The need for the Financial Industry Regulatory Authority ("FINRA"), which oversees securities arbitration hearings, to revise its arbitrator disclosure procedures is under a spotlight because of a FINRA arbitration case brought by actor Larry Hagman, star of the 1980s program "Dallas," against Citigroup.
On October 6, 2010, Hagman won an $11 million arbitration case against Citigroup Global Markets for the actions of a Smith Barney broker. Hagman and his wife claimed that the broker breached her fiduciary duty by creating an unsuitable portfolio of securities and improperly selling them a life insurance policy that had annual premiums of $168,000. The Hagmans' arbitration victory was thorough. The panel of arbitrators awarded them $1.1 million in compensatory damages, $10 million in punitive damages payable to a charity of the Hagmans' choice, and attorneys' fees of nearly $460,000.
Citigroup filed a petition to vacate the award in a California court. Arbitration awards cannot easily be appealed, and the vast majority of petitions to vacate are denied because the grounds to overturn an award are severely limited.
The Hagmans were not so fortunate. On February 9, 2011, a judge vacated the award because one of the arbitrators did not disclose a potential conflict of interest involving his own lawsuit against a business partner who had allegedly breached his fiduciary duty resulting in substantial losses to the arbitrator's retirement funds. Under FINRA rules, arbitrators must disclose whether they were involved in a dispute involving the same subject matter with the prior five years. Purportedly, the arbitrator's own case did not involve the securities industry, and did not involve asset allocation, which was at the heart of the Hagmans' case. Thus, it appears the arbitrator did not believe his case fell within the FINRA disclosure requirements. The judge disagreed, ruled that the arbitrator should have disclosed his prior dispute, and vacated the award.
This dispute highlights a glaring failure in FINRA's arbitration process. All arbitration parties, both investors and brokerage firms alike, devote significant time, energy and resources in claims that often involve large sums of money. They necessarily rely on FINRA to ensure that the arbitrators selected for their cases are free from any actual or potential conflicts of interest that may color their view of a dispute. FINRA must make more detailed and thoughtful inquiries into potential arbitrators' backgrounds to ensure the absence of disqualifying factors. FINRA must also clearly and fully disclose the arbitrators' backgrounds to avoid a losing party petitioning a court to nullify a hard fought award. Only when FINRA corrects these deficiencies will parties have confidence in the finality of the arbitration process.
