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When in Doubt, Disclose:
A Primer on Securities Arbitrator Disclosure and Recusal
ecurities arbitrations must be fair. That means that the "judges" - the arbitrators deciding a securities dispute - must disclose to the parties any real or potential conflicts of interest. They also must conduct an investigation to discover potential conflicts of interest. The "teeth" behind these requirements is that a court of law may vacate an arbitration award. Although not a routine occurrence, courts have vacated NASD arbitration awards because arbitrators failed to disclose real or perceived conflicts of interest, or even failed to conduct adequate investigations into such conflicts.
The starting point in the analysis is the NASD Code of Arbitration Procedure. Rule 10312 of the NASD Code of Arbitration Procedure requires potential arbitrators, "to disclose to the director of arbitration any circumstances which might preclude such arbitrator from rendering an objective and impartial determination." This includes any financial or personal interest in the outcome of the arbitration. Moreover, this also includes, "any existing or past financial, business, professional, family or social relationships that are likely to affect impartiality or might reasonably create an appearance of partiality or bias." Importantly, Rule 10312 gives the Director of Arbitration the authority to disqualify an arbitrator based upon the information that he/she discloses.
Moreover, prospective arbitrators should disclose to the parties any relationship that they, their families, or business partners may have with any party involved in the arbitration, any of the parties' counsel, or any of the witnesses to be called at the arbitration hearing. Arbitrators are required to disclose not only actual conflicts of interest, but also anything that might give an appearance of partiality. Notably, the duty to disclose continues throughout the course of the arbitration proceeding, and an arbitrator is required to disclose any interest, relationship, or circumstances that arise, are recalled or are discovered.
Additionally, prospective arbitrators are also required to make a reasonable investigation in order to discover potential conflicts of interest such as those discussed above. In a case out of the U.S. Court of Appeals for the Ninth Circuit, an NASD arbitration award was vacated after it was discovered that the panel chairman's law firm had represented the parent company of the respondent brokerage firm. Notably, the arbitrator at issue failed to conduct an investigation prior to serving as an arbitrator on the panel, and he was unaware of the perceived conflict.
Citing to the NASD Code of Arbitration Procedure, the court stated that the NASD Rule 10312 required the chairman, a lawyer, to conduct an investigation prior to the arbitration hearing regarding the parties involved. The court noted that while a lack of knowledge of a conflict of interest may preclude a finding of actual bias, an impression of partiality can be found where a conflict of interest exists and the panel chairman/lawyer could have discovered it by conducting a reasonable investigation.
In another case on point, the U.S. Court of Appeals for the Eighth Circuit vacated an NASD arbitration award where an arbitrator was employed (as the VP, CFO and compliance officer, in fact) of an investment firm that did a substantial amount of business with the respondent brokerage firm. The arbitrator failed to disclose not only his position at his firm, but also his firm's business relationship with the respondent.
In that case, the court found that the duty of disclosure extends specifically to arbitrators' indirect relationships, such as those between their employers and any arbitration party or its counsel.
Arbitrators and others frequently consult the NASD Arbitrator's Reference Guide for guidance on numerous issues that arise in arbitration. Regarding disclosure and recusal, the guide contains a checklist for use by a potential arbitrator when he/she is determining whether to participate in a hearing. The checklist asks the prospective arbitrator to answer questions such as:
Have you or your family maintained an account individually or beneficially with the respondent brokerage firm?
Have you ever sued or been sued by a brokerage firm?
Have you ever been sued in connection with a securities matter that you handled for an Investment? and
Have you or a member of your immediate family invested in or held any of the securities that are the subject of this dispute
during the time periods in question?
In closing, there obviously is a wide variety of situations where a conflict of interest may exist or arise. In order to ensure the integrity of the arbitration process, arbitrators must do a thorough job investigating and disclosing any and all potential conflicts.
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Sponsored by James J. Eccleston, an attorney representing stockbrokers, financial planners and
investors nationwide in arbitration, litigation and regulatory matters, and a shareholder with the law firm
Shaheen, Novoselsky, Staat, Filipowski & Eccleston
P.C.(www.snsfe-law.com). This Web site contains material
of general interest. It is neither intended to, nor constitutes, either legal advice or investment advice.
Always consult an attorney and/or investment advisor when building and protecting your wealth.
All content Copyright © 2008 Advocate Capital Management, Inc. except where noted. All rights reserved.
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