Arbitration is a form of private dispute resolution which is often governed by a private organization that maintains lists of available arbitrators and provides rules under which the arbitration will be conducted.
Typically, arbitration is the result of a pre-dispute contract entered into by the parties wherein they agreed that if a dispute should arise, it would not go to a traditional court, but will be decided in a private arbitration forum.
Arbitration is nonetheless a binding adjudicatory process because the arbitrator (sometimes a retired judge, or a seasoned attorney) renders a decision at the conclusion of an arbitration hearing. In general, the arbitrator is an impartial person chosen by the parties. The arbitrator reads briefs and documentary evidence, hears testimony, examines evidence, and renders an opinion after a hearing. Thereafter, once the arbitration award is confirmed by a court, the award will be entered as a judgment. The arbitration decision is final and binding, and subject to very, very limited court review.
I. Limited Liability Company Dissolution and Award of Attorney’s Fees
We were engaged by Clients (Clients), two members of a four (4) member single-purpose limited liability company, which acquired a historic residential home in Sag Harbor for the purpose of rehabilitation and resale. Clients were two investor-members of the LLC who committed to funding acquisition and improvement costs. The other two members were father (F) and son (S), and the four parties jointly agreed in the LLC operating agreement that S would act as construction manager overseeing the renovation of the project.
The parties observed formalities and properly conducted themselves by jointly holding meetings and passing resolutions relative to the ongoing project. But an impasse swiftly set in after S negligently failed to secure the historic home to its foundation, causing a variety of structural issues. And then, bad luck took an even worse turn. Unbeknownst to Clients, S was being sued by another homeowner (JC) for negligent and faulty construction practices on his residence. JC obtained a $650,000 judgment against S and started to commence judgment enforcement proceedings against S. At the same time, Clients refused to infuse additional capital into the project because their contributions were not being matched by F and S. Clients requested that the LLC project be liquidated so that each of the parties could recoup their investments and move on.
Fearful that a liquidation would cause his interests to be attached by JC, S devised a scheme to divest himself of his interest by claiming that he transferred it to F. Despite an express clause in the LLC operating agreement requiring any transfer to be made “in writing” and with the “approval of all members,” S filed for chapter 13 bankruptcy and listed in his petition the so-called transfer that he made to F months before the bankruptcy filing. However, the LLC operating agreement expressly stated that the LLC would liquidate and dissolve upon an event of default (which included a bankruptcy filing) and that the voting rights of the withdrawn (bankrupt) member would cease upon said filing. With that, Clients undertook to organize a vote and, as a plurality of members, did in fact vote to liquidate and terminate the LLC. F objected to the termination, and litigation ensued in New York State Supreme Court. Ultimately, the matter was referred to arbitration.
One of the hurdles faced by Clients was the language of the Operating Agreement pertaining to the Arbitrator’s right to award counsel fees. Unlike traditional language granting an award to the prevailing party, the operating agreement here permitted an award of counsel fees based upon the Arbitrator’s express finding of “dilatory tactics” by the non-prevailing party. Hence, it was not just important to prevail in the arbitration: we had to take it one step further by demonstrating that the F/S conduct was bad faith.
Ultimately, the Firm did just that. At the inception of the arbitration, we painstakingly combed through hundreds of emails between the parties and pieced together thirty separate email chains demonstrating the frivolity of F and S’s claims that S “transferred” his membership interests to F. Through extensive cross-examinations during the arbitration hearing, the Firm demonstrated that after the period of S’s so-called “transfer” of his membership interests to F, S repeatedly continued to hold himself out as a “member,” “partner,” “owner” and “agent” of the LLC in email discussions between the four parties. In fact, we also demonstrated that F likewise represented (after the purported transfer) that S was also an owner and member of the LLC.
The effort paid off. The Arbitrator found in favor of our Clients, ordered the liquidation and dissolution of the LLC, and awarded one hundred percent (100%) of Clients’ attorneys’ fees and costs assessed against F and S’s shares based upon their dilatory tactics of manufacturing a false narrative that was designed to evade S’s judgment creditor (JC).
II. FINRA Award Against Investment Advisor for Unsuitable Investments
The Firm represented an 81-year-old retired computer technician (Claimant) against a registered investment advisor (Respondent) in a FINRA arbitration proceeding. FINRA is an acronym for the Financial Industry Regulatory Authority. Established to protect investors and ensure the market’s integrity, it is a government-authorized not-for-profit organization which oversees, inter alia, broker-dealers. In fact, FINRA operates the largest securities resolution forum within the United States.
Respondent was the Claimant’s investment advisor and managed the Claimant’s retirement accounts. During 2020 when the complained-of events took place, Respondent was aware that Claimant required an investment strategy that would safeguard — and not unnecessarily risk – Claimant’s retirement principal.
Against this backdrop, during March 2020, despite a written direction to maintain the existing portfolio “as is,” Respondent unilaterally, and without advance consent from the Claimant, sold the Claimant’s well-diversified blue-chip holdings and placed seventy-nine percent (79%) of the Claimant’s funds into a “short” position, a super aggressive strategy which backfired when the market actually did very well during April 2020.
A. Liability for Suitability and Asset Allocation Errors
At the hearing before three Arbitrators (due to the size of the claim), the Firm presented both lay and expert witnesses, arguing that the investments that Respondent purchased for Claimant’s account unnecessarily exposed Claimant to uninvited and unwanted risk.
Our expert witness testified that Respondent’s conduct violated well-settled practice and procedures guidelines which requires, among other things, that in recommending a transaction, Respondent should have a reasonable basis to believe that a recommended transaction or investment strategy is suitable for the customer, based on the information obtained through the reasonable diligence. Indeed, the evidence at the hearing established that Respondent was required to recommend and employ an investment strategy that Respondent had a reasonable basis to believe (based on Claimant’s employment status, investment objective, risk tolerance, age, sophistication and financial wherewithal) was suitable. Indeed, our expert opined that a review of historical data and empirical studies provides strong support for the contention that the asset-allocation decision is a vital component of the portfolio-management process, in fact, it has been recognized by prevailing scholars that “the most important part of [investment] policy determination is asset allocation,” as studies have demonstrated that ninety percent (90%) or more of the performance in investment portfolio returns are driven by the asset-allocation decision.
B. “Well-Managed Account” Damages
Thereafter, the Firm presented expert testimony concerning the damages Claimant sustained. Indeed, Respondent strenuously argued that Claimant sustained no damages because, over the lifetime of the account, the Claimant’s account had increased in value. To counter that position, the Firm sought damages pursuant to the “Well Managed Account” theory: in essence, not just seeking damages for the quantum lost as a result of the Respondent’s poor investment strategy, but providing the Claimant with the benefit of the value that the account would have grown to if the Respondent had left the account in place, so that the Claimant could achieve the benefit of the increasing market which occurred after April 2020. The expert explained to the three-arbitrator panel that market-adjusted damages utilize industry benchmarks to compute what an investor would have received had the portfolio been invested properly.
C. The Award
Within 10 days of the conclusion of the hearing, the FINRA three-member Panel awarded Claimant $200,000, rejecting the Respondent’s defenses to liability and damages, and embracing the Firm’s damages presentation premised upon the Well-Managed Account theory of damages.