Second Circuit Clarifies Materiality Standard to Vacate Arbitral Award

By Karen E. Clarke, Of Counsel at Castaybert PLLC

The Court of Appeals for the Second Circuit has recently reconfirmed the high bar to set aside an arbitration award on the ground that it was procured by fraud.  In Odeon Capital Group LLC v. Ackerman, ___ F.3d ___, 2017 WL 3091560, *2 (2d Cir. July 21, 2017), which concerned a FINRA arbitral award, the Court held that a petitioner seeking to vacate an award due to fraud must demonstrate that “the fraud was material to the award.”  Odeon Capital failed to meet that burden because, although it argued that respondent had committed perjury in the arbitration hearing, it “failed to establish that [respondent’s] alleged perjury had any impact on the arbitration award.”  Id.

Background

Bret Ackerman, a trader at Odeon Capital, commenced a FINRA arbitration seeking more than $5 million in damages on a variety of claims including failure to pay commissions owed, breach of his employment agreement, disability discrimination, retaliation arising out of an investigation into one of his trades, and filing of a false termination notice.  A three-arbitrator panel took testimony in a six-day hearing, including substantial testimony from Ackerman regarding an on-the-record interview request he had received from FINRA regarding certain trades.  The arbitration panel rejected the bulk of Ackerman’s claims, finding for him only on his unpaid wages claim.  The panel awarded him only $1,102,193 on that claim and ordered that negative information be expunged from his U-5 form.  2017 WL 3091560 at *2.

Odeon petitioned to vacate the FINRA award, arguing (among other things) that it had been procured by fraud.  Odeon alleged that Ackerman had committed perjury at least twice during his testimony regarding the FINRA interview, misleading the arbitration panel concerning the status and outcome of a FINRA regulatory investigation into his trading activity.  Odeon did not become aware of this alleged perjury until after the award was issued.  The district court denied Odeon’s motion to vacate and confirmed the FINRA arbitration award.  Id. at *2, 3.

The Second Circuit’s Analysis

The Second Circuit, in a unanimous opinion by Judge Pooler, agreed that the arbitration award could not be vacated.  (The Second Circuit disagreed with a separate portion of the district court decision regarding attorneys’ fees.)

Under the Federal Arbitration Act (“FAA”), a court may vacate an arbitration award that “was procured by corruption, fraud, or undue means.”  9 U.S.C. § 10(a)(1).  The Court began by enunciating a three-part test distilled from Karppinen v. Karl Kiefer Mach. Co., 187 F.2d 32, 34 (2d Cir. 1951):  “A petitioner seeking to vacate an award on the ground of fraud must adequately plead that (1) respondent engaged in fraudulent activity; (2) even with the exercise of due diligence, petitioner could not have discovered the fraud prior to the award issuing; and (3) the fraud materially related to an issue in the arbitration.”  2017 WL 3091560 at *3.  Then, assuming that a party’s furnishing of “material perjured evidence” to the arbitrators would qualify as fraudulent activity, the key issue presented to the Odeon Court was the appropriate standard for evaluating whether the alleged fraud was “material” to the arbitration.  Id.

On that issue, the Second Circuit looked to the materiality standards adopted by other Circuits:  “For fraud to be material within the meaning of Section 10(a)(1) of the FAA, petitioner must demonstrate a nexus between the alleged fraud and the decision made by the arbitrators, although petitioner need not demonstrate that the arbitrators would have reached a different result.”  Id. (citing cases from the Fifth, Sixth, and Eleventh Circuits).  The Court found this “nexus” standard to be consistent with the 1951 Karppinen analysis, where vacatur was denied because the allegedly perjured evidence “had no bearing on the real issues before the arbitrators and cannot reasonably be thought to have affected their decision in determining any relevant questions before them.”  Id. at *4 (quoting Karppinen, 187 F.2d at 35).

Applying that materiality standard, the Second Circuit agreed with the district court that “Odeon cannot demonstrate Ackerman’s alleged perjury was material to the arbitration award.”  This was due in part to the fact that there was no document explaining the rationale for the arbitrators’ decision because neither party had asked for a reasoned decision from the arbitration panel.  The Court observed that the arbitrators had granted Ackerman relief only on his claim for unpaid wages, which alleged that Odeon had failed to pay him amounts due under the terms of his employment agreement.  The award did not provide any explanation for how the panel arrived at its $1,102,193 damages award on that claim.  Consequently, “[t]here is simply no basis in the record to find that Ackerman’s testimony regarding the FINRA investigation played any role in the arbitrators’ award on his unpaid wages claim.”  Id. at *4.

The Second Circuit also rejected Odeon’s argument that that because Ackerman was the primary witness on the wage claim, any perjury he committed during his testimony tainted the entirety of his testimony and undermined his credibility.  The Court deemed that argument, which it equated to a position “that any untruth could serve as a basis for vacating the award regardless of its materiality,” to be “wholly inconsistent with the language of the FAA, which allows vacatur only where the award was ‘procured by … fraud.’”  The Court explained, “If the alleged fraud went only to a collateral issue, or to an issue that did not influence the arbitrators’ findings, then that fraud cannot serve as a basis for vacating the award because the award was not ‘procured by’ fraud.”  Id.  After distinguishing other cases in which the perjured testimony did appear to have some effect on the arbitral decision, the Court concluded,

Here, however, nothing in the award indicates that the arbitrators relied heavily on Ackerman’s truthfulness in making its award.  Indeed, given that Ackerman sought damages in excess of five million dollars and received roughly one-fifth of that amount, and that Ackerman prevailed on just one of his eleven claims, it appears the arbitrators took most of what Ackerman said with a grain of salt.  Accordingly, we affirm the district court’s finding that the alleged perjury was immaterial to the arbitration award.

Id. at *5.

Conclusion

The holding in Odeon Capital may illustrate the perils of not requesting a reasoned decision from the arbitrators.  In fact, no one can know what was material to the arbitrators’ decision because there was no document explaining their reasons for finding in Ackerman’s favor on the claim for unpaid commissions or the basis for their calculation of the amounts due.  Forgoing a reasoned decision may reduce the costs or duration of the arbitral process, but it may also effectively foreclose any viable appeal.