McCarthy v. Citigroup Global

United States Court of Appeals
For the First Circuit
No. 06-1001
JAMES W. MCCARTHY,
Plaintiff, Appellee.,
v.
CITIGROUP GLOBAL MARKETS INC.,
Defendant, Appellant.
ON APPEAL FROM A JUDGMENT OF THE UNITED STATES
DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE
[Hon. Joseph A. DiClerico, Jr., U.S. District Judge]
Before
Lipez and Howard, Circuit Judges,
and Gorton,* U.S. District Judge.
John R. Skelton, with whom John F. Adkins, Carol E. Head, and
Bingham McCutchen LLP, were on brief for appellant.
Stacey P. Nakasian, with whom William A. Jacobson, Shanna L.
Pitts, and the Law Offices of William A. Jacobson, Inc., were on
brief for appellee.
September 19, 2006
*
Of the District of Massachusetts, sitting by designation
LIPEZ, Circuit Judge. In this appeal, we must review the
district court's decision to vacate an arbitration award and remand
on the ground that the award was in manifest disregard of the law.
In an unusual circumstance, this is the second time in this case
that the district court has vacated an arbitration award in favor
of the appellee and remanded on that ground.
The award of the arbitration panel was not in manifest
disregard of the law. Instead, the district court engaged in an
analysis of the merits of the arbitration panel's award and found
legal error. Such an analysis is proscribed by the standards of
review that apply in this circuit to a district court's review of
arbitration awards. Therefore, we must vacate the district court's
ruling and direct the district court to enter a judgment confirming
the arbitration award.
I.
A. Factual Background
Plaintiff James W. McCarthy ("McCarthy") was a financial
consultant at Smith Barney, predecessor of Defendant Citigroup
Global Markets Inc. ("CGMI"), from 1985 until his resignation in
May 2003. As of 1993, he worked in the Manchester, New Hampshire
office of CGMI. CGMI is an investment bank and brokerage firm with
its principal place of business in New York City. It is a
subsidiary of Citigroup Inc., one of the world's largest financial
services companies.
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While an employee, McCarthy participated in the Capital
Accumulation Plan ("CAP Plan"), which was sponsored by CGMI's
parent company, Traveler's Group, Inc. The CAP Plan is a program
designed to retain employees by giving them the opportunity to
purchase restricted shares of Citigroup, either in the form of
Citigroup restricted stock at discounted prices on a tax-deferred
basis, or as grants of non-qualified stock options for Citigroup
common stock. An eligible employee must sign, at least annually,
a form electing to participate in the CAP Plan, wherein the
employee designates the amount of earnings he wants deducted from
his paychecks and used in the CAP Plan.
Under the CAP Plan restricted stock program, the
restricted stock is acquired at a twenty-five percent (25%)
discount from market value and is purchased with wage deductions
from payroll checks. However, the stock purchases are subject to
a vesting period of two years. When the restricted shares vest,
the participant pays ordinary income taxes and payroll taxes based
on the market value of the shares on the vesting date, unless the
participant has elected to pay taxes at the time of the payroll
deduction. McCarthy had paid income and payroll taxes on many of
the shares at issue here. If a participant in the CAP Plan
resigns, as McCarthy did, the participant forfeits both the
unvested restricted shares and the wages deducted from the
paychecks. The unvested restricted shares are cancelled, the
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underlying restricted Citigroup stock reverts to Citigroup, and
CGMI does not return the wages to the participant. Under the CAP
Plan stock option program, a participant can choose to receive up
to one-third of the restricted shares in the form of non-qualified
stock options on Citigroup common stock. If employment terminates
voluntarily, unvested options may not be exercised. As with the
restricted stock program, when an option is exercised, income and
payroll taxes are withheld.
McCarthy resigned on May 9, 2003. From 1993 until his
resignation, McCarthy voluntarily elected in writing to direct the
equivalent of 20-25% of his compensation to be invested through the
CAP Plan. He participated mostly in the restricted stock plan, but
at times also purchased stock options under the CAP Plan. McCarthy
sought to recover his contributions to the CAP Plan that had
resulted in the purchase of unvested shares, as well as funds that
had not been used to purchase shares. Pursuant to the terms of the
CAP Plan, these contributions had been forfeited.
B. Procedural Background
Pursuant to the parties' arbitration agreement and the
regulatory framework of the securities industry, McCarthy commenced
arbitration proceedings against CGMI with the National Association
of Securities Dealers ("NASD") on December 29, 2003.1 McCarthy
1
The NASD is the primary self-regulatory organization
responsible for the regulation of persons and companies involved in
the securities industry in the United States, with delegated
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asserted statutory claims under the New Hampshire wage laws (the
"Wage Law") and equitable claims.
A hearing was held on November 18, 2004 (the "First
Hearing"). The arbitrators in the First Hearing (the "First
Panel") ruled in favor of CGMI and dismissed McCarthy's claims (the
"First Award"):2
[McCarthy's] request for relief is denied. The evidence
and documents presented in evidence at the hearing
demonstrated that [McCarthy] knowingly and willingly
participated in the [CAP Plan] by signing the election
forms twice a year for several years. [McCarthy]
benefitted financially from participation in the [CAP
Plan] to a substantial degree over the years. While
[McCarthy] invoked New Hampshire wage law to support his
case, the Panel considered it irrelevant because the
Panel considered the case to be a contract dispute
regarding an inventive compensation plan commonly used at
the firm and commonly used in the securities industry.
On December 16, 2004, McCarthy asked the district court to vacate
the First Award. CGMI cross-moved to confirm it. Focusing on the
language above, the district court remanded the matter to the NASD
for further arbitration proceedings ("First Remand Order"):
authority from the U.S. Securities and Exchange Commission. See
"About NASD", http://www.nasd.com/AboutNASD/index.htm (last visited
August 15, 2006).
2
In the context of arbitration, an "award" can denote both
the decision an arbitration panel reaches and the authenticated
document containing the decision. See 2 Martin Domke, Domke on
Commercial Arbitration, Appx. B-1 § 19(a) (3d. ed. 2003)("An
arbitrator shall make a record of an award. The record must be
signed or otherwise authenticated by any arbitrator who concurs
with the award. The arbitrator or the arbitration organization
shall give notice of the award, including a copy of the award, to
each party to the arbitration proceeding.").
-5-
The [arbitration] panel does not appear to have intended
"irrelevant" to have its usual meaning. Instead, the
panel concluded that McCarthy was not protected by the
wage laws because he had profited from the CAP in the
past and had voluntarily agreed to its terms. As such,
the panel acknowledged the applicability of the wage laws
but decided not to apply them because of the
circumstances attending McCarthy's claim. The panel also
decided not to consider the wage laws because plans like
the CAP are commonly used in the securities industry. In
doing so, the panel set aside the governing law in favor
of its perception of an equitable result and industry
practices. The panel's decision not to consider the New
Hampshire wage laws demonstrates its disregard for the
governing law.
The district court concluded that "the case must be remanded to
have McCarthy's claim decided under the New Hampshire wage laws
through arbitration." Although CGMI filed an appeal from the First
Remand Order (the "First Appeal"), it never pursued that First
Appeal. Instead, CGMI voluntarily withdrew it. On March 18, 2005,
we entered a judgment dismissing the First Appeal and sending the
case back to the district court.
McCarthy re-filed his claim with the NASD, which convened
a second arbitration panel comprised of three new arbitrators (the
"Second Panel"). McCarthy withdrew all of his equitable claims,
moving forward with only his claims based on New Hampshire law.
The parties submitted briefs to the Second Panel, along with copies
of the Wage Law, case law, the district court's First Remand Order,
the CAP Plan documents, and exhibits reflecting McCarthy's
participation in the CAP Plan. The Second Panel heard argument and
testimony from several witnesses on August 2, 2005 (the "Second
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Hearing"). CGMI argued that the CAP Plan did not violate the Wage
Law and, in the alternative, that McCarthy was not entitled to any
damages regardless of the status of the CAP Plan under the Wage
Law.3 McCarthy asserted that the First Remand Order required the
Second Panel to apply the Wage Law to his claims, and under the
Wage Law the CAP Plan was illegal. On August 18, 2005, the Second
Panel issued its award denying McCarthy's claims with prejudice
(the "Modified Award"):
[McCarthy] requested that the panel . . . declare that
the CAP Plan is illegal under New Hampshire law, to the
extent the CAP Plan is implemented (i) through wage
deductions, which are not actually used to purchase stock
in Citigroup, or (ii) so as to cause employees to forfeit
wages.
. . .
The Panel heard testimony from [McCarthy] and witnesses
of both parties and considered the documentary evidence
from each side as well. The Arbitrators fully considered
all claims and defenses, including the applicability of
the New Hampshire Wage Laws, which were heavily argued on
both sides . . . . After full consideration of the
matter, the panel decided to deny all claims with
prejudice.
On September 8, 2005, McCarthy filed with the district
court a motion to vacate the Modified Award, asserting again that
the arbitrators had manifestly disregarded controlling law.
McCarthy also claimed that the award should be vacated because CGMI
3
CGMI asserted that "McCarthy is not entitled to any damages
because, if he held all his vested shares, McCarthy netted over one
million dollars from voluntarily participating in the CAP Plan, and
CGMI is entitled to recover those shares or their market value in
excess of McCarthy's cost of any unvested stock."
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improperly encouraged the arbitrators to ignore the district
court's legal findings as they were set forth in the First Remand
Order, and because the arbitrators refused to be polled as to
whether they would follow the law. CGMI again filed a cross-motion
for confirmation of the award.
In a Second Remand Order dated December 15, 2005, the
district court vacated the Modified Award because it was in
manifest disregard of the law, denied CGMI's cross-motion for
confirmation of the award, and remanded the case for a third
arbitration proceeding, if necessary (the court urged the parties
to settle).4
II.
A. Standard of review
We review a district court's decision to vacate or
confirm an arbitration award de novo. See Bull HN Info. Sys., Inc.
v. Hutson, 229 F.3d 321, 330 (1st Cir. 2000). The touchstone for
review of arbitration awards is 9 U.S.C. § 10.5 "Section 10
4
In the Second Remand Order, the district court rejected
McCarthy's "polling" argument, stating that McCarthy had "cited no
case or any other legal authority supporting his request for a
poll." McCarthy did not renew this argument on appeal and we do
not address it.
5
In relevant part, 9 U.S.C. § 10 states:
(a) In any of the following cases the United States court
in and for the district wherein the award was made may
make an order vacating the award upon the application of
any party to the arbitration --
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authorizes vacatur of an award in cases of specified misconduct or
misbehavior on the arbitrators' part, actions in excess of arbitral
powers, or failures to consummate the award." Advest, Inc., v.
McCarthy, 914 F.2d 6, 8 (1st Cir. 1990); see also Nat'l Cas. Co. v.
First State Ins. Group, 430 F.3d 492, 497 n.4 (1st Cir. 2005).
"Courts do, however, retain a very limited power to review
arbitration awards outside of section 10." Advest, 914 F.2d at 8.
As we have put it:
In the main, a successful challenge to an arbitration
award, apart from section 10, depends upon the
challenger's ability to show that the award is (1)
unfounded in reason and fact; (2) based on reasoning so
palpably faulty that no judge, or group of judges, ever
could conceivably have made such a ruling; or (3)
mistakenly based on a crucial assumption that is
concededly a non-fact.
Id. at 8-9 (quoting Local 1445, United Food & Commercial Workers v.
Stop & Shop Cos., 776 F.2d 19, 21 (1st Cir. 1985)(internal
quotation marks omitted). In some of our cases, we have referred
to this non-statutory standard of review as "manifest disregard of
(1) where the award was procured by corruption, fraud, or
undue means;
(2) where there was evident partiality or corruption in
the arbitrators, or either of them;
(3) where the arbitrators were guilty of misconduct in
refusing to postpone the hearing, upon sufficient cause
shown, or in refusing to hear evidence pertinent and
material to the controversy; or of any other misbehavior
by which the rights of any party have been prejudiced; or
(4) where the arbitrators exceeded their powers, or so
imperfectly executed them that a mutual, final, and
definite award upon the subject matter submitted was not
made.
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the law." Wonderland Greyhound Park, Inc. v. Autotote Sys., Inc.,
274 F.3d 34, 35 (1st Cir. 2001).6 We have elaborated that we mean
by "manifest disregard of the law" a situation "where it is clear
from the record that the arbitrator recognized the applicable law
-- and then ignored it." Advest, 914 F.2d at 9. To succeed under
this standard "there must be some showing in the record, other than
the result obtained, that the arbitrators knew the law and
expressly disregarded it." Advest, 914 F.2d at 10 (quoting O.R.
Securities, Inc. v. Prof'l Planning Assoc., Inc., 857 F.2d 742, 747
(11th Cir. 1988). "'[D]isregard' implies that the arbitrators
appreciated the existence of a governing legal rule but wilfully
decided not to apply it." Id. (emphasis added).7
6
In P.R. Tel. Co., Inc. v. U.S. Phone Mfg. Corp., 427 F.3d 21(1st Cir. 2005), we stated that "[u]nder the FAA, an award may be
vacated for legal error only when in 'manifest disregard of the
law.'" Id. at 25. Insofar as this statement means that the FAA
does not foreclose extra-statutory judicial review of arbitration
awards on a limited basis, e.g. the "manifest disregard of the law"
standard, this statement is correct. However, insofar as this
statement means that the "manifest disregard of the law standard"
is a part of the FAA itself, it would be mistaken. Nowhere in 9
U.S.C. § 10 does the phrase "manifest disregard of the law" appear.
See Advest, 914 F.2d at 9 n.5 ("The lane of review that has opened
out of this language is a judicially created one, not to be found
in 9 U.S.C. § 10.").
7
See also Domke, § 38:9 ("Although subject to slight
variations in wording, courts generally apply the following two
part test in determining if the award should be vacated for
manifest disregard of the law: (1) Did the arbitrator know of the
governing legal principal yet refused to apply it or ignored it all
together? and (2) Was the law ignored by the arbitrators well
defined, explicit and clearly applicable to the case? Only if the
court determines that both prongs of this test are satisfied will
it overturn an award for manifest disregard of the law.").
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B. The district court's reasoning
On appeal, CGMI maintains that the Second Panel's
Modified Award was improperly vacated under the manifest disregard
of the law standard. McCarthy, inter alia, asserts that the
district court's Second Remand Order was correct.
1. The First Remand Order
Although not the subject of this appeal, the court's
First Remand Order provides a useful insight into its reasoning in
this case. As noted above, the First Panel explained the First
Award against McCarthy in these terms:
While [McCarthy] invoked New Hampshire wage law to
support his case, the Panel considered it irrelevant
because the Panel considered the case to be a contract
dispute regarding an inventive compensation plan commonly
used at the firm and commonly used in the securities
industry.
(Emphasis added.) Focusing on the Panel's use of the word
"irrelevant", the district court concluded that "the panel set
aside the governing law in favor of its perception of an equitable
result and industry practices. The panel's decision not to
consider the New Hampshire wage laws demonstrates its disregard for
the governing law." The court saw the First Panel's reasoning as
an instance "where it is clear from the record that the
arbitrator[s] recognized the applicable law -- and then ignored
it." Advest, 914 F.2d at 9. Lest there be any doubt about this
point, the court explained again in the Second Remand Order the
problem with the First Award: "In the first award, the panel stated
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that the New Hampshire wage laws were irrelevant. As such, the
panel explicitly disregarded the governing law." The court's First
Remand Order, given the court's interpretation of the First Award,
was a conventional application of the manifest disregard of the law
standard.
2. The Second Remand Order
The district court's application of the manifest
disregard of the law standard to the Modified Award presents a
different story. We again quote the reasoning of the Second Panel
in the Modified Award:
The Panel heard testimony from [McCarthy] and witnesses
of both parties and considered documentary evidence from
each side as well. The Arbitrators fully considered all
claims and defenses, including the applicability of the
New Hampshire Wage Laws, which were heavily argued by
both sides. After full consideration of the matter, the
Panel decided to deny all claims with prejudice.
The district court focused on the Second Panel's statement that it
had "fully considered all claims and defenses, including the
applicability of the New Hampshire Wage Laws," and found in that
statement a troubling ambiguity. As the court explained in its
Second Remand Order:
[t]he [Second] panel did not say whether it concluded
that the wage laws were applicable or not applicable or
whether it had applied that law in making its decision.
Therefore, while the second panel's statement did not
clearly demonstrate a manifest disregard of the governing
law, as the first panel did, the second panel left open
the possibility that, contrary to the court's direction
in the [First] remand order, the panel concluded that the
New Hampshire wage laws do not apply.
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The district court acknowledged that the mere
"possibility that . . . the panel concluded that the New Hampshire
wage laws do not apply" is not itself a manifest disregard of the
law.8 As the district court put it: "[T]he second panel's
statement did not clearly demonstrate a manifest disregard of the
governing law, as the first panel did." In the absence of such an
expression of manifest disregard of the law in the Modified Award
itself, the district court decided to pursue a further inquiry:
In the first award, the panel stated that the New
Hampshire wage laws were irrelevant. As such, the panel
explicitly disregarded the governing law so that it was
not necessary to look behind that decision to determine
its basis.
(Emphasis added.)
There is authority in our precedents for a court to go
behind the award of an arbitration panel to the record itself in
8
We disagree with the district court that the Modified Award
of the Second Panel can be read as a possible statement that the
New Hampshire wage law is irrelevant, particularly in light of the
explicit statement by the Second Panel that it "fully considered
all claims and defenses, including the applicability of the New
Hampshire Wage Laws, which were heavily argued by both sides." If
the court had vacated the award of the Second Panel on this basis
alone, we would have simply vacated its judgment on this misreading
of the Modified Award. However, as we explain below, the district
court also identified a second possibility in the Modified Award –
namely, that the Second Panel had applied the New Hampshire wage
law and still found the CAP lawful. In looking behind the award of
the Second Panel to determine its basis, the court explained in its
decision why this second possibility would also be a manifest
disregard of the law. Focusing on that explanation in the balance
of our opinion, we explain its incompatibility with the narrow
scope of review that a court must observe in reviewing the decision
of an arbitration panel.
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conducting a manifest disregard of the law inquiry. For example,
we have said that "there must be some showing in the record, other
than the result obtained, that the arbitrators knew the law and
expressly disregarded it." Advest, 914 F.2d at 10 (emphasis
added). But resorting to the record in search of manifest
disregard of the law is constrained by the narrow scope of the
manifest disregard of the law standard itself. To repeat, manifest
disregard of the law means, at its core, that "arbitrators knew the
law and explicitly disregarded it." P.R. Tel. Co., 427 F.3d at 32(internal quotation marks omitted). "Put differently, disregard
implies that the arbitrators appreciated the existence of a
governing legal rule but wilfully decided not to apply it." Id.(internal citation and quotation marks omitted).
The manifest disregard of the law inquiry must not run
afoul of the well-established principle that courts "do not sit to
hear claims of factual or legal error by an arbitrator as an
appellate court does in reviewing decisions of lower courts."
United Paperworkers Int'l Union v. Misco, Inc., 484 U.S. 29, 38
(1987); see also Poland Spring Corp. v. United Food & Commercial
Int'l Union, 314 F.3d 29, 33 (1st Cir. 2002) (a court does not
conduct appellate review "to hear claims of factual or legal error
by an arbitrator or to consider the merits of an award"). "Even
where such error is painfully clear, courts are not authorized to
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reconsider the merits of arbitration awards." Advest, 914 F.2d at
8 (internal quotation marks and citation omitted).
The district court did not observe this limitation on its
authority to review an arbitration award. Instead of finding
manifest disregard of the law by the Second Panel, it found an
application of the Wage Law with which it disagreed. To
demonstrate this point, we quote several excerpts from the court's
Second Remand Order:
CGMI's arguments to the arbitration panel, that the CAP
was lawful because McCarthy's compensation, paid in cash
and restricted stock, conferred a benefit to him, because
McCarthy had agreed to participate in the CAP and was a
sophisticated and intelligent financial consultant, and
because McCarthy had benefitted in the past from the CAP,
are not pertinent to the principles of New Hampshire law.
Instead, CGMI's argument is based on the reasoning of the
Court of Appeals of New York . . . . CGMI represented to
the arbitration panel that the New Hampshire wage laws
allowed deductions as long as they accrued 'to the
benefit of the employee,' . . . that the New Hampshire
laws, like the New York law, allowed [such] a deduction
. . . .
[But] under New Hampshire law, unlike New York law, a
deduction is not lawful simply because it accrues to the
benefit of an employee . . . .
CGMI also argued that the CAP was a lawful deduction as
a payment into a savings fund held by someone other than
the employer and that it was empowered by the federal tax
treatment of similar plans to offer the CAP . . . .
Neither argument is persuasive.
Nevertheless, it is perhaps arguable that the panel was
sufficiently confused or misled by CGMI's arguments to
conclude that the CAP deductions comported with New
Hampshire law. Even assuming that the CAP deductions
were lawful, however, CGMI did not offer the arbitration
panel any justification under New Hampshire law for its
failure to pay McCarthy the compensation that he had
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earned before he resigned. CGMI's oft-repeated theory .
. . does not comport with New Hampshire law.
After this extensive merits review, the district court
concluded:
In the absence of any explanation, there appears to be no
arguable or plausible basis for the [Second] panel to
have ruled either that the New Hampshire wage laws did
not apply to McCarthy's claims or that CGMI's failure to
pay McCarthy earned compensation, based on the forfeiture
provision in the CAP, was lawful. In either case, the
panel's decision necessarily was made in manifest
disregard of the law.
To make its meaning unmistakable, the district court added in a
footnote to its decision that "[b]ecause neither alternative basis
for the decision is reasonable, given the governing law, a remand
for clarification would not be beneficial here." Therefore, if
there were to be a third arbitration proceeding, the district court
directed that a new panel be convened. In that circumstance, the
court said the parties were "to request that the arbitration panel
provide an explanation or reasons for its decision to allow
meaningful judicial review."
Although the district court's legal analysis of the
relationship between the Wage Law and the CAP Plan was thoughtful
(indeed, the court was thoughtful about this case throughout the
lengthy proceedings), there are several errors in the district
court's Second Remand Order. First, with its insistence that the
next arbitration panel, if one were constituted, provide an
explanation or reasons for its decision to allow meaningful
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judicial review, the court ignored the basic principle that
"arbitrators need not explain their award" at all. P.R. Tel. Co.,
427 F.3d at 32 (internal citation omitted). Second, although it
theoretically left open the possibility that a third arbitration
panel could explain why McCarthy's claim failed under New Hampshire
law, the court's elaborate rejection of that possibility in its
Second Remand Order delivered an unmistakable message to a third
panel -- such a decision would be difficult to justify. Courts
should avoid such messages when remanding cases to arbitration
panels. See Domke, § 30:6 ("[C]areful consideration should also be
given that remanding the case does not make the court itself decide
the issue in controversy or instruct the arbitration in such
direction.").
Third, in looking behind the Modified Award, the court
did not examine the record of proceedings before the panel for
manifest disregard of the law -- that is, "some showing in the
record, other than the result obtained, that the arbitrators knew
the law and expressly disregarded it." Advest, 914 F.2d at 10(internal citation omitted). Instead, the court conducted its own
analysis of the compatibility of the CAP Plan with the Wage Law and
concluded that the Modified Award in favor of CGMI, absent some
further explanation, was wrong. Moreover, in conducting that legal
analysis, the court did not find that "rare" instance of manifest
disregard we described in Advest, where "the governing law may have
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such widespread familiarity, pristine clarity, and irrefutable
applicability that a court could assume the arbitrators knew the
rule and, notwithstanding, swept it under the rug." 914 F.2d at
10. Instead, the court's analysis reveals a legal landscape devoid
of statutory language or a decision of the New Hampshire Supreme
Court that irrefutably proscribes the CAP Plan under the Wage Law.
At most, after a merits analysis of the Modified Award, the
district court arguably found a legal error in its result.
However, our precedents forbid a district court from conducting
such a review of an arbitration award. See Poland Spring Corp.,
314 F.3d at 33 (a court does not conduct appellate review "to hear
claims of factual or legal error by an arbitrator or to consider
the merits of an award"). We must therefore vacate the district
court's Second Remand Order and direct the court to enter a
judgment confirming the Second Panel's Modified Award.9 Each party
is to bear its own costs.
So ordered.
9
Relying on Montes v. Shearson Lehman Bros., Inc., 128 F.3d
1456 (11th Cir. 1997), where the court found an award in manifest
disregard of the law, McCarthy also asserts that CGMI "undermined
the integrity of the Second Hearing" by "repeatedly urg[ing] the
Second Panel during oral argument to disregard the law," and that
this conduct constitutes an independent basis for vacating the
Modified Award. The district court rejected that argument: "the
circumstances in this case are not sufficiently similar to those in
Montes to permit application here of that narrowly limited
decision." We see no reason to disturb this ruling.
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