Awarding punitive damages in arbitration defines securities' due process downward.код для вставкиСкачать
Awarding Punitive Damages in Arbitration Defines Securities’ Due Process Downward BY KARL E. NEUDORFER Modern securities law practice is, in many respects, coextensive with the practice ofsecurities industry arbitration. Brokers and dealers in the securities industry have seized upon arbitration’s ability to deliver less expensive, more efficient, and authoritative resolutions ofdisputes with customers and employees than does the public court system. In fact, University ofKentucky Prof.Thomas J. Stipanowich,who is joining Alternatives’ publisher CPR Institute as its new president in January, has observed that in many circles, arbitral proceedings are viewed as “[a]veritablesurrogate for the public justice system.” But are they? The increase in securities arbitration over the past decade raises a number of questions that remain unanswered. Foremost among them, and central to modern securities arbitration, is whether securities arbitrators have the power and authority to issue punitive damages, and, if so, whether such awards should be subjected to constitutional or public policy limitations. T h e modern debate over a securities arbitrator’s authority to issue punitive damages begins with the New York Court of Appeals decision in Garrity v. LyleStuartInc., 353 N.E.2d 793 (N.Y. 1976). Writing that the “day is long past since barbaric man achieved redress by private measures,” Id. at 797, the Garrity court held that the issuance of punitive damages fell beyond the scope of an arbitrator’s authority, even in those cases in which the parties had entered into an arbitration agreement expressly providing for punitive damages. Id. at 794. The decision’s ramifications soon were felt throughout the securities industry. It was not long before securities brokers and dealers seized upon the Garrity rule to insulate themselves from exposure to arbitral awards of punitive damages by including New York choice-of-law provisions in their customer agreements and employment contracts. Furthermore, most securities firms placed a separate clause in their customer agreements requiring that all contro- versies be submitted to arbitration under the arbitration rules of one of the self-regulatory organizations, or SROs, such as the New York Stock Exchange or the National Association of Securities Dealers. Combined, the effect of these provisions was to require that all disputes be resolved through arbitration, and then to preclude arbitrators from issuing punitive damages against securities dealers. Thus, customer agreements and employment contracts of this nature functioned as a means of protecting securities brokers and dealers from punitive damages without ever making forthright mention of that fact. But not every court was as willing to enforce such clauses as securities dealers might have hoped, and ultimately, the Garrity rule and its incorporation into securities firms’ customer agreements created a schism in the federal courts. Some federal circuit courts were willing to uphold these New York choice-of-law clauses as a ban on arbitral awards of punitive damages, provided that the clauses in issue stood in accordance with the parties’ intentions. The Second U.S. Circuit Court of Appeals, for example, cited the Federal Arbitration Act (FAA), 9 U.S.C. $9 1-16, as support for the proposition that arbitration agreements must be enforced according to their terms and therefore that a New York choice-of-law clause in a customer agreement with a securities firm precluded arbitral punitive damages awards. See Barbier v. Shearson Lehman Hutton Inc., 948 F.2d 117, 122 (2d Cir. 1991). O n the other hand, other federal circuit courts construed New York choice-of-law clauses in customer agreements as an indication of the parties’ intent that New York law should govern the substantive standards as to when remedies should and should not be granted, not the question of whether a particular type of remedy was available in an arbitral forum. Courts falling into this latter camp likewise supported their conclusions with the FAA, holding that the federal policy in favor of arbitration and the law give arbitrators broad discretion to fashion remedies, including issuing punitive damages, and that i t requires any doubts regarding the CO MMENTA RY Karl E. Neudorfer, a recent graduate of the Ohio State University School of Law, i s an associate at Shayne & Greenwald, i n Columbus, Ohio. arbitrability of a claim to be resolved in favor of arbitration. See, e.g., Bonar v. Dean Witter Reynold Inc., 835 F.2d 1378 (1 Ith Cir. 1988). It followed directly that securities arbitrators enjoyed the authority to issue punitive damages in circumstances they deemed appropriate. The Supreme Court, however, had yet to speak on the matter. At long last, it did so in Mastrobuono v. Shearson Lehman Hutton Inc., 514 U.S. 52 (1995). The Mastrobuono court enforced an arbitral punitive damages award against a securities dealer despite the presence of a New York choice-of-lawclause in the customer agreement it had signed with the plaintiff. In doing so, however, the Court may have created more questions than it answered. It framed the issue as being whether the parties’ inclusion of a New York choice-of-law clause incorporated the Garrity rule into their agreement. In what seemed, at least superficially, a strong blow to securities firms, the Court answered that question in the negative. Because the NASD arbitration rules referenced in the customer agreement‘s arbitration clause provided that arbitrators may award “damages and other relief,” the Court held that they did not require the conclusion that the provisions of the agreement authorized punitive damages. But, the Court reasoned, their incorporation into the Mastrobuonos’ contract would at least bear an interpretation maintaining that punitive awards were contemplated by the parties at the time of contracting. When that determination was coupled with the New York choice-of-law provision, the Court found the customer agreement to be, at best, an ambiguous manifestation of the parties’ intentions regarding the arbitrators’authority to issue punitive damages. The Court then cited the federal policy favoring arbitration as grounds for resolving controversies over the arbitrability of disputes in favor of arbitration and seconded that conclusion with the hndamental contract law rule that ambiguous contracts be construed against the drafter, meaning, of course, the defendant brokerage firm. Then, construing Shearson Lehman Hutton’s customer agreement against its drafter, the Court harmonized the facially discordant New York choice-of-law and arbitration clauses by finding that the choice-of-law clause (continued on following page) Awarding Punitive Damages Defines Due Process Downward (continued from front page) “encompass[ed]substantive principles that New York courts would apply, but not to include those special rules limiting the authority of arbitrators. Thus, the choice-of-law provision covers the rights and duties ofthe parties, while the arbitration clause covers arbitration; neither sentence intrudes upon the other.” Mmtrobuono, 5 14 U.S.at 64. But because passages such as this one seem to speak only to the language used in the arbitration agreement at issue in that case, the extent to which Mustrobuonoresolved the dispute among the federal circuits over arbitrators’ authority to issue punitive damages remains elusive. In fact, as authors Bradford D. Kaufman and Anne Tennant Cooney point out, “this case came down to the mundane chore of the Supreme Court interpreting the terms of a single, isolated contract.” UNANSWERED QUESTIONS Mastrobuono therefore left a host of questions unanswered, and it caused new problems as well. What the Mastrobuonocourt failed to take into account was the fact that Shearson Lehman Hutton, by virtue of its NASD membership, would have been forced to arbitrate any disputes arising between itself and its customers regardless of whether it had signed a contract mandating such a result. Consequently, while the Mustrobuono decision expressly allows for securities dealers to draft their customer agreements to preclude arbitral punitive damages awards, provided that such provisions are explicit and written with precision, it is not clear that NASD member firms could incorporate such a clause into their customer contracts without running afoul of the NASD arbitration rules. But those rules, as they were read by the Mattrobuonocourt, prevent securities firms from drafting contracts that preclude arbitrd punitive damages awards. The effect of such a reading is that NASD member firms are required to subject themselves to arbitral proceedings to resolve controversieswith customers or employees and simultaneously to allow for arbitrators to level punitive damages against them. It should be underscored, however, that those arbitral proceedings are not equipped with the public justice system’s due process machinery, despite the fact that this machinery has been mandated by the Supreme Court‘s punitive damages jurisprudence and is designed to prevent the possibilityofarbitrary deprivations of property that exists whenever punitive damages are issued. The conclusion that securities firms subject to the NASD rules cannot contract around arbitral punitive damages awards-even in spite of the fact that a narrow reading of the Mustrobuono holding might otherwise allow them to do so-is supported by the NASD’s adoption of what have come to be known as the Anti-Goren rules. The Anti-Goren rules operate to prohibit securities dealers from including language in arbitration agreements that restricts an arbitrator‘s authority to issue awards of any sort, including, presumably, punitive damages. Though Martrobuono’s holding apparently is narrow enough to allow for securities bro- kerage firms to preclude arbitral punitive damages awards with express and clear language in their customer agreements, doing so may expose an NASD member firm to sanctions by that body. Thus, the state of the law at this point seems to be that punitive damage awards in the securities arbitration context must be allowed, even in the face of a New York choiceof-law clause and even if all the parties to it are New York residents. But the real questions, the ones to which this article must now must turn, are whether such arbitral awards are proper or fair, and whether they are in keeping with constitutional due process requirements. STATE ACTION The question ofwhether securities arbitration punitive damages awards face limits set forth by the U.S. Constitution’s due process guarantees ultimately turns upon a threshold question ofwhether the award issuer is a state actor. The Supreme Court has established a threeprong test for evaluating whether actions fall within the rubric of “state action.” See Edmonson u. Leesuille Concrete Co. Inc., 500 U.S. 614, 620 (1991). The first of the three factors to be considered is the “extent to which the actor relies on governmental assistance and benefits. ...” The second asks whether the actor is performing a traditional government function. .. .” And the third considers “whether the injury caused is aggravated in a unique way by the inciden[ce] ofgovernment authority.” Id. The issuance of punitive damages by (continued on following page) ABOUT THE CPR I N S T I T U T E F O R D I S P U T E RESOLUTION 0 RG A N I Z E D BY P RO M I N ENT C 0 R P0 RATE C 0 UN S EL , THE CPR INSTITUTE FOR DISPUTE RESOLUTION has become a leader i n developing uses of private alternatives t o the costly litigation confronting major corpor;itions and public entities. The membership of CPR, a nonprofit organization, consists of more than 500 large companies, leading U.S. law firms, academics and judgcs. Scc “Who‘s Involved” a t o u r Web site, www.cpradr.org. TO ITS MEMBERS, CPR OFFERS EXTENSIVE BENEFITS AND SERVICES, including research access t o CPR’s unique ADR darabase; training and counseling; a complete library of ADR practice tools and model procedures; and semi-annual conferences for CPR Sustaining Members. WOULD YOU LIKE FURTHER INFORMATION ABOUT CPR? SLY o u r Web site d t www.cpradr.org o r complete the following form: ,. N,, 111 securities arbitrators satisfies all three of these conditions. First, it is the authority of federal law that compels securities brokerage firms to submit to punitive awards, irrespective of their fairness. In particular, the NASD is a creature of congressional creation, and no less an authority than the U.S. Code is the fountainhead from which power over its members springs. Congress enacted laws that make registration in an SRO “registered pursuant to section 7803 of [Title 15 of the U.S. Code]” a prerequisite to trading in securities. But the NASD is the only SRO that satisfies this requirement. Furthermore, 15 U.S.C. $ 780-3(b)(2)requires that any securities association registered with the U.S. Securities and Exchange Commission pursuant to § 780-3, which is to say the NASD alone, be equipped with the power to force compliance with “the rules of the association.” One such rule, NASD Code of Arbitration Procedure Rule 10301(a), mandates that securities disputes “shall be arbitrated under this Code.” Thus, it is essentially federal law that compels the arbitration of securities disputes between brokers and their customers or employees. As Kaufman and Cooney put it, “[tlhelogic is straightforward: ( 1 ) the [Securities] Exchange Act mandates that securities firms be members ofthe NASD, an entity created by Congress, and (2) the [SEC], a government agency, made effective the NASD rule ordering its member firms to arbitrate all their disputes.” As such, securities arbitrators rely heavily on “governmental assistance and benefits” in issuing punitive damages. Second, the Supreme Court has held that issuing punitive damages is a “traditional government function,” observing that “[plunitive damages have long been a part ofuaditional state tort law.” Sihoodv. Km-McGee Cop.,464 US. 238,255 ( 1984).This passage does not unequivocally require the conclusion that punitive damages are within the exclusive purview of state authority, but it certainly tolerates it. Perhaps even more important is the Gavity court‘s recognition that one of the purposes “of the rule of law is to require that the use of coercion be controlled by the State.” Garrity, 353 N.E.2d at 796. In support of this view, it should be recognized that the issuance of punitive damages historically has been considered as remaining within the exclusive authority of the state precisely because their purpose is, as the name suggests, to punish the defendant rather than to recompense the plaintiff for injuries suffered. Put differently, punishment is and should remain a function of governmental authority. If it is not, “vigilante justice” would become sound public policy, or at least there would be very little theoretical justification for limiting it. It is for that reason that “[flor centuries the power to punish has been a monopoly of the State, and not that of any private individual.” Id. at 796. Of course, punitive damages are a form of punishment. As the Supreme Court recognized, “a civil sanction that cannot fairly CPR AWARDS Each year a t i t s January members’ meeting i n New York, the CPR Institute for Dispute Resolution, Alternatives‘ publisher, presents Awards for Excellence i n Alternative Dispute Resolution i n a variety of categories. The accompanying article i s part of a series of Alternatives adaptations and updates of the publication awards. This month’s article i s b y former Ohio State Journal on Dispute Resolution Executive Editor Karl E. Neudorfer, an associate a t Shayne & Greenwald i n Columbus, Ohio. I t i s based on his article ”Defining Due Process Down: Punitive Damages and Mandatory Arbitration of Securities Disputes,” 1 5 Ohio State J. on Disp. Res. 207 (1999),which won a $2,000 first prize i n the Student Articles category 17th annual awards presentation earlier this year. CPR has presented the awards annually since 1983. For details and deadlines on the 2000 awards, see the CPR News announcement on page 188 of this issue. be said to serve a remedial purpose, but rather can be explained only as also serving either retributive or deterrent purposes, is punishment.” U.S. u. Halper, 490 U.S. 435, 448 ( 1 989). Thus, issuing punitive damages is rightly viewed as a “traditional government function.” Finally, the persons or bodies issuing punitive damages must be regarded as state actors because the injuries that they cause are “aggravated in a unique way by the inciden[ce] of governmental authority.” Not only are securities dealers forced into arbitral proceedings by the NASD, and in turn the authority of federal law, but when punitive damages arbitral awards are challenged by those against whom they were leveled, it is the state’s authority in the form of the public justice system that enforces them. Likewise, judicial confirmation of arbitral awards is provided under the FAA. This is significant because in Shelly u. Kraemer, 334 U.S. 1,20 ( 1 948), the Supreme Court‘s awareness of an injury’s aggravation by judicial enforcement (i.e., governmental action) prompted it to write that “[sltate action, as that phrase is understood by the Fourteenth Amendment, refers to exertions of state power in all its forms.” As a result, when arbitral punitive damages awards are issued against securities brokers and dealers, they are “aggravated in a unique way by the inciden[ce] ofgovernmental authority.” Having run arbitral punitive damages awards through the Edmonson state action calculus, it is difficult to deny that under the Edmonson factors, securities arbitrators issuing punitive damages against one of the parties before them can be described in all fairness as state actors. Their authority to do so derives from federal law, the issuance of punitive damages traditionally has been a function wholly within the state’s capacity, and the injuries they cause-deprivations of property-are aggravated in a unique way by judicial enforcement of the award. Each of these conclusions satisfies one of the Edmonson factors, such that in the aggregate they form the basis for placing punitive damages awards within the securities context under the scope ofstate action. As state actors, then, securities arbitrators issuing punitive damages are bound by the Constitution’s due process guarantees. It is due process that operates to secure the constitutionality of punitive damage awards. Such procedural protections ensure that persons or institutions are not deprived of their property arbitrarily or unfairly. When punitive damages are at stake, however, the threat of such an arbitrary deprivation is legion. As the Supreme Court wrote, “[plunitive damages pose an acute danger of arbitrary deprivation ofproperty.” HondaMotor Co. u. Oberg, 512 U.S. 415, 432 (1994).That “acute danger” mandates that any state actor who issues punitive damages against a private party be bound by the Due Process Clauses ofthe U.S. Constitution. With regard to securities arbitrators issuing exemplary awards, however, no such procedural protections-which is to say the process that is due-are in place. For example, in PacificMu(continued on following page) ‘I NEED I NFORMATION ON,,, I You need a quick answer about a consumer ADR policy question. Here‘s how CPR‘s Alternatives can help: 0 . . Go to your bookshelf and check “Consumer ADR” in the Alternatives index appearing every February. 0 . . Log onto the CPR Web site, www.cpradr.org. Click on PUBLICATIONS, then ALTERNATIVES, then click on INDEX TO VOLUME 1 4 (1996), INDEX TO VOLUME 1 5 (1997), INDEX TO VOLUME 1 6 (1998). or INDEX TO VOLUME 17 (1999). You will find entries for Consumer ADR articles. 0 . . Go to LEXIS-NEXIS, select the ADR library, then enter altern.” Search “Consumer ADR” for all Alternatives references dating back to 199.3 or for the specific titles you found in an index. “ 0 . . Go to WESTLAW, enter “db ALTHCL.” Search “Consumer ADR” for all Alternatives references dating back to 1991 or for the specific titles you found in an index. Securities’ Due Process (continued from previous page) tzlal Life Insurance Co. u. Haslip, 499 U.S. 1 (1991), the Supreme Court was willing to uphold the constitutional validity of a jury’s punitive award, but only because the jury’s discretion in making such an award was limited by an instruction requiring it to consider the twofold purpose of punitive damages, retribution and deterrence, and because the award then was subjected to review at both the trial and appellate court levels. Thus, the Court observed that multiple layers of review, in which both trial and appellate judges are required to set forth in the record a detailed exposition ofseveral factors contributing to the justice ofthe award, coupled with a charge establishing guidelines for assessment of punitive damages according to the degree of reprehensibility of the defendant‘s conduct and the necessity for deterrence, translate into the fact that jury discretion was “not unlimited” and “confined to deterrence and retribution.” Id. at 19. Absent these procedural safeguards, however, it is not clear that the Haslipcourt would have reached the same result. It should not be surprising, then, that when punitive damages are awarded absent an adherence to the procedures discussed and endorsed in Haslip, the Court has indicated that the awards fall beyond the constitutionally permissible bounds. Thus, in Honda Motor Co. u. Oberg, the Supreme Court held unconstitutional an amendment to the Oregon Constitution barring judicial review of the size of punitive damage awards except in extraordinary circumstances. See Oberg, 512 U.S. at 418. In other words, the elimination ofjust a single component of the procedural protections approved in Haslip rendered a punitive damages award unconstitutional. It must be counted as curious, though, that none of these procedural safeguards are available in the securities arbitration arena. Therefore, it is doubtful that awards of exemplary damages by securities arbitrators could be regarded as consistent with the Fifth and Fourteenth Amendments’ due process guarantees. None of the procedures set forth in Haslip or Oberg-narrowed jury discretion, judicial review, or appellate review-is available to the parties coming before an arbitration panel armed with the power to issue punitive damages. Furthermore, as Judge C. Arlen Beam of the Eighth Circuit pointed out, in arbitration “[d]iscovery is abbreviated if available at all. The rules of evidence are employed, if at all, in a very relaxed manner. T h e factfinders . .. operate with almost none of the controls and safeguards assumed in Haslip.” Lee u. Chica, 983 E2d 883, 889 (8th Cir. 1993)(Beam, J., concurring in part and dissenting in part). Exacerbating the problem even further is the fact that judicial review ofpunitive awards under the FAA is so restricted that it has been rendered virtually meaningless, as it permits judges to vacate arbitral awards only in the most egregious of circumstances. And finally, because arbitrators rarely if ever are required to set forth the bases for their resolution of conflicts, the possibility of error in assessing punitive damages is not insubstantial. With the chances of error so great, and the possibility for meaningful judicial review so slim, these considerations would seem to require the conclusion that punitive damages awards by securities arbitrators are neither constitutional nor just. This view is reinforced by the fact that arbitral punitive damages awards are an inadequate mechanism to deter bad conduct. In order that punitive damages operate to protect the public by deterring others from engaging in the culpable conduct from which the exemplary damage award stems, it is necessary that the reasons underlying the award be made public. Arbitral awards, however, are rarely published, and when they are, the decision often comes down in a single sentence and is not accompanied by an exposition of the arbitrator‘s reasons for issuing the award or even a recital ofthe dispute’s facts. The effect of all this is to render arbitral awards of punitive damages an ineffective and inappropriate means of deterring securities firms’ egregious behavior. In the final analysis, the effect of the Mastrobuono decision remains unclear. What is clear, however, is that securities arbitrators should be required to adhere to the exacting due process standards established by the Constitution and the Supreme Court. Yet unwavering conformity with due process guidelines is inconsistent with the goals of arbitration as well as a person’s motivation to enter the arbitral forum. Therefore, until there exists some mechanism for reconciling the two, punitive damage awards should be regarded as an unacceptable and constitutionally improper component of the securities arbitra* 11111 tion process.