During the evidentiary hearings, Claimants made an oral Motion for Discovery Sanctions against Respondent. Respondent opposed the Motion. The Panel held any ruling on the Motion for Discovery Sanctions in abeyance until the conclusion of the evidentiary hearings. After the hearings concluded, the Panel issued an Order on April 30, 2019, instructing the parties to file briefs on the Motion for Discovery Sanctions. Both parties filed briefs on or about May 31, 2019. In its Motion for Discovery Sanctions post-hearing brief, Claimants argued that Respondent failed to produce critical documents responsive to Claimants' discovery request and thereby concealed documents relevant to the central issues in the matter. In its opposition to the Motion for Discovery Sanctions post-hearing brief, Respondent argued, among other things, that it complied with all discovery obligations and did not engage in any conduct warranting sanctions. . . .
SIDE BAR: FINRA Arbitration Code Rules for Imposing SanctionsFINRA Code of Arbitration Procedure for Customer Disputes Rule 12212: Sanctions(a) The panel may sanction a party for failure to comply with any provision in the Code, or any order of the panel or single arbitrator authorized to act on behalf of the panel.Unless prohibited by applicable law, sanctions may include, but are not limited to:
- Assessing monetary penalties payable to one or more parties;
- Precluding a party from presenting evidence;
- Making an adverse inference against a party;
- Assessing postponement and/or forum fees; and
- Assessing attorneys' fees, costs and expenses.
(b) The panel may initiate a disciplinary referral at the conclusion of an arbitration.(c) The panel may dismiss a claim, defense or arbitration with prejudice as a sanction for material and intentional failure to comply with an order of the panel if prior warnings or sanctions have proven ineffective.FINRA Code of Arbitration Procedure for Customer Disputes Rule 12511: Discovery Sanctions(a) Failure to cooperate in the exchange of documents and information as required under the Code may result in sanctions. The panel may issue sanctions against any party in accordance with Rule 12212(a) for:
- Failing to comply with the discovery provisions of the Code, unless the panel determines that there is substantial justification for the failure to comply; or
- Frivolously objecting to the production of requested documents or information.(b) The panel may dismiss a claim, defense or proceeding with prejudice in accordance with Rule 12212(c) for intentional and material failure to comply with a discovery order of the panel if prior warnings or sanctions have proven ineffective.
Claimants (joint and several): $2,000 Initial Claim Filing Fee; $200 discovery-related motion fees; $32,900 in hearing session feesRespondent Morgan Stanley: $3,025 Member Surcharge; $6,175 Member Process Fee; $200 discovery-related motion fees; $33,350 in hearing session fees
During the course of the evidentiary hearing, the Panel was made aware of Respondent's alleged failure to comply with a discovery request Order, which was granted pre-hearing by the prior Chairperson with respect to the production of documents related to the termination of a key employee of Respondent. After hearing oral argument on the issue by both parties, the full Panel issued the same Order as was previously issued by the prior Chairperson for production of "all" related documents by midnight. The Panel noted that the prior Chairperson's Order did not limit itself to "pre-termination" or "post-termination" documents when it stated "all." Respondent did not send the requested documents to Claimants' counsel by midnight, nor did Respondent's counsel provide opposing counsel with the courtesy of an email by midnight explaining why "all" the ordered documents were not being produced. The evidentiary hearing was delayed, for a second time, to permit both parties to provide oral argument on the "settlement privilege" which Respondent's counsel alleged applied to the documents that Respondent was withholding and proposing to have the Panel review "in camera." The Panel again ordered the withheld documents to be handed to Claimants' counsel, and not to the Panel for in camera review. The Panel took note of the extreme prejudice Respondent's failure of compliance caused Claimants' counsel in preparing their case and asserting their claims without the withheld documents which the Panel deemed were highly relevant to the dispute in question, the central figure of which was the terminated employee whose related documents were being withheld. Claimants' counsel repeatedly requested that Respondent be assessed monetary sanctions for its failure of compliance with the Panel's Orders. At the conclusion of the evidentiary hearing, the Panel ordered both parties to submit post-hearing briefs on the issue of the sanctions requested by Claimants against Respondent.The Panel noted that Rule 12506(b)(2) of the Code related to parties' obligation to "act in good faith when complying with subparagraph (1) of this rule. 'Good faith' means that a party must use its best efforts to produce all documents required or agreed to be produced. If a document cannot be produced in the required time, a party must establish a reasonable timeframe to produce the document." The Panel also took note of Rule 12212 of the Code related to sanctions: "(a) The panel may sanction a party for failure to comply with any provision in the Code, or any order of the panel or single arbitrator authorized to act on behalf of the panel. Unless prohibited by applicable law, sanctions may include, but are not limited to:Assessing monetary penalties payable to one or more parties; . . ."In accordance with the above, after due deliberation and upon consideration of the negative effect that Respondent's noncompliance with the Panel's Orders had on its efforts to achieve a fair arbitration hearing, the Panel hereby orders Respondent to pay monetary sanctions to Claimants in the amount of $3,000,000.00. . .
SIDE BAR: Note that Morgan Stanley was not so much embroiled in a pre-hearing Discovery dispute with complaining customers as it was ordered by the Panel of Arbitrators during the course of the evidentiary hearing to produce specified documents.The production was not to take place "round" midnight or "after" midnight BUT "by midnight."When the clock struck 12, Morgan Stanley was obligated to produce as ordered.And Morgan Stanley's gamesmanship continued with delays and an insistence upon a preliminary in camera review. An exasperated FINRA Arbitration Panel noted the "extreme prejudice" Morgan Stanley's non-compliance caused Claimants' counsel in preparing their case and asserting their claims without the withheld documents, which the Panel deemed were "highly relevant." Wall Street has promulgated a mandatory form of arbitration upon its customers with FINRA's approval. If Wall Street wants to play games with those who would prefer to be in court, then it's time that FINRA Arbitration Panels start sending a message about the cost of non-compliance with FINRA's Code of Arbitration. The larger question is whether FINRA-the-regulator will act upon the industry's penchant for jerking around customers during mandatory arbitration. By way of testing FINRA's impartiality and consistency, let's see if the regulator tackles Morgan Stanley's conduct in the Torres/Litovitch-Quintana arbitration.
The FINRA arbitration award- which imposes a $3 million discovery sanction that is nearly twelve times the compensatory damages award of 5261,42I.63, almost six times the Petitioners' claimed attorneys' fees for the entire case, and nearly $1 million more than the sanctions Petitioners requested - must be vacated under the Federal Arbitration Act, 9 U.S.C. $ 10 (the "FAA"). The sanction was not coercive (the documents had been produced months earlier), the sanction was not remedial and had no bearing on Petitioners' costs or fees for the discovery issue (there was no spoliation issue and Petitioners stated in writing that the discovery issue required "several hours" of additional time at the hearing and approximately a "dozen" additional hours to address), and the sanction was undeniably punitive in violation of applicable law and beyond the authority of the arbitrators. Not only did the arbitrators exceed their authority, two of the three arbitrators failed to comply with FINRA disclosure rules, creating a presumption of evident partiality.
Two arbitrators failed their most fundamental obligation as arbitrators by making incomplete and inaccurate disclosures that were expressly required by FINRA Rules. The integrity of arbitration depends upon impartial arbitrators who fairly decide cases on the merits and disclose any and all prior interests, relationships, or circumstances that may create an "impression of possible bias." Commonwealth Coatings,Inc. v. Continental Cas. Co., 393 U.S. 145, 148-9 (1968). The failure to make such disclosures requires vacatur. Id.Here, Arbitrator Jill Pilgrim (who is an attorney) failed to disclose the fact that she had been named in a foreclosure action brought by CitiMortgage, Inc., which was an affiliate of Citigroup Global Markets, Inc. ("CGMI") - a key entity in the underlying arbitration and a party to the joint venture Morgan Stanley Smith Barney LLC ("MSSB"). This undisclosed foreclosure action was filed at the same time Petitioners were allegedly losing money due to an "illegal loan" scheme by CGMI. Tr. 45-6; 54 at.5; also Ex. 61.2 CGMI was also the broker-dealer that acted as custodian, executed trades and was a lender for Petitioners' investment accounts when they were opened. [Ex. 8 at 6I]. Arbitrator Pilgrim's foreclosure and subsequent loan modification with an affiliate of CGMI during the period at issue in this dispute was expressly required to be disclosed under FINRA rules (in fact, she disclosed a foreclosure action involving Wells Fargo (an unrelated party) but not the one with CitiMortgage). Her failure to disclose the action and related loan modification in an arbitration involving CGMI's lending practices creates a presumption of partiality and requires vacatur under 9 U.S.C. $ 10(a)(2).Separately, Arbitrator Ruiz (also an attorney) failed to disclose that she had brought a medical malpractice action for herself and her deceased child, and that those claims were dismissed with prejudice on appeal based solely on the Puerto Rico statute of limitations - which was the key legal defense MSSB asserted in the arbitration Instead, Arbitrator Ruiz made an incomplete and potentially misleading disclosure referencing only a claim on behalf of another minor son that was settled with court approval. Although FINRA Rules require ongoing disclosure of non-securities related litigation (including disclosure of any details that might have relevance to the pending arbitration), Ms. Ruiz made no mention that the very same Puerto Rico statutes of limitation at issue in the arbitration had been enforced to extinguish the claims she brought for herself and a deceased son. Arbitrator Ruiz's loss was undoubtedly tragic, but MSSB had aright to know how Arbitrator Ruiz was directly impacted by the central legal defense in the arbitration, and this failure to disclose creates an impression of bias and independently requires vacatur under 9 U.S.C. $ 10(a)(2).
On October 12, 2017, Petitioners requested MSSB produce all email correspondence or agreements relating to the termination of MSSB's former employee, Angel Aquino ("Mr. Aquino"). ECF No. 18 at 3. After MSSB objected to producing these documents, Petitioners filed a Motion to Compel. Id. On November 8, 2018, the arbitration panel ordered MSSB to produce the documents by December 10, 2018. Id.On January 14, 2019, the first day of evidentiary hearings, Petitioners discovered that Mr. Aquino sent a demand letter to MSSB that led to a settlement agreement wherein MSSB paid Mr. Aquino $250,000. ECF No. 18-3 at 1. Petitioners asked MSSB to turn over the demand letter and any related "e-mail and letter traffic outlining the nature of his claim and what led to this newly revealed $250,000 payment." Id. Petitioners believed MSSB was required to turn over these documents under the discovery order issued November 8, 2018, and they made an ore tenus motion for sanctions based on MSSB's alleged violation. Id. at 2 ("I want sanctions, Madam Chair. I should not be walking into a hearing for my clients that lost $3 million and be sandbagged by those lawyers."). After hearing argument, the arbitration panel ("the Panel") ordered MSSB to produce the settlement agreement as well as any "document related to Mr. Aquino that has not been produced." ECF No. 18-3 at 3. Although MSSB believed the documents relating to the settlement were outside the scope of the parties' discovery agreement, MSSB produced the settlement agreement that evening. ECF No. 9 at 11. MSSB did not provide any emails.The next morning, Petitioners renewed their request for all "e-mail traffic" related to the settlement. ECF No. 9-39 at 3. The Panel ordered MSSB to produce those documents by the end of the day. ECF No. 9 at 13. While MSSB located 37 pages of emails related to the settlement that day, it did not provide them to Petitioners because it believed they were privileged. Id. On January 16, 2020, the Panel overruled MSSB's privilege objections and ordered MSSB to produce the documents. Id. MSSB produced the email documents that day. Id. Petitioners again moved for sanctions. ECF No. 18 at 4. Finally, on January 20, 2019, MSSB produced 240 pages of documents encompassed by the Panel's order. Petitioners moved for sanctions in the amount of $50,000 per day since December 10, 2018, the date it believed the documents should have been produced under the original discovery order. Id. The Panel reserved judgment on the motions for sanctions. Id.
Three public arbitrators served on the Panel that issued the Award: Barr, Pilgrim, and Ruiz. Id. at 7. Each arbitrator signed an Oath of Arbitrator containing a Disclosure Checklist, which states the questions contained within are "intended to help [the arbitrator] comply with the disclosure requirements as stated in FINRA Rule 12405 of the Customer Code and Rule 13408 of the Industry Code." ECF No. 9-19 at 8. The Disclosure Checklist instructs arbitrators to "provide a full explanation" to any question to which they answered, "yes." ECF No. 9-19 at 3.On Arbitrator Ruiz's Disclosure Checklist, she answered, "Already on Disclosure Report," when asked "Have you ever been a party to a non-investment related lawsuit?" ECF No. 18-10 at 15. In the Disclosure Report, she made the following disclosure:A malpractice action against the hospital where my child was born. Because my son was a minor I was the plaintiff in his name K DP 2002-0262 (801) IRLANDA RUIZ AGUIRRE VS. HATO REY COMMUNITY HOSPITAL. We reached a settlement in 2013 that the Court approved. The case is inactive. My lawyer Arturo Luciano is the one who has all the documentation.ECF No. 18-9 at 6.After the Award was issued, MSSB discovered a Spanish-language decision on appeal in the case Arbitrator Ruiz disclosed in her Disclosure Report. ECF No. 9 at 11. The Court's review of the decision, which is attached to MSSB's Motion to Vacate (ECF No. 9- 31), reveals the following facts. In 1995, Arbitrator Ruiz gave birth to twin males; one of them passed away a few hours after birth and the other survived but suffered injuries. In 2002, Arbitrator Ruiz and her husband brought a medical malpractice suit against the hospital where she delivered her sons in their individual capacities and on behalf of their minor sons. In 2011, the appellate court dismissed the individual claims and the claims on behalf of Arbitrator Ruiz's deceased son pursuant to the Puerto Rico statute of limitations. The remaining claims on behalf of Arbitrator Ruiz's living minor son proceeded until, according to the Disclosure Report, the court approved a settlement between the parties in 2013. ECF No. 18-9 at 6.On Arbitrator Pilgrim's Arbitrator Disclosure Checklist, she answered, "Already on Disclosure Report," when asked, "Has any lender ever instituted foreclosure proceedings involving you or a property owned in whole or in part by you directly or indirectly?" ECF No. 18-13 at 5. In the Disclosure Report, she disclosed she had a mortgage from Wells Fargo Bank, with whom had been a defendant in two foreclosure proceedings. ECF No. 18- 12 at 6. She also disclosed she had a mortgage with "CitiMortgage (Citigroup)" and a home equity line of credit with "Citibank." ECF No. 18-12 at 4. MSSB contends that CitiMortgage was an affiliate of Citigroup Global Markets, Inc. ("CGMI"), who it argues was a "key entity in the underlying arbitration and a party to the joint venture Morgan Stanley Smith Barney LLC ("MSSB")." ECF No. 9 at 6. CGMI sold its interest in the joint venture in June 2013. ECF No. 18 at 10.After the Award was issued, MSSB discovered that in October 2013, CitiMortgage filed a foreclosure action against Arbitrator Pilgrim. ECF No. 9 at 9. Upon Arbitrator Pilgrim entering into a loan modification with CitiMortgage on January 16, 2014, CitiMortgage filed an Attorney's Affirmation with the court stipulating to discontinue the foreclosure action. ECF No. 9-23 at 2. The affirmation stated that Arbitrator Pilgrim was never served with the summons and complaint. ECF No. 9-23 at 1.
[A]rbitrator Ruiz was not directly impacted by the Statute of Limitations defense in the arbitration. There is no evidence she was directly impacted by any part of the arbitration. Rather, Arbitrator Ruiz was impacted by a statute of limitations defense raised in a totally unrelated lawsuit. MSSB asks this Court to find that a reasonable person would believe that a potential conflict existed because MSSB raised the same defense in a securities-related proceeding as a hospital raised in Ruiz's medical malpractice suit seven years earlier. The Court cannot do so. Accordingly, MSSB has failed to meet its burden to establish there was evident partiality in Arbitrator Ruiz.
While MSSB claims that Arbitrator Pilgrim's letter to CitiMortgage's counsel was "angry" there is no evidence in the record that would show Arbitrator Pilgrim harbored any animosity toward CitiMortgage. At most, the letter shows that Arbitrator Pilgrim was concerned with the behavior of Mr. Gallo, outside counsel for CitiMortage, and cautioned him that this issue "implicates [his] professional and ethical conduct." ECF No. 22-2. It is clear from the letter than Arbitrator Pilgrim did not understand why she was being served with foreclosure papers when CitiMortgage granted her a loan modification and her CitiMortgage Homeowner Support Specialist reassured her that there was no pending foreclosure action against her. See ECF 22-2. Contrary to MSSB's assertion, it can hardly be said that Pilgrim was "in litigation with CGMI's affiliate" when the foreclosure action was discontinued before service. ECF No. 22 at 4, n. 3.
The Court agrees with Petitioners that the sanctions award was compensatory rather than punitive. The Panel stated in the Award that they were ordering MSSB to pay Petitioners the monetary sanctions "upon consideration of the negative effect that [MSSB's] noncompliance with the Panel's Orders had on its efforts to achieve a fair arbitration hearing." ECF No. 9-12 at 4. The Panel noted "the extreme prejudice [MSSB's] failure of compliance caused [Petitioners'] counsel in preparing their case and asserting their claims without the documents which the Panel deemed were highly relevant to the dispute in question, the central figure of which was the terminated employee whose related documents were being withheld." ECF No. 9-12 at 3-4. . . .
at Page 7 of the 11Cir Opinion[M]organ Stanley's contention that Arbitrator Ruiz holds a potential bias against parties raising a Puerto Rico statute-of-limitations defense is the kind of remote, uncertain, and speculative assertion of partiality that cannot support a vacatur of an arbitration award. The district court committed no clear error in finding that the undisclosed information would lead no objective reasonable person to believe that a potential conflict existed.
Given the absence of overlap between the parties to the foreclosure action and the parties to the arbitration and that the undisclosed foreclosure action was discontinued more than three years before this arbitration was initiated, we cannot conclude that an objective reasonable person would believe a potential conflict existed. Morgan Stanley has failed to satisfy its burden of showing partiality that is direct, definite, and capable of demonstration.
Here, the Panel imposed monetary sanctions against Morgan Stanley pursuant to Rules 12212 and 12511. The Panel described Morgan Stanley's repeated failure to comply with the Panel's discovery orders. The Panel also noted that -- by withholding documents the Panel deemed "highly relevant to the dispute" -- Morgan Stanley's noncompliance with the Panel's discovery orders caused "extreme prejudice" to Petitioners.
[T]he Panel took note of the extreme prejudice Respondent's failure of compliance caused Claimants' counsel in preparing their case and asserting their claims without the withheld documents which the Panel deemed were highly relevant to the dispute in question, the central figure of which was the terminated employee whose related documents were being withheld. . . .
additional charges relating to the firm's failure to provide required supervisory materials to numerous arbitration claimants. The settlement announced today is the first of its kind - in that it provides for distribution of $9.5 million to two groups of customers who had arbitration claims against the firm. FINRA estimates that several thousand customers may be eligible to receive payments. FINRA also imposed a $3 million fine on the firm for its failure to provide pre-9/11 emails and updates to a supervisory manual.
Also as part of the settlement announced today, Morgan Stanley is required - again, at its own expense - to retain an independent consultant acceptable to FINRA to review the firm's procedures for complying with discovery requirements in arbitration proceedings relating to the firm's retail brokerage operations. The firm will be required to implement the independent consultant's recommendations for improving those procedures, or alternative improvements acceptable to the independent consultant.
"The integrity of our process demands that brokerage firms comply with their obligations to search diligently for, and provide in a timely way, information and documents required in arbitration proceedings and regulatory investigations," said Susan Merrill, FINRA Executive Vice President and Chief of Enforcement. "The action announced today underscores FINRA's commitment to ensuring that firms live up to those obligations. We are particularly pleased that this unique settlement directs the bulk of the monetary sanction to the customers in arbitrations, to remedy MSDW's discovery failures."