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MCDANIEL v. BEAR STEARNS & CO.

January 16, 2002

BERNARD MCDANIEL AND MAUREEN MCDANIEL, CLAIMANTS-PETITIONERS
V.
BEAR STEARNS & CO., INC. AND BEAR STEARNS SECURITIES CORP., RESPONDENTS-RESPONDENTS.



The opinion of the court was delivered by: Shira A. Scheindlin, United States District Judge.

  OPINION AND ORDER

Bear Stearns & Co., Inc. ("Bear Stearns"), a New York investment bank, offers clearing services for other broker-dealers through its subsidiary Bear Stearns Securities Corporation ("BSSC"). BSSC served as the clearing firm for broker-dealer A.R. Baron ("Baron") at a time when Baron engaged in criminal and fraudulent conduct. Petitioners Bernard and Maureen McDaniel ("Claimants") were Baron customers during this time.

On July 31, 2001, an arbitration panel (the "Panel") found Bear Stearns and BSCC (collectively "Bear") jointly and severally liable to Claimants for breach of contract and for aiding and abetting Baron's fraud. The arbitrators issued a thirty-six page arbitration award (the "Award") which offered detailed findings of fact and explained their conclusions of law. In this motion to vacate that Award, Bear has attacked the Panel's decision on numerous grounds. As discussed below, none of the issues raised by Bear show that the Panel exceeded its power or manifestly disregarded the law or evidence so as to require vacating the Award.

The Supreme Court has more than once told lower courts that the Federal Arbitration Act ("FAA") establishes a strong federal policy favoring arbitration. See e.g., Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 62(1995); Shearson/Am. Express, Inc. v. McMahon, 482 U.S. 220, 226(1987). This policy reflects a desire to enforce arbitration agreements into which parties have entered as well as to encourage swift and efficient dispute resolution. See Dean Witter Reynolds Inc. v. Beard, 470 U.S. 213, 220(1987); Willemijn Houdstermaatschappit, BV v. Standard Microsystems Corp., 103 F.3d 9, 12 (2d Cir. 1997). "Undue judicial intervention would inevitably judicialize the arbitration process, thus defeating the objective of providing an alternative to judicial dispute resolution." Tempo Shane Corp. v. Bertek Inc., 120 F.3d 16, 19 (2d Cir. 1997) (quotation marks omitted). For these reasons, arbitration decisions are accorded "great deference." Id.

An investment bank such as Bear that has repeatedly agreed to arbitration — and, in fact, drafted the contract requiring these parties to arbitrate — was well-aware of the binding nature of arbitration and the deference that courts must afford to arbitration awards. Bear knows that a motion to vacate is not an appeal; federal courts are not supposed to "superintend arbitration proceedings." Id. (quotation marks omitted). It also knows that district courts do not hear appeals from decisions of arbitration panels which, by definition, are final and binding.

Bear has payed lip service to the vacatur standards of "exceed[ing] its power" and "manifest disregard" in asking this Court, sub silentio, to substitute its judgment for that of the Panel. If I had that authority, I might indeed have decided the case differently.*fn1 However, the Court's review of an arbitration award is rigidly narrow. Given these constraints, Bear's motion undermines the concept of swift and efficient dispute resolution.

For the reasons stated below, Bear's motion to vacate the Award is denied and Claimants' cross-motion to confirm the Award is granted.

I. BACKGROUND

A. The Role of Clearing Firms and the Applicable Regulatory Scheme

In a typical clearing arrangement, a clearing firm provides many backroom and administrative functions for another broker-dealer's customer accounts. See Gerald B. Cline and Raymond L. Moss, Liability of Clearing Firms: Traditional and Developing Perspectives, 1062 PLI/Corp. 139, 143(1998) Generally, the clearing firm is responsible for maintaining records and mailing customer account documentation, as well as receiving, maintaining and delivering customers' securities and funds. See id. Henry F. Minnerop, The Role and Regulations of Clearing Brokers, 48 Bus. Law. 841, 841(1993). The clearing firm may also extend credit in order to finance customer transactions in margin accounts or, in some cases, may execute transactions on exchanges or on the over-the-counter markets. See id. Meanwhile the broker-dealer, referred to as the `introductory broker', maintains many of the functions that require direct personal contact with customers, such as soliciting customers, providing investment advice, and accepting customer orders for the purchase or sale of securities. See id.

According to Rule 382 of the New York Stock Exchange ("NYSE"), as amended in 1982, a clearing agreement must "specifically identify and allocate the respective functions and responsibilities of the introducing and carrying organizations . . ." Ross v. Bolton, 904 F.2d 819, 825 (2d Cir. 1990) (quoting Rule 382, reprinted in NYSE Guide (CCH) ¶ 2382). The Rule also requires that a customer whose account has been "introduced" to a clearing firm receive notice of the existence of the clearing agreement introductory broker and clearing firm, and a notice of the allocation of responsibilities between them. See NYSE Rule 382.

B. The Parties and Relevant Non-Parties

In June or early July 1995, Bear and Baron entered into an Agreement for Securities Clearing Services (the "Clearing Agreement").*fn2 See Award, Ex. A to Declaration of Michael D. Schissel, attorney for defendants ("Schissel Dec."), at 16. At that time, Richard Harrington was President of BSSC and in charge of its clearing business, Peter Murphy was a Managing Director of BSSC and Andrew Bressman was President of Baron. In September, 1995, claimant Bernard McDaniel opened a brokerage account with Baron. See Statement of Claim, Ex. B to Schissel Dec., ¶ 3. He opened another account with Baron in late April 1996, this time with his wife, Maureen McDaniel. See Exs. C-2, R-18.*fn3 Roman 0kin eventually became Claimants' broker at Baron.

During the time when Claimants maintained their accounts with Baron, Baron engaged in criminal activity, securities laws violations and fraudulent activity, some of which affected Claimants' accounts. See Award at 14; Respondents' Memorandum of Law in Support of Their Motion to Vacate and in Opposition to the Petition to Confirm the Arbitration Award ("Def. Mem.") at 20. On May 29, 1996, the Securities and Exchange Commission ("SEC") issued an emergency temporary cease-and-desist order against Baron, Bressman and 0kin to halt Baron's fraudulent trading practices. Baron ceased doing business at the end of June 1996, and filed a Chapter 11 bankruptcy petition on July 3, 1996. See Statement of Claim, ¶¶ 21-22. On July 11, 1996, upon the application of the Securities Investor Protection Corporation ("SIPC"), Baron was placed into liquidation under the control of an independent trustee. See Def. Mem. at 15; SEC Order Instituting Proceedings ("Bear's OIP"), Ex. C-7 at 21 n. 1. On May 13, 1997, Baron and thirteen of its officers and employees were indicted on charges of criminal securities fraud. See Bear's OIP at 21 n. 3. With the exception of John McAndris, Baron's former Chief Financial Officer, all of the defendants pled guilty to enterprise corruption and grand larceny. See id. McAndris was tried and, on February 26, 1998, he was found guilty on twenty-five charges. See id.

The Baron investigation led to an investigation of Bear's relationship with Baron. See Def. Mem. at 20. On August 5, 1999, Bear consented to the SEC's entry of an Order Instituting Proceedings (the "OIP"), without admitting or denying the SEC's findings.*fn5 See Bear's OIP at 20 n. 1; SEC Order Instituting Proceedings ("Harrison's OIP"), Ex. C-6, at 2; Respondents' Reply Memorandum in Support of Their Motion to Vacate and In Opposition to the Motion to Confirm the Arbitration Award ("Def. Repl.") at 6. Pursuant to the settlement agreement, Bear was required to pay a $5 million civil penalty and $30 million to a fund to satisfy the claims of Baron's customers. See Def. Mem. at 36; Ex. C-7 at 20. In addition, Bear was required to retain an Independent Consultant to recommend supervisory and compliance policies which BSSC was required to adopt. See Def. Mem. at 36-37; Ex. C-7 at 19-20.

C. Claimants' Allegations Against Bear

On January 27, 1997, Claimants filed a Statement of Claim with the National Association of Securities Dealers ("NASD") against Bear Stearns, BSSC and Michael Davis, a Baron employee who helped handle Claimants' account. See Statement of Claim. Claimants alleged that Bear caused them to suffer losses of not less than $900,000 during the period from the Fall of 1995 to the Summer of 1996. They alleged that Bear was liable to them under the following theories: control person liability, failure to register Baron as an `approved person' pursuant to NYSE requirements, violations of NYSE Rule 382, issuance of false and misleading confirmations and statements in violation of SEC Rule 10b-10 and NASD Rule 2230, breach of duty of fair dealing in violation of NASD Rule IM 2310-2(a)(1) and IM 2310-2(d) violations of credit requirements and Regulation T [12 C.F.R. § 220.8(d)], breach of contract, negligence, fraud, alter-ego liability for Baron's wrongful acts, aiding and abetting Baron's conversion and fraud, and refusal to honor transfer instructions. See id. ¶¶ 70-94. They sought compensatory damages, punitive damages of three times compensatory damages, and all costs of the proceeding. See id. ¶¶ 95-96. In its Answer, Bear asserted the following affirmative defenses: failure to state a claim, failure to investigate, notice of Baron's misconduct and ratification of that misconduct, loss causation on the part of Claimants, assumption of risk, waiver, and estoppel. See Amended Answer, Ex. D. to Schissel Dec., ¶¶ 66-80.

D. Arbitration Proceedings

Arbitration hearings took place in Boston on April 25, 26, 27, and 30 and May 1, 2001.*fn6 See Petition ¶ 9. On April 25, Claimants filed a Motion in Limine seeking to offer into evidence the OIPs relating to Bear and Harrington. See Award at 9. After considering the submissions and the oral arguments of the parties, the Panel granted Claimants' motion subject to various conditions. See Award at 10; see also infra Part I.E.2 (discussing conditions). On April 26, 2001, Bear made an oral motion to admit as evidence the "Wells Submission," a memorandum Bear had submitted in connection with the SEC's administrative proceedings relating to the Bear-Baron relationship. See Award at 10; Ex. R-27. After hearing oral argument, the Panel granted Bear's motion. See id. at 10-11. The Panel admitted the body of the Wells Submission and most of the exhibits to that document, but did not accept into evidence the attached trial testimony and deposition transcripts. See id. at 11.

The presentation of evidence concluded on May 1, 2001. See id. at 12. The parties declined the opportunity to present oral closing arguments and opted instead to file post-hearing briefs. See id.; see also Claimants' Post-Hearing Brief ("Pl. Post-Hear. Mem."), Ex. G to Schissel Dec.; Respondents' Post-Hearing Memorandum ("Def. Post-Hear. Mem."), Ex. H to Schissel Dec. Proceedings ended on June 12, 2001, upon the filing of the post-hearing briefs. See Award at 13.

E. The Arbitration Award

The Panel awarded Claimants $600,000 in compensatory damages and $211,571.60 in prejudgement interest on those damages. See id. at 26, 28-31. It explained that, although Claimants had suffered $788,988 in damages, those damages would be reduced to $600,000 because Claimants had contributed to and compounded their own losses. See id. at 26. The Panel also awarded Claimants $1 million in punitive damages, $25,000 as a sanction for delay caused by Bear, and $75,000 in attorney's fees as a sanction against Bear for failure to cooperate with discovery. See id. at 29, 31. It also held that Bear should be responsible for two-thirds of the forum fees. See id. at 28. All of the compensatory award and all but $68,135.60 of the prejudgment interest was offset by the $743,436 that Claimants had already received from the restitution fund financed by Bear. See id. at 27-28.

II. LEGAL STANDARD

"Arbitration awards are subject to very limited review in order to avoid undermining the twin goals of arbitration, namely, settling disputes efficiently and avoiding long and expensive litigation." Willemijn Houdstermaatschappit, 103 F.3d at 12 (quotation marks omitted). The Federal Arbitration Act (the "FAA") lists specific instances where an award may be vacated. See 9 U.S.C. § 10(a). of relevance to this action are the provisions permitting vacatur when "the arbitrators exceeded their powers, or so imperfectly executed them that a mutual, final, and definite award upon the . . . matter submitted was not made," or where the arbitrators were guilty of "misconduct in . . . refusing to hear evidence pertinent and material to the controversy."*fn7 9 U.S.C. § 10(a). Where arbitrators are accused of exceeding their powers, a court must ask "whether the arbitrators had the power, based on the parties' submissions or the arbitration agreement, to reach a certain issue, not whether the arbitrators correctly decided that issue." DiRusso v. Dean Witter Reynolds Inc., 121 F.3d 818, 824 (2d Cir. 1997). Arbitrators' determinations regarding admission of evidence are not open to review "except where fundamental fairness is violated." Polin v. Kellwood Co., 103 F. Supp.2d 238, 261 (S.D.N.Y. 2000) (quoting Tempo Shain Corp. v. Bertek, 120 F.3d 16, 20 (2d Cir. 1997)). Arbitrators are only required to hear proffered evidence that is "pertinent and material," and their determination of what is "pertinent and material" will only be deemed erroneous if it "deprives a party of a fundamentally fair arbitration process." Id. (quoting Bell Aerospace Co. Div. of Textron, Inc. v. Local 516, Int'l Union, United Automobile, Aerospace and Agric. Implement Workers of Am., 500 F.2d 921, 923 (2d Cir. 1974).

The Second Circuit has also recognized that a court may vacate an arbitration award that was rendered in "manifest disregard of the law." Greenberg v. Bear, Stearns & Co., 220 F.3d 22, 28 (2d Cir. 2000); Halligan v. Piper Jafray, Inc., 148 F.3d 197, 202 (2d Cir. 1998). However, "[r]eview for manifest error is `severely limited'." Greenberg, 220 F.3d at 28 (quoting DiRusso, 121 F.3d at 821). The Second Circuit has cautioned that "manifest disregard clearly means more than error or misunderstanding with respect to the law." Halligan, 148 F.3d at 202 (quotation marks omitted). Specifically, a court may not vacate an arbitration award unless it finds 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." Greenberg, 220 F.3d at 28 (citing DiRusso, 121 F.3d at 821).

In very limited situations, a court may vacate an award because arbitrators have manifestly disregarded the evidence. See Halligan, 148 F.3d at 202 (vacating an award where arbitrators "manifestly disregarded the law or the evidence or both"); Beth Israel Med. Ctr. v. Local 814, No. 99 Civ. 9828, 2000 WL 1364367, at *6 (S.D.N.Y. Sept. 20, 2000); Green v. Progressive Mgmt. Inc., No. 00 Civ. 2539, 2000 WL 1229755, at *2 (S.D.N.Y. Aug. 29, 2000) (noting that Halligan extends "manifest disregard" standard to review of the evidence); News, L.P. v. Newspaper & Mail Deliverers' Union of New York and Vicinity, No. 99 Civ. 5165, 1999 WL 1095613, at *7 (S.D.N.Y. Dec. 2, 1999) (same). "[J]udicial review of an arbitrator's factual determinations is quite limited." Beth Israel Med. Ctr., 2000 WL 1364367, at *6. A court may only vacate an arbitrator's award for manifest disregard of the evidence if "there is `strong evidence' contrary to the findings of the arbitrator and the arbitrator has not provided an explanation of his decision." Id. (citing Halligan, 148 F.3d at 204; Daily News, 1999 WL 1095613, at *7; Greenberg, 1999 WL 642859, at *1). A court may not review the weight the arbitration panel accorded conflicting evidence. Id. (citing Campbell v. Cantor Fitzgerald & Co., 21 F. Supp.2d 341, 349 (S.D.N.Y. 1998), aff'd, 205 F.3d 1321 (2d Cir. 1999)); Sobol v. Kidder, Peabody & Co., Inc., 49 F. Supp.2d 208, 216 (S.D.N.Y. 1999) (citing Chisholm v. Kidder, Peabody, 966 F. Supp. 218, 229 (S.D.N.Y. 1997), aff'd, No. 97-7828, 1998 WL 695041 (2d Cir. 1998)). Nor may a court question the credibility findings of the arbitrator. See Beth Israel Med. Ctr., 2000 WL 1364367, at *6 (citing Campbell, 21 F. Supp.2d at 349); Greenberg, 1999 WL 642859, at *1 ("The Court will not second-guess the credibility findings of the arbitration panel.")

The party seeking vacatur of an arbitration award bears the burden of proving manifest disregard. See Greenberg, 220 F.3d at 28 (citing Willemijn Houdstermaatschappit, 103 F.3d at 12). But, even if that party proves that the arbitrators' decision is based on a manifest error of fact or law, a court must nevertheless confirm the award if grounds for the decision can be inferred from the facts of the case. See Willemijn Houdstermaatschappit, 103 F.3d at 13; Green, 2000 WL 1229755, at *2.

III. DISCUSSION

A. Aiding and Abetting Award

1. Manifest Disregard for the Law*fn8

a. The Law on Clearing Firm Liability

Under New York law, the elements for a claim of aiding and abetting fraud are: (1) an existing fraud, (2) knowledge of the fraud, and (3) substantial assistance to advance the fraud's commission. See Cromer v. Berger, 137 F. Supp.2d 452, 470 (S.D.N.Y. 2001) (citing Wight v. BankAmerica Corp., 219 F.3d 79, 91 (2d Cir. 2000)). Generally, "substantial assistance" exists where: (1) a defendant "affirmatively assists, helps conceal, or by virtue of failing to act when required to do so enables the fraud to proceed," and (2) "the actions of the aider/abettor proximately caused the harm on which the primary liability is predicated." Id. (citing Diduck v. Kaszycki & Sons Contractors, Inc., 974 F.2d 270, 284 (2d Cir. 1992); Nigerian Nat'l Petroleum Corp. v. Citibank, N.A., No. 98 Civ. 4960, 1999 WL 558141, at *8 (S.D.N.Y. July 30, 1999); Kolbeck v. LIT Am., Inc., 939 F. Supp. 240, 249 (S.D.N.Y. 1996)). Where defendant does not owe a fiduciary duty directly to the plaintiffs, however, mere "inaction" by the defendant cannot constitute "actionable participation." Id. (citing Kolbeck, 939 F. Supp. at 247); see also Stander v. Fin. Clearing & Svcs., 730 F. Supp. 1282, 1287 (S.D.N.Y. 1990). Indeed, "the `scienter' requirement scales upward," and plaintiffs have the additional burden of showing that the assistance rendered is "both substantial and knowing;" in other words, there must be "something close to ...


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