We all make mistakes. No matter how careful you are, how well prepared you are, mistakes happen to the best of us, even experts.
Does an expert’s mistake spell disaster for your case? Not necessarily, according to a surprising reversal by the 5th Circuit Court of Appeals.
In this recent securities case involving a mistake in expert testimony, the 5th Circuit ordered a lower court to “undo” its decision to vacate a multi-million dollar arbitration award against securities broker defendant Morgan Keegan.
The reason? Although acknowledging the expert in the case relied on erroneous numbers, the appellate court determined that the mistake, without more, did not mean the arbitration award was procured by fraud.
What’s the difference between an expert mistake and fraud? More than $9 million, according to this case.
A $9 Million Mistake?
The case arose when 18 investors claimed that securities broker Morgan Keegan allegedly engaged in an improper scheme inducing them to invest in “highly risky” bond funds between 1998 and 2008. The investors’ claims were heard by an arbitration panel of the Financial Industry Regulatory Authority (FINRA), in which the investors’ securities analyst expert gave allegedly false testimony. The testimony resulted in an arbitration award for the investors of more than $9 million.
Morgan Keegan persuaded the U.S. District Court for the S.D. of Texas to vacate the award. In vacating the award, the district court found in part that the arbitration panel based its damages calculations on knowingly false expert witness testimony.
The investors appealed the lower court’s decision to vacate the award, and the 5th Circuit sided with the investors - reversing, remanding, and ordering the entry of a judgment enforcing the arbitration award against Morgan Keegan.
At the arbitration, the investors’ technical expert witness, a securities analyst, provided testimony on the issue of damages. However, approximately one week later, during a different arbitration involving other claimants (but the same defendant), the same expert provided revised calculations that revealed an error. In explaining the reason for the differing numbers, the expert explained that one of his staff members had, quite simply, made a mistake. The expert stated that he hadn’t been aware of the errors when he testified in the arbitration at issue here.
Although acknowledging the expert’s testimony during the arbitration was based upon a mistake, the 5th Circuit reversed the district court’s decision to vacate the arbitration award in favor of the investors. The 5th Circuit reasoned that, despite the error in the expert’s testimony, the award was not procured by fraud.
Agree to Disagree…
Both the district court and the appellate court agreed on the rule: A court may refuse to enforce an arbitration award where the award was procured by fraud. From there, however, they parted ways.
The appellate court first determined that fraud requires a showing of bad faith. The circuit gave concrete examples, none of which were involved in this instance, including bribery, undisclosed bias of an arbitrator, willfully destroying or withholding evidence, and perjury. The expert’s false testimony simply didn’t amount to fraud under the meaning discussed by the court.
Requirements to Show an Arbitration Award was Procured by Fraud
Under the Federal Arbitration Act (FAA), in order to show an arbitration award was procured by fraud, a party has a burden of proof that requires meeting all the elements of a three part test.
A party must show:
(1) that the fraud occurred by clear and convincing evidence;
(2) that the fraud was not discoverable by due diligence before or during the arbitration hearing [emphasis added]; and
(3) the fraud materially related to an issue in the arbitration.
Because the defendant failed to meet the second element of the test, the court never addressed the other two.
Focusing solely on the second element, the circuit court determined the dispositive factor was one of timing and due diligence. The circuit court concluded that the error was discovered by the expert after the expert gave his testimony, but that opposing counsel was made aware of the error and provided corrected numbers – in conjunction with the separate arbitration, interestingly - almost two weeks before the arbitration award was issued.
The court stated, “Had Morgan Keegan performed its due diligence, the fact that [the investors’ expert’s] calculations failed to include some internally-priced securities would have been discovered even before [the expert] testified in the [instant] arbitration, thus obviating any concern that the arbitration panel would rely on erroneous calculations in issuing the award.”
Thus, the circuit held that the brokerage company couldn’t meet its burden of proof.
Another important factor in the circuit court decision involved the circumstances under which the expert testimony was given - that of arbitration. The 5th Circuit noted that judicial review of arbitration decisions should not be undertaken lightly. Quoting the U.S. Supreme Court, the 5th Circuit noted, “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.”
Although a party has the right to ask a court to review the arbitrator’s decision, if a party has agreed to arbitrate, by virtue of that decision the party gives up much of that right’s practical value. As a result, a reviewing court may only set aside an arbitrator’s decision in “very unusual circumstances.”
The Bottom Line
In this important reversal and remand of a district’s court’s decision to vacate an award made before an arbitration panel of the Financial Industry Regulatory Authority (FIRNA), the Circuit Court pointed out that mistakes can happen to the best of us, even experts, and don’t necessarily spell doom for your case.
This reversal leaves a few simple lessons for securities defendants and experts:
- An expert mistake, without more, doesn’t equal fraud.
- Timing and due diligence are critical, and sometimes knowledge can be imputed.
- If you agree to something ahead of time, it’s tough to change the rules mid-game (for example, an agreement to arbitrate).
Do you think this will be the end of the line for this case? Or is this expert issue, like another I recently addressed, (and incidentally argued just yesterday before the U.S. Supreme Court), ripe for review?
The case is Morgan Keegan & Co., Inc. v. Garrett, 11-20736 (5th Circuit, Oct. 23, 2012).