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Justice Lewis Stone of the Manhattan Supreme Court tackled a rarely litigated question in an opinion last month. In determining whether to vacate an arbitration award by the National Association of Securities Dealers, he faced the issue of whether to apply the state or federal standard. The state standard applied, he ruled. But, as both he and practitioners point out, the answer may be largely moot, since either standard makes it very difficult to overturn an arbitral award. The case arose from Parker W. Knight Jr.’s termination of employment in January 2002 from Banc of America Securities. He had been a managing director and head of international syndicated finance, the court said. At the time of the termination, the bank claimed that the $1.6 million Knight had received for his work in 2000 was discretionary and that his compensation would be reduced by $1 million. Knight sued, and the NASD panel awarded him $680,000 in an unreasoned award that offered no explanations for the panel’s ruling. NASD arbitrators issue unreasoned awards unless the parties ask otherwise. Banc of America sought to vacate the award leading Justice Stone to decide whether he would review the ruling under the Federal Arbitration Act or New York’s CPLR Article 7511. Citing the New York Court of Appeals, Stone found that the state standard applied. Banc of America Securities v. Knight., 11889/03. Theoretically, the state approach differs from its federal counterpart. Under the Federal Arbitration Act, a judge may overturn an arbitral award if it is in “manifest disregard of the law.” The state standard posited under CPLR Article 7511 does not apply this approach and the Court of Appeals has added the concept of “irrationality” as a non-statutory consideration. In other words, Stone wrote, a court may vacate an award if it is irrational. ‘MANIFEST DISREGARD’ The case seemed clear and simple except that Justice Stone had to contend with a myriad of state rulings applying the “manifest disregard” standard. One by one, he discussed and then rejected several 1st and 2nd Department rulings. “This Court, after reviewing these cases,” held the judge, “has concluded that the rule set forth by the Court of Appeals … is the governing New York law. … Accordingly, this Court finds that there is no independent ‘manifest disregard’ or equivalent New York standard as a basis for a New York Court acting under New York standard to set aside an arbitration award.” Stone then held that the Federal Arbitration Act “does not purport to create rules for State courts for the review of an arbitration award, even if the agreement to arbitrate was subject” to the act. The Federal Arbitration Act applies to cases involving interstate or international commerce, said John Fellas, an arbitration litigator at Hughes Hubbard & Reed’s New York office. In this case, it was unclear whether the parties were from different states or if the case involved interstate commerce. Regardless, the court found that the act did not intend to replace state enforcement standards “so long as they recognize the substantive thrust of the [Act] — to enforce written arbitration agreements in interstate and foreign commerce and in admiralty.” MOOT POINT After an examination of standards for enforcing arbitration awards, the court held that the bank lost under either. Practitioners agreed that it makes little difference whether state or federal standards apply. “Generally the law that you use doesn’t make a difference,” said Donald Davidson of Bingham McCutchen. Davidson, a litigator who generally represents broker-dealers in NASD arbitrations, said that arbitration awards are rarely overturned regardless of the standard used. “I think the judge was interested in parsing out the difference,” said Laura Hoguet of Hoguet, Newman & Regal who represented Knight. “This case will focus people’s attention on this issue.” DEFINING ‘IRRATIONALITY’ To add to the confusion was the lack of guidance offered by New York courts in defining “irrationality.” The federal standard of “manifest disregard of the law” has been well-defined in decisions, but the “irrationality” standard expounded by the Court of Appeals has never been explained, Stone said. “No one knows what ‘irrationality’ means,” said Hoguet. “For irrationality to be found, perhaps a Court should know it when it sees it,” said the judge, in referring to U.S. Supreme Court Justice Potter Stewart’s 1964 opinion determining whether a type of pornography constituted obscenity. Applying this murky definition, Stone again rejected Banc of America’s claims to overturn the arbitral award. In doing so, he rejected Banc of America’s claim that an unwritten award was evidence of irrationality. The judge said that most arbitration awards, particularly those adjudicated by the NASD, exclude explanations. This makes them quicker and cheaper alternatives to judicial trials. It is a main reason that parties employ arbitration, said Hoguet, and an implication that they might be faulty would undermine a major justification for using arbitration instead of courts.

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