A New York lower court has denied a “feeder” hedge fund’s motion to vacate an arbitration award issued by a majority of an American Arbitration Association panel in connection with an investor’s claim against the fund for losses related to the Madoff Ponzi scheme. In Wiederhorn v. Merkin (601265/2010), New York Supreme Court, New York County, instead confirmed the $1.5 million award in favor of the investor, Noel Wiederhorn, and against J. Ezra Merkin’s hedge fund, Ascot Partners, which delegated management of the assets in the fund to Ponzi-man extraordinaire, Bernard Madoff. Wiederhorn had argued at the arbitration hearing that the feeder fund failed to disclose Madoff’s exclusive role in management of the invested funds, and thus should reimburse Wiederhorn for his losses. (In case you skipped all of 2009, Madoff has pled guilty to securities fraud and is serving a 150-year sentence in federal prison.)
A two-arbitrator majority of the panel wrote a 23-page opinion explaining its award. That opinion was authored by Chairperson David Robbins, a well-known voice in securities arbitration. As a result, the court had a clear roadmap into the factual and legal basis of the panel’s award. The court took pains to acknowledge that the Majority applied principles of equity in reaching its decision, and that arbitrators are free to use their equitable powers to achieve a just result.
In addition, the court found that the Majority did not manifestly disregard the law (query whether a state court should apply state law grounds or FAA grounds for a motion to vacate) by refusing to recognize the Martin Act preemption doctrine, since there is a split among the Departments of the Appellate Division in New York as to the doctrine’s applicability. The First Department has held that the Martin Act, New York State’s securities statute that does not provide a private right of action to aggrieved parties, preempts common law causes of action arising out of securities transactions, whereas the Second and Fourth Departments have disagreed. Thus, there is no “well-settled” principle of law for the panel to disregard.
I predict that other investors in Madoff feeder funds will press arbitration claims to shift responsibility for Madoff-related losses to those feeder funds, whose principals may still have substantial assets. If this court confirmation is any indication, arbitrators will feel free to apply equitable principles to force those with some assets left to pay restitution to investors whose life savings were decimated by Madoff.
JG (with H.T. to Ed Pekarek)
If you can’t recover your assets, shift responsibility. Very interesting. What happens then about taking personal responsibility for had decisions?
I generally believe that reasoned awards are dangerous because they provide opportunities for courts to engage in an inappropriate level of intrusive review. In this case, however, the majority’s well-crafted award, with its emphasis on the arbitrators’ power to do equity, probably helped the court to confirm the award and resist the challenger’s invocation of “manifest disregard of the law” grounds to vacate. In addition, the court emphasized the remedy as consistent with equity — the investor got the amount he invested back, but no additional damages and no attorney’s fees — a fair outcome under the circumstances. It is encouraging to see the court’s response to a thoughtful, deliberative decision by the majority of the arbitrators.
One of the best write-ups, if not the best, I have seen. A few comments/amplifications: The award was confirmed as a jugdment against Ezra Merkin, not against his management company GCC, or against the hedge fund limited partnership, Ascot (Delaware LLP). Apparent basis for the assessment of damages under the award was New Jersey Blue Sky law (“thou shalt not lie in sale of securities” statute). Under these statutes, reliance, loss causation, no or insufficient due diligence, are not defenses. Award was exactly equal to the amounts the invetsor invested in Ascot in 2003 and 2004, plus pre-judgment interest. NJ statute does not provide for attys fees. Award did not award claimant a net positive figure for “costs” (which are expressly provided for under what Prof. Long, Caruso, others have rightly described as a mandatory, full-recovery, statute). Oh well. That’s “equity” for you. Too late in the date to claim that “manifest disredard” is not a basis to set aside arb awards in NY (Wien, 6 NY3d 471), but it it is also clearly part of the well-settled law of the State of New York that arbitrators are “not bound by principles of substantive law or by rules of evidence.” Silverman, 61 NY2d 299. The app divs epsecially in the 1st Dept have reaffirmed Silverman on this point many times. Go figure. Lost in all this talk about equity are the following salient facts: (1) numerous Merkin investors did not know Ascot was 99% plus Madoff and that all assets were custodied there; (2) Ascot did business the same way for 16 years (transfer alkl funds to Madoff); (3) Merkin skimmed a 1-1/5% per year management fee; (4) Merkin did not disclose Madoff’s role; (5) Merkin claimed in his offerign materials that Ascot’s success was due primarily to Merkin’s “skills and experience” (necessarily implying that he, Merkin, actively managed the fund); (6) Explictly or implicitly, Merkin assumed a duty to perform independent due diligence; he therefore had a correlative duty to disclose how dependent he was on Madoff for the generation of management fees. I do not see that as a case which is based primarily on “the equities.” I see that as a case based on legally actionable partial, false and misleading disclosures by a fiduciary (i.e., equally actionable in court). Note: the Blue Sky Laws are generally subejct to short statutues; in New Jersey, two years from actual or constructive notice of claim. Other theories of recovery require proof of causation and risk of “compromise” awards. Contract theories should not raise a Martin Act preemption issues (in court or in arbitration). Next battle: Merkin will appeal; must be post a bond? What is the effect of the NYAG freeze order? How about when Mr. Merkin runs out of appeals? Stay tuned. -Wiederhorn’s lawyer.