Mastrobuono v. Shearson Lehman Hutton, Inc.

• Decision Date: 30 March 1994
• Docket Number: No. 93-1581,93-1581
• Parties: , Fed. Sec. L. Rep. P 98,147 Antonio C. MASTROBUONO and Diana G. Mastrobuono, Plaintiffs-Appellants, v. SHEARSON LEHMAN HUTTON, INC., a corporation, Nick DiMinico, Richard F. Benzer and Mark Stevenson, Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 713

20 F.3d 713

62 USLW 2625, Fed. Sec. L. Rep. P 98,147

Antonio C. MASTROBUONO and Diana G. Mastrobuono, Plaintiffs-Appellants, v. SHEARSON LEHMAN HUTTON, INC., a corporation, Nick DiMinico, Richard F. Benzer and Mark Stevenson, Defendants-Appellees.

No. 93-1581.

United States Court of Appeals, Seventh Circuit.

Argued Oct. 26, 1993.

Decided March 30, 1994.

Peter J. Karabas, James L. Fox, Donald P. Colleton (argued), Abramson & Fox, Chicago, IL, for plaintiffs-appellants.

Thomas M. Knepper, Robert J. Mandel (argued), Therese M. Obringer, Neal, Gerber & Eisenberg, Chicago, IL, for defendants-appellees.

Before BAUER and COFFEY, Circuit Judges, and SKINNER, District Judge. ^*

SKINNER, District Judge.

An arbitration panel awarded $400,000 in punitive damages to the customers of a brokerage firm on their claims of unauthorized trading, churning, and margin exposure. The district court vacated the award because New York law, the governing law chosen by the parties, does not permit arbitrators to award punitive damages. We affirm.

In October 1985, the plaintiffs-appellants, Antonio and Diana Mastrobuono ("plaintiffs"), opened a brokerage account with Shearson Lehman Hutton, Inc. ("Shearson"). The plaintiffs are Illinois residents. Nick DiMinico, a vice president and licensed representative of Shearson in its Houston, Texas office, solicited and serviced the plaintiffs' account. Although Shearson's principal place of business is in New York, the most significant contacts in this case were with Illinois.

Paragraph 13 of the Client Agreement between plaintiffs and Shearson provides:

This agreement ... shall be governed by the laws of the State of New York.... [A]ny controversy arising out of or relating to [the plaintiffs'] accounts ... shall be settled by arbitration in accordance with the rules then in effect, of the National Association of Securities Dealers, Inc. or the Board of Directors of the New York Stock Exchange, Inc. and/or the American Stock Exchange Inc. as [the plaintiffs] may elect....

In January 1989, the plaintiffs filed suit in the United States District Court for the Northern District of Illinois, claiming that the defendants had subjected their account to unauthorized trading, churning, and margin exposure. Plaintiffs stated federal claims and state statutory and tort claims; they requested punitive damages on the state claims. In April 1989, Shearson moved to compel arbitration before the National Association of Securities Dealers ("NASD"). The district court granted the motion.

The plaintiffs filed an amended complaint in arbitration, alleging violations of the NASD Rules of Fair Practice, SEC Rule 10b-5, Sec. 15-1 of the Securities Exchange Act, the Illinois Consumer Fraud Act, the Texas Deceptive Trade Practices-Consumer Protection Act, breach of fiduciary duty and negligence. The plaintiffs again sought punitive damages under the state law claims, including treble and punitive damages under the Texas statute. Hearings on all of the claims were held in Chicago, Illinois on August 11-12 and September 29, 1992 before a panel of three arbitrators. On the last day of the hearings, after the close of proofs, Shearson submitted a Memorandum Regarding Claim for Punitive Damages, arguing that the panel had no authority to award punitive damages. The panel accepted the filing and permitted plaintiffs to file a reply memorandum.

The panel awarded the plaintiffs $115,274.00 for commissions and $44,053.00 for margin interest "as satisfaction for their claims." Shearson has paid the compensatory damages portion of the award. The panel also awarded $400,000 in punitive damages. Shearson filed a motion in the district court to vacate the award of punitive damages because New York law, the governing law of the Client Agreement, precludes an arbitral award of punitive damages. The plaintiffs moved to confirm the award, or in the alternative for a trial on the amount of punitive damages to be awarded, or as a further The district court denied the plaintiffs' motion and vacated the award of punitive damages under Sec. 10(a)(4) of the Federal Arbitration Act ("FAA"), 9 U.S.C. Sec. 10(a)(4). 812 F.Supp. 845 (N.D.Ill.1993). The court held that the plaintiffs had "contractually waived any potential award of punitive damages in arbitration," id. at 846, and that the arbitrators exceeded their power by making the award. The court denied the motion to sever the punitive damages claims for trial because punitive damages were precluded by the arbitration agreement, and because neither Illinois nor New York law permits a separate cause of action solely for punitive damages. This appeal followed.

alternative for a trial on the punitive damages claims.

SHEARSON'S WAIVER

The plaintiffs argue that Shearson waived its objections to the claim for punitive damages by not raising the issue until the proofs in arbitration had closed. We disagree. The plaintiffs had an opportunity to respond to Shearson's late submission, and they certainly were not prejudiced in any way. The arbitrators and the district court had the opportunity to consider the arguments of both parties.

DISCUSSION

I. Scope of review

We first address plaintiffs' argument that the district court violated the standard of review imposed by the Federal Arbitration Act. In relevant part, Sec. 10(a)(4) of the FAA permits a court to vacate an award "[w]here the arbitrators exceeded their powers." The arbitrator's errors of law and contract construction are normally unreviewable under this standard. Chicago Typographical Union No. 16 v. Chicago Sun-Times, Inc., 935 F.2d 1501 (7th Cir.1991). However, our narrow scope of review does not immunize an award clearly unauthorized by the terms of the agreement. See Miller Brewing Co. v. Brewery Workers Local Union No. 9, 739 F.2d 1159, 1164 (7th Cir.1984), cert. denied, 469 U.S. 1160, 105 S.Ct. 912, 83 L.Ed.2d 926 (1985) (court may reverse award that "clearly" was not "within the contemplation of the parties and ... implicitly authorized by the agreement"). As the Court of Appeals for the Second Circuit has observed, where the arbitrators are not entitled to award punitive damages due to a choice of law provision in the parties' agreement, it is "manifest" that the arbitrators would exceed their powers by awarding punitive damages. Barbier v. Shearson Lehman Hutton Inc., 948 F.2d 117, 122 (2d Cir.1991). "[T]here is no clearer case of a case falling ... within" Sec. 10(a)(4) of the Act. Id. The district court properly reviewed the panel's authority to award punitive damages.

II. Enforcement of the arbitration agreement

The FAA created "a body of federal substantive law establishing and regulating the duty to honor an agreement to arbitrate." Moses H. Cone Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 25 n. 32, 103 S.Ct. 927, 942 n. 32, 74 L.Ed.2d 765 (1983). Because there is a "liberal federal policy favoring arbitration agreements," id. at 24, 103 S.Ct. at 941, courts should "liberally construe the scope of arbitration agreements." Mitsubishi Motors v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 627, 105 S.Ct. 3346, 3354, 87 L.Ed.2d 444 (1985). Doubts concerning "the scope of arbitrable issues" should be resolved in favor of arbitration. Moses H. Cone, 460 U.S. at 24-25, 103 S.Ct. at 941-42. However, the federal policy "is simply to ensure the enforceability, according to their terms, of private agreements to arbitrate." Volt Info. Sciences, Inc. v. Board of Trustees of Leland Stanford Jr. Univ., 489 U.S. 468, 476, 109 S.Ct. 1248, 1254, 103 L.Ed.2d 488 (1989) (emphasis added). We may not rewrite the agreement to enhance arbitrability or otherwise expand the scope of the arbitrator's powers.

Under New York law, the governing law of the agreement, arbitrators may not award punitive damages. Garrity v. Lyle Stuart, Inc., 40 N.Y.2d 354, 386 N.Y.S.2d 831, 831-32, 353 N.E.2d 793, 794 (1976). The plaintiffs argue at length that the Garrity rule as applied to the agreement is preempted by the FAA. Preemption becomes an issue only if the parties intended to Where, as here, the parties have agreed to abide by state rules of arbitration, enforcing those rules according to the terms of the agreement is fully consistent with the goals of the FAA, even if the result is that arbitration is stayed where the Act would otherwise permit it to go forward. By permitting courts to "rigorously enforce" such agreements according to their terms ... we give effect to the contractual rights and expectations of the parties, without doing violence to the policies behind the FAA.

arbitrate on terms foreclosed by applicable state law:

Volt, 489 U.S. at 479, 109 S.Ct. at 1256. Here the parties agreed to arbitrate all of their controversies under New York law. By choosing New York law without excluding its arbitration rules, the parties adopted Garrity as a binding rule.

In Pierson v. Dean, Witter, Reynolds, Inc., 742 F.2d 334 (7th Cir.1984), we examined a brokerage agreement that also compelled arbitration of all controversies under New York law. Although the plaintiffs in Pierson may not have realized that "the plain wording of their arbitration clause" precluded any award of punitive damages, we held that "the Piersons cannot use their failure to inquire about the ramifications of that clause to avoid the consequences of agreed-to arbitration." Id. at 338-39.

Notwithstanding Pierson, the plaintiffs argue that the Garrity rule is inapplicable here because the agreement does not expressly bar punitive damages. Paragraph 13 of the agreement provides that "any controversy arising out of or relating to" the plaintiffs' account "shall be settled by arbitration." According to the plaintiffs, a demand for punitive damages is a "controversy" which, in the absence of an express exclusion from a broad arbitration clause, must be submitted to arbitration.

We do not think the Garrity rule can be characterized as a specific exclusion from the...