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Continuing a recent trend of disputing arbitration decisions, New York’s Appellate Division, 1st Department, has thrown out a $25 million punitive damages award. The court ruled Tuesday in Sawtelle v. Waddell & Reed Inc., 2330, that the award violated the constitutional requirement that punitive damages be proportionate to compensatory damages. The award was about 25 times the amount of compensatory damages. The U.S. Supreme Court has found a 4-to-1 ratio to be “close to the line” of the outer limits of constitutionality. Seth M. Schwartz, a partner at New York-based Skadden, Arps, Slate, Meagher & Flom who argued the case for the brokerage firm Waddell & Reed, called the decision “a landmark.” “It’s the first time that I know of that a court has applied the constitutional standards for punitive damages awards to an arbitration decision,” he said. The ruling also stands out as one of the few — but increasingly common — examples of a court vacating an arbitration decision. According to conventional wisdom, arbitration awards are virtually unappealable. Indeed, in the lower court’s decision in Sawtelle, Manhattan Supreme Court Justice Michael D. Stallman noted that the power to review an arbitration award is “among the narrowest known to the law.” Yet this is the third time in a year that the 1st Department has vacated an arbitration award. In October, in Sands Brothers & Co., Ltd. v. Generex Pharmaceuticals Inc., 2002 N.Y. Slip Op. 07711, the court threw out a $28 million arbitration award, finding that because the arbitrators failed to comply with the court’s earlier instructions, the claimant was no longer permitted to seek lost profits, which comprised the bulk of the award. The court also recently affirmed a lower court decision in which Manhattan Supreme Court Justice Charles Edward Ramos reduced a $5.6 million award to something less than $400,000, based on the arbitration panel’s “irrational refusal to even consider the applicable law.” The decisions heartened some lawyers who have questioned whether arbitration is the panacea that some of its proponents have suggested. “Arbitration is quite rightly meant to provide an alternative to the formal processes of the court route but it’s not meant to be a refuge from the rule of law,” said Philip M. Berkowitz, a New York-based partner at Seyfarth Shaw. “This [ Sawtelle] decision throws open the curtains and shines the light of day on the arbitration process,” he said. Sawtelle, which was originally heard by an NASD panel, centered on a dispute between Waddell & Reed and a former employee, Stephen B. Sawtelle. The company claimed it fired Sawtelle, a mutual fund broker, for misconduct that included bribing union officials and signing customers’ names to forms. Sawtelle, who was a star broker and 17-year veteran of the company, countered that Waddell fired him in retaliation for testifying against another Waddell broker in a federal investigation. He claimed the company also tried to steal his clients after he left, although ultimately he managed to retain the lion’s share of his 2,800 customers. ARBITRATION AWARD The arbitration panel sided with Sawtelle, finding that the firm “demonstrated reprehensible conduct” in orchestrating a smear campaign against him. On that basis, it awarded Sawtelle some $1.8 million in compensatory damages (later reduced to $1.1 million), $747,000 in attorney fees and $25 million in punitive damages. At the time, the award was believed to be the biggest judgment ever for an individual employment case. On review, Justice Stallman upheld virtually all of the award, including the $25 million in punitive damages and minus only the attorney fees, which he found had been awarded twice. The court reasoned that, although the amount of punitive damages was quite high, constitutional limits did not apply because the U.S. Supreme Court’s decisions on the issue dealt purely with due process concerns not relevant to private arbitration proceedings. But the appellate division disagreed, finding that the court was concerned with the irrationality of a punitive damages award as well. “In agreeing to arbitration, Waddell did not waive its right to the protection of any constitutional and statutory constraints on the award of punitive damages,” Justice Joseph P. Sullivan wrote for a unanimous court. The panel found further that by ignoring constitutional law, the arbitrators’ award was in “manifest disregard of the law.” “In this context, ‘disregard’ implies that the arbitrator appreciates the existence of a clearly governing legal principle but decides to ignore or pay no attention to it,” the court wrote. “Here, in awarding $25 million in punitive damages, the panel completely ignored applicable law, an error that provides a … basis for vacating the award.” Jeffrey Liddle, who represented Sawtelle, was not available for comment. The appeals panel also included Acting Presiding Justice Eugene Nardelli and Justices Richard T. Andrias, John T. Buckley and David Friedman.

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