United States District Court, Western District of New York
November 29, 2001
THE GMS GROUP, LLC, AND JOSEPH COSTA, PLAINTIFFS, VS. NATHAN BENDERSON, DEFENDANT.
The opinion of the court was delivered by: John T. Curtin, United States District Judge.
Plaintiffs bring this action pursuant to the Federal Arbitration Act,
9 U.S.C. § 1, et seq., seeking judicial review of an arbitration
award rendered by the National Association of Securities Dealers ("NASD")
Dispute Resolution, Inc., on April 6, 2001, in the claim titled Benderson
v. The GMS Group, LLC and Joseph Costa, NASD Arbitration No. 98-02618.
Plaintiffs have moved for an order vacating the award pursuant to
9 U.S.C. § 10. Oral argument of the motion was heard by the court on
October 26, 2001. For the following reasons, plaintiffs' motion is
The factual and procedural background of the underlying dispute is set
forth at length in the pleadings and supporting affidavit of Lionel G.
Hest, plaintiffs' arbitration counsel (Item 3), and the responding
affidavit of Patrick J. Finegan, Jr., defendant's arbitration counsel
(Item 14). Plaintiff GMS Group, LLC, is a securities dealer/broker
registered with the United States Securities and Exchange Commission
("SEC"), and is a member of NASD. GMS is a limited liability corporation
with its principal place of business in Livingston, New Jersey. Plaintiff
Joseph Costa is an employee and registered representative of GMS.
Defendant Nathan Benderson is a resident of Orchard Park, New York, and
is owner, president, and chief executive officer of the Benderson
According to Mr. Benderson's Statement of Claim, filed with the NASD on
June 6, 1998, Benderson had been doing a "fixed income" investment
business with GMS and Costa for several years prior to December 1996,
when he discussed with Costa the availability of investment alternatives
"to perhaps extract something" from the generally reported advances in
the stock markets (Item 3, Ex. B, p. 4). Costa suggested index options,
which involve contracts (referred to as "puts" or "calls") to buy or sell
a specified number of shares or commodities within a set time period and
at a predetermined price, based on the rise and fall of the various
securities indices. Between December 1996 and May 1997, Benderson
(through GMS and Costa) executed several index option transactions, which
resulted in a net loss of $1,513,340.00 (id., pp. 5-11). Benderson sought
restitution of this amount, as well as loss of opportunity costs,
punitive damages, and attorneys' fees, based on the following causes of
1. Common law fraud, based on alleged violations of
SEC, NASD, and New York Stock Exchange ("NYSE")
rules prohibiting fraudulent practices in
2. Common law fraud, based on alleged violations of
NASD and NYSE rules requiring a broker to have
reasonable grounds for recommending securities
transactions suitable for the customer.
3. Common law fraud, based on alleged
misrepresentations by Costa as to the soundness of
4. Breach of contract, based on Costa's alleged
failure to adhere to the underlying brokerage
agreement to make investment recommendations for
the customer's benefit.
5. Breach of fiduciary duty, based on Costa's alleged
failure to act in accordance with his solicited
professional obligation of financial
6. Negligence, based on the foreseeable harm
proximately caused by Costa's alleged failure to
meet the standards set forth in the SEC, NASD and
NYSE suitability and supervision rules.
7. Securities law violations, based on several federal
and state statutory and regulatory provisions.
(Id., pp. 30-41.)
On December 1, 1998, GMS and Costa filed their answer to the claim,
denying all allegations of wrongdoing and setting forth several
affirmative defenses (see Item 3, Ex. C). GMS and Costa contended that
Benderson himself initiated the index option transactions at issue by
contacting Costa to inquire about an investment device he had heard about
whereby he could "place a bet" that the stock market would decline in
According to the answer, Benderson directed Costa to execute the
transactions despite Costa's several unsuccessful attempts to dissuade
him and repeated oral and written warnings about the risks of index
options trading (see id., p. 2).
A hearing was commenced on February 24, 2000, before a panel of three
NASD arbitrators. The hearing concluded on March 1, 2001, after a total
of eleven days of testimony and argument.*fn1 At the conclusion of the
hearing, counsel for GMS and Costa requested a written opinion explaining
the panel's rationale for its disposition of each claim. On April 6,
2001, the panel issued its award, finding as follows:
After considering the pleadings, the testimony and
evidence presented at the hearing, the Panel has
decided in full and final resolution of the issues
submitted for determination as follows:
1. [GMS and Costa] be and hereby are jointly and
severally liable for and shall pay to [Benderson]
the sum of $150,000.00 as compensatory damages.
2. [Benderson]'s request for punitive damages is hereby
3. All other requests for relief are hereby denied.
(Item 3, Ex. A, p. 2.) The award also contained a brief case summary and
other basic information about the claim, but it did not contain a written
explanation of the arbitrators' rationale.
On May 11, 2001, GMS and Costa filed this action for judicial review
under the Federal Arbitration Act, accompanied by an application for an
order to show cause why the arbitration award should not be vacated and
remanded to the NASD for further findings. Benderson has responded to the
application. Upon consideration of the matters set forth in the pleadings
and at oral argument, I find that plaintiffs have failed to meet the
heavy burden of proof necessary to justify vacating the arbitration
award, and the case must therefore be dismissed.
Federal court review of an arbitration award is governed by Section
the Federal Arbitration Act, which provides:
(a) In any of the following cases the United States
court in and for the district wherein the award was
made may make an order vacating the award upon the
application of any party to the arbitration —
(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, upon
sufficient cause shown, or in refusing to hear
evidence pertinent and material to the controversy;
or of any other misbehavior by which the rights of
any party have been prejudiced.
(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.
(5) Where an award is vacated and the time within
which the agreement required the award to be made
has not expired the court may, in its discretion,
direct a rehearing by the arbitrators.
9 U.S.C. § 10(a).
In addition to these statutory grounds, the Second Circuit has also
recognized that an arbitration award may be vacated if it is in "manifest
disregard of the law." Halligan v. Piper Jaffray, Inc., 148 F.3d 197,
201-02 (2d Cir. 1998) (citing cases), cert. denied, 526 U.S. 1034
(1999). Application of this judicially created ground, which was
introduced by the Supreme Court in Wilko v. Swan, 346 U.S. 427, 436-37
(1953), is "severely limited." Merrill Lynch, Pierce, Fenner & Smith,
Inc. v. Bobker, 808 F.2d 930, 933 (2d Cir. 1986). In order to justify
modifying or vacating an award on the ground of manifest disregard, a
court must find both that (1) the arbitrators knew of a governing legal
principle yet refused to apply it or ignored it altogether, and (2) the
law ignored by the arbitrators was well defined, explicit, and clearly
applicable to the case. Dirussa v. Dean Witter Reynolds Inc., 121 F.3d 818,
821 (2d Cir. 1997), cert. denied, 522 U.S. 1049 (1998). "To adopt a less
strict standard of judicial review would be to undermine [the] well
established deference to arbitration as a favored method of settling
disputes when agreed to by the parties." Bobker, 808 F.2d at 933.
The burden of proving that the arbitrators acted in manifest disregard
of the law rests with the party making the application. Willemijn
Houdstermaatschappij, BV v. Standard Microsystems Corp., 103 F.3d 9, 12
(2d Cir. 1997). The burden is "an extremely high one, especially where,
as here, numerous legal theories are presented to a panel, and the award
is rendered without opinion." Wall Street Associates, L.P. v. Becker
Paribas, Inc., 818 F. Supp. 679, 686 (S.D.N.Y. 1993), aff'd, 27 F.3d 845
(2d Cir. (1994).
The federal courts, including the Second Circuit, have repeatedly
reaffirmed the principle that arbitrators are not required to provide
written rationale for their awards. See, e.g., Wall Street Associates, 27
F.3d at 849. Indeed, "courts generally will not look beyond the lump sum
award in an attempt to analyze the reasoning processes of the
arbitrators." Barbier v. Shearson Lehman Hutton Inc., 948 F.2d 117, 121
(2d Cir. 1991) (quotation and citation omitted).
When the arbitrators have not provided a specific explanation or
rationale, the reviewing court "must confirm the arbitrators' decision
`if a ground for
the arbitrator[s'] decision can be inferred from the
facts of the case.' This is so even if the ground for their decision is
based on an error of fact or an error of law." Standard Microsystems, 103
F.3d at 12-13 (quoting Sobel v. Hertz, Warner & Co., 469 F.2d 1211, 1216
(2d Cir. 1972)). If the record provides "even a barely colorable
justification for the outcome reached" by the arbitrators, the court must
confirm the award. Id. at 13. In conducting its review, "it is not the
court's function to weigh the evidence anew or to make findings of fact.
Rather, the court's role is limited to reviewing the evidence in the case
to determine whether a basis exists for the outcome reached." Ahing v.
Lehman Brothers, Inc., 2000 WL 460443, at *9 (S.D.N.Y. April 18, 2000)
(citing Campbell v. Cantor Fitzgerald & Co., Inc., 1998 WL 740927, at *2
(S.D.N.Y. October 21, 1998)).
In Halligan v. Piper Jaffray, Inc., the Second Circuit addressed the
scope of district court review of an NASD panel's arbitration award in
favor of a securities brokerage firm on an employee's age discrimination
claim. The employee claimed in his federal court complaint that the
award, issued without any written explanation or rationale, reflected the
arbitration panel's manifest disregard of employment discrimination law.
The district court disagreed, finding factual and legal support for the
panel's denial of relief, but the Second Circuit reversed. The court first
examined the "increasingly important" issue of the arbitrability of age
discrimination claims under a mandatory arbitration clause in an
employment agreement. 148 F.3d at 200. Next, the court discussed the
standards for "manifest disregard" review in the context of employment
discrimination arbitration before "[i]ndustry self-regulatory
organizations (SRO's) like the NASD. . . ." Id. at 202. Against this
background, the court then examined the arbitration record to find
"overwhelming evidence" in support of the plaintiff's discrimination
claim, as well as sufficient indication that the arbitrators were
correctly advised of the applicable legal principles. Id. at 203-04.
The court stated as follows:
In view of the strong evidence that [the plaintiff]
was fired because of his age and the agreement of the
parties that the arbitrators were correctly advised of
the applicable legal principles, we are inclined to
hold that they ignored the law or the evidence or
both. Moreover, the arbitrators did not explain their
award. It is true that we have stated repeatedly that
arbitrators have no obligation to do so. But, . . .
[a]t least in the circumstances here, we believe that
when a reviewing court is inclined to hold that an
arbitration panel manifestly disregarded the law, the
failure of the arbitrators to explain the award can be
taken into account. Having done so, we are left with
the firm belief that the arbitrators here manifestly
disregarded the law or the evidence or both.
Id. at 204 (citations and footnotes omitted).
Plaintiffs place heavy reliance on the Second Circuit's holding in
Halligan, arguing that the "overwhelming" evidence presented to the
arbitrators clearly establishes that the award was rendered in manifest
disregard of NASD Rules regarding the suitability of recommended
securities transactions. Specifically, plaintiffs cite NASD
Rule 2860(19), which provides:
(A) No member or person associated with a member
shall recommend to any customer any transaction for
the purchase or sale (writing) of an option contract
unless such member or person associated therewith has
reasonable grounds to believe upon the basis of
information furnished by such customer after
reasonable inquiry by the member or person associated
therewith concerning the customer's investment
financial situation and needs, and any
other information known by such member or associated
person, that the recommended transaction is not
unsuitable for such customer.
(B) No member or person associated with a member
shall recommend to a customer an opening transaction
in any option contract unless the person making the
recommendation has a reasonable basis for believing,
at the time of making the recommendation, that the
customer has such knowledge and experience in
financial matters that he may reasonably be expected
to be capable of evaluating the risks of the
recommended transaction, and financially able to bear
the risks of the recommended position in the option
(Item 1, ¶ 17.) Plaintiffs also cite NASD Rule 2310, which provides:
Recommendations to Customers (Suitability)
(a) In recommending to a customer the purchase, sale or exchange of
any security, a member shall have reasonable grounds for believing that
the recommendation is suitable for such customer upon the basis of the
facts, if any, disclosed by such customer as to his other security
holdings and as to his financial situation and needs.
(b) Prior to the execution of a transaction recommended to a
non-institutional customer, other than transactions with customers
where investments are limited to money market mutual funds, a member
shall make reasonable efforts to obtain information concerning:
(1) the customer's financial status;
(2) the customer's tax status;
(3) the customer's investment objectives;
(4) such other information used or considered to be reasonable by such
member or registered representative in making recommendations to
Plaintiffs argue that, by their express terms, these rules apply only
when there is a recommendation made by the broker. According to
plaintiffs, the undisputed evidence presented at the arbitration hearing
clearly shows that Costa did not "recommend" to Benderson that he trade
in index options. Instead, it was Benderson who approached Costa and
initiated the discussion about betting on the market. Benderson asked how
that could be accomplished, and Costa responded "OEX" (index options).
Plaintiffs contend that Costa did not encourage or recommend trading in
index options. To the contrary, he warned Benderson about the risks
involved, told Benderson he had never traded in index options, and asked
him if he was sure he really wanted to do that.*fn2
Plaintiffs offer the alternative argument that, even if Costa did make
a recommendation to purchase index options, the undisputed hearing
evidence provides reasonable grounds to believe that the recommendation
was within the standards set forth in the NASD suitability rules (see
Item 3, ¶¶ 28-37). Plaintiffs further contend that the hearing
evidence provides no basis for finding "scienter" on the part of Costa or
GMS necessary for statutory or common law fraud liability. According to
plaintiffs, Halligan instructs that in the face of such evidence (or lack
thereof), the district court can also take into account the failure of
the arbitrators to explain the award as a factor in determining whether
the panel "manifestly disregarded the law or the evidence or both."
Halligan, 148 F.3d at 204.
I agree with plaintiffs' reading of Halligan. I do not agree with
plaintiffs' contention that, as in Halligan, the record in this case
provides "overwhelming" or "strong" evidence to support a finding that the
arbitrators manifestly disregarded the law or the evidence or both. For
example, defendant refers to hearing testimony indicating that, after
Benderson's initial inquiry about the possibility of extracting profits
from the anticipated decline in the markets generally, the actual
information about the appropriate device for doing so came directly from
Costa.*fn3 Defendant also refers to the hearing testimony of Douglas
Henderson, a partner in KMPG Financial Services' National Regulatory
Practice and former Director of the NASD District Office in New York City
(see Curriculum Vitae, attached to Gottlieb Aff., Item 14, Ex. D). Mr.
Henderson was called by Costa and GMS as an expert witness to provide his
opinion as to whether Costa made a recommendation to Benderson.
course of extensive questioning by the panel members, Mr. Henderson was
asked by the Chairman to explain "what constitutes a recommendation." He
I will qualify my answer by saying there isn't a
bright definition around this. The NASD and other
securities regulators have purposely shied away from a
clear definition about recommendation and you go back
through the pronouncements by the regulators and you
will see that they are very careful not to box in a
definition if you will.
It's like insider trading or pornography. The
regulators have chosen to take this position. We know
it when we see it, but when you look at the
pronouncements you will see that the regulators almost
always will say that it is a [facts] and circumstances
specific definition, so you end up looking at
particular case[s] and arriving at what constitutes a
recommendation or what may not [constitute] a
recommendation. . . .
(Item 14, Gottlieb Aff., Ex. D, pp. 1896-97.)
Further scrutiny of Mr. Henderson's hearing testimony reveals the
panel's struggle with the notion that Costa's response to Benderson's
question about how to make money by betting on the market's decline, made
in the context of a long-standing financial relationship based primarily
on Costa's expertise in trading municipal bonds, could not be considered
a recommendation within the meaning of the NASD suitability rules (see
id., pp. 1898-1918). In addition, the undisputed facts borne out by
Costa's own hearing testimony show that he had no experience in high-risk
index options trading (see, e.g., id., Ex. G, pp. 560-84). This alone
suggests a reasonable basis for the panel to conclude that Costa did not
comply with the obligations imposed by the suitability rules, or that he
otherwise breached his professional or fiduciary obligations as
Benderson's broker. Based on this record, considered in the context of
the numerous legal theories presented to the panel, it cannot be said
that the arbitrators were aware of but refused to apply clearly
applicable legal principles.
Significantly, it is noted that the lump sum of the award was
$150,000.00, less than one-tenth of the actual damages claimed. No
punitive damages or attorneys' fees were awarded, and the parties were
otherwise directed to pay their own arbitrations costs. In light of this
result, and considering the facts and circumstances of the dispute as set
forth in the materials submitted in connection with the present
application, I am not inclined (as the circuit court was in Halligan)
to accord any special significance to the absence of a written
In short, because the record submitted to the court provides, at a
minimum, "a barely colorable justification for the outcome reached" by
the arbitrators, Standard Microsystems, 103 F.3d at 13, plaintiffs have
failed to meet their burden of proving that the arbitrators acted in
manifest disregard of the law. The court's function is not to decide
whether the evidence and testimony presented at the hearing was
credible, or whether the panel should have been persuaded by it.
Instead, under the deferential standard of review that applies to the
manifest disregard doctrine, the court need only determine
justification for the award can be ascertained from the submissions made
to the arbitrators. As demonstrated by the discussion above,
justification can easily be found here. Finally, when questioned at oral
argument, the parties advised that they had no further authority to bring
to the court's attention.
Accordingly, there is no basis for the relief sought by plaintiffs in
the complaint and application for an order vacating the arbitration
Based on the foregoing, plaintiffs' application for an order vacating
the arbitration award rendered in the claim titled Benderson v. The GMS
Group, LLC and Joseph Costa, NASD Arbitration No. 98-02618, is denied.
There being no basis for the relief sought in the complaint, the case is
dismissed. The Clerk of the Court is directed to enter judgment in favor