Opinion
No. 3:04-0963.
June 7, 2005
ORDER
For the reasons explained herein and in the Memorandum entered contemporaneously herewith, the Court rules as follows:
(1) Defendant's Request for Oral Argument (Docket Entry No. 10) is hereby DENIED on the ground that oral argument will not benefit the Court in this case;
(2) Plaintiffs' Motion to Vacate and Modify Arbitration Award (Docket Entry No. 1) is hereby GRANTED; and
(3) the Court modifies the arbitration award to provide as follows: the Hensons are entitled to recover from Morgan Stanley compensatory damages in the sum of $196,396.00, pursuant to Tenn. Code Ann. § 48-2-121 § 48-2-122; attorney's fees in the amount of $65,465.00, and litigation expenses of $13,027.00, pursuant to Tenn. Code Ann. § 48-2-122(f); and the claim filing fee of $1,425.00. Morgan Stanley is also responsible for the balance due on the arbitration fee of $5,625.00. Accordingly, this case is hereby DISMISSED.
IT IS SO ORDERED.
MEMORANDUM
Pending before the Court is the Motion to Vacate and Modify Arbitration Award (Docket Entry No. 1) filed by Plaintiffs Gerald and Gilda Henson, to which Defendant Morgan Stanley DW Inc., has responded in opposition. Venue lies in this Court under 9 U.S.C. §§ 10 11 because the matter was tried in Nashville, Tennessee, before an arbitration panel of the National Association of Securities Dealers on July 28 and 29, 2004, the panel entered its arbitration award in this District in August 2004, and Plaintiffs timely filed their Motion to Vacate and Modify Arbitration Award on October 22, 2004. (Docket Entry No. 3, Ex. III.)I. FACTS AND PROCEDURAL HISTORY
For many years Gerald Henson worked outdoors in technical positions for BellSouth in Knoxville, Tennessee. Gilda Henson held a clerical position at the U.S. Department of Energy. Both have had some health problems. In early 2000 BellSouth offered early retirement to some of its employees in the form of lump-sum cash payments rather than the pensions the employees expected to receive. For Gerald Henson, who was then 54 years old, this option meant the receipt of approximately $229,000 in cash. At that time, the Hensons jointly owned approximately $100,000 in cash that had been invested in Class A shares with a front-end load at American Funds in 1999 and Gilda Henson owned a retirement account in the approximate amount of $12,000. Hoping to accept BellSouth's offer of early retirement, the Hensons attended an investment seminar presented at the union hall by Adam Burnett and Brad Stafford of Morgan Stanley. The Hensons met with Burnett and Stafford at the conclusion of the seminar, and they met with Burnett once and Stafford once at the Morgan Stanley offices before deciding to open accounts at Morgan Stanley in the spring of 2000.
The parties disputed what transpired in those conversations. The Hensons testified at the arbitration hearing that they did not have investment experience and they wanted to know whether they could safely retire on their $340,000 in cash assets and still draw approximately $2,000 per month for living expenses. The Hensons testified that the investment advisors told them they could do so and recommended an investment strategy to them. They did not understand the differences between Class A and Class B shares of mutual funds, and the differences were not explained to them. The Hensons testified they agreed to transfer all of their cash and invest it in Class B shares of Morgan Stanley mutual funds in reliance on the advice they received.
The investment advisors testified that the Hensons informed them they were retiring and planned to do a lot of camping in their travel trailer and possibly work at campgrounds. They wanted to take the maximum allowable monthly cash, tax-exempt distribution from their retirement accounts, known as a 72(t) distribution, to fund their living expenses, and they did not want to pay a front-end load. The advisors explained to the Hensons the types of investment accounts available through Morgan Stanley and the differences in the kinds of shares. Given the size of the investment, the advisors warned the Hensons that they would have to maintain an aggressive investment strategy to avoid invading principal. The Hensons indicated they had seen the market rise and fall, they understood the risk of investing, and they wanted to take the maximum 72(t) distribution, which was $2,200 per month. A May 2000 notation in Burnett's calendar pertaining to the Hensons stated: "wanted 10% out a year an aggressive return. Understood all risks." (Docket Entry No. 3, Ex. XIX, Tab 3.)
In May 2000, the Hensons transferred to Morgan Stanley the $229,000 lump-sum retirement payment Gerald Henson received, $101,000 in joint assets, and $12,000 from Gilda Henson's retirement account. All of the cash was invested in Morgan Stanley mutual funds, which were predominantly stock funds. This occurred at the height of the bull market, which started a downward slide in June 2000 and continued into 2002. Stafford testified that he spoke with Gerald Henson about their declining investments, but Henson wanted to continue the initial strategy. Gerald Henson denied he spoke to Stafford or Burnett. By May 2002, the Hensons were unhappy with the substantial losses in their portfolio. They closed their Morgan Stanley accounts and moved their remaining funds to Edward Jones. Because the money had been invested in Morgan Stanley Class B shares, the Hensons were charged a back-end sales commission when the funds were transferred.
In the two-year period the funds were invested at Morgan Stanley, the Hensons withdrew approximately $55,000 under 72(t) for living expenses. Plaintiffs presented two experts who gave their opinions that the Morgan Stanley investments were unsuitably risky given the Hensons' age, financial condition, and other relevant factors. The experts also testified that Class A shares would have been a superior investment for the Hensons because they could have taken advantage of a breakpoint to reduce the front-end sales commission and they would have paid less in investment expenses over time. They stated that the investment of the entire portfolio in Class B shares violated Morgan Stanley's own policy that no more than $100,000 should be so invested. They also stated that the $101,000 the Hensons had invested in American Funds Class A shares should not have been transferred to Morgan Stanley because sales commissions had just been paid on those investments, expenses would have been lower, and the investments were suitable for the Hensons.
Defendant's expert testified that the Morgan Stanley investments were not unsuitably risky in light of the Henson's desire to take the maximum 72(t) distribution, which compelled a need for asset growth. Defendant's expert and Plaintiffs' damages expert independently calculated the total profit/loss in the Plaintiffs' accounts and arrived at the same numbers. Defendant's expert testified that the Hensons' investments, when compared to the SP 500 over the same period of time, underperformed by only $21,500. Plaintiffs' damages expert calculated the Plaintiffs' statutory damages under the Tennessee Securities Act, Tenn. Code Ann. § 48-2-121 48-2-122, and reached the undisputed figure of $196,396. Defendant's expert conceded that Morgan Stanley incorrectly charged sales commissions on Class B shares sold to satisfy the Hensons' 72(t) distributions.
The Hensons' Statement of Claim against Morgan Stanley asserted claims under federal and state securities laws, as well as state law claims for negligence, breach of fiduciary duty, and misrepresentation. They contended that they were entitled to recover what they termed "rescissionary" damages under Tenn. Code Ann. § 48-2-122(a) (1) (B), that is, their original investment, less the amount of income received when the securities were sold, plus the legal rate of interest, which is ten (10) percent. They sought punitive damages on the ground that Morgan Stanley had engaged in nationwide abuse in the sale of its Class B shares. (See Docket Entry No. 3, Ex. VI, Tab 9.) The Hensons also sought attorney's fees and litigation expenses.
The Hensons provided the arbitration panel with copies of the applicable provisions of the Tennessee Securities Act. (Docket Entry No. 3, Ex. VI, Tab 12.) During closing argument, their counsel discussed the Tennessee Securities Act and highlighted its language mandating a full recovery to the claimants. He also referred to other common law claims raised by the Hensons. Counsel asked for $196,396 in compensatory damages, $200,000 in punitive damages, $65,465 in attorney's fees (one-third contingent), $13,027 in litigation expenses, and $1,425 for the filing fee, for a total of $476,313. (Docket Entry No. 9, Hovani Decl., Ex. A.)
The arbitration panel issued a decision in favor of the Hensons finding that Morgan Stanley was "liable," but awarded compensatory damages only in the sum of $59,505.44. The panel did not explain how it arrived at that figure, nor did the panel identify under what statute or common law claim the damages were awarded. (Docket Entry No. 3, Ex. III.) The panel also awarded the Hensons $13,027 in litigation costs and $20,000 in attorney's fees under Tenn. Code Ann. § 48-2-122(f). The panel awarded the Hensons the claim-filing fee and denied the claim for punitive damages. The panel further required Morgan Stanley to pay $5,625.00 as the balance due for the arbitration fees.
The Hensons now ask this Court to modify the arbitration award, or in the alternative, to vacate the award and direct a new hearing on the grounds that the arbitrators exceeded their powers and acted in manifest disregard of the law by awarding damages in an amount different from the damage award required by the Tennessee Securities Act. Morgan Stanley opposes the motion, suggesting that the Court is limited by a very narrow standard of review and it does not appear that the panel acted in manifest disregard of the law or exceeded the scope of its powers. The panel may have awarded compensatory damages on one of the Hensons' common law claims rather than under the Tennessee Securities Act.
II. STANDARD OF REVIEW
This Court may set aside an arbitration award only if certain statutory or judicially created grounds are present. Merrill Lynch, Pierce, Fenner Smith, Inc. v. Jaros, 70 F.3d 418, 420 (6th Cir. 1995). A number of grounds are set out in the federal statutes, 9 U.S.C. §§ 9 10, permitting vacation of an award if there is a "breakdown in the integrity of the arbitration process itself." Id. As an alternative to the statutory grounds, the courts have created a basis for vacation where the arbitration award was made "in manifest disregard of the law." Id. at 421. This is a very narrow standard of review.Id. Mere error in interpretation or application of the law is not sufficient to meet the standard. Id. The decision must "fly in the face of clearly established legal precedent." Id. An arbitration panel does not act in manifest disregard of the law unless: "(1) the applicable legal principle is clearly defined and not subject to reasonable debate; and (2) the arbitrators refused to heed that legal principle." Id.
III. ANALYSIS
Tennessee Code Annotated § 48-2-122(a)(1) provides:Any person who:
. . .
(B) Sells a security in violation of § 48-2-121(a) (the purchaser not knowing of the violation of § 48-2-121(a), and who does not carry the burden of proof of showing that the person did not know and in the exercise of reasonable care could not have known of the violation of § 48-2-121(a));
shall be liable to the person purchasing the security from the seller to recover the consideration paid for the security, together with interest at the legal rate from the date of payment, less the amount of any income received on the security, upon the tender of the security, or, if the purchaser no longer owns the security, the amount that would be recoverable upon a tender, less the value of the security when the purchaser disposed of it and interest at the legal rate from the date of disposition.
Tennessee Code Annotated § 48-2-121(a) provides that it is unlawful for any person, in connection with the offer, sale or purchase of any security in Tennessee, directly or indirectly to:
(1) Employ any device, scheme or artifice to defraud;
(2) Make any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading; or
(3) Engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person.
Plaintiffs' Statement of Claim against Morgan Stanley relied on these statutes, which are included in the Tennessee Securities Act. The evidence in the record supported a finding under the statute that the Morgan Stanley brokers failed to state material facts that they necessarily were required to state in order to prevent other statements they made to the Plaintiffs from being misleading in light of all the circumstances. Plaintiffs' counsel brought to the attention of the arbitration panel the existence of the statutes in arguing the evidence, he provided copies of the statutes, he highlighted in his argument the mandatory language of § 48-2-122(a) (1) (B), and he asserted that Plaintiffs relied on the statutes in seeking a full recovery in damages against Morgan Stanley. While the arbitration panel expressly referred to Tenn. Code Ann. § 48-2-122(f) in awarding attorney's fees and costs to the Plaintiffs, the panel did not cite § 48-2-121 (a) and/or § 48-2-122 (a) (1) (B) in making its award of compensatory damages. The panel gave no clue as to the authority upon which it relied to award damages and the panel did not explain how it reached the damages figure of $59,505.44, when Defendant did not dispute that Plaintiffs' damages under Tenn. Code Ann. § 48-2-122(a)(1)(B) amounted to $196,396. As Plaintiffs point out, § 48-2-122(a)(1)(B) states that any person who violates § 48-2-121 (a) "shall be liable" to the purchaser for damages as calculated by the formula supplied in the statute. The panel found Morgan Stanley "liable."
An arbitration panel is not required to explain or give a reason for its award. Dawahare v. Spencer, 210 F.3d 666, 669 (6th Cir. 2000); Indocomex Fibres PTE, LTD v. Cotton Co. Int'l, Inc., 916 F. Supp. 721, 728 (W.D. Tenn. 1996). If this Court "can find any line of argument that is legally plausible and supports the award then it must be confirmed. Only where no judge or group of judges could conceivably come to the same determination as the arbitrators must the award be set aside."Jaros, 70 F.3d at 420.
The facts of the Dawahare case are distinguishable from the facts of the present case. There, an investor claimed that the investment advisor, Spencer, had engaged in unsuitable and excessive trading at two different brokerage firms, Smith Barney and Dean Witter, causing the investor more than $600,000 in damages. 210 F.3d at 668. The parties submitted the dispute to an arbitration panel with the National Association of Securities Dealers. Id. The panel denied the investor's claim against Smith Barney, but found in his favor against Dean Witter, awarding $25,000 in compensatory damages and $24,000 in punitive damages. Id. The panel also found Spencer liable for $1,000 in damages. Id. The investor moved to vacate the award and defendants moved to confirm the award. Id. The district court rejected the investor's contentions that the award was marked by evident partiality or was in manifest disregard of the law, id. at 669, and the Sixth Circuit affirmed. Id. at 671.
While noting the very narrow standard of review applicable to arbitration awards, the Sixth Circuit emphasized that Dawahare had pointed to nothing in the record that indicated the arbitration panel was aware of the law he alleged it ignored.Id. at 670. The court said this was "important because manifest disregard requires awareness of the relevant law." Id. The court stated that "Dawahare's vague assertion that the arbitrators manifestly disregarded the common law of damages falls far short of the necessary showing of the law that clearly applied in the case and of conscious disregard of that law by the arbitrators." Id. at 670-671. The court also observed that the investor's damages expert had been impeached on cross-examination and the arbitration panel was entitled to believe the expert's testimony entirely, in part, or not at all. Id. at 671. In light of these factors, the Sixth Circuit declined to engage in a more extensive review of the arbitration award. Id.
In this case, by contrast, Plaintiffs' attorney argued the applicable Tennessee statutes and provided copies of them to the arbitration panel. Defendant did not dispute that Plaintiffs' damages under the Tennessee statutes amounted to $196,396, if Morgan Stanley were found to be liable. Plaintiffs' expert was not impeached on this point, and there was no proof to the contrary as to the amount of Plaintiffs' damages. Yet, the arbitrators did not cite any legal authority to support their partial damages award, they did not provide any explanation as to how they reached the sum of $59,505.44, and they did not explain why they relied on § 48-2-122(f) to award attorney's fees and costs, but they ignored the statutory damages calculation formula contained in § 48-2-122 (a) (1) (B) as Plaintiffs requested.See King v. Pope, 91 S.W.3d 314, 323 (Tenn. 2002) (observing that "[s]ince the Tennessee Securities Act of 1980 was enacted with the goal of protecting investors, this Court's primary concern is with the investors of this state."); Ainsworth v. Skurnick, 960 F.2d 939, 939 (11th Cir. 1992) (upholding district court's decision to award investor mandatory damages under Florida securities statute where arbitrators found broker negligent, but failed to award damages); Specialized Tours, Inc. v. Hagen, 392 N.W.2d 520 (Minn. 1986) (holding Minnesota Securities Act, similar to Tennessee Securities Act, mandates full damages on finding of liability); Lambrecht v. Bartlett, 656 P.2d 269 (Okla. 1982) (holding similar securities statute provides damages calculation formula). Thus, the Court concludes that Dawahare, although similar to this case in many respects, is not controlling because its analysis can be distinguished on the salient points that convinced the Sixth Circuit to affirm the district court order confirming the arbitration award in that case.
Morgan Stanley contends that Plaintiffs' motion to vacate the award should be denied because the arbitration panel could have relied on one of the common law claims of negligence, breach of fiduciary duty or misrepresentation that Plaintiffs raised in order to determine the amount of damages awarded, without relying on the Tennessee Securities Act at all. While this speculative view might have some appeal because of the lack of any logical explanation, it seems nonsensical for the arbitration panel to award compensatory damages on some common law theory and yet award attorney's fees and costs under the very statute that mandates an award of compensatory damages to the Plaintiffs, § 48-2-122. Morgan Stanley strains the cohesion of the statute when it argues that subsection (f) does not, by its express terms, require a predicate finding of liability under the statute before attorney's fees and costs may be awarded.
Defendant urges the Court to interpret the arbitration award as ambiguous and to "clarify" the arbitration panel's decision by holding that damages were awarded under a common law theory, not under the Tennessee Securities Act. See M C Corp. v. Behr GMBH Co., KG, 326 F.3d 772, 782 (6th Cir. 2003). Where an arbitration award appears to be ambiguous, the Court must remand the matter to the arbitration panel for clarification. See id. But here, the panel's decision does not appear to be ambiguous. The panel found in favor of the Hensons on the issue of liability. The panel then acted in manifest disregard of the Tennessee Securities Act when the panel did not follow the mandatory statutory formula for calculating compensatory damages. See Jaros, 70 F.3d at 421.
The Plaintiffs' expert utilized the statutory formula provided in the Tennessee Securities Act, including interest at ten percent (10%), and calculated the Plaintiffs' total damages to be $196,396.00. Defendant's own expert agreed with the calculations made by Plaintiffs' expert, including the profit/loss figures that supported the statutory damages if Defendant was found liable. Therefore, there was no dispute as to the mathematical calculation of damages under the statute. Furthermore, there was no separate proof of damages under another theory to support the ruling by the panel. The panel cannot simply ignore the undisputed evidence in the record as to the amount of Plaintiffs' damages or reject it when there is none to the contrary and also ignore the mandates of the statute relied upon by the expert in determining the damages. The panel was aware of the applicable statute. Defendant did not contend the statute was inapplicable to the case and agreed what the damages should be if Defendant was found liable. The panel's finding of damages in the amount of $59,504.44 is inexplicable and is not supported by the evidence in the arbitration record and the controlling law. The Court concludes the panel's award is arbitrary and capricious, it is in manifest disregard of the law because it "flies in the face" of a clearly established state statute, and the award must be modified.
IV. CONCLUSION
Accordingly, Plaintiffs' Motion to Vacate and Modify Arbitration Award (Docket Entry No. 1) shall be GRANTED.
The Court modifies the arbitration award to provide as follows: the Hensons are entitled to recover from Morgan Stanley compensatory damages in the sum of $196,396.00 under § 48-2-122; attorney's fees in the amount of $65,465.00 (one-third contingent) and litigation expenses of $13,027.00 under § 48-2-122 (f); and the claim filing fee of $1,425.00. Defendant is also responsible for the balance due on the arbitration fee of $5,625.00.
An appropriate Order shall be entered.