If you think that arbitration discovery orders are not as official or binding as court orders, think again; FINRA panels have ordered sanctions against customers, firms and associated persons ranging from monetary penalties to dismissal of claims due to failure to comply with discovery orders, and these decisions have been upheld in court.
FINRA’s Rule 12511(a), dealing with discovery sanctions in customer cases for claims filed on or after April 16, 2007, states that “failure to cooperate” in required discovery exchanges “may result in sanctions.” Panels may issue sanctions both for failure to comply with the discovery provisions (absent substantial justification for same) and for “frivolously objecting” to production. Paragraph (b) of the same rule gives panels the authority to dismiss “a claim, defense or proceeding with prejudice . . . for intentional and material failure to comply with a discovery order of the panel if prior warnings or sanctions have proven ineffective.” There is a similar provision for cases dealing with “industry” claims (between brokers and employees), which is FINRA Rule 13511.
FINRA Rule 12212(c) gives authority to customer-based panels to dismiss “a claim, defense or arbitration with prejudice as a sanction for material and intentional failure to comply with an order of the panel if prior warnings or sanctions have proven ineffective.” The same rule for industry panels is contained in FINRA Rule 13212.
Over the past few years, panels have increasingly used these rules to sanction parties and to dismiss claims. Following are a sampling of such cases:
1. In Laurence Pilgeram as trustee v. Morgan Stanley Smith Barney, FINRA Case #10-04909, the respondent firm moved to dismiss the customer’s claim prior to the hearing due to the customer’s failure to produce documents ordered eight months earlier by the Las Vegas-based arbitrator. In October 2012, the arbitrator granted the motion and assessed the hearing session fees against the customer.
2. In Tushar Patel v. optionsXpress, Inc., FINRA Case #10-04834, a Providence, RI panel in July 2012 granted the respondent firms’ pre-hearing motion to dismiss the customer’s unauthorized trading and negligence claims pursuant to FINRA Rule 12212(c). The panel stated that the dismissal was based on Patel’s failure to produce any discovery during a one year period, despite his obtaining a postponement of the hearing ostensibly to comply with discovery orders. The panel also assessed the entire $2,700 cost of pre-hearing session fees against Patel.
3. In Stavros Oscar Cid and Teresa Cid JTWROS v. John Joseph Abadiotakis and Citigroup Global Markets, Inc., FINRA Case #10-04784, an unauthorized trading/suitability case, the New York-based panel made a pre-hearing ruling that the customers owed the firm a sanction of $10,000 for their failure to comply with discovery and for failing to appear at the first scheduled hearing date. When the customers did not appear at the hearing date scheduled for six months later (despite their counsel’s appearance), the panel granted Citigroup’s motion to dismiss. The panel’s July 2012 award specifically stated that the dismissal was a sanction pursuant to FINRA Rule 12212(c) for failing to adequately respond to discovery orders and for claimants’ non-appearance at the hearing. The panel also assessed half the hearing session fees and all the adjournment fees against claimants.
4. In John Boelke v. Paulson Investment Company, Inc., FINRA Case #11-01172, involving a pro se associated person claim against a member firm, the Ft. Lauderdale-based panel in March 2012 granted the firm’s motion to dismiss with prejudice and granted sanctions due to Boelke’s apparent non-responsiveness (failure to communicate, failure to comply with discovery order, and failure to appear at the hearing). The panel granted the firm’s counterclaim for $25,000 in attorneys’ fees and $1,873 in costs as well as $3,900.00 in hearing session fees against Boelke.
It’s not just individuals who are being hit with discovery sanctions. In the case of Meri Ramazio and Tamara Smolchek v. Merrill Lynch Pierce Fenner & Smith Inc., FINRA Case #10-04432, a Boca Raton arbitration panel in an employment-related deferred compensation case slammed Merrill Lynch for its initial failure to comply with the panel’s order requiring it to turn over a privilege log to the claimants. Merrill was penalized to the tune of $1,000 per hour until the privilege log was produced (resulting in an initial discovery sanction of $3,500). The arbitration award contained an additional discovery sanction of $100,000 ($50,000 payable to each claimant). Merrill was also sanctioned for introducing into evidence medical records that the panel forbade it from using, resulting in a $10,000 award to claimant Tamara Smolchek for that misdeed. The arbitration panel also awarded $5,150,000 in regular and $5,000,000 in punitive damages against Merrill on claimants’ employment-related claims, and ordered it to pay the entire hearing session fees of $38,900. Merrill’s petition to vacate the arbitration order was denied by Florida’s federal court in the Southern District (Merrill Lynch v. Smolchek and Ramazio, 2012 WL 4056092, S.D. Fla, Sept. 17, 2012, and is now on appeal to the Eleventh Circuit.
Courts generally grant deference to decisions of arbitration panels, and have upheld such sanctions. For example, in D. Weckstein & Co. Inc. v. Bui, 2009 NY Slip Op 3292 (NY Supreme Court Jun 11, 2009), the court upheld an award that granted sanctions and attorneys fees of $36,034.67 to a brokerage firm after the claimant failed to comply with the panel’s discovery orders. The court noted that under New York law, courts will not disturb a panel’s rational decision, even for errors of law or fact, unless the award “violated a strong public policy, was totally irrational, or the arbitrator in making the award clearly exceeded a [specific statutory] limitation. . .”
In Freedom Investors Corporation v. Kahal Shomrei Hadath and Sydney V. Pinter, No. 11 Civ 5975 (S.D.N.Y., Feb. 7, 2012), involving a margin credit dispute, the Southern District court in New York upheld an arbitration panel’s award granting $5,000 as a discovery sanction against the customers Kahal and Pinter due to their failure to produce documents ordered by the panel. The court also upheld the $149,223 in damages assessed against the customers.
More recently, in the case of In Re Bear, Stearns & Co. Inc. et al v. International Capital & Management Company LLC, 32 Misc. 3d 607 (Sup Ct., NY Co. 2011), aff’d, 2012 NY Slip Op 06546 (App Div, 1st Dept. Oct. 2, 2012), the court held that a panel did not exceed its powers or violate public policy when it awarded Bear, Stearns $316,922.53 in attorney fees it incurred in connection with ICMC’s prosecution and withdrawal of fraud claims just before trial. The court found that the panel had awarded counsel fees to Bear, Stearns as a sanction for discovery abuse at least twice during the arbitration, and ICMC had paid the fees without objection. It further noted that a party cannot avoid the assessment of attorney fees simply by withdrawing its claim for same during the hearing’s closing arguments.
The takeaway from this is that parties and their counsel need to take discovery orders seriously. A party failing to prepare a good-faith response to a discovery request, or failing to comply with a panel’s order, faces significant penalties for non-compliance. Arbitrators have granted monetary sanctions and motions to dismiss for failure to produce discovery, and courts have been upholding the panels’ decisions.
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