Legal Updates

Teach Your Arbitrator Well

Arbitration is attractive to many because it is perceived as a faster, less expensive and sometimes more practical alternative to the courts.  Indeed, as compared with the formal trappings of litigation, the relative informality of arbitration can be quite appealing.  But these very attributes do have their downside and, in fact, can result in decisions that (for some) seem illogical, frustrating and unfair.

A recent federal court decision, Citigroup Global Markets, Inc. v. Salerno, is a case in point.  While the speed and relative low cost of arbitration are two of its greatest benefits, Citigroup teaches that failing to spend the time and resources necessary to educate the arbitrator in all material aspects of the law can have disastrous – and very expensive – consequences.

The arbitration at issue in Citigroup arose from an alleged scandal involving WorldCom stock.  The complainants, Joseph and Beverly Salerno, were consumers of financial services.  According to the Salernos, Citigroup and one of its former securities analysts failed to disclose conflicts of interest when recommending that the Salernos purchase WorldCom stock and when advising that the Salernos hold onto the stock as its share price plummeted.

Unable to resolve the matter informally with Citigroup and the analyst, the Salernos filed for arbitration with the National Association of Securities Dealers.  After a three-day hearing, an arbitration panel awarded the Salernos $913,000 in compensatory damages and $1.5 million in punitive damages.

Citigroup asked the federal district court (the U.S. District Court for the District of Massachusetts) to review and vacate the arbitrator’s decision, arguing that the punitive damages award was in manifest disregard of the law because the statutes cited by the panel do not, in fact, provide or allow for punitive damages.

The court agreed with Citigroup that the arbitration panel made a mistake of law in awarding $1.5 million in punitive damages to the Salernos.  However, the court nonetheless upheld the award because, in the court’s view, an arbitrator cannot “manifestly disregard” the law if the arbitrator does not know what the law is.  Moreover, said the court, the duty to educate the arbitrator on applicable law belongs to the party seeking to enforce it.  Upon reviewing the record of the arbitration proceedings, the court concluded that, while Citigroup knew the Salernos were seeking punitive damages, Citigroup failed to educate the arbitrator on the fact that such damages are not available under applicable law.  Consequently, the court held that the panel’s decision, while erroneous, was not in “manifest disregard of the law” and, as such, must stand.

Citigroup has appealed the decision to the federal appeals court.  Unless and until Citigroup wins on appeal, which is far from certain, the lesson of the case is this:  Teach your arbitrator well, with respect to both the facts and the law, including the merits of your case and the fallacies of your opponent’s.  Granted, this may require a dedication of time and resources that is somewhat at odds with the informal trappings of arbitration.  But this is surely better than becoming trapped in a bad arbitration decision—especially when the stakes are high.