Neutral Corner - August 2004

Post-Sawtelle Tremors: Arbitration Faces New Questions about the Sustainability of Punitive Awards

By Constantine N. Katsoris*

For decades, arbitration has provided the advantage of speedy resolution of securities disputes by persons knowledgeable in the area, without excessive costs.

Before Shearson/American Express v. McMahon, 482 U.S. 220, 107 S.Ct. 2332 (1987), this procedure was largely voluntary on the part of the investing public. The voluntary nature, however, was changed by McMahon, spurring the Securities Industry Conference on Arbitration, or SICA, to implement safeguards in the process, such as expanded discovery procedures, arbitrator selection method, recording arbitration hearings, etc.

Not surprisingly, some of the resulting changes nudged securities arbitration somewhat closer to litigation, but these changes were necessary in order to prevent trial by surprise and ambush. Understandably, these new safeguards raised the cost of the arbitration and also stretched out the resolution period between filing a complaint and the rendering of an award. Nevertheless, obtaining an arbitration award was still much quicker than resolution through the courts-that is, until the recent fiasco involving the New York case of Sawtelle v. Waddell & Reed, Index No. 115056/01 (Part 5, N.Y. State Supreme Court Jan. 22, 2004). See also "Record Punitive Damages Are Overturned - Again - As Court Appoints a New Panel," 22 Alternatives 54 (April 2004).

After McMahon, SICA's code provided that awards be in writing, be deemed to be final, and not subject to review or appeal, except as provided by law.

It was not required, however, that the arbitrators issue opinions. Although arguments can be made in favor of such opinions, it was the prevailing consensus that, as a practical matter, such opinions would be used as a platform and blueprint for many more appeals. Opinions identify or magnify targets - meaningful or otherwise - for the losing party to attack, and result in increased costs and undue delay in the payment of any award. See Katsoris, "The Resolution of Securities Disputes," 6 Fordham Corporate and Financial Law 307 at 346-7.

A Writing Is Needed

In the case of punitive damages, however, written opinions have been strongly recommended. The opinions should specifically and thoroughly explain the award's basis, so that the offending party and appellate court can better understand the rationale behind the unusual punishment being meted out. Id. at 347.

The Sawtelle case itself was hardly speedy. It involved multiple hearing sessions over a period of several years. The NASD panel issued an award of about $28 million, which included $25 million for punitive damages and $1.8 million for compensatory damages plus interest and attorneys' fees. After the award, the New York Supreme Court upheld the $25 million punitive damages portion and reduced the compensatory portion to about $1.1 million.

On appeal, the Appellate Division vacated the punitive damage award, noting that it was grossly disproportionate to the compensatory damages award and was made in "manifest disregard of the law." The appellate court remanded it to the original arbitrators' panel for reconciliation of the issue of punitive damages and otherwise affirmed the lower court's judgment, 304 A.D. 2d 103, 754 (N.Y.S.2d 264 (N.Y.App.Div. 1st Dept. 2003). The claimant was paid the reduced compensatory award plus attorneys' fees and interest, leaving open only the punitive damages issue.

The panel reviewed materials again, held a hearing, and issued a second award for the same $25 million in punitives, adding to the award some examples of respondents' reprehensible conduct. The new punitive award was subsequently vacated by the trial court that had originally approved it. It directed that the issue of punitive damages be submitted to a new panel - a decision that will now be re-appealed to the same Appellate Division.

Effectiveness is Threatened

It is not this author's intention to discuss the adequacy or excessiveness of a $25 million punitive damages award in connection with a $1.1 million compensatory award. That issue will be decided by the courts, or the legislature, over the course of time.

Instead, the concern is the path followed in Sawtelle that, if repeated elsewhere, could undermine arbitration's effectiveness by eroding its attributes - speed, economy and finality.

How do we prevent future Sawtelle cases? First, when panels issue punitive awards, the panel members should explain not only their reasons for punishment, but also give some justification and blueprint as to their computation to defuse an appellate court's concern as to guidelines. Having said that, however, it also is incumbent upon courts to short-circuit needless delay, which rips at the fiber of the arbitration process.

In Sawtelle, wouldn't it have served the parties better if the courts reduced the punitive award to a figure acceptable to the court - and, if not acceptable to the parties, then let the parties proceed with a new hearing or panel? At least in that manner the parties would have the opportunity of making a rational judgment of whether to proceed or accept, as they did on the compensatory write-down.

Hopefully, the pattern of review exercised in Sawtelle will not be repeated. Otherwise, it will deal a crippling blow to the efficacy of arbitration.

"Post-Sawtelle Tremors: Arbitration Faces New Questions about the Sustainability of Punitive Awards," Katsoris, Constantine N. Alternatives to the High Cost of Litigation. Copyright ©, 2004, May. CPR Institute for Dispute Resolution. Reproduced with permission of John Wiley & Sons, Inc.

*Wilkinson Professor of Law, Fordham University School of Law; J.D. 1957, Fordham University School of Law; L.L.M. 1963, New York University School of Law; Securities Industry Conference on Arbitration (Public Member 1977-97), (Emeritus Public Member 1998-2002), (Chairman 2003 to present); National Arbitration Committee of NASD (Public Member 1974-81); Public Arbitrator at NASD (1968 to present) and NYSE (1971 to present); Arbitrator and Chairperson Trainer at NASD and NYSE (1994-96); Mediator at NASD and NYSE (1997 to present); Private Judge at Duke Law School's Private Adjunction Center (1989 to present); Arbitrator at the American Arbitration Association (1992 to present); Board of Advisors, Securities Arbitration Commentator (member 1997 to present).

Dispute Resolution News

Oath of Arbitrator: Elimination of Notarization Requirement

In the past, NASD Dispute Resolution has received some complaints from arbitrators about the requirement that their Oath of Arbitrator be notarized. In response to these complaints, we undertook a study to determine whether it would be feasible to eliminate the notarization requirement. Based on the results of this study, we have determined that arbitrators will no longer be required to have the Oath of Arbitrator notarized. While notarization of the Oath is no longer required, arbitrators are reminded that the Oath must still be signed and returned to NASD Dispute Resolution before the arbitrator makes any decisions or attends any hearing. As part of the Oath, arbitrators are required to review three documents: the Temporary and Permanent Arbitrator Disqualification Criteria; the Arbitrator Disclosure Checklist; and the Arbitrator Disclosure Report.

NASD Dispute Resolution wishes to stress the importance of an arbitrator's obligation to carefully review and sign the Oath promptly after appointment to a case.

Arbitrator Classification Changes

By Barbara L. Brady - Associate Vice President and Director of Neutral Management

In the June 2004 issue of this newsletter, we announced that the Securities and Exchange Commission (SEC) approved NASD's 2003 proposed rule change to amend certain rules of the NASD Code of Arbitration Procedure ("Code") relating to arbitrator classification and disclosure in NASD arbitrations.

The changes to Rules 10308 and 10312 - which went into effect on July 19, 2004 - required that all arbitrators confirm their classifications as either public or non-public arbitrators. Given these changes to the Code, NASD Dispute Resolution's Department of Neutral Management sent over 9,000 surveys to its current Roster of Arbitrators in an effort to determine whether all arbitrators are properly classified.

A majority of our arbitrators responded by completing the survey and returning it in a timely manner. In addition to these responses, however, NASD Dispute Resolution has received several requests for further explanation as to why the public and non-public arbitrator classifications were changed. This article will address those requests for additional information by providing relevant background information that explains the need for these changes.

In 2002, the SEC commissioned Professor Michael A. Perino, visiting professor of Columbia Law School and Associate Professor of St. John's University School of Law, to assess the adequacy of current NASD and NYSE arbitrator disclosure requirements. In performing his assessment, Professor Perino reviewed self-regulatory organization (SRO) rules and regulations, conducted extensive interviews with representatives of SROs, and contacted lawyers experienced in securities arbitrations, members of the Securities Industry Association (SIA), and representatives of the Public Investors Arbitration to obtain their views on whether the current disclosure rules were adequate. In November 2002, the SEC released Professor Perino's report (the "Perino Report" or "Report"), which outlines the results of his assessment and provides recommendations for enhancing some provisions of the Code.

The Perino Report concluded that "available empirical evidence suggests that SRO arbitrations are fair and that investors perceive them to be fair." The Report also found that "the current SRO conflict disclosure requirements generally appear adequate." The Report, however, did recommend several amendments to SRO arbitrator classification and disclosure rules that might "provide additional assurance to investors that arbitrators are in fact neutral and impartial." The changes to Rules 10308 and 10312, as well as several other related changes to the definition of public and non-public arbitrators, are consistent with the Report's recommendations.

According to the Report, "critics of SRO arbitrations consistently point to the presence of industry arbitrators on arbitration panels and the classification of arbitrators as public or non-public as the primary sources of potential pro-industry bias." Hence, the Report recommended that the SROs evaluate current rules to determine whether it would be advisable to broaden their definitions of industry arbitrators. In response to this recommendation, and with the input of its National Arbitration and Mediation Committee, NASD amended the definitions of public and non-public ("industry") arbitrators in several ways to further ensure that individuals with significant ties to the securities industry are not able to serve as public arbitrators. For example, the definition of "non-public arbitrator" in Rule 10308(a)(4) has been amended to, among other things, increase from three years to five years the period for transitioning from a non-public to a public arbitrator. In Rule 10308(a)(5)(A), the definition of "public arbitrator" has been amended to: 1) prohibit anyone who has been associated with the industry for at least 20 years from ever becoming a public arbitrator, regardless of how many years ago the association ended; and 2) exclude from the definition of public arbitrator, attorneys, accountants, and other professionals whose firms have derived 10 percent or more of their annual revenue, in the last 2 years, from clients involved in the activities defined in the definition of non-public arbitrator; and 3) provide that investment advisers may not serve as public arbitrators and may only serve as non-public arbitrators if they otherwise qualify under Rule 10308(a)(4).

The Report also recommended that NASD expand the definition of "immediate family member" to include spouses, parents, and children, regardless of whether the children are declared as dependents or are members of the arbitrator's household. In response to this recommendation, NASD amended Rule 10308(a)(5)(B) to define "immediate family member" as recommended by the Report and to include stepparents and stepchildren in the definition as well. In addition, although the Report did not address the issue, NASD determined that it was consistent with the Perino Report recommendations to amend the definition of the term "immediate family member" to also include anyone, related or not, who is a member of the household of a non-public arbitrator. We are aware that these changes will affect some arbitrators serving in our forum.

We also recognize that some arbitrators may be unhappy with either their new classification or their inability to continue serving in the forum. However, please understand that the rule changes were made after considerable thought and consideration, and significant regulatory scrutiny. Our mission continues to be maintaining the integrity of this forum, which requires us to provide arbitrators who are impartial in appearance as well as in fact. We believe these changes help us achieve our mission.

Read the Notice to Members 04-49 or the rule filing for a more detailed explanation of these amendments.

New Expungement Rule

For claims filed on or after April 12, 2004, new Rule 2130 of the NASD Code of Arbitration Procedure ("Code") requires that there be certain affirmative findings to support an expungement order or, if there are no such findings, that NASD be named as a party in any court proceeding seeking or confirming expungment relief.

Although the new rule applies to claims filed on or after April 12, 2004, registered persons also may request expungement of claims filed against them prior to April 12, 2004. If you have any questions relating to the process for expungements on cases filed prior to April 12, 2004, please feel free to contact the case administrator assigned to the case.

Under new Rule 2130, members and associated persons seeking to expunge customer dispute information from the Central Registration Depository ("CRD") system must obtain an order from a court of competent jurisdiction directing such expungement or confirming an arbitration award containing expungement relief.

A respondent seeking expungement relief in arbitration would ask for expungement in his or her request for relief (normally contained in the answer). In the event the arbitrators dismiss the claim against the respondent, the arbitrators would then decide whether to grant expungement on the basis of an affirmative finding by the arbitration panel that:

  • the claim, allegation, or information is factually impossible or clearly erroneous;
  • the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds; or
  • the claim, allegation, or information is false.

The award must state whether expungement was granted and, if so, on what basis.

If the parties settle the arbitration, they may jointly ask the arbitration panel for a stipulated award, request that the panel make affirmative findings (see list above), and order expungement. The arbitrators would then determine whether to grant expungement relief and, if so, state in the award the basis on which the expungement relief was granted. Arbitrators who believe that they do not have enough information to make one of the three affirmative findings have several options: ask the parties to submit additional information; conduct a telephonic or in-person hearing to obtain testimony; or decline to sign the stipulated award.

Once the panel has made an affirmative finding, the members or associated persons must then obtain a court order to have a record in the CRD expunged. Members and associated persons seeking a court order to expunge a record must name NASD as an additional party and serve NASD with all appropriate documents unless NASD waives that requirement.

Read the Notice to Members 04-16 or the rule filing for detailed information on expungements.

All arbitrators must receive training on the expungement process.

Latest in Arbitrator Training

Enhanced Panel Member Training

As part of the process of applying to become an arbitrator for NASD, it is mandatory that individuals successfully complete the basic panel member training course. The course consists of four parts: a self-study component requiring approximately 2-3 weeks of preparation prior to the course; a live, on-site training session; completion of a final exam with a minimum score of 80%; and a positive evaluation of the trainee by the trainer(s).

Beginning in September 2004, NASD Dispute Resolution will extend the length of the current in-person training session to include the showing of a new videotape titled "Civility in Arbitration." The videotape and the accompanying study guide was prepared by a committee of the Securities Industry Conference on Arbitration (SICA). To help offset the costs of enhancing this training program, the training fee will be increased from $100 to $125. This is the first increase in the panel member training fee since March 2, 1998. Arbitrators who previously completed the basic panel member training course need not take the course again.

Mandatory Expungement Training for Arbitrators

Expungement training is mandatory for all active arbitrators on the NASD Roster. Such training is available in two forms: an online training module as indicated on our Web site, or by participating in a telephone training program titled: "Workshop on Expungement."

  • Online Training Module - An online course on expungement is now available. Like all of NASD Dispute Resolution's online courses, the Expungement course is available 24 hours a day, seven days a week. Because the expungement training is mandatory, NASD is not charging arbitrators for this training. All available arbitrators have been pre-enrolled for this course. If you have not yet received your user ID and password, please contact Lisa Angelson.
  • Workshop on Expungement - This workshop, similar to the "Workshop on Discovery" conducted by NASD Dispute Resolution in March 2004, will be hosted by Linda Fienberg, President of NASD Dispute Resolution. The Workshop is scheduled for October 6, 2004 from 12:00 p.m. to 1:00 p.m. (Eastern time). The Workshop is being offered at no charge to arbitrators on NASD's Roster, and arbitrators who participate for the full Workshop will receive credit for the mandatory expungement training.

Arbitrators will be receiving detailed information about how to participate in the "Workshop on Expungement." Look for this announcement in your mail and on our Web site.

2004 NASD Arbitrator Training Programs and Schedules

Our training schedule for 2005 will be posted in the fall, and announced in this newsletter.

SEC Approvals

Arbitrators to Be Compensated for "Last-Minute" Postponements

On May 17, 2004, the SEC approved SR-NASD-2003-164 (Three-Day Adjournment). The rule amends NASD IM-10104, Rule 10306, and Rule 10319 of the NASD Code of Arbitration Procedure to impose a fee on parties of $100 per arbitrator and to compensate arbitrators in the event a hearing on the merits is adjourned within three business days before a scheduled hearing session. One fee will apply per postponement request even though several days of hearing sessions may be cancelled. As announced in Notice to Members 04-53, the effective date of this rule is August 16, 2004.

Suspension for Failing to Pay Arbitration Awards

On June 10, 2004, the SEC approved SR-NASD-2003-69 (Failure to Pay Arbitration Awards). The rule filing (1) amends Article V, Section 4 of NASD's By-Laws to permit NASD, for a period of two years after the award is entered to suspend former associated persons who terminated their registration before the award was entered and failed to pay an arbitration award or settlement; and (2) amends Article VI, Section 3 of the By-Laws to clarify that NASD may suspend the association, not just the registration, of any person who fails to pay an arbitration award. As announced in Notice to Members 04-57, the effective date of this rule is September 9, 2004.

Voluntary Direct Communication Between Parties and Arbitrators

On June 30, 2004, the SEC approved SR-NASD-2003-163 (Voluntary Direct Communication Between Parties and Arbitrators). The proposal permits parties in an arbitration to communicate directly with the arbitrators if all parties and the arbitrators agree, and establishes guidelines for such direct communication. As announced in Notice to Members 04-62, the effective date of this rule is September 30, 2004.

Question & Answer on the Parties' Use of the NASD's Discovery Guide

Question: As Chairperson of an arbitration panel, is my decision-making power weakened if the parties use NASD's Discovery Guide?

Answer: No. The purpose of creating NASD's Discovery Guide was not to weaken a panelist's authority to rule on discovery motions, but to help parties determine which documents should be exchanged automatically, without intervention from either the panel or staff. The Discovery Guide also serves to provide the parties with procedures and timeframes for exchanging such documents.

View information about NASD Dispute Resolution Online Arbitrator Training.

Regional Updates

In this new feature of our newsletter, we will share the latest news and information from the five regional offices of NASD Dispute Resolution. We hope these regional updates will be of interest to you.

Southeast Regional Update

NASD Dispute Resolution is pleased to announce that it will open a new hearing location in Birmingham, Alabama in September 2004. The Southeast Regional Office in Boca Raton, Florida will administer the Birmingham location. If someone you know may be interested in serving as an arbitrator or mediator in Birmingham, please contact the Southeast Regional Director, Rose Schindler, at (561) 447-4939 or our Recruitment Supervisor, Neil McCoy, at (212) 858-4283.

Northeast Regional Update

As part of our continuing efforts to make the arbitration process more efficient, the Northeast Regional Office is urging its arbitrators to schedule the start time for hearings for 9:00 am. This will allow more cases to be completed during the scheduled session, and reduce the need to schedule additional sessions.

We have remodeled our office to create a conference room capable of accommodating large numbers of parties and their counsel comfortably. This is in addition to our seven other conference rooms. We have also created a large mediation room to accommodate larger mediation cases and have maintained a smaller room for caucusing.

Western Regional Update

In the Western Region, arbitrators may volunteer to serve in the following hearing locations: Honolulu, Anchorage, Salt Lake City, Las Vegas and Reno. However, arbitrators should keep in mind that, pursuant to NASD national policy, arbitrators who volunteer to serve in hearing locations beyond their primary location are not entitled to reimbursement of their travel and hotel expenses. Detailed information regarding reimbursement may be found under "Guidelines for Arbitrator Reimbursement." When in doubt, arbitrators serving for any of NASD Dispute Resolution's Regional Offices should ask the staff whether they would be entitled to reimbursement of travel expenses upon appointment to any hearing outside their primary hearing location.

Mid-Atlantic Regional Update

In accordance with its commitment to have a hearing location in all fifty states by 2005, NASD Dispute Resolution is pleased to announce that it will open a new hearing location in Columbia, South Carolina at the end of September 2004. The Mid-Atlantic Regional Office in Washington, D.C. will administer the Columbia hearing location. Mayra Santor, Dispute Resolution Staff Attorney, and Zeb Barnhardt, Jr., NASD Arbitrator and Mediator, co-hosted an open house for potential arbitrators in Columbia, South Carolina this past May.

Should someone you know be interested in serving in Columbia, please contact Marya Santor at (202) 728-8177 or our Recruitment Supervisor, Neil McCoy, at (212) 858-4283.

Midwest Regional Update

A Personal Message from Scott Carfello, the new Regional Director of the Midwest Regional Office:

"I just wanted to say a quick hello to all the neutrals who work with the Midwest office. I started in March of 2004, and am still learning new and exciting things every day. I hope to have the opportunity to meet you in the future, whether in Chicago or in one of the other cities under the jurisdiction of the Midwest Regional Office. I would also like to thank those of you who sent their congratulations and words of support and encouragement. I sincerely appreciate the collegiality. Please also feel free to call me should you have any questions or suggestions for improvement."

NASD Dispute Resolution is pleased to announce that it will open new hearing locations in Wichita, Kansas and Des Moines, Iowa in September 2004. Both hearing locations will be administered by the Midwest Regional Office in Chicago, Illinois. If someone you know might be interested in serving in either Wichita or Des Moines, please contact Deborah Woods at (312) 899-4431 or our Recruitment Supervisor, Neil McCoy, at (212) 858-4283.

Messages from the Editor

New Editor-in-Chief

I would like to take this opportunity to introduce myself as the new Editor-in-Chief of The Neutral Corner. I am honored to have this opportunity. I intend on contributing to the already successful role this newsletter serves in keeping you updated on the latest in the field of dispute resolution. Since this publication is here to educate you, any suggestions about topics for discussion would certainly be appreciated. We consider this newsletter a living document that can always be improved and welcome any ideas or comments you may wish to share. Please send them to Lisa Angelson, Editor, The Neutral Corner, NASD Dispute Resolution, One Liberty Plaza, 165 Broadway, 27th Floor, New York, New York 10006. You may also contact me at (212) 858-4392.

Comments and Feedback

The Neutral Corner welcomes your comments, feedback, or questions on the material presented in this publication or on other arbitration and mediation issues. The Neutral Corner also invites readers to submit articles on important issues of law and procedure relating to mediation, arbitration, or other alternative dispute resolution processes.

Please send your article to Lisa Angelson, Editor, The Neutral Corner, Department of Neutral Management, NASD Dispute Resolution, One Liberty Plaza, 165 Broadway, 27th Floor, New York, New York 10006.


Linda D. Fienberg
NASD Dispute Resolution

George H. Friedman
Executive Vice President
NASD Dispute Resolution

Kenneth L. Andrichik
Senior Vice President
Mediation & Business Strategies

Jean I. Feeney
Vice President &
Chief Counsel

Dorothy Popp
Associate Vice President,
Director of Operations

Richard W. Berry
Associate Vice President &
Director, Case Administration

Barbara L. Brady
Associate Vice President &
Director, Neutral Management

Elizabeth R. Clancy
Vice President &
Regional Director, Northeast Region

Judith Hale Norris
Vice President &
Regional Director, Western Region

Rose Schindler
Associate Vice President &
Regional Director, Southeast Region

Shari Sturm
Regional Director,
Mid-Atlantic Region

Scott Carfello
Regional Director,
Midwest Region

Lisa Angelson
Associate Director of
Neutral Management and
Editor of The Neutral Corner

NASD Dispute Resolution Offices

Northeast Region
One Liberty Plaza
165 Broadway
27th Floor
New York, NY 10006
(212) 858-4400
Fax: (212) 858-4429

Mid-Atlantic Region
1735 K Street, NW
Washington, DC 20006
(202) 728-8958
Fax: (202) 728-6952

Southeast Region
Boca Center Tower 1
5200 Town Center Circle
Second Floor
Boca Raton, FL 33486
(561) 416-0277
Fax: (561) 416-2267 

Western Region
300 S. Grand Avenue
Suite 900
Los Angeles, CA 90071
(213) 613-2680
Fax: (213) 613-2677

Midwest Region
10 S. LaSalle Street
Suite 1110
Chicago, IL 60603-1002
(312) 899-4440
Fax: (312) 236-9239