A federal district court just vacated a FINRA arbitration award in favor of Goldman Sachs because anarbitrator had failed to disclose the full extent of some pending legal problems. Sure, these things happen on appeal but what makes this case shocking was the court's criticism of FINRA's failure to undertake a substantive and timely inquiry into the arbitrator's background. Yet another black eye for mandatory Wall Street arbitration.
Goldman Sachs Fund Under Fire
The federal court for the Eastern District of Pennsylvania recently considered dueling motions to confirm, on the one hand, and to vacate/remand, on the other hand, a Financial Industry Regulatory Authority ("FINRA") arbitration. Goldman, Sachs & Co et al. v. Athena Venture Partners, L.P. (EDPA, 13-MC-130, August 1, 2013). The underlying arbitration involved the complaints by Athena Venture Partners, L.P. involving its August 2007 investment in Goldman Sachs' Liquidity Partners 2007, L.P. Fund.
In the FINRA arbitration, Claimant Athena alleged that respondents Goldman Sachs, Sheffer, and Gettleman had solicited a $5 million investment by representing the fund as a "terrific, low principal risk short term investment with potential higher yields than other available cash investments." In the Matter of the FINRA Arbitration Between Athena Venture Partners, L.P. , Claimant, and Goldman, Sachs And Co., Eric W. Gettleman, and Scott T. Sheffer, Respondents (FINRA Arbitration 09-04771, March 13, 2013). After some 15 months and a loss of $3 million, Claimant Athena alleged that the fund had not been managed in accordance to the representations. Claimant alleged, among other causes of action, misrepresentation, fraud, failure to supervise, and suitability.
Respondents disputed the allegations and characterized Athena as a sophisticated investor on notice of the speculative nature of the fund's investments and its risk profile - as purportedly set forth in a Private Placement Memorandum.
Apparent Victory For Respondents
All in all, a fairly garden variety FINRA arbitration. On March 13, 2013, a three-member FINRA Arbitration Panel found in favor of Respondents and recommended the expungement of the matter from Respondent Sheffer's records. Based upon the FINRA Arbitration Decision, the Panel found little, if any, merit in Claimant's case and deemed Athena as sophisticated and on notice of many of the risk factors of the fund. Frankly, this was a slam dunk victory for Respondents.
The FINRA Decision, however, was only signed by two of the three arbitrators - Arbitrator Demetrio S. Timban, Jr.'s signature was missing.
On May 9, 2013, the arbitration respondents sought an order confirming the award; whereas, on June 7, 2003, arbitration Claimant Athena sought an order vacating/remanding the award. Of note in the motions, was that Athena was arguing that the FINRA Arbitration Panel had exceeded its powers by proceeding with the hearing and issuing the award because of disqualifying conduct of Arbitrator Timban.
The Replacement Arbitrator
As the Court noted in its Memorandum, the arbitration panel was composed of two public arbitrators (both licensed attorneys) and one non-public arbitrator. About one year after the parties were notified of the composition of the panel, FINRA notified them that one of the non-public arbitrators had withdrawn and would be replaced by Timban, also an attorney.
I Got This One Thing You Should Know About
Following the November 2011 commencement of hearings, on March 22, 2012, Timban submitted the following updated disclosure:
In September of 2011, I was served with a complaint from the State of New Jersey, Case #11-10-01215-1 charging me with the unauthorized practice of law. The specific incident in question involved my representation of a family friend in a local municipal court in Evesham Township. While representing the family friend in the matter, I failed to make a motion for admission pro hac vice because while I am admitted in both Michigan and New York, I am not admitted in New Jersey. I take full responsibility for the oversight and I am working with the State to settle this and I am confident this matter will be expunged from my record. I have also informed the state bars of Michigan and New York. I am fully confident that this will in no way affect my ability to be fair and impartial in my duties to FINRA.
At Page 18 of the Court's Memorandum
SIDE BAR: According to the FINRA Arbitration Decision, there were 17 hearing dates that ran from November 2, 2011, through October 15, 2012, with a hiatus from the fifthe hearing session on November 4, 2011, until the resumption of hearings on October 8, 2012.
The disclosed September 2011 NJ complaint referenced by Timban occurred about two months before the beginning of the hearings. Further, Timban's March 22, 2012, disclosure of the NJ complaint occurred after five hearing sessions but prior to the resumption of the remaining 12 sessions.
Okay, it may seem like no big deal. Timban informs FINRA and the parties that in September 2011 he was named in a NJ complaint alleging unauthorized practice of law. As Timban seems to explain things, it was a tempest in a teapot involving a favor for a family friend and the matter seemed headed for a somewhat amicable settlement. All in all, you get the encouraging sense that it's a minor misunderstanding and that Timban is good to go for sitting in on the FINRA arbitration.
Ahhh . . . but things are not always as the seem or as they are spun. As the Court noted:
In reality, however, Mr. TImban's disclosure was not entirely truthful or complete. Rather, it now appears that the extent of his unauthorized practice of law in the State of New Jersey was not limited to the one, isolated incident which he disclosed. Instead, it appears that he actually opened an office for the practice of law . . . [from which] he actively practiced . . . for nearly one year, if not longer.
At Page 19 of the Court's Memorandum
As It Turns Out . . .
In fact, the Court explains that Timban was indicted by a Grand Jury in Burlington County, NJ for unauthorized practice of law and was the subject of two complaints filed with the Attorney Discipline Board for the State of Michigan in April and July 2012 -one of which involved allegations that he had knowingly written a check against insufficient funds in a probate matter. The Court asserts that Timban pled no contest and was suspended from the practice of law in Michigan for 176 days as of November 20, 2012.
As the Court notes with a tinge of astonishment,
Apparently, Mr. Timban failed to disclose amy of this information to either FINRA or the parties involved in this action and it was only discovered after the arbitration hearings in this matter concluded and the award issued."
At Page 20 of the Court's Memorandum
The Court doesn't quite understand FINRA's action or inaction in response to Timban's March 22, 2012 disclosure. For one thing, the Court found no evidence in the record showing that FINRA's Director of Dispute Resolution took any action to remove Timban from the case. Also a tad odd, neither the Claimant nor any Respondent requested the arbitrator's removal following his disclosure. Consider this scathing commentary from the Court that is spread out in all its glory as Footnote 7 :
This Court finds it remarkable that neither of these parties nor, more particularly, FINRA saw fit to conduct any investigation or due diligence into Mr. Timban's qualifications after he revealed that he was the subject of a complaint by the State of New Jersey for unauthorized legal practice. Given that the parties were required by the terms of the subscription agreement to submit any disputes which arose thereunder to arbitration under the auspices of, inter alia, FINRA, and given that FINRA bills itself as the largest independent securities regulator in the country, one would expect that public confidence in the integrity of the arbitral process would be of paramount importance. Indeed FINRA's June 21, 2013 announcement that it will now conduct annual background checks on its arbitrators and additional review before appointment seems, to this Court, to be an important step in the right direction, albeit "too little too late" in this cases . . .
Summing up the facts before it, the Court held that:
Here, in failing to provide these parties with three qualified arbitrators, FINRA failed to provide what the parties agreed to in the Subscription Agreement We therefore conclude that vacatur of the award in this case is proper . . . then arbitrators here so imperfectly executed their powers that a mutual, final and definite award was not made.
At Page 21 of the Court's Memorandum
Accordingly, the Court denied the motion to confirm, and granted the motion to vacate and remanded the case back to FINRA.
Bill Singer's Comment
On August 2, 2013, The North American Securities
Administrators Association ("NASAA") announced its support for The Investor
Choice Act of 2013 (H.R. 2998), which would prohibit the use of mandatory
pre-dispute agreements by broker-dealers and investment advisers. The proposed
legislation does not, however, prohibit investors from voluntarily electing
alternative dispute resolution. READ the FULL TEXT of the Act at BrokeAndBroker.com