Mandatory Employee Arbitration Clauses: Still A Good Deal for the Employer? How Merrill Lynch is Making Employers Think Twice

| Zuckerman Spaeder Team

On Sept. 17, 2012, a U.S. District Court denied Merrill Lynch’s petition to vacate an arbitration panel’s award of $10.2 million to two of its former advisors, Tamara Smolchek and Meri Ramazio.  The award – split almost evenly between $5.2 million in compensatory damages for deferred compensation and $5 million in punitive damages – helps to illustrate the growing (and changing) role that arbitration plays in disputes between high-level executives and their employers.

For decades it has been conventional wisdom that employee arbitration clauses favor the employer by taking potentially sensitive cases away from a jury (because “everyone knows” that juries are “more sympathetic to employees”).  (Or, as a more employer-friendly article puts it, arbitration can reduce the likelihood of an “irrational award” because arbitrators “tend to be more conservative than juries.”)

Additionally, arbitration clauses can favor the employer where the employee is required to share in some (or all) of the costs of the arbitration by discouraging plaintiffs who would otherwise have been able to secure plaintiffs’ counsel on a contingent fee basis for a trial by jury.  (Note that courts continue to grapple with this issue, and many courts have determined that if an arbitration clause would unduly burden a plaintiff from exercising his or her legal rights, that arbitration clause is invalid and the plaintiff is free to litigate in court instead.  See, e.g., Ball v. SFX Broadcasting, Inc., 165 F. Supp. 2d 320, 238-40 (N.D.N.Y. 2001) (discussing cases).

Is this still the case?  Read on.

Maybe not.  These traditionally assumed advantages may not be present in the context of suits by suits – after all, high-level executives are less likely to be deterred by the unfamiliarity or up-front expense of arbitration, and their claims may play equally well (or better) in front of an educated arbitrator than a jury.

What about that other long-cited advantage of arbitration, that because discovery is “less formal” and therefore quicker and less expensive?  Well, that’s true in some cases, but increasingly, major arbitration services such as the American Arbitration Association have adopted rules for employment arbitration cases that permit the arbitrator to order “such discovery, by way of deposition, interrogatory, document production, or otherwise, as the arbitrator considers necessary” to fully and fairly resolve the case.  Sound familiar?

Indeed, because many arbitrators are retired judges, this can and often does result in a discovery process that is exactly as complex and time-consuming as litigation, replete with productions of mountains of documents, hundred-page privilege logs, motions to compel, sanctions, in camera review of contested documents, and so on.  Moreover, because (as we’ll see below) one of the very few grounds for overturning an arbitration award is that the arbitrator “refused to hear evidence pertinent” to the case, arbitrators are sometimes less willing than a trial judge to sustain a party’s objection to the production of documents on the grounds of undue burden or expense.  Paradoxically, this can mean the supposedly “streamlined” arbitration discovery process actually permits a litigant to seek more discovery than he or she would have otherwise been able to procure in court!

But despite all the changes to the arbitration process over the years, one thing remains constant:  an arbitrator’s award is (essentially) final.  Unlike a jury’s verdict – to which the losing party always has at least one appeal as of right -- the arbitration decision cannot be appealed except on very narrow grounds.  Specifically, U.S. arbitrations[1] are generally governed by the Federal Arbitration Act, 9 U.S.C. § 1 et seq., which provides that an appropriate court “must” confirm any valid arbitration award in its entirety unless the opposing party can demonstrate that:

(1)   the award was procured by corruption, fraud, or undue means;

(2)   there was evident partiality or corruption in the arbitrators;

(3)   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.

9 U.S.C. § 10(a).[2]

This can be a double-edged sword to the employer; on the one hand, the employer knows that an arbitration award is essentially final and that the company will not be burdened with years of potential appeals.  On the other hand – as Merrill Lynch found out – if the arbitration award goes the other way, courts almost universally confirm arbitration awards, no matter their size, and even if such awards contain factual or legal errors that would merit reversal of a jury’s verdict.

Here, Merrill Lynch had an arbitration clause with its advisors requiring that any dispute be submitted for arbitration before a panel of arbitrators appointed by the Financial Industry Regulatory Authority (FINRA), applying the FINRA Code of Arbitration Procedure for Industry Disputes.  

Former Merrill Lynch brokers Tamara Smolchek and Meri Ramazio brought such a complaint in 2010, two years after they resigned from Merrill following its acquisition by Bank of America, asking that the arbitration panel award them immediate vesting and payment of certain long-term compensation bonuses.  Smolchek and Ramazio claimed that their resignation constituted “good reason” under the terms of their employment agreements because of the change in control of Merrill Lynch, and thus triggered the immediate vesting of those benefits.

After a 17-day arbitration hearing – exactly as burdensome and expensive as a three-and-a-half-week trial, by the way – the arbitration panel found in favor of the brokers, awarding them $5.2 million in vested bonuses and an additional $5 million in punitive damages.

Merrill Lynch attempted to vacate the arbitrator’s $10.2 million award pursuant to 9 U.S.C. § 10(a)(2), (3), and (4), alleging that the arbitrators demonstrated “evident partiality,” “refused to hear evidence pertinent and material to the controversy,” and “exceeded their powers” by imposing sanctions without providing Merrill Lynch the opportunity to explain itself.  Complaint ¶¶ 8-10, 17-76.

The bulk of Merrill Lynch’s complaint focused on the claim of “evident partiality.”  To that end, Merrill Lynch claimed that the arbitration panel:  (1) failed to disclose certain conflicts of interest on the part of the arbitrators, id. ¶¶ 24-29; (2) permitted opposing counsel to review privileged documents, id. ¶¶ 32-34; (3) imposed various allegedly punitive discovery sanctions while Merrill Lynch prepared a privilege log, id. ¶¶ 35-36; (4) imposed sanctions, sua sponte, for Merrill Lynch’s use of medical records during cross-examination at the hearing, id. ¶ 44; (5) precluded Merrill Lynch’s corporate representative from attending the hearing, id. ¶ 56; and (6) issued numerous inconsistent rulings that supposedly evidenced a consistent partiality in favor of the brokers, id. ¶¶ 54-55, 57-61.

After concluded that Merrill Lynch waived its objections with respect to (1) (because Merrill Lynch had conducted an independent investigation prior to the hearing and failed to object to the arbitrator with the alleged conflict), the Court considered the specific instances of alleged misconduct raised by Merrill Lynch in the light that it “should defer to an arbitrator’s decision wherever possible” (quoting Robbins v. Day, 954 F.2d 679, 682 (11th Cir. 1982) and summarily finding – in less than a paragraph in a twelve-page decision – that “the panel had at least some reasonable basis for the actions it took” for each of the claimed grievances and thus did not deny Merrill Lynch a “fundamentally fair hearing.”

In other words:  the court was unwilling to dig into the substantive merits of whether the arbitration panel’s decisions systematically reflected a bias in favor of the employees – in fact, the Court noted that “the panel’s decisions were in some cases detrimental to Merrill Lynch’s case.”  But so long as those decisions had “at least some reasonable basis,” the court – like many courts that we’ve seen reviewing motions to vacate arbitration awards – was going to uphold the arbitration award.

The lesson is clear:  when writing an arbitration clause into an employment agreement (employers) or signing said agreement (employees), both parties should be aware that the arbitrator’s decision will likely be final, regardless of the merits or how it was reached.


[1]  Foreign arbitration awards are given even more deference; they are typically subject to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, codified at 9 U.S.C. § 201 et seq., which provides that such awards can be refused only where the party demonstrates a procedural defect in the hearing itself, or shows that the award would be contrary to state law or public policy in the country in which the prevailing party is seeking to enforce the award.

[2]  Arbitration awards can be “modified” or “corrected” – but not set aside in their entirety – on similar grounds set forth in 9 U.S.C. § 11; that discussion is beyond the scope of this post.

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As the regulatory and business environments in which our clients operate grow increasingly complex, we identify and offer perspectives on significant legal developments affecting businesses, organizations, and individuals. Each post aims to address timely issues and trends by evaluating impactful decisions, sharing observations of key enforcement changes, or distilling best practices drawn from experience. InsightZS also features personal interest pieces about the impact of our legal work in our communities and about associate life at Zuckerman Spaeder.

Information provided on InsightZS should not be considered legal advice and expressed views are those of the authors alone. Readers should seek specific legal guidance before acting in any particular circumstance.