. Super 357, 361, 447 A.2d 485 (1984).  Therefore, arguments would have to be directed to an "irregularity," "partiality," or the arbitrators "exceeding their powers."  

It is necessary to note that the time limitation to file a Petition to Vacate in state court in Pennsylvania is 30 days after the delivery of the copy of the award to the applicant.  In addition, the NASD now requires that awards be satisfied within 30 days.  Therefore, a Petition to Vacate must be filed prior to that time, and the NASD must be notified of the filing to prevent a membership disqualification or suspension.

A party may also attempt to file a Petition to Vacate in federal court pursuant to the requirements of the Federal Arbitration Act ("FAA".)  9 U.S.C. § 1 et. seq.  The standard for review under § 10 of the FAA is very similar to the standard cited above for Pennsylvania "statutory" arbitration and states, in part, that the award may be vacated:

1. Where the award was procured by corruption, fraud, or undue means;
2. Where there was evident partiality or corruption in the arbitrators, or either of them;
3. Where the arbitrators were guilty of misconduct in refusing to postpone the hearing;
4. Where the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the subject matter submitted was not made.

Some federal courts, including the Third Circuit Court of Appeals, have recognized that there is also a non-statutory basis to argue that the arbitrators' award is "in manifest disregard for the law" or is not "fundamentally rational."  See, Brown Associates v. Allstar Drywall, 195 F. Supp. 2d 682 (E.D. Pa. 2002), citing, Tanoma Mining Co. v. Local Union No 1269, 896 F. 2d 745 (3rd. Cir. 1990).  Hence, this standard could offer more arguments than the review offered under a state court Petition to Vacate.  Yet, it should be realized that despite this non-statutory basis, the judicial review in the federal courts is "severely limited" and "extremely narrow."  Id.  "District Courts have very little authority to upset arbitrators' awards and an award will be properly vacated only if there is absolutely no support at all in the record justifying the arbitrators' determinations."  Id., citing, United Transp. Union Local 1589 v. Suburban Transit Corp., 51 F. 3d 376 (3rd Cir. 1995).  Under this standard, it must be clear that it was "evident that the arbitrators recognized the applicable law, but chose to ignore it."  Id., at 684. 

Further, it may be difficult to show that the arbitrators recognized the applicable law, yet chose to ignore the law, because often there is no "reasoning" of the arbitrators stated in the award.  In fact, the NASD encourages the arbitrators not to give legal reasoning in the awards, and, unfortunately, reasoning is not required.  See, Bernhardt v. Polygraphic Company of America, 350 U.S. 198 (1955) (Supreme Court of United States ruled that "arbitrators… need not give their reasons for their results.") 

It should also be noted that there is a line of cases in several federal Circuit Courts where the courts have ruled that they do not have jurisdiction over the Petition to Vacate unless there is a separate basis for jurisdiction, other than the Federal Arbitration Act.  The courts have ruled that "it is well settled that the FAA does not confer subject matter jurisdiction on the federal courts even though it creates federal substantive law."  See e.g., Greenburg v. Bear, Stearns & Co., 220 F.3d 22 (2nd Cir. 2000), citing, Southland Corp. v. Keating, 465 U.S. 1 (1984); Moses Cone Mem. Hospit. v. Mercury Construction, 460 U.S. 1 (1983).  Thus, federal question jurisdiction does not arise merely because a Petition to Vacate is filed pursuant to 9 U.S.C. §10.  At least one Pennsylvania District Court has followed this reasoning in a non-securities matter.  See,  In re: Gorski Construction Co., 199 U.S. Dist. Lexis 14659 (E.D. Pa. 1999).  However, other Pennsylvania District Courts have issued opinions where this jurisdictional question has not been raised.  See, Olick v. Nickles, 2002 U.S. Dist. Lexis 5448 (E.D. Pa. 2002) (petition filed to vacate NASD arbitration award). 

Further, the Second Circuit in Greenberg  also ruled that simply raising federal law claims in the underlying arbitration is insufficient to supply the "independent basis" for jurisdiction.  Greenburg, at 26.  Hence, there is a line of reasoning that "diversity of citizenship" is required.  Although in Pennsylvania a litigant could make a reasoned argument that there is federal question jurisdiction as a result of claims for violations of the Securities Act of 1933 or Securities Exchange Act of 1934 in the underlying arbitration.  See, Gouger v. Bear Stearns & Co., 823 F. Supp. 282 (E.D. Pa. 1993) (Jurisdiction found to exist based upon underlying claims pursuant to Securities Exchange Act of 1934.)

With respect to the timing of the a Petition to Vacate in the federal courts, such must be filed within three months of the entry of the arbitration award.  9 U.S.C. § 12.  Due to the fact that any NASD award must be satisfied within 30 days, proof of a Petition to Vacate must be filed within that time to prevent any action by the NASD which would affect membership.

In conclusion, whether a Petition to Vacate is filed in state or federal court, it should be recognized that the scope of review is very limited and the likelihood of success remains slight.  As stated above, the federal standard of "manifest disregard for the law" may provide more arguments to vacate an "outlandish" arbitration award, yet, there is always the possibility that the federal court could decline jurisdiction based upon the reasoning that there was no subject matter jurisdiction, and that the FAA does not provide an independent basis for jurisdiction. In any event, prior to the filing of the Petition to Vacate, careful analysis is required to select not only the proper jurisdiction, but also to argue the most favorable standard of review in order to increase the chances of success on vacating the award. 

*Peter is an associate in our Philadelphia, Pennsylvania office and may be reached at (215) 575-2632 or pandrews@mdwcg.com.