Commercial Litigation and Arbitration

Arbitration — Elements for Proving Fraud in Procuring Award — Error of Expert Witness Insufficient — Error of Fact or Law by Arbitrators ≠ Reversible Act of Exceeding Their Powers

Morgan Keegan & Co. v. Garrett, 2012 U.S. App. LEXIS 22057 (5th Cir. Oct. 23, 2012):

A group of eighteen investors (collectively, "Appellants") alleged that Defendant-Appellee Morgan Keegan & Company, Inc. ("Morgan Keegan") engaged in a fraudulent scheme that induced Appellants to invest substantially in four highly risky mutual funds that Morgan Keegan managed and sold (the "Funds"). Accordingly, Appellants brought claims before an arbitration panel of the Financial Industry Regulatory Authority ("FINRA") pursuant to the Texas Securities Act and for statutory and common-law fraud. The arbitration panel ultimately issued an award in Appellants' favor. Morgan Keegan moved to vacate the award and Appellants moved to confirm. The district court vacated the award and granted Morgan Keegan attorneys' fees and expenses. The court based its decision on a finding that either the award was procured by fraud, or, alternatively, that the arbitration panel exceeded its powers. Because we conclude that these holdings were in error, we REVERSE and REMAND with instructions to enter judgment enforcing the arbitration award.

I. Facts and Procedural History

In their Second Amended Statement of Claims, Appellants alleged that Morgan Keegan "misleadingly and intentionally overvalued assets held by the Funds and used principal from the Funds to pay purported dividends to maintain the illusion that the investments were sound, making the [F]unds essentially operate as a 'Ponzi' scheme." ***

Before the final arbitration hearing, Morgan Keegan filed motions in the arbitration proceeding to declare the claims at issue not subject to FINRA arbitration. Specifically, Morgan Keegan alleged that Appellants' claims were derivative claims, and therefore not subject to FINRA arbitration. In addition, Morgan Keegan argued that Appellants William C. Goodwin ("Goodwin") and J. Stephen Harris ("Harris") were not "customers" of Morgan Keegan so there was no binding agreement to arbitrate their claims. The arbitrators rejected Morgan Keegan's arguments, and the arbitration continued.

At the final arbitration hearing, Dr. Craig McCann ("Dr. McCann"), a securities analyst, provided expert testimony on Appellants' behalf. Dr. McCann testified to, inter alia, his calculations of the percentage of losses in the Funds attributable to losses on the Funds' internally-priced securities that Morgan Keegan had allegedly deliberately overpriced. The arbitration panel issued an award in Appellants' favor.

Approximately one week later, Dr. McCann testified in the related Arispe arbitration regarding the Funds' losses due to internally-priced securities. In that proceeding, however, Dr. McCann testified to different numbers than he had testified to in the earlier Garrett arbitration. In doing so, Dr. McCann explained that one of his staff members had failed to account for certain internally-priced securities in the calculations, and that correcting the mistakes had generated different numbers. In addition, Dr. McCann asserted that he had learned of the errors after giving his testimony in the Garrett arbitration. It is undisputed that Dr. McCann's corrected numbers were provided to Morgan Keegan (through the same lawyers) in conjunction with the Arispe arbitration almost two weeks before the award issued in Garrett.


According to the district court's opinion, the arbitrators had exceeded their authority because (1) the panel heard claims from Goodwin and Harris, with whom Morgan Keegan had no agreement to arbitrate, and (2) Appellants' claims were derivative claims and therefore were not subject to FINRA arbitration. Morgan Keegan & Co. v. Garrett, 816 F. Supp. 2d 439, 441-42 (S.D. Tex. 2011). Alternatively, the district court vacated the award on the ground that it was procured by fraud because Dr. McCann had knowingly testified to incorrect numbers, and "the [arbitration] panel based its damages calculations on [Dr. McCann's] knowingly false testimony." Id. at 442. ***

After prevailing on its motion to vacate the arbitration award, Morgan Keegan moved for an award of attorneys' fees and expenses incurred in the district court proceedings from all Appellants except Goodwin and Harris pursuant to the Attorneys' Fees Provision contained in the Morgan Keegan Client Agreements (the "Attorneys' Fees Provision"). The district court granted Morgan Keegan's motion, and awarded $150,000 in attorneys' fees and $11,374.06 in expenses. ***

A. Order Vacating the Arbitration Award


This case involves the vacatur of an arbitration award on two of the four available statutory grounds for vacatur delineated in § 10 of the Federal Arbitration Act (the "FAA"). See 9 U.S.C. § 10(a); Hall St., 552 U.S. at 584-86 (2008) (holding that §§ 10 and 11 provide the "exclusive grounds for expedited vacatur" under the FAA). Specifically, the district court concluded that Dr. McCann provided knowingly false testimony to the arbitration panel so that vacatur of the award for fraud under § 10(a)(1) was appropriate. In addition, the district court determined that vacatur of the award was appropriate under § 10(a)(4) because the arbitrators had exceeded their powers by hearing claims not subject to FINRA arbitration, in particular, derivative claims and the claims of Goodwin and Harris with whom Morgan Keegan claimed it had no agreement to arbitrate.

1. The District Court Erred in Holding that the Arbitration Award was Procured by Fraud


"Enforcement of an arbitration award may be refused . . . if the award was procured by fraud." Karaha Bodas Co. v. Perusahaan Pertambangan Minyak Dan Gas Bumi Negara, 364 F.3d 274, 306 (5th Cir. 2004). This court has recognized that "[f]raud requires a showing of bad faith during the arbitration proceedings, such as bribery, undisclosed bias of an arbitrator, or willfully destroying or withholding evidence." Trans Chem. Ltd. v. China Nat'l Mach. Imp. & Exp. Corp., 978 F. Supp. 266, 304 (S.D. Tex. 1997), aff'd and adopted by, 161 F.3d 314 (5th Cir. 1998). Furthermore, "[t]here is no doubt that perjury constitutes fraud within the meaning of the [FAA]." Bonar v. Dean Witter Reynolds, Inc., 835 F.2d 1378, 1383 n.7 (11th Cir. 1988).

Under Section 10(a)(1) of the FAA, "a party who alleges that an arbitration award was procured by fraud must demonstrate: (1) that the fraud occurred by clear and convincing evidence; (2) that the fraud was not discoverable by due diligence before or during the arbitration hearing; and (3) the fraud materially related to an issue in the arbitration." Barahona v. Dillard's, Inc., 376 F. App'x 395, 397 (5th Cir. 2010) (unpublished); see also Karaha Bodas, 364 F.3d at 306. With regard to the third prong, although "[i]t is not necessary to establish that the result of the arbitration would have been different if the fraud had not occurred," Karaha Bodas, 364 F.3d at 306-07, section 10(a)(1) does require "a nexus between the alleged fraud and the basis for the panel's decision," Forsythe Int'l, S.A. v. Gibbs Oil Co. of Tex., 915 F.2d 1017, 1022 (5th Cir. 1990). Under the FAA, Morgan Keegan must meet its burden of proof on each of the three prongs. See Barahona, 376 F. App'x at 398 & n.2 (declining to reach two of the prongs because failure to satisfy even one of the three was dispositive). Because Morgan Keegan failed to satisfy the second prong, we conclude that the district court erred in vacating the arbitration award on fraud grounds and therefore we do not reach the other prongs.

Footnote 4. We note, however, the total absence of any evidence supporting a finding that Dr. McCann committed intentional fraud. The evidence presented supports nothing more than a conclusion that a member of Dr. McCann's staff made a calculation error that he did not discover until after he testified in the Garrett arbitration.

During the Arispe arbitration and prior to the issuance of the award in the Garrett arbitration, Dr. McCann provided revised calculations that show the error now claimed by Morgan Keegan to constitute the "fraud." Those calculations were provided to the same lawyers who represent Morgan Keegan in Garrett. Additionally, the calculations by Dr. McCann -- both erroneous and "correct" -- used Morgan Keegan's own numbers. Had Morgan Keegan performed its due diligence, the fact that Dr. McCann's calculations failed to include some internally-priced securities would have been discovered even before Dr. McCann testified in the Garrett arbitration, thus obviating any concern that the arbitration panel would rely on erroneous calculations in issuing the award. Accordingly, Morgan Keegan "cannot meet its burden of proof" under the second prong because the grounds for fraud were discoverable by due diligence before or during the Garrett arbitration. Barahona, 376 F. App'x at 398. Thus, we conclude that Morgan Keegan presented no evidence that this "fraud" was not discoverable sooner. See Trans Chem., 978 F. Supp. at 306 ("CNMC also fails to meet . . . the three-part test for showing fraud or undue means . . . because it has not shown that TCL's allegedly improper behavior was not discoverable by due diligence before or during the arbitration hearing."). Thus, even if the evidence supported a finding of fraud, which it does not, this prong is unsatisfied; we conclude that the district court erred in vacating the arbitration award on fraud grounds and expressly vacate the finding that Dr. McCann committed fraud.

2. The District Court Erred in Holding that the Arbitrators Exceeded Their Powers

Even absent a finding of fraud, the district court could properly have vacated the arbitration award if the arbitrators exceeded their powers. See Valentine Sugars, Inc. v. Donau Corp., 981 F.2d 210, 213 (5th Cir. 1993); see also Delta Queen Steamboat Co. v. Dist. 2 Marine Eng'rs Beneficial Ass'n, 889 F.2d 599, 602 (5th Cir. 1989) ("Judicial review of arbitration awards is extremely limited. . . . However, federal courts [may] scrutinize the award to ensure that the arbitrator acted in conformity with . . . jurisdictional prerequisites. . . . Where an arbitrator exceeds his contractual authority, vacation or modification of the award is an appropriate remedy.") (internal citations omitted). That said, "in deciding whether the arbitrator exceeded his jurisdiction, 'any doubts concerning the scope of arbitrable issues should be resolved in favor of arbitration.'" Kergosien v. Ocean Energy, Inc., 390 F.3d 346, 355 (5th Cir. 2004), overruled on other grounds by Hall St., 552 U.S. at 584-86 (quoting Moses H. Cone Mem'l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983)); see Am. Eagle Airlines, Inc. v. Air Line Pilots Ass'n, Int'l, 343 F.3d 401, 405 (5th Cir. 2003) ("Where the arbitrator is 'even arguably construing or applying the contract and acting within the scope of his authority the fact that a court is convinced he committed serious error does not suffice to overturn that decision.'" (quoting E. Associated Coal Corp. v. United Mine Workers of Am., Dist. 17, 531 U.S. 57, 62 (2000))). ***

Here, the undisputed evidence proves that the parties had an agreement to arbitrate. Appellants' Standard Client Agreements with Morgan Keegan provide that "all controversies between the undersigned and Morgan Keegan (or any of Morgan Keegan's present or former officers, directors, agents or employees) which may arise from any account or for any cause whatsoever, shall be determined by arbitration." ***

In addition, after the instant dispute arose, both sides -- including Goodwin and Harris -- agreed to the FINRA Submission Agreement with respect to Appellants' suit. In doing so, the parties agreed to "submit the present matter in controversy, as set forth in the . . . statement of claim, answers, and all related cross claims, counterclaims and/or third-party claims which may be asserted, to arbitration in accordance with the FINRA By-Laws, Rules, and Code of Arbitration Procedure." Thus, it is clear that the parties expressly agreed to abide by the FINRA Rules, which provide at Rule 12409 that "[t]he panel has the authority to interpret and determine the applicability of all provisions under the Code. Such interpretations are final and binding upon the parties." Accordingly, because the parties agreed to submit the instant issues to arbitration, we may only set aside the arbitration panel's decision in "very unusual circumstances." First Options, 514 U.S. at 942. The potentially "unusual circumstance[]" at issue is whether the arbitration panel "exceeded [its] powers" under § 10(a)(4). We conclude that it did not.

The district court erroneously held that the arbitrators exceeded their authority by arbitrating derivative claims and Goodwin's and Harris's non-"customer" claims. In doing so, the district court impermissibly premised its decision to vacate upon finding error in the arbitration panel's conclusion that Appellants' claims were not derivative and that Goodwin's and Harris's claims were "customer" claims. The high standard for the district court to vacate the arbitration panel's award on the merits was unmet here. See, e.g., Stolt-Nielsen S.A. v. AnimalFeeds Int'l Corp., 130 S.Ct. 1758, 1767 (2010) (noting that a party seeking vacatur of an arbitration award "must clear a high hurdle," and that "in order to obtain that relief . . . [i]t is not enough . . . to show that the [arbitration] panel committed an error--or even a serious error"); United Paperworkers Int'l Union, AFL-CIO v. Misco, Inc., 484 U.S. 29, 36-38 (1987) ("The courts are not authorized to reconsider the merits of an award even though the parties may allege that the award rests on errors of fact or on misinterpretation of the contract. . . . 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."); Reed v. Fla. Metro. Univ., Inc., 681 F.3d 630, 637 (5th Cir. 2012) ("[A] court may not decline to enforce an award simply because it disagrees with the arbitrator's legal reasoning.").

As stated above, FINRA Rule 12409 vested the arbitration panel with "the authority to interpret and determine the applicability of all provisions under the Code." Thus, it was clearly within the arbitration panel's scope of authority to decide whether, under the FINRA Rules, Appellants' claims were derivative and Goodwin and Harris were "customers" for purposes of arbitration. The arbitration panel determined that Appellants' claims were not derivative and that Goodwin and Harris were "customers," thereby subjecting the claims to FINRA arbitration under the Code. Because we conclude that the arbitration panel did not exceed its powers in reaching these conclusions, we decline to reach the merits of Morgan Keegan's assertions that Appellants' claims were derivative or that Goodwin and Harris were not customers. The district court erred in holding otherwise.

Share this article:


Recent Posts