By Ali Fenno
On November 22, 2016, the Fourth Circuit issued a published opinion in the civil case of UBS Financial Services, Inc. v. Padussis. In UBS Financial, the Fourth Circuit addressed whether an arbitration award of over $900,000 to Gary Padussis (“Padussis”) could be vacated or modified in light of Padussis’s insolvency and UBS Financial Services’ (“UBSFS”) lack of participation in the selection of the arbitrators. In affirming the district court, the Fourth Circuit held that there was no basis for overturning the arbitrators’ award and that UBSFS’s motion should be dismissed in its entirety.
Facts of the Case and Procedural History
Padussis began working for UBSFS in 2009, bringing with him a team of financial advisors and an established list of clients. As part of his initial compensation, UBSFS granted Padussis a $2.7 million loan, for which he signed a promissory note that provided the balance of the loan would become fully due in the event he ended his employment with UBSFS. Also executed by Padussis was a Letter of Understanding describing his compensation and a Financial Advisor Team Agreement that governed the operations of his team. Each agreement entered into by the parties provided that any dispute would be subject to arbitration before the Financial Industry Regulatory Authority (“FINRA”).
Two years later, Padussis resigned from UBSFS on the grounds that it had ruined his team of financial advisors and cost him valuable clients. When he did not pay the $1.6 million remaining balance on the promissory note, USBS initiated arbitration proceedings. Padussis responded with counterclaims alleging that UBSFS’s interference with his team of financial advisors and clients amounted to tortious conduct and a breach of contractual duties.
Pursuant to the FINRA Code of Arbitration Procedure for Industry Disputes (the “FINRA Code”), the Director of FINRA Dispute Resolution (the “Director”) mailed a list of potential arbitrators to Padussis and USBFS on August 21, 2013. Each party was then supposed to indicate their preferences by striking four arbitrators from the list and ranking the remaining ones. The lists were to be returned to the Director within 20 days of their being sent so he could then select a three-person arbitration panel based on those rankings. Padussis returned his list of preferences within the proscribed time, but USBFS did not, allegedly because it never received the list from the Director.
On September 11, UBSFS received a letter, dated September 3, reminding the parties to return their list of preferences by the September 10 deadline. It then filed a motion to extend the deadline. Padussis opposed the motion, claiming that UBSFS had notified him in mid-August that it was transferring to new counsel and that the list of preferences had not yet been sent. Padussis argued that this transfer of counsel caused confusion over who was sending the list and was the reason the list was never sent.
Although FINRA Rule 13207(c) allows a Director to extend the Code’s deadlines for good cause, FINRA’s Regional Director, acting for the Director as consistent with FINRA Rule 13100(k), denied UBSFS’s motion. The Director affirmed the denial, finding that UBSFS did not have good cause to extend the deadline because the list of arbitrators and a courtesy reminder of the deadline were both timely mailed, and FINRA did not receive any mail returned as undeliverable. Accordingly, FINRA proceeded with the arbitration process and selected a three-person panel of arbitrators based off of Padussis’s list of preferences.
UBSFS challenged the composition of the panel based on his lack of participation in the selection of the arbitrators, but his challenge was denied. Then, on October 27, 2014, the panel issued its final decision, awarding UBSFS $1,683,262 for the balance on the promissory note and Padussis $932,887 for damages UBSFS caused to his business.
However, faced with a statutory lien and the prospect of bankruptcy, Padussis admitted that he could not pay the full $932,887, leaving UBSFS in a position of owing Padussis over $900,000. UBSFS subsequently filed the present action to vacate the award on the grounds that UBSFS did not participate in the arbitrator selection process. It argued in the alternative that the award should be offset because of Padussis’s admission of being unable to pay the award owed to UBSFS.
The district court declined to vacate the arbitration award and to impose an offset, and UBSFS appealed.
Narrow Standard of Review
The Fourth Circuit first established the extremely narrow scope of judicial review of an arbitration award. It noted that an arbitration award should only be modified if it is one of the limited circumstances listed in the Federal Arbitration Act, or if under common law, it “fails to draw its essence from the contract” or “evidence a manifest disregard of the law.” The court emphasized that in reviewing an arbitration award, whether an arbitrator did their job “well, or correctly, or reasonably,” is not the concern. Instead, courts should ask whether the arbitrators exceeded their powers because they did not meet certain thresholds of arbitrability such as not being appointed according to the parties’ agreement. Deference should be given to arbitrators on questions outside those thresholds that regard the merits of the case or procedural questions.
The court found support for this narrow scope in public policies that focus on using arbitration as a tool to avoid the costs and delays of litigation. It noted that parties entering into agreements to arbitration do so in the hope of avoiding “a protracted set of legal proceedings.” Narrowing the judicial review of arbitration awards furthers this intent.
Rightful Appointment of Arbitrators
The Fourth Circuit next addressed UBSFS’s claim that the arbitrators were not selected according to the parties’ agreement. It first confirmed that, pursuant to Section 5 of the Federal Arbitration Act, arbitration awards will be vacated where the arbitrators’ appointment violates the parties’ contract. It then noted that here, UBSFS and Padussis agreed that all disputes would be subject to arbitration before FINRA and thus subject to the FINRA Code.
However, the Fourth Circuit rejected UBSFS’s claim that the rules for selecting arbitrators were not followed. The court listed every step FINRA and the Director took in selecting the panel and noted that not a single requirement was skipped. And even though UBSFS did not get to participate in the selection of the arbitrators, the court found that this outcome was explicitly allowed in FINRA Rule 13404(d), which requires a Director to appoint arbitrators without a party’s input when the list of arbitrators is not returned.
Because FINRA clearly followed the FINRA Code’s rules for selecting arbitrators, the Court decided that the issue raised by UBSFS was instead whether FINRA properly applied the rules when it found that UBSFS did not have good cause to extend the deadline for submitting its list of preferences. But the Fourth Circuit concluded that this constituted a procedural question, and relying on the Supreme Court’s decision in Howsam v. Dean Witter Reynolds, Inc., affirmed that such a “procedural question which grow[s] out of the dispute and bear[s] on its final disposition [is] presumptively not for the judge, but for the arbitrator, to decide.” The court also noted that the power to determine whether good cause existed was explicitly given to FINRA in FINRA Rule 13412. Furthermore, the court reasoned that arbitrators would be more expert about the issue because it concerned, as stated in Dockser v. Schwartzberg, “the written rules governing the parties’ proceeding.” Accordingly, the Court refused to question FINRA’s decision that there was not good cause for extending the deadline for returning the list of preferences.
Refusal to Reduce the Award
The court next addressed UBSFS’s request for the arbitral award to be offset based on Padussis’s admission of being unable to pay his portion of the award. The court first noted that complying with UBSFS’s request would result in a net profit for UBSFS and thus eliminate any damages he might owe to Padussis. It also found that the offset would constitute a modification of the arbitration award because the agreement explicitly denied “any and all relief not specifically addressed” in the arbitrators’ final decision, which never mentioned the possibility of an offset.
Pursuant to the Federal Arbitration Act, a court may modify an award if it will effectuate the intent of the arbitrators. Here, the court concluded that this modification would not effectuate the intent of the arbitrators because the award never mentioned an offset and there is no other evidence in the record suggesting such an intention. UBSFS contended that the offset of the award would reflect the intent of the arbitrators because it would provide a “simple, fair result” without changing the arbitrators’ valuation decision. But the court rejected this claim, reasoning that UBSFS should have determined the arbitrators’ intent by asking for an offset during the arbitration proceedings. Accordingly, because evidence in the record and the arbitration award did not indicate that the intent of the arbitrators would be effectuated by an offset, the Fourth Circuit chose to not impose an offset on these grounds.
UBSFS last claimed that the offset should be imposed regardless of the arbitrators’ actual intent and that the court should recognize a presumption favoring an offset. The court disagreed, reasoning that such an action would put a “judicial gloss” on the arbitration award. A judicial gloss on this award would be impermissible because the award explicitly limited itself to the relief specifically rendered in the arbitrators’ final decision.
Accordingly, because the intent of the arbitrators would not be effectuated by the offset, and because a presumption of an offset would directly conflict with the arbitrator’s final decision, the court held that granting an offset in this case would be inappropriate.
The Fourth Circuit concluded that UBSFS simply did not want to abide by a result it did not like. Because UBSFS had agreed to arbitration, the dispute was within the scope of that agreement, and the rules for arbitration were selected in the agreement and then followed, the court could find no reason to vacate or modify the award. Accordingly, it affirmed the district court’s decision to deny UBSFS’s motion in its entirety.