Alabama Supreme Court Vacates Arbitration Award Based on Its Finding of an ‘Evident Partiality’ on Behalf of One of the Arbitrators

Recently, the Alabama Supreme Court vacated an arbitration award based on its holding that one of the arbitrators had an evident partiality based on his failure to disclose potential conflicts, where the arbitrator did not do anything to fulfill his duty to investigate and discover the conflicts.

The Municipal Workers Compensation Fund, Inc. (“the Fund”) administers a self-insured workers’ compensation fund for the benefit of its members. The Fund entrusted the management and investment of approximately $50 million in assets to Morgan Asset Management, Inc. (“MAM”) and Morgan Keegan & Co., Inc. (“Morgan Keegan”). The Fund claims that it sustained losses in excess of $15 million as a result of MAM’s and Morgan Keegan’s alleged wrongful acts and omissions concerning the Fund’s assets.

As a result, the Fund initiated arbitration proceedings against MAM and Morgan Keegan, asserting claims for breach of fiduciary duty, breach of contract, negligence, fraud, violations of NASD and NYSE Rules, and violations of the Alabama Securities Act. The arbitration provisions contained in the parties’ contract provided that arbitration was to be conducted before the Financial Industry Regulatory Authority (“FINRA”) in accordance with FINRA’s rules and procedures. The FINRA Rules contain specific rules requiring disclosure by potential arbitrators of any circumstance which might preclude the arbitrator from rendering an objective and impartial determination, including the existence of any current or past financial, business, or professional relationships with any party.

After reviewing the disclosures of 30 proposed arbitrators, the parties selected a final panel of three arbitrators, one of whom was Eric Kunis. In his disclosures, Kunis stated that he had no potential conflicts to disclose even though he was a vice president/partner in Maxim Group, LLC (“Maxim”), a financial services firm that had a close, ongoing relationship with Morgan Keegan. Following a hearing, the three-person arbitration panel issued its award denying the Fund’s claims in their entirety. The trial court entered a judgment based on the arbitration award. The Fund moved the trial court to vacate its judgment, contending that after the arbitration award was entered, the Fund discovered that Kunis had failed to disclose Maxim’s relationship with Morgan Keegan, as well as the fact that Maxim had an attorney-client relationship with Greenberg Traurig, the law firm representing Morgan Keegan in the arbitration proceeding.[1] The trial court denied the Fund’s motion, holding that although Kunis had failed to make the required disclosures, his failure to disclose did not amount to an “evident partiality” required to vacate the award. The Fund appealed.

On appeal, the Alabama Supreme Court recognized that 9 U.S.C. § 10(a)(2) provides that an arbitration award may be vacated where there was “evident partiality” in the arbitrators. Alabama has adopted a “reasonable impression of partiality” as the standard for determining whether evident partiality exists under § 10(a)(2), which requires  credible evidence that gives rise to an impression of bias that is direct, definite and capable of demonstration, as distinct from a mere appearance of bias that is remote, uncertain and speculative.

The Fund argued that Kunis’ failure to disclose the business relationship between Maxim, Morgan Keegan and Greenberg Traurig created a “reasonable impression of partiality” constituting an “evident partiality” on Kunis’ part. In response, MAM and Morgan Keegan argued that the Fund had failed to establish that Kunis was even aware of the facts relating to the existence of the complained of business relationship. In support of their argument, Morgan Keegan and MAM relied on Gianelli Money Purchase Plan & Trust v. ADM Investor Services, Inc., 146 F. 3d 1309 (11^th Cir. 1998), wherein the Eleventh Circuit adopted a per se rule that a finding of evident partiality is precluded by an arbitrator’s lack of actual knowledge of the information upon which an alleged conflict was founded.

The Fund countered with the argument that, where an arbitrator has a duty to investigate potential conflicts, the law will impose constructive knowledge of any undiscovered conflict upon the arbitrator where the arbitrator does nothing to fulfill his or her duty to investigate. The Fund argued that the case of Schmitz v. Zilveti, 20 F. 3d 1043 (9^th Cir. 1994), was controlling. In Schmitz, the Ninth Circuit held that a “reasonable impression of partiality” may exist even though an arbitrator lacks actual knowledge of underlying undisclosed facts, if the arbitrator has constructive knowledge of those facts.

The Court found the holding in Schmitz was the better view and concluded that the “reasonable impression of partiality” standard constituting an “evident partiality” under § 10(a)(2) may be satisfied even though an arbitrator lacks actual knowledge of the facts giving rise to the conflict when the arbitrator was under a duty to investigate in order to discover possible conflicts and failed to do so. In such a situation, the arbitrator will be deemed to have constructive knowledge of the conflict of interest, and the failure to disclose the conflict may result in a “reasonable impression of partiality.”

Turning to the facts of the instant case, the Court recognized that the FINRA Rules imposed upon Kunis the duty to make a reasonable effort to discover the business relationship between Maxim, Morgan Keegan, and Greenberg Traurig, and he did nothing to satisfy this duty. Therefore, Kunis had constructive knowledge of the business relationship between these parties. Because Kunis had constructive knowledge and because of the presence of the conflict itself, Kunis’ failure to disclose this relationship resulted in a reasonable impression of partiality. Given the nature and extent of the business relationship, the Court concluded that the impression of bias arising from that relationship was direct, definite and capable of demonstration. Accordingly, the Court held that the Fund established an evident partiality on the part of Kunis under § 10(a)(2) and that the Fund was entitled to have the judgment entered on the arbitration award vacated.