The federal case was brought by Louisiana retirees who had suffered financial losses as a result of the Stanford Ponzi scheme. The defendant Pershing "was a clearing broker for Stanford Group Company, a broker-dealer controlled by Allen Stanford which sold worthless securities to the Louisiana Retirees." The retirees sued Pershing for $80 million. "They claim that Pershing, as Stanford Group Company's clearing broker, failed to exercise due diligence in its business relationship with Stanford Group Company and failed to disclose adverse financial information which would have resulted in the Ponzi scheme being uncovered sooner than it was."
The dispute was arbitrated before a three-member panel under the Financial Industry Regulatory Authority (FINRA) rules and procedures. "After a two-week hearing at which the panel heard over 1,600 pages of testimony from fifteen witnesses and considered over 900 separate exhibits," the panel ruled in favor of Pershing and against the retirees. The retirees sought to vacate the award and commenced the eastern district case.
The retirees presented three arguments in support of the vacatur effort:
The "arbitration proceeding was fundamentally unfair because severe prejudice occurred . . . when Pershing did not disclose certain documents which were not produced by Pershing until [the Eastern District] Court ordered them produced" in the vacatur suit.
"[T]he obvious partiality and bias of the arbitrators because of the apparent 'assumed veracity' of Pershing" when the arbitral panel accepted Pershing's claims that the disputed documents were privileged and did not conduct an in camera hearing to make its own determination.
"[T]the Panel committed manifest error reviewing the evidence that was actually presented to the arbitration hearing based upon the review standard of the Second Circuit because of the application of New York Law."
As the district court noted, the retirees' "primary argument centers on whether the panel arbitrarily and improperly denied the . . . Retirees documents to which they were entitled." The documents at issue were emails and other documents that Pershing claimed were privileged. The panel, without conducting an in camera hearing to inspect and determine for itself the propriety of Pershing's privilege claim, denied the discovery of the contested documents.
The U.S. district court, in an unusual procedural decision for a vacatur action, permitted limited discovery. It ordered Pershing to turn over the contested documents to a U.S. magistrate and directed the magistrate to rule on the propriety of Pershing's privilege claim. "The Court found—under the specific facts of this case—that a review of those documents not produced in arbitration would best allow this Court to measure whether and, if so, the extent to which the Louisiana Retirees were prejudiced by the omission of such documents." The magistrate, and subsequently the district court, found that several of the documents at issue should have been disclosed and, implicitly, that the arbitration panel erred by not permitting their disclosure and use at the hearing. As a consequence, the court also implicitly held that the panel erred by not conducting its own in camera hearing.
As a preface to considering the retirees' arguments that the award should be vacated because they were denied the opportunity to present the withheld the documents as evidence, the court relied upon a Fifth Circuit decision in the case Karaha Bodas Co. v. Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, 364 F.3d 274, (5th Cir. 2004):
An arbitrator is not bound to hear all of the evidence tendered by the parties. He must give each of the parties to the dispute an adequate opportunity to present its evidence and arguments. It is appropriate to vacate an arbitral award if the exclusion of relevant evidence deprives a party of a fair hearing. Every failure of an arbitrator to receive relevant evidence does not constitute misconduct requiring vacatur of an arbitrator's award. A federal court may vacate an arbitrator's award only if the arbitrator's refusal to hear pertinent and material evidence prejudices the rights of the parties to the arbitration proceedings.
With that background, and magistrate's ruling before it, the district court held:
"[T]he Court observes that nothing in the FINRA arbitration rules requires in camera review prior to ruling on a discovery motion. To the extent the Louisiana Retirees claim that the manner in which the panel resolved discovery issues rendered the proceeding fundamentally unfair, the Court rejects that argument. Even if this Court would have proceeded differently, this Court cannot conclude that the entire arbitration proceeding was tainted because of it."
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"A FINRA arbitration panel has great latitude to determine the procedures governing their proceedings and to restrict or control evidentiary proceedings." [citation omitted] Indeed, even in federal court the decision whether to conduct an in camera inspection is wholly within the discretion of the district court. [citation omitted] The record reveals that discovery was extensively litigated before the panel, which decided six motions to compel, received multiple rounds of briefing from the parties, and held a telephonic hearing to address the [claimed] privilege and the request for an in camera review.
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The discovery process was not fundamentally unfair.
With respect to the argument that the tribunal erred by effectively withholding the documents as privileged when they were not, the district court repeated the oft quoted maxim, "The court may not refuse to enforce an arbitral award solely on the ground that the arbitrator may have made a mistake of law or fact," and reiterated its conclusion that the "Court does not find that the . . Retirees were deprived of a fair hearing as a result of the decision."
Finally, with respect to the retirees' claim of bias and partiality based on the tribunal's refusal to conduct an in camera hearing and its reliance on Pershing's statements that the documents were privileged, the district court noted the following:
At the beginning of the arbitration hearing, counsel for the Louisiana Retirees stated that they accepted the panel. At the end of the arbitration hearing, counsel for the Louisiana Retirees agreed that they had enjoyed "a full and fair opportunity" to present their case. [citation omitted] Counsel for the Louisiana Retirees even thanked the panel for its time. [citation omitted] At that point, the Louisiana Retirees already knew of all the panel's decisions described above, yet they failed to object. It was only once the arbitration panel ruled against them that the bias argument emerged."
Thus, the court ruled that the retirees waived their right to object based upon bias.
Commentators' Analysis
The challenge of every arbitrator in managing the arbitration process is to balance efficiency, cost savings and speed with fairness and assuring that (as stated in §10 of the FAA) "evidence pertinent and material to the controversy" is heard. The critical word, not in the FAA, is "all." The FAA does not require a tribunal to hear all evidence that is pertinent and material, and therein rests both the challenge for arbitrators and the rationale underlying the Pershing decision.
In discussions among peers the question has been asked: Is it appropriate for a tribunal, acting as "judge and jury," to conduct in camera hearings and potentially be prejudiced by documents or testimony not available to the opposing party? The court in the Pershing case adroitly handled that issue by having a magistrate review the documents in controversy. If a tribunal does such, is it deferring to a non-arbitrator some of its duties and thereby impairing the enforceability of its award?
This commentator is aware of no decision addressing that issue. However, there is a simple solution: the parties can agree to the procedure. Note, however, that if such occurs this commentator strongly recommends that the actual parties and not their counsel sign the agreement. Agreeing to permit persons other than the tribunal to hear and decide an issue relevant to the dispute will likely be deemed to be an amendment of the arbitration agreement. As such, best practice procedure is to have the actual parties sign the agreement to avoid challenges with respect to proper authority.
In retrospect, the tribunal in the Pershing case likely should have conducted some procedure to ascertain the propriety of Pershing's privilege claims. Had it done so, it may have avoided the district court challenge and better performed its primary task of protecting the integrity of the process and issuing an enforceable award.