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The fact that an arbitration concerns issues of federal law is not enough to confer jurisdiction on a district court to review the award, the 2nd U.S. Circuit Court of Appeals ruled yesterday. For the first time in the Second Circuit, the appeals court, in Greenberg v. Bear, Stearns & Co. Inc., 99-9041, found that jurisdiction exists where the petitioner seeking to vacate the arbitration award is doing so “primarily on the ground” that the arbitrator showed a “manifest disregard of federal law.” Howard Greenberg filed suit alleging that New York-based Bear, Stearns & Co. Inc. violated securities laws in its role as clearing broker for Sterling Foster & Co., now defunct, during Sterling Foster’s underwriting of the initial public offering of the company ML Direct in 1996. Greenberg charged that Bear, Stearns was aware — or should have been so — of a fraudulent scheme by Sterling Foster, whose trades it cleared. The defunct brokerage underwrote a public sale of 1.1 million shares of ML Direct. At the same time, it sold short an additional 2.3 million shares of ML Direct, to be covered by shares to be obtained from existing shareholders, despite the fact that the ML Direct prospectus stated that those shares were subject to a lock-up agreement for 12 months, and that “there were no agreements or understandings” regarding exceptions to the lock-up. Bear, Stearns, Greenberg said, issued confirmations to purchasers that did not reveal the short sales made by Sterling Foster or the profit the brokerage house had made on the sales. But the three-judge arbitration panel that heard the case dismissed Greenberg’s claims in a decision that was confirmed by written award in March 1999. Greenberg moved to have the award vacated in the Southern District on the grounds that “it violated public policy and manifestly disregarded the law.” Judge John S. Martin denied the motion in August 1999. ‘ALTERNATIVE’ REQUIRED The Second Circuit, in an opinion by Judge John M. Walker Jr., said the court “must decide whether, and under what circumstances a federal court may entertain a motion to vacate an award where, as in this case, alternative bases for jurisdiction are absent.” The appeals court concluded, he said, that “the fact that the arbitration itself concerns issues of federal law does not, on its own, confer subject- matter jurisdiction on a federal district court to review the award.” Walker said that Greenberg filed his petition under Section 10 of the Federal Arbitration Act (FAA), but “it is well-settled that the FAA does not confer subject-matter jurisdiction on the federal courts even though it creates federal substantive law.” The FAA and federal case law outside the circuit lists several grounds for reviewing awards in arbitration, the judge said, including fraud, prejudicial conduct by the arbitrator, and manifest disregard of the law, which is the subject of this claim. Under this analysis, he said, the court must first determine what the federal law is and then explore whether the law had been disregarded. “This process so immerses the federal court in questions of federal law and their proper application that federal question subject-matter jurisdiction is present,” he said. Nonetheless, on the merits the Second Circuit found that Greenberg had failed to support his charge that the arbitration panel had disregarded the federal law at stake in his case, Section 10(b) of the Securities Exchange Act. “In this case, however, Bear, Stearns employees testified that they did not know about Sterling Foster’s fraud, and, thus, the arbitrators could reasonably have concluded that Bear, Stearns lacked the knowledge required for Section 10(b) liability,” he said. “The petitioner argues that Bear, Stearns should be deemed to have knowledge of the fraud because it had the necessary information before it, but it is by no means clear that the doctrine of imputed knowledge applies in this context.” Moreover, he said, the arbitrators could have concluded that the language in the confirmations sent by Bear, Stearns was not “actually false.” “In addition, there is no well-settled law imposing a duty on a clearing broker, who is unaware of an introducing broker’s undisclosed and excessive profit, to inquire into the matter and then inform the latter’s customers of such self-dealing,” he said. “In sum, the arbitrators did not ignore or refuse to apply well-defined and clearly applicable law in rejecting any of [Greenberg's] claims in such a way that would amount to manifest disregard.” Senior Judge James L. Oakes and Sixth Circuit Judge Damon J. Keith, sitting by designation, joined in the opinion. Leslie Trager of New York’s Morley and Trager represented Greenberg. Jack P. Levin and P. Benjamin Duke of Washington, D.C.-based Covington & Burling represented Bear, Stearns.
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