Last week the US Second Circuit Court of Appeals wrote what should be the final chapter in one of the largest international arbitrations to emerge from the US financial crisis of 2007-2008.
The case was an “international” arbitration only in the sense that Claimant was a Swiss company while Respondent was a US affiliate of a Swiss investment bank. The arbitration took place in New York under the arbitration rules of the Financial Institutions Regulatory Authority (FINRA), and resulted in an award issued by a three-member tribunal, without reasons as is customary in FINRA arbitrations, in favor of Claimant for more than $400 million of investment losses. After two years of post-award litigation focused on the bank’s claims of inadequate disclosure by the non-lawyer arbitrator, the judgment confirming the award has been upheld and the matter presumably has reached a conclusion. (STMicroelectronics, N.V. v. Credit Suisse Securities (USA) LLC, 2011 U.S. App. LEXIS 11116 (2d Cir. June 2, 2011)).
My topic for discussion is the Second Circuit’s rejection of the bank’s claim of misconduct by the arbitrator in regard to his disclosures during the appointment process. But for financial crisis aficionados I offer this brief recap of the essential facts: The bank, having assured the customer that it would abide the latter’s instructions to invest its funds only in federally-guaranteed securities, mainly pools of student loans, instead put the client’s funds in risky derivatives bearing no federal guarantees, and the bank consistently mis-identified the investments in the e-mail confirmations so that the client would think its instructions were being heeded. When the scheme was uncovered, the customer was left with worthless, unmarketable securities. Two of the bank’s investment managers were eventually prosecuted for securities fraud, convicted, and sentenced to jail terms.
The bank’s challenge to the non-lawyer arbitrator — a retired finance professional acting frequently as an expert witness and consultant in customer-bank disputes — claimed the arbitrator made misleading and inadequate disclosures that concealed the fact that he was engaged mainly by customers and therefore was pre-disposed toward the customer position on issues germane to the dispute. The Second Circuit, in agreement with the District Court, held that the bank had failed even to establish its factual premise that the arbitrator worked predominantly for customers — and so the Court had no occasion to reach what it said were difficult and unresolved issues of whether the type of predisposition alleged, when concealed by non-disclosure, could support the vacatur of an award on grounds of “misconduct” by the arbitrator resulting in “prejudice” to the party. (FAA Section 10(a)(3)).
What I find to be an especially curious element of the Court’s analysis of the bank’s position is its observation (with a decided note of criticism) that the bank had failed even to request use of the discovery methods under the Federal Rules of Civil Procedure to secure details about the challenged arbitrator’s expert witness engagements. The Court stated that while it had shown reluctance in several cases to allow discovery to be used to mount challenges to awards based on arbitrator bias, it had not entirely foreclosed this type of use of court-annexed evidence-gathering.
But if, as the Court seems to suggest, this would have been a suitable occasion for discovery in aid of a post-award inquisition on an arbitrator, what are the criteria, inferable from this case, against which such requests will be measured in the future?
The first element would appear to be that the applicant for discovery has a substantial non-speculative concern about the arbitrator based upon concrete (but insufficient) evidence already in its possession. Here the bank had the formal written disclosure that said the arbitrator had had prior expert engagements on “both sides” of bank customer disputes. But the bank’s investigation, triggered by an offhand remark by the arbitrator during the hearings, revealed that he had apparently testified mainly for customers.
Second, it would appear that the discovery applicant should have at least a credible legal position that, if the facts turn out to be as the applicant alleges, vacatur of the award under the FAA would be appropriate. In STMicro v. Credit Suisse, the bank’s position was that if indeed the arbitrator had been an expert/consultant mainly for customers against banks, but had not so indicated in the written disclosures, this would constitute misconduct prejudicial to the bank warranting vacatur. Neither the parties’ briefs nor the Court’s own research uncovered case law pointing in either direction on this issue.
Third, the applicant should have a plausible position that the alleged arbitrator misconduct had a material impact on the outcome. This is technically part of the second element above (i.e. “prejudice”). But it deserves to be stated and considered separately from whether the alleged conduct was in fact misconduct at all. In ST Micro v. Credit Suisse, the arbitral tribunal had issued an unreasoned award giving money damages in excess of $400 million; the award did not even indicate which of several causes of action (fraud, contract, negligence, fiduciary duty, etc.) had been sustained. In such circumstances, it cannot be excluded that the challenged arbitrator was a particularly effective advocate of the customer’s position in the deliberations of the Tribunal. Applicants for post-award discovery on arbitrator conduct may face a higher burden where there is a reasoned, unanimous award – suggesting that any misconduct or bias of one arbitrator, who was not the presiding arbitrator, was inconsequential. A similarly higher burden may be imposed even when the unanimous award is unreasoned but is made by a tribunal that includes party-appointed arbitrators. If the challenged arbitrator is the other party’s appointee, but the challenging party’s appointee subscribes to the award, the court may doubt that the applicant has a prima facie case of prejudice. In the Second Circuit case under discussion, all three arbitrators had been appointed by FINRA based on the parties’ rankings of a list of candidates.
Fourth, the court must consider that the discovery request is made in a proceeding that likely started with a petition to confirm the award – and was met, in response, with a cross-motion to vacate. Confirmation proceedings are supposed to be streamlined and expedited, according to the Supreme Court. And the grounds for vacatur are to be narrowly construed. Such discovery requests must be viewed in the context of federal arbitration policy as reflected in FAA jurisprudence.
To answer tentatively the question posed in the title of this post, the Second Circuit in STMicro v. Credit Suisse can scarcely be said to have opened the floodgates for discovery designed to mount an award challenge based on arbitrator bias or misconduct. But parties seeking such discovery will surely find STMicro v Credit Suisse in their research. And so it is useful to consider, as this post has attempted, precisely what are or should be the factors guiding judicial discretion in addressing such discovery requests.