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Arbitration: Analyzing Manifest Disregard, Restores Overturned Securities Award (Web)

In McCarthy v. Citigroup Global Markets Inc., No. 06-1001 (Sept. 19, 2006)(available at, the First U.S. Circuit Court of Appeals reversed a district court's decision to vacate an arbitration, finding that an arbitration panel award was not in manifest disregard of the law.

The district court had analyzed the award’s merits and found legal error. That analysis, a unanimous First Circuit panel found, is proscribed by the standards of review that apply. The appeals court vacated the district court's ruling and directed the district court to enter a judgment confirming the arbitration award.

While an employee, McCarthy participated in a capital accumulation plan–referred to below as the “CAP Plan,” which was sponsored by CGMI's parent company, Traveler's Group Inc. The CAP Plan is a program designed to retain employees by giving them the opportunity to purchase restricted Citigroup shares, either in the form of Citigroup restricted stock at discounted prices on a tax-deferred basis, or as grants of nonqualified stock options for Citigroup common.

McCarthy resigned in May 2003, but sought to recover his CAP Plan contributions that had resulted in unvested shares, as well as funds that had not been used to purchase shares. The CAP Plan forfeited unused allocated funds in the event employment ended, even though the funds are deducted from wages.

Under the parties' arbitration agreement, and the securities industry’s regulatory framework, McCarthy initiated arbitration proceedings against CGMI with the National Association of Securities Dealers in December 2003. He asserted statutory claims under New Hampshire wage laws, and equitable claims.

The first arbitration hearing, in November 2004, resulted in an award against McCarthy. The award stated that “While [McCarthy] invoked New Hampshire wage law to support his case, the Panel considered it irrelevant because the Panel considered the case to be a contract dispute regarding an inventive [sic] compensation plan commonly used at the firm and commonly used in the securities industry.”

On Dec. 16, 2004, McCarthy asked the district court to vacate the award. Focusing on the panel's use of the word “irrelevant,” the district court concluded that “the panel set aside the governing law in favor of its perception of an equitable result and industry practices. The panel's decision not to consider the New Hampshire wage laws demonstrates its disregard for the governing law.” According to the First Circuit, the district court saw the first panel's reasoning as an instance “where it is clear from the record that the arbitrator[s] recognized the applicable law--and then ignored it.”

The district court concluded that “the case [had to] be remanded to have McCarthy's claim decided under the New Hampshire wage laws through arbitration.”

McCarthy re-filed his claim with the NASD, which convened a second arbitration panel comprising three new arbitrators. McCarthy withdrew his equitable claims, focusing solely on his claims based on New Hampshire law.

In August 2005, the second panel issued its award denying McCarthy's claims with prejudice, noting,

[McCarthy] requested that the panel  . . . declare that the CAP Plan is illegal under New Hampshire law, to the extent the CAP Plan is implemented (i) through wage deductions, which are not actually used to purchase stock in Citigroup, or (ii) so as to cause employees to forfeit wages.

The panel heard testimony from McCarthy and both parties’ witnesses, and considered the documentary evidence from each side as well. It fully considered all claims and defenses, including the applicability of the New Hampshire wage laws. The panel denied all claims with prejudice.

In September 2005, McCarthy filed with the a motion to vacate the modified award, asserting again that the arbitrators had manifestly disregarded controlling law.

In a second remand order dated Dec. 15, 2005, the district court vacated the modified award because it was in manifest disregard of the law, and remanded the case for a third arbitration proceeding, if necessary.

According to the First Circuit panel’s opinion, the district court “focused on the Second Panel's statement that it had ‘fully considered all claims and defenses, including the applicability of the New Hampshire Wage Laws,’ and found in that statement a troubling ambiguity.”

The panel noted that the second arbitration panel didn’t say “whether it concluded that the wage laws were applicable or not applicable or whether it had applied that law in making its decision.” Since, unlike the first panel, the second panel's statement did not clearly demonstrate a manifest disregard of the governing law, “the second panel left open the possibility that, contrary to the court's direction in the [First] remand order, the panel concluded that the New Hampshire wage laws do not apply,” according to the second remand order.

In the absence of an express state of manifest disregard of the law, the district court decided to pursue a further inquiry, since there is authority for a court to go behind a panel’s award, to the record itself, in conducting a manifest disregard of the law inquiry. There is precedent, the First Circuit points out, that “there must be some showing in the record, other than the result obtained, that the arbitrators knew the law and expressly disregarded it.”

But that inquiry is limited, the appellate panel noted. The decision, notes that Federal Arbitration Act Section 10 (9 U.S.C. § 10) “authorizes vacatur of an award in cases of specified misconduct or misbehavior on the arbitrators' part, actions in excess of arbitral powers, or failures to consummate the award.”

The panel opinion explains that overturning an arbitration award, besides the Section 10 standards, “depends upon the challenger's ability to show that the award is (1) unfounded in reason and fact; (2) based on reasoning so palpably faulty that no judge, or group of judges, ever could conceivably have made such a ruling; or (3) mistakenly based on a crucial assumption that is concededly a non-fact.” (Citations omitted.)

Manifest disregard of the law stands for a situation “where it is clear from the record that the arbitrator recognized the applicable law--and then ignored it.” Advest Inc.v. McCarthy, 914 F.2d 6, 10 (1st Cir. 1990).

The First Circuit warns that the manifest disregard inquiry “must not run afoul of the well-established principle that courts ‘do not sit to hear claims of factual or legal error by an arbitrator as an appellate court does in reviewing decisions of lower courts.’”

The Court of Appeals concludes that the district court did not observe these limitations on its review authority. Instead of finding manifest disregard of the law by the second arbitration panel, the district court instead “found an application of the Wage Law with which it disagreed” after an extensive merits review.

The First Circuit lists several errors in the district court's second remand order: First, by insisting that the next arbitration panel provide an explanation for its decision to allow meaningful judicial review, the court ignored the basic principle that arbitration awards don’t need to be explained.

Second, while the district court theoretically left open the possibility that a third arbitration panel could explain why McCarthy's claim failed under New Hampshire law, its elaborate rejection of that possibility in its second remand order “delivered an unmistakable message to a third panel--such a decision would be difficult to justify,” the appellate opinion states, adding that courts should avoid such messages when remanding cases to arbitration panels.

Third, in looking behind the modified award, the court didn’t examine the record before the panel for manifest disregard of the law. Instead, the court conducted its analysis of the compatibility of the CAP Plan with the wage law and concluded that the award in favor of the employer was wrong.

The Court of Appeals vacated the district court's second remand order and directed the court to enter a judgment confirming the second panel's modified award in favor of CGMI.

--Victoria Brassart, CPR Intern