California Court of Appeals Reinstates $5 Million Award Against Morgan Stanley

July 3, 2014

This is an update of Former Morgan Stanley Smith Barney Brokers Win $5 Million Employment Dispute Arbitration Award (BrokeAndBroker.com, June 20, 2012).

In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in April 2011 and thereafter amended, Claimants Paladino and Vitale asserted:
  • fraudulent misrepresentation;
  • promissory fraud;
  • fraudulent concealment and/or omission;
  • negligent misrepresentation;
  • negligent concealment and/or omission;
  • breach of implied covenant of good faith and fair dealing;
  • intentional interference with existing and prospective economic advantage;
  • breach of oral and written contract;
  • violations of the California Labor Code;
  • promissory estoppel;
  • failure to supervise/negligent supervision; and
  • constructive fraud
The allegations arose in relation to the Claimants' employment with Respondent Morgan Stanley. Initially, the Claimants sought unspecified compensatory and punitive damages plus attorneys' fees, and other fees and costs.  At the close of the hearing, Claimants requested a total of $6,550,053.93 in damages. In the Matter of the FINRA Arbitration Between John P. Paladino and Todd G. Vitale, Claimants, vs. Morgan Stanley Smith Barney, Respondent (FINRA Arbitration 11-01633, June 19, 2012).

Respondent Morgan Stanley generally denied the allegations and asserted various affirmative defenses.

Discovery Difficulties

On February 29, 2012, Claimants filed a Motion to Compel, which the Respondents opposed. On March 21, 2012, the Chair of the FINRA Arbitration Panel conducted a pre-hearing conference on Claimants' motion and on March 21, 2012, issued a Discovery Order granting Claimants' motion.

A few weeks later, on April 19, 2012, Claimants filed a request for an expedited discovery hearing to address discovery issues, including Respondent's alleged violation of the Discovery Order. Claimants sought an award of attorneys' fees and discovery sanctions against Respondent, which Respondent opposed.

On May 14, 2012, the Chair determined the discovery issues to be moot because the parties had resolved the issues between themselves. Notwithstanding, the Chair determined that Claimants' request for discovery sanctions would be heard by the full Panel at the evidentiary hearing. After due deliberation, the Panel granted Claimants' request for discovery sanctions.

Award

The FINRA Arbitration Panel found Respondent Morgan Stanely liable and ordered the firm to pay to:
  • Respondent Paladino: $2,000,000.00 in compensatory damages
  • Respondent Vitale:$2,600,000.00 in compensatory damages
Further, Respondent was ordered to pay to the Claimants:
  • $354,816.54 in attorneys' fees pursuant to California Civil Code Section 1717;
  • $200.00 as reimbursement for Claimants' initial claim filing fee; and
  • $10,000.00 for discovery sanctions.
Bill Singer's Comment

In keeping with the top secret, hush-hush, need-to-know protocols under which FINRA's arbitrations are conducted and the ensuing decisions issued, this case discloses far less to us than what I deem necessary and appropriate - however, that's an oft-repeated criticism in this blog.  For industry colleagues of  Paladino and Vitale at other major firms such as Merrill Lynch, Wells Fargo, JP Morgan, and UBS, this decision may hold out some hope for pay-back if the severance between former employee and employer does not go smoothly.
What we can assume is that Claimants were two relatively high-powered Morgan Stanley Smith Barney registered persons with likely a few hundred million in assets under management and their departure from the firm was undertaken amidst much gnashing of teeth.

In response to the Claimants' request for some $6.6 million in damages, the outcome was about $5 million. Although you would have to personally ask Claimant Vitale and Claimant Paladino whether they are happy with the Award, my guess is that they would deem the result a victory.  Moreover, Respondent Morgan Stanley likely did not help itself out by engaging in what the Panel likely saw as gamesmanship during Discovery.

UPDATE

You'd sort of think that the FINRA Decision was the end of this matter. Think again. This dispute took on a second and then a third life on appeal. Todd G. Vitale, Et Al.,Plaintiffs and Appellants, v. Morgan Stanley Smith Barney, LLC, Defendant and Respondent. (California Court of Appeal, Fourth Appellate District, June 30, 2014). 

The Opinion by the California Court of Appeal (the "Court") finally provides us with the detail so woefully lacking in the FINRA Decision. By way of background, we learn:

Morgan Stanley recruited Appellants away from UBS Securities, and Appellants have worked for Morgan Stanley as investment advisors since 2008. Appellants contended that they were induced to join Morgan Stanley based on express promises made by Morgan Stanley management that: (1) Vitale would become a salaried sales manager within six months of joining Morgan Stanley and a branch manager within a year of joining the firm; and (2) once Vitale transitioned his clients to Morgan Stanley and became a salaried manager, Paladino would take over his and Vitale's combined books of business. 

Morgan Stanley did not make Vitale a salaried manager. Consequently, Paladino never was able to take over the combined books of business . . .

Pages 2-3 of the Court Opinion

As the FINRA arbitration made its way on appeal through the California state court system, a key point of contention revolved around the selection of and disclosures by Barry E. Kersh, one of three arbitrators (the industry panelist) on the hearing panel. As explained in the Court's Opinion:

Morgan Stanley's primary complaints about the arbitration award were: (1) Kersh failed to disclose that his son-in-law, Matthew Childs, was an advisor working with Morgan Stanley in the San Diego area, and had been recruited to work for Morgan Stanley from Southwest, where Kersh works; (2) Childs and Kersh's daughter, Mandy Childs (Mandy),2 were in the midst of a contentious marital separation; (3) Kersh's other son-in-law, Andrew Harvey, who works with Kersh at Southwest was aggressively recruited by Morgan Stanley, albeit unsuccessfully; and (4) Mandy allegedly had one or more investment accounts at Morgan Stanley. In raising those contentions, Morgan Stanley added: "Members of the [Morgan Stanley] management team involved in the recruitment of Mr. Childs and Mr. Harvey were involved in the events underlying the arbitration proceedings, some of them even testified at the arbitration."

Page 6 of the Court Opinion

The Superior Court of San Diego County granted Morgan Stanley's petition to vacate the arbitration award. That lower court found that Kersh had failed to make the necessary disclosures concerning his background and affiliations; and, further, that Appellants had not proven that Kersh's relationships to Morgan Stanley were known by Morgan Stanley. The matter was then appealed to the Court of Appeals, which found:

Although we conclude the arbitrator failed to make certain disclosures, these undisclosed facts could not cause an objective observer to doubt the arbitrator's impartiality. In addition, we determine Morgan Stanley was aware of certain key facts, namely its efforts to recruit two of the arbitrator's coworkers, and thus the arbitrator was not required to disclose those facts. We reject Morgan Stanley's argument that the arbitrator's failure to disclose that the two coworkers recruited by Morgan Stanley were his sons-in-law or that he had a poor relationship with one of the recruited coworkers, who now works at Morgan Stanley, but played no role in the subject arbitration, justified the order vacating the arbitration award. We therefore reverse the order vacating the arbitration award with directions to the superior court to enter an order confirming the arbitration award. Because we reverse that order, we do not reach Appellants' appeal of the order denying their motion for reconsideration.

Page 1 of the Opinion

In explaining its rationale, the Court noted that:

The superior court vacated the arbitration award on two primary grounds. One, Kersh did not disclose that his daughter had worked for a brokerage firm in the past. Two, Kersh did not disclose that his daughter had investment accounts with Morgan Stanley. Based on these omissions, the court found that Kersh "failed to comply with [FINRA] Rule 13408" because he did not accurately respond to FINRA checklist question Nos. 8 and 17. Absent from the court's order, however, is any explanation regarding how Kersh's failure to make these disclosures would have caused "a person aware of the facts to reasonably entertain a doubt that the proposed neutral arbitrator would be able to be impartial."  . . .

Page 14 of the Court Opinion

More pointedly, the Court offers this analysis and explanation:

We do not conclude that Kersh's failure to disclose any of these facts supports the superior court's order vacating the arbitration award. Morgan Stanley did not sufficiently address why the familial relationship between Kersh on one hand and Harvey and Childs 23 on the other would create a reasonable belief that Kersh " 'was biased for or against a party for a particular reason.' [Citation.]" (Haworth, supra, 50 Cal.4th at p. 389, original italics.) The fact that Kersh was the father-in-law to both Harvey and Childs does not predispose Kersh to favor or disfavor Morgan Stanley. Indeed, Morgan Stanley makes no argument of perceived bias based on these relationships alone. Instead, Morgan Stanley contends a person could reasonably believe that Kersh would be biased against Morgan Stanley because of the financial impact on Kersh caused by Morgan Stanley's recruitment efforts. Thus, the critical fact is that Morgan Stanley recruited two of Kersh's coworkers, a fact actually known to Morgan Stanley before the subject arbitration.

In addition, we are not persuaded that Kersh's failure to disclose his turbulent relationship with Childs or the divorce proceedings involving Childs and Mandy would lead a " 'reasonable person' " who is a " 'well-informed thoughtful observer' " to doubt Kersh's impartiality. (See Haworth, supra, 50 Cal.4th at p. 389.) Childs and Kersh's strained relationship and the impending divorce do not create the impression that Kersh would be biased against Morgan Stanley in the subject arbitration. We do not deem it reasonable that an arbitrator would be biased against a large business entity merely because his son-in-law, with whom he has an acrimonious relationship, works for the entity and is getting a divorce from the arbitrator's daughter. This is especially true in the context of a FINRA arbitration where the subject arbitrator is the industry insider and would depend on his reputation within the industry for future work. In fact, the record makes clear that Morgan Stanley agreed to use Kersh in three other arbitrations, one of 24 which also involved Morgan Stanley's recruiting practices and resulted in an award largely in Morgan Stanley's favor. It is counterintuitive and speculative that Kersh would jeopardize his role as an arbitrator within a specific industry simply because he feels ill will toward his son-in-law who works at another brokerage firm.

Pages 22 -24 of the Court Opinion

In a press release from Erwin J. Shustak, Esq. and George C. Miller, Esq., of Shustak & Partners, P.C., which represented Morgan Stanley brokers Todd Vitale and John Paladino in the arbitration, Shustak commented that:

Morgan Stanley selected this same arbitrator to sit on this and three other FINRA cases in which the firm was a party. The firm had successfully recruited one of Kersh's sons-in-law away from Kersh's firm and unsuccessfully attempted to recruit his other son-in-law. As the appeals court found, MS knew these facts all along. Only after they lost this case and faced a $5 million award, did the firm cry foul. The appellate court held that Morgan Stanley could not sit back, wait to see the outcome of the case and, only when it was hugely unsuccessful, play 'gotcha' by trying to vacate the award relying on facts the firm knew all along.