Amicus Curiae Brief — Mastrobuono v. Shearson Lehman Hutton, Inc.

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Iu the Supreme Court of the Unite

—— ee eee

OCTOBER TERM, 1994

ANTONIO C. MASTROBUONO, ET AL., PETITIONERS

SHEARSON LEHMAN HUTTON, INC., ET AL.

ON WRIT OF CERTIORARI TO THE UNITED STATES COURT

OF APPEALS FOR THE SEVENTH CIRCUIT

BRIEF FOR THE UNITED STATES AND

THE SECURITIES AND EXCHANGE COMMISSION

AS AMICI CURIAE IN SUPPORT OF PETITIONERS

SIMON M. LORNE

General Counsel

PAUL GONSON

Solicitor

JACOB H. STILLMAN

Associate General Counsel

LUCINDA O. MCCONATHY

Assistant General Counsel

SusAN S. MCDONALD

Special Counsel

MARK PENNINGTON

Special Counsel

Securities and Exchange

Commission

Washington, D.C. 20549

Drew S. Days, III

Solicitor General

LAWRENCE G. WALLACE

Deputy Solicitor General

MALCOLM L. STEWART

Assistant to the Solicitor

General

Department of Justice

Washington, D.C. 20530

(202) 514-2217

THE CLERK

| Supreme Court,

U.S.

FILED |

NOV 16 1994

QUESTION PRESENTED

Whether the district court erred in vacating the

arbitral award of punitive damages in this case.

(1)

TABLE OF CONTENTS

Page

Interest of the United States and the Securities and

a cnssneneeesusncnocsecces 1

SE 3

Le 7

Argument:

I. With respect to agreements between brokers and

customers executed after September 7, 1989,

federal law prohibits the enforcement of any

contractual provision that would deprive cus-

tomers of remedies that would be available in a

EN 10

Il. The arbitrators in this case did not exceed their

powers, and vacatur of the punitive damages

award was therefore improper ............................. 12

A. Under the Federal Arbitration Act, a court

asked to vacate an arbitral award must ac-

cord substantial deference to the arbitrator’s

construction of the governing agreement........ 12

B. The arbitrators did not exceed their powers

in awarding punitive damages in this case.... 19

a cctusmpennsunecesccccoce 29

TABLE OF AUTHORITIES

Cases:

Advest, Inc. v. McCarthy, 914 F.2d 6 (1st Cir.

ESE SESE SRSA a a 14

Ainsworth v. Skurnick, 960 F.2d 939 (11th Cir.

1992), cert. denied, 113 S. Ct. 1269 (1998)........ 16

Andros Compania Maritima v. Marc Rich & Co.,

A.G., 579 F.2d 691 (2d Cir. 1978) —.......0000....... 14

Antwine V. Prudential Bache Sec., Inc., 899 F.2d

eo ecpeseectomscces 14

AT&T Technologies v. Communications Workers,

a sesenantusenvonns 16, 18, 20

Cases—Continued: Page

Baravati v. Josepthal, Lyon & Ross, Inc., 28 F.3d

_ £ AEC RSRREISNE Ee er SAtiore eS 23, 24, 27

Barbier v. Shearson Lehman Hutton Inc., 948 F.2d

ff . & RR e eee 6, 16

Brown V. Rauscher Pierce Refsnes, Inc., 994 F.2d

Ue I 15

City of New York v. FCC, 486 U.S. 57 (1988) ...... 12

Davis v. Chevy Chase Financial Ltd., 667 F.2d 160

I i i lal 14, 15

Federated Dep’t Stores v. J.V.B. Indus., 894 F.2d

£ t Fane ENieSreerer eet cesses 14

Flender Corp. Vv. Techna-Quip Co., 953 F.2d 273

A I I sci nccrietceennintneiatildidiaialieniibetias 14-15

French V. Merrill Lynch, Pierce, Fenner & Smith,

784 F.2d 902 (9th Cir. 1986)... on 15

Garrity v. Lyle Stuart, Inc., 358 N.E. 2d 793 (N. Y.

SEITIIED cnniinsnctncanenitiaintesnnadiakscaiiietaimantnenbeanatiatahettabiatl 5, 22

Gilmer v. Interstate/Johnson Lane Corp., 500 U.S.

Sy ED ccnnccvcinnitenbbaicttecsstebbuteonbnaladdesddeiatiieid 21, 22, 24

Hill v. Norfolk & Western R., 814 F.2d 1192 (7th

i, RRS ee 16

Hines Vv. Davidowitz, 312 U.S. 52 (1941) —..............

Honda Motor Co. Vv. Oberg, 114 S. Ct. 2331 (1994).. 20

Kaiser Steel Corp. v. Mullins, 455 U.S. 72 (1982)... 11

Lee Vv. Chica, 983 F.2d 883 (8th Cir. 1993) ............ 15

Mcellroy v. PaineWebber, Inc., 989 F.2d 817 (5th

a a 15

Mitsubishi Motors Corp. v. Soler Chrysler-

Plymouth, Inc., 473 U.S. 614 (1985) -........ ..20, 21, 22

Moses H. Cone Memorial Hosp. v. Mercury Constr.

WE tt SE eee 21

Olson Vv. Paine, Webber, Jackson & Curtis, Inc., 806

Pe Fae Ce Ce CD cetlrettrestictcrerctenentescensionne 11

Perry Vv. Thomas, 482 U.S. 483 (1987) ..................... 26

Quinn Vv. Gulf & Western Corp., 644 F.2d 89 (2d

a i i 11

Rodriguez De Quijas v. Shearson/American Ex-

press, Inc., 490 U.S. 477 (1989) ....................--..-.. 14, 22

Saturn Distribution Corp. v. Williams, 905 F.2d

719 (4th Cir.), cert. denied, 498 U.S. 983

CIGD) cecencccececcensserascaneniacscscnsene , 26

Cases—Continued: Page

Securities Industry Assoc. Vv. Connolly, 883 F.2d

1114 (ist Cir.), cert. denied, 495 U.S. 956

SIEIITIET . srisspitnennsbianthaiaieainatinsnscmins thickatinndiddn tienda. 26

Shearson/American Express, Inc. V. McMahon,

i RO RE a 2, 10, 14, 20, 21

Southland Corp. v. Keating, 465 U.S. 1 (1984)...... 26

TXO Production Corp. v. Alliance Resources Corp.,

i eee ree ae 20

United Paperworkers Int’l Union, AFL-CIO v.

Misco, Inc., 484 U.S. 29 (1987) 200.2002... eeeccene 13,17

United Steelworkers of America v. Enterprise

Wheel & Car Corp., 363 U.S. 593 (1960) ............. 18, 17

Volt Info. Sciences v. Board of Trustees, 489 U.S.

atte ET a ctunhtestistetensnetetantiamensiemanmied 20-21, 26, 27-28

Webb v. R. Rowland & Co., 800 F.2d 808 (8th Cir.

RCN teil = Ee Se in A acl Ee ee le 26

Wilko v. Swan, 346 U.S. 427 (1958) .......0000..0000.0... 14

Willoughby Roofing & Supply Co. v. Kajima Int'l,

Inc., 598 F. Supp. 353 (N.D. Ala. 1984), aff'd,

776 F.2d 269 (11th Cir. 1985) ...........000.000000.... 19

W.R. Grace & Co. v. Local Union 759, Int’l Union

of the United Rubber Workers, 461 U.S. 757

PE ERS POS cee D- Mee ee ee aero 17

Statutes and rules:

Federal Arbitration Act, 9 U.S.C. 1 et seq.:

ee eS aE 14

fo SE Te | ea een 14, 15, 16, 20

§ 10(a) (4), 9 U.S.C. 10(a) (4) (1988 & Supp.

_& _ as inesisecndbitaidteniiiipinlinbiasaitiitaiaiiiadl 5, 7, 15, 20

Labor-Management Act, 1947, 29 U.S.C. 141 et

a a Ee oO ee 12

Securities Exchange Act of 1934, 15 U.S.C. 78a

ahaa atinireiclicitltctttiniiniiditdesamentrimtinemas 1,2

§ 6(b) (6), 15 U.S.C. 78f(b) (6) _0 10

SE ES ane ee 1

§ 15A(b) (6), 15 U.S.C. 780-3 (b) (6) 00. 10, 12

§ 15(b) (8), 15 U.S.C. 780(b) (8) 0. 2

§ 19(g) (1), 15 U.S.C. 78s(gz) (1) 000. 10, 12

fC 4

§ 29(a), 15 U.S.C. 78ec(a) ............ 10

Rules—Continued: Page

AMEX Rule 497 ................---<c--.....- PEE SIE A 6

NASD Code of Arbitration Procedure, Section

I ii artle insite cent dennis tneainasntgnmasimmeninenstaiaiiaanatd 24

NASD R. of Fair Practice:

En Sa ae 6

EE 6, 7, 10, 11, 12, 21

NUD inciccciticsiscctinnsicisnbenicasstithieiiidinegiindamts 6

Miscellaneous:

Note, Vacatur of Commercial Arbitration Awards

in Federal Court: Contemplating the Use and

Utility of the “Manifest Disregard” of the Law

Standard, 27 Ind. L. Rev. 241 (1998) -................ 15

Order Approving Proposed Rule Changes by the

NYSE, NASD and AMEX Relating to the Arbi-

tration Process and the Use of Predispute Arbi-

tration Clauses, Comm. Rel. No. 34-26805, 54

fe 6 AER acer 2

EA A ides snedelhidamtnnctanhsenceianinipnniiaitciietasitaraabines 6

OT stink siicsnacicnisdinitdteeenashemcapinadiiebstmmmgameniiuetinen 2,6

i AID isieensescemnriibietaghiesentiinttinmninactinhteansmemmeuneaceee 3

Oh Fa stinncccntntrepcnnnenpnantntocinncuntanisitntmnenanentntateties 10, 21

Restatement (Second) of Contracts............................ 25

S. Rep. No. 75, 94th Cong., Ist Sess. (1975) .......... 10-11

In the Supreme Court of the United States

OCTOBER TERM, 1994

No. 94-18

ANTONIO C. MASTROBUONO, ET AL., PETITIONERS

Vv.

SHEARSON LEHMAN HUTTON, INC., ET AL.

ON WRIT OF CERTIORARI TO THE UNITED STATES COURT

OF APPEALS FOR THE SEVENTH CIRCUIT

BRIEF FOR THE UNITED STATES AND

THE SECURITIES AND EXCHANGE COMMISSION

AS AMICI CURIAE IN SUPPORT OF PETITIONERS

INTEREST OF THE UNITED STATES AND

THE SECURITIES AND EXCHANGE COMMISSION

This case involves a dispute between a securities

broker-dealer and two of its customers, which was

arbitrated pursuant to a pre-dispute arbitration

agreement under the rules of the National Associa-

tion of Securities Dealers, Inc. (NASD).? The issue

1 The NASD is registered with the Securities and Exchange

Commission as a national securities association under Section

15 A of the Securities Exchange Act of 1934, 15 U.S.C. 780-3.

It is the only such registered national securities association.

Subject to comprehensive oversight by the Commission, the

NASD has primary responsibility under the Act for regula-

tion of those who sell securities in the over-the-counter mar-

(1)

is whether a choice-of-law provision in the arbitration

agreement precluded the customers from obtaining

punitive damages—a remedy that would have been

available to them if their claims had been resolved in

court rather than arbitration.

As part of its regulatory mandate under the Se-

curities Exchange Act of 1934, 15 U.S.C. 78a et seq.,

the Securities and Exchange Commission has the re-

sponsibility for overseeing and approving the rules

of the NASD and other self-regulatory organiza-

tions (SROs), such as the New York Stock Ex-

change (NYSE) and the American Stock Exchange

(AMF1), to assure that they adequately protect

the rights of customers. See Shearson/American Ex-

press Inc. v. McMahon, 482 U.S. 220, 233-234

(1987). This oversight extends to the administra-

tion of arbitration systems by the NASD, NYSE,

AMEX and other SROs.* The arbitration systems

operated by the NASD and other SROs pursuant to

rules approved by the Commission play an important

role in investor protection by affording brokerage

ket. By virtue of Section 15(b) (8) of the Exchange Act, 15

U.S.C. 780(b) (8), all broker-dealers that deal with retail

customers in non-exempt securities must belong to the NASD.

2 In addition to the NASD, NYSE, and AMEX, the Munici-

pal Securities Rulemaking Board, Pacific Stock Exchange,

Chicago Stock Exchange (formerly the Midwest Stock Ex-

change), Boston Stock Exchange, Chicago Board Options Ex-

change, Cincinnati Stock Exchange and Philadelphia Stock

Exchange also administer arbitration programs. See Order

Approving Proposed Rule Changes by the NYSE, NASD and

AMEX Relating to the Arbitration Process and the Use of

Predispute Arbitration Clauses, Comm. Rel. No. 34-26805, 54

Fed. Reg. 21,144, 21,145 n.7 (1989) (hereinafter 1989

Release) .

firm customers a simple, quick, and inexpensive

means of redress. A large percentage of customer

accounts with securities broker-dealers are subject

to account agreements that require arbitration of

disputes between the parties.* The Commission has

a substantial interest in ensuring that arbitration

agreements between brokerage firms and their cus-

tomers comply with applicable SRO rules, including

rules that require that arbitration not be used as a

means to deprive customers of remedies that would

be available in a judicial forum. The Commission is

also concerned that arbitration not be made more

complex, time-consuming, and expensive by failure

to adhere to the fundamental principle that construc-

tion of an arbitration contract is for the arbitrators,

not the courts, and that arbitration agreements be

interpreted in a manner consistent with the Federal

Arbitration Act.

The United States has a similar interest, in other

litigation contexts, in the correct interpretation and

application of the Federal Arbitration Act and in

the effectiveness of the arbitral remedies authorized

by that Act.

STATEMENT

In 1985 petitioners, Illinois residents, became cus-

tomers of respondent Shearson Lehman Hutton, Inc.,

a securities broker-dealer firm and member of the

* See 1989 Release, 54 Fed. Reg. at 21,153 n. 51, which re-

ported the results of a 1988 Commission study of 65 broker-

dealer firms representing 90% of all customer trading ac-

counts in the United States. According to that study, 96% of

the margin accounts, 95% of the options accounts, and 39%

of the cash accounts were subject to pre-dispute arbitration

agreements.

NASD. The customer agreement executed by peti-

tioners and the firm provided, in relevant part, that

[the agreement] shall be governed by the laws

of the State of New York. * * * [A]ny contro-

versy arising out of or relating to [the petition-

ers’] accounts * * * shall be settled by arbitra-

tion in accordance with the rules then in effect,

of the National Association of Securities Dealers,

Inc. or the Boards of Directors of the New York

Stock Exchange, Inc. and/or the American Stock

Exchange, Inc. as [the petitioners] may elect.

Pet. App. 44.

In January 1989 petitioners filed suit in the United

States District Court for the Northern District of

Illinois against Shearson and respondent Nick Di-

Minico, the Shearson employee who handled their

account. Petitioners’ complaint alleged unauthorized

trading, churning, and margin exposure in their ac-

count. Petitioners sought compensatory damaages

under federal securities law, as well as compensa-

tory and punitive damages under state law.* In

April 1989 respondents filed a motion to compel arbi-

tration, which the district court granted. Pet. App.

3-4.

Petitioners commenced arbitration before the

NASD. Their complaint alleged violations of the

NASD Rules of Fair Practice, the Securities Ex-

change Act, SEC Rule 10b-5, the Illinois Consumer

Fraud Act, and the Texas Deceptive Trade Practices-

Consumer Protection Act. Petitioners also alleged

breach of fiduciary duty and negligence. Hearings

* Punitive damages are not available under the Exchange

Act. See 15 U.S.C. 78bb(a).

were conducted before a panel of three arbitrators

in August and September 1992. Respondents con-

tended, inter alia, that the arbitrators had no au-

thority to award punitive damages. In October 1992

the arbitrators awarded the petitioners approxi-

mately $160,000 in compensatory damages and

$400,000 in punitive damages. Pet. App. 4-5.

Respondents then moved in federal district court

for vacatur of the punitive damages award. Petition-

ers moved to confirm the award; in the alternative,

they contended that their claim for punitive damages

should be tried before the district court. Pet. App.

5-6. The district court granted respondents’ motion

to vacate. Under New York law, the court noted,

the power to award punitive damages is reserved to

the courts and may not be exercised by arbitrators.

Id. at 33 (citing Garrity v. Lyle Stuart, Inc., 353

N.E.2d 793, 794 (N.Y. 1976)). The court con-

cluded that “[b]Jecause the [petitioners] agreed to

arbitrate their dispute in accordance with laws of

the State of New York, and because the Agreement

does not explicitly or by incorporation authorize the

award of punitive damages, the remedies available to

them are limited by the Garrity rule.” Pet. App.

38-39.

The court of appeals affirmed. Pet. App. 1-27. The

court of appeals first rejected petitioners’ contention

that the district court had reviewed the arbitral

award under an insufficiently deferential standard.®

The court acknowledged that “[t]he arbitrator’s er-

rors of law and contract construction are normally

5 Section 10(a) (4) of the Federal Arbitration Act, 9 U.S.C.

10(a) (4) (1988 & Supp. V 1993), provides that an arbitral

award may be vacated if, inter alia, “the arbitrators exceeded

their powers.”

unreviewable,” but asserted that the “narrow scope

of review does not immunize an award clearly un-

authorized by the terms of the agreement.” Pet. App.

8. The court concluded that “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.” Jd. at 8-9

(citing Barbier v. Shearson Lehman Hutton Inc., 948

F.2d 117, 122 (2d Cir. 1991) ).

The court of appeals next held that the inclusion

in the arbitration agreement of a choice-of-law clause

referencing New York law precluded an arbitral

award of punitive damages. The court stated that

“Tb]ecause any condition imposed by New York law

can be found in the books, a choice of law provision

suffices to incorporate the Garrity rule.” Pet. App.

14. The court rejected petitioners’ argument that

Rule 21(f) (4) of the NASD Rules of Fair Practice

required a different outcome. That Rule provides:

No agreement [between a member and a .cus-

tomer] shall include any condition which * * *

limits the ability of a party to file any claim in

arbitration or limits the ability of the arbitrators

to make any award.°

*NASD Rule 21(f) was developed under the auspices of

the Securities Industry Conference on Arbitration (SICA),

which was formed in 1977 to work with the Commission to

monitor and improve the system of SRO arbitration. See

1989 Release, 54 Fed. Reg. at 21,144-21,145. The relevant pro-

visions of the rules of the NYSE and the AMEX are sub-

stantially identical to the NASD Rule discussed here. Com-

pare NASD Art. III, Rule 21(f) of the NASD’s Rules of Fair

Practice with NYSE Rule 636 and AMEX Rule 427.

The court held that “[t]o the extent that this pro-

vision conflicts with New York law, the governing

law of the agreement under all the circumstances,

we must conclude that the parties intended to be

bound by New York law.” Pet. App. 17.

SUMMARY OF ARGUMENT

1. NASD Rule 21(f)(4) forbids the inclusion in

broker-client arbitration agreements of provisions

limiting the ability of arbitrators to award relief

that would be available in a judicial forum. That

Rule has an effective date of September 7, 1989;

with respect to agreements executed after that date,

the Rule has the force of federal law and precludes

the enforcement of contractual provisions that are

inconsistent with its terms. With respect to agree-

ments (such as the contract at issue here) signed

on or before September 7, 1989, Rule 21(f) (4) does

not apply. This case consequently presents a question

of contract interpretation, not of preemption by fed-

eral securities law. Regardless of the resolution of

this case, however, it is important that the Court

leave no confusion as to the operation of Rule

21(f)(4) with respect to agreements signed after

the Rule’s effective date.

2. ‘The arbitrators in this case did not “exceed[]

their powers” within the meaning of 9 U.S.C.

10(a)(4). The arbitral award of punitive damages

should therefore have been confirmed.

a. Under the Federal Arbitration Act, a losing

party is not entitled to appeal the arbitrator’s deci-

sion on grounds of legal error. Although the Act

permits a court to vacate an arbitral award under

certain narrow circumstances, judicial review under

the statute must reflect substantial deference to the

arbitrator’s construction of an ambiguous agreement.

As this Court has recognized in decisions under the

federal labor statutes, the arbitrator’s discretion is

particularly broad—and judicial interference with

the exercise of that discretion particularly inappro-

priate—in the formulation of appropriate remedies.

While the court of appeals purported to respect the

stringent limitations on its reviewing authority, its

decision to affirm the vacatur of the arbitral award

was based in essence on its belief that the arbitrator

had misconstrued the contract. That belief provides

a fundamentally inadequate basis for vacatur: The

essence of arbitration is the parties’ agreement that

the arbitrator rather than the courts will be entrusted

with the task of interpreting their contract.

b. The arbitral award of punitive damages in this

case was based on an entirely reasonable reading °*

the parties’ agreement. As this Court has repeatedly

emphasized, an agreement to arbitrate ordinarily has

the consequence only of changing the forum in which

a dispute is to be resolved; it does not entail a waiver

of substantive rights. This Court has also stressed

that the FAA was intended to counteract prior hos-

tility to arbitration as a means of dispute resolution.

The Garrity rule, by contrast, rests largely on the

mistrust of arbitrators that the FAA has rejected,

and its application would transform the agreement

to arbitrate into a surrender of substantive rights.

The parties are unquestionably permitted (insofar

as the FAA is concerned) to agree to such con-

straints on the arbitrator’s remedial power. Because

the Garrity rule runs counter to the premises under-

lying the FAA, however, such an agreement should

not be inferred by the courts (as a basis for vacating

an arbitration award) absent an unambiguous indi-

cation that this was the parties’ intent.

The agreement at issue in this case provides no

clear indication that the parties intended to preclude

an award of punitive damages. Although the agree-

ment referenced the law of New York, it was plainly

within the contemplation of the parties that other

bodies of law (most obviously the federal securities

laws) might be consulted in the process of resolving

any disputes that might arise. The agreement ex-

pressly provided that any arbitral proceedings would

be conducted in accordance with the rules of the

NASD; and those rules do not restrict the types of

relief an arbitrator may award. In our view, these

provisions are most reasonably harmonized by apply-

ing New York law to determine what substantive

rights and obligations are created by the contract,

while applying NASD rules to resolve questions con-

cerning the conduct of the arbitral proceedings and

the scope of the arbitrators’ authority. We note as

well that the Garrity rule would clearly be preempted

if the agreement contained no choice-of-law clause

and New York law applied on the basis of the State’s

connection to the parties, the contract, and the con-

tested transactions. The choice-of-law clause in this

agreement should not be read to incorporate state law

principles that would be preempted if New York law

applied of its own force as a result of the State’s

connection to the relevant primary conduct.

alt |

ARGUMENT

I. WITH RESPECT TO AGREEMENTS BETWEEN

BROKERS AND CUSTOMERS EXECUTED AFTER

SEPTEMBER 7, 1989, FEDERAL LAW PROHIBITS

THE ENFORCEMENT OF ANY CONTRACTUAL

PROVISION THAT WOULD DEPRIVE CUSTOM-

ERS OF REMEDIES THAT WOULD BE AVAIL-

ABLE IN A JUDICIAL FORUM

Rule 21(f)(4) of the NASD Rules of Fair Prac-

tice prohibits member firms from including in their

customer agreements any contractual provision that

‘limits the ability of a party to file any claim in

arbitration or limits the ability of the arbitrators to

make any award.” As explained by the Commission

when it approved the Rule,

[t]his provision makes clear that the use of arbi-

tration for the resolution of investor/broker-

dealer disputes represents solely a choice of arbi-

tration as a means of dispute resolution. Agree-

ments cannot be used to curtail any rights that

a party may otherwise have had in a judicial

forum. If punitive damages * * * would be

available under applicable law, then the agree-

ment cannot limit parties’ rights to request them,

nor arbitrators’ rights to award them.

1989 Release, 54 Fed. Reg. at 21,154. NASD Rule

21(f)(5) provides that “[t]he requirements of sub-

paragraphs (f)(1) through (4) shall apply only to

new agreements signed by an existing or new cus-

tomer of a member after September 7, 1989.”

With respect to contracts executed after Septem-

ber 7, 1989, Rule 21(f)(4)—like the rules of SROs

generally—carries the force of federal law. See, e.g.,

15 U.S.C. 78f(b) (6), 780-3(b) (6), 78s(g) (1), and

78cec(a) ; McMahon, 482 U.S. at 233-234; S. Rep. No.

75, 94th Cong., Ist Sess. 24 (1975) (noting that

SROs “must exercise governmental-type powers if

they are to carry out their responsibilities under the

Exchange Act’). It is well established that “illegal

promises will not be enforced in cases controlled by

the federal law.” Kaiser Steel Corp. v. Mullins, 455

U.S. 72, 77, 85-86 (1982). Accord Quinn v. Gulf &

Western Corp., 644 F.2d 89, 91 (2d Cir. 1981)

(court would not enforce contract provision to pay

contingent fee that violated federal procurement stat-

ute and regulation).’ Rule 21(f)(4) would there-

fore preclude enforcement, with respect to agree-

ments executed after its effective date, of a contract-

ual provision that prevents arbitrators from award-

ing punitive damages when such damages would be

available in a judicial forum in the relevant State.

The court of appeals’ opinion reflects some confu-

sion regarding the legal significance of the NASD

Rules. The court stated, for example, that “[t]o the

extent that [Rule 21(f) (4)] conflicts with New York

law, the governing law of the agreement under all

circumstances, we must conclude that the parties in-

tended to be bound by New York law.” Pet. App. 17.

See also id. at 20 (“We resolve any apparent conflict

between New York law and NASD rules in favor of

New York law, the generally applicable law of the

agreement.”). With respect to contracts executed

’ This principle is subject to exceptions not relevant here.

See, e.g., Olson Vv. Paine, Webber, Jackson & Curtis, Inc., 806

F.2d 721, 743 (7th Cir. 1986) (recognizing general principle

that illegai contract terms will not be enforced, but enforcing

contractual provision that violated a Commodity Futures

Trading Commission (CFTC) regulation because to do so

would not harm a party the regulation was intended to protect

and failing to enforce the contract would “produce a sanction

disproportionate to the wrong’’).

after September 7, 1989, that mode of analysis would

clearly be wrong. Private parties have no authority

to enter into contractual arrangements that are for-

bidden by federal law, or to agree that federal regula-

tions will be superseded by contrary state law. To

permit enforcement of such provisions in new broker-

age agreements would undermine the ability of the

NASD to carry out its responsibilities under the Ex-

change Act to adopt and enforce rules consistent with

the Act to regulate the conduct of their member

broker-dealer firms and ass ciated persons. See 15

U.S.C. 780-3(b) (6) (NASD Rules must be designed

“to promote just and equitable principles of trade

* * * and, in general, to protect investors and the

public interest”); 15 U.S.C. 78s(g)(1). Cf. City of

New York v. FCC, 486 U.S. 57 (1988).

The arbitration agreement at issue in the present

case was executed in 1985, well before the promulga-

tion of Rule °1(f)(4). This case therefore presents

a question of contract interpretation, not of preemp-

tion by federal securities law. Regardless of the res-

olution of this case, however, it is important that the

Court leave no confusion as to the operation of Rule

21(f)(4) with respect to agreements signed after the

Rule’s effective date.

Il. THE ARBITi.ATORS IN THIS CASE DID NOT

EXCEED THEIR POWERS, AND VACATUR OF

THE PUNITIVE DAMAGES AWARD WAS THERE-

FORE IMPROPER

A. Under The Federal Arbitration Act, A Court Asked

To Vacate An Arbitral Award Must Accord Sub-

stantial Deference To The Arbitrator’s Construction

Of The Governing Agreement

In reviewing arbitral decisions under the Labor-

Management Relations Act, 1947, this Court has

consistently made clear that “the question of inter-

pretation of the collective bargaining agreement is a

question for the arbitrator. It is the arbitrator’s con-

struction which was bargained for; and so far as the

aibitrator’s decision concerns construction of the con-

tract, the courts have no business overruling him be-

cause their interpretation of the contract is different

from his.” United Steelworkers of America v. Enter-

prise Wheel & Car Corp., 363 U.S. 593, 599 (1960).

In United Paperworkers Int’l Union, AFL-CIO, v.

Misco, Inc., 484 U.S. 29 (1987), the Court recently

reaffirmed that

[b]ecause the parties have contracted to have

disputes settled by an arbitrator chosen by them

rather than by a judge, it is the arbitrator’s view

of the facts and of the meaning of the contract

that they have agreed to accept. Courts thus do

not sit to hear claims of factual or legal error by

an arbitrator as an appellate court does in re-

viewing decisions of lower courts. * * * The

arbitrator may not ignore the plain language of

the contract; but the parties having authorized

the arbitrator to give meaning to the language

of the agreement, a court should not reject an

award on the ground that the arbitrator mis-

read the contract.

Id. at 37-38.

These principles are equally applicable to review of

arbitral awards pursuant to the Federal Arbitration

Act.* The Act does not empower a losing party to

appeal the arbitrator’s decision on grounds of legal

error. Rather, the statute provides that the prevail-

8 Indeed, this Court has noted that “the federal courts have

often looked to the [Federal Arbitration] Act for guidance in

labor arbitration cases.” Misco, 484 U.S. at 40 n.9.

ing party may seek a judicial order confirming the

award, “and thereupon the court must grant such

an order unless the award is vacated, modified, or

corrected as prescribed in sections 10 and 11 of this

title.” 9 U.S.C. 9. Section 10(a) of the Act, 9 U.S.C.

10(a), quoted at Pet. 4-5, sets forth narrow grounds

for vacatur of an award governed by the statute.

Although this Court has not had occasion to address

in detail the standards governing application of this

provision,’ the courts of appeals have repeatedly em-

phasized that the grounds for vacatur are to be nar-

rowly construed and that a court may not refuse to

confirm an award simply because it disagrees with

the arbitrator’s construction of the contract.”®

®In Wilko v. Swan, 346 U.S. 427 (1953), the Court observed

that under the FAA “the interpretations of the law by the

arbitrators in contrast to manifest disregard are not subject,

in the federal courts, to judicial review for error in inter-

pretation. The United States Arbitration Act contains no

provision for judicial determination of legal issues such as is

found in the English law.” Jd. at 436-437 (footnote omitted).

The specific holding of Wilko—that predispute agreements to

arbitrate claims under the Securities Act of 1933 are not

enforceable—has since been overruled. See Rodriguez De

Quijas Vv. Shearson/American Express, Inc., 490 U.S. 477

(1989). The Court has continued to recognize, however, that

under the FAA “judicial scrutiny of arbitration awards nec-

essarily is limited.” Shearson/American Express Inc. V.

McMahon, 482 U.S. 220, 232 (1987).

1 See, e.g., Davis v. Chevy Chase Financial Ltd., 667

F.2d 160, 165 (D.C. Cir. 1981); Advest, Inc. v. McCarthy,

914 F.2d 6 (ist Cir. 1990); Andros Compania Maritima Vv.

Marc Rich & Co., A.G., 579 F.2d 691, 704 (2d Cir. 1978);

Antwine V. Prudential Bache Sec., Inc., 899 F.2d 410, 413

(5th Cir. 1990); Federated Dep’t Stores v. J.V.B. Indus., 894

F.2d 862, 866 (6th Cir. 1990); Flender Corp. v. Techna-Quip

In the instant case the court of appeals acknowl-

edged that “[t]he arbitrator’s errors of law and con-

tract construction are normally unreviewable under

[9 U.S.C. 10(a)(4)].” Pet. App. 8. (Section 10

(a) (4) states that an arbitral award may be vacated

if, inter alia, the arbitrators “exceeded their powers.” )

The court asserted, however, that the “narrow scope

of review does not immunize an award clearly un-

authorized by the terms of the agreement.” Ibid.

That reasoning provides no basis for vacatur of the

award in the instant case. In the first place, it is by

no means apparent that even “clear” error in the

interpretation of the contract constitutes a ground

Co., 953 F.2d 273, 278 (7th Cir. 1992); Lee v. Chica, 983 F.2d

883, 885 (8th Cir. 1998); French v. Merrill Lynch, Pierce,

Fenner & Smith, 784 F.2d 902, 906 (9th Cir. 1986).

There is, we acknowledge, some divergence among the cir-

cuits with respect to the standards governing vacatur of

arbitral awards under the FAA. The courts of appeals have

disagreed, for example, as to the propriety of vacatur on

grounds other than those specified in Section 10(a). See

generally McIlroy v. PaineWebber, Inc., 989 F.2d 817, 820

& n.2 (5th Cir. 1993); Brown v. Rauscher Pierce Refsnes,

Inc., 994 F.2d 775, 779 & n.3 (11th Cir. 1993); Note, Vacatur

of Commercial Arbitration Awards in Federal Court: Con-

templating the Use and Utility of the “Manifest Disregard”

of the Law Standard, 27 Ind. L. Rev. 241 (1993). For pur-

poses of the instant case, however, those areas of disagree-

ment are less important than is the uniform consensus that

judicial review of an arbitral award under the FAA must

reflect substantial deference to the arbitrator’s construction

of an ambiguous agreement. See Davis, 667 F.2d at 166

(“Although various tests have been employed in implementa-

tion of this broad standard, it is apparent that the arbitrator’s

award should not be upset in such a case if it represents a

plausible interpretation of the contract.”).

for vacatur under Section 10(a)." In any event, as

we explain in Point B, infra, there is no basis for

the court of appeals’ conclusion that the arbitral

award of punitive damages was “clearly unauthor-

ized” by the parties’ agreement.

The court of appeals also asserted that “where the

arbitrators are not entitled to award punitive dam-

ages 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.”

Pet. App. 8-9 (quoting Barbier v. Shearson Lehman

Hutton Inc., 948 F.2d 117, 122 (2d Cir. 1991)). Al-

though that language is not entirely clear, it appears

to suggest that the question whether a contract au-

thorizes the award of a discrete category of relief is

to be resolved by the court de novo, on the theory that

an arbitrator exceeds his powers by awarding a rem-

edy that the agreement does not in fact permit. That

11 Compare Ainsworth v. Skurnick, 960 F.2d 939, 941 (11th

Cir. 1992) (“although great deference is normally accorded

an arbitration award, an award that is arbitrary or capricious

is not required to be enforced”), cert. denied, 113 S. Ct. 1269

(1993) with Hill v. Norfolk & W. Ry., 814 F.2d 1192, 1194-

1195 (7th Cir. 1987) (under either the FAA or the labor stat-

utes, “the question for decision by a federal court asked to set

aside an arbitral award * * * is not whether the arbitrator or

arbitrators erred in interpreting the contract; it is not whether

they grossly erred: in interpreting the contract; it is whether

they interpreted the contract”). Cf. AT&T Technologies Vv.

Communications Workers, 475 U.S. 648, 649-650 (1986)

(“Whether ‘arguable’ or not, indeed even if it appears to the

court to be frivolous, the union’s claim that the employer has

violated the collective-bargaining agreement is to be decided,

not by the court asked to order arbitration, but as the parties

have agreed, by the arbitrator.”).

theory is contrary to this Court’s precedents.” In

Enterprise Wheel the Court considered a closely anal-

ogous question. The arbitrator in that case found

that employees had been discharged in violation of

the collective bargaining agreement; he ordered re-

instatement and back pay extending beyond the ex-

piration of the contract. The court of appeals vacated

the award insofar as it provided relief for the period

after the contract’s expiration. This Court reversed.

The Court observed that the agreement “could have

provided that if any of the employees were wrong-

fully discharged, the remedy would be reinstatement

and back pay up to the date they were returned to

work.” 363 U.S. at 598. The employer’s attack on

the arbitral award, the Court recognized, boiled down

to the assertion that the contract, properly construed,

did not so provide. Ibid. The Court rejected that

contention, explaining that “[i]t is the arbitrator’s

construction which was bargained for; and so far as

the arbitrator’s decision concerns construction of the

contract, the courts have no business overruling him

because their interpretation of the contract is differ-

“ from his.” Jd. at 599. That same principle applies

ere.

Indeed, in the context of labor arbitration, this Court has

emphasized that the arbitrator’s discretion is particularly

broad—and judicial interference with the exercise of that

discretion particularly inappropriate—“when it comes to

formulating remedies.” Misco, 484 U.S. at 41 (quoting

Enterprise Wheel, 363 U.S. at 597).

'* Cf. W.R. Grace & Co. v. Local Union 759, Int’l Union of

the United Rubber Workers, 461 U.S. 757, 765 (1983) (“Be-

cause the authority of arbitrators is a subject of collective

bargaining, just as is any other contractual provision, the

scope of the arbitrator’s authority is itself a question of con-

Nor can a de novo standard of review be defended

on the ground that “the question of arbitrability—

whether a collective-bargaining agreement creates a

duty for the parties to arbitrate the particular griev-

ance—is undeniably an issue for judicial determina-

tion.” AT&T Technologies v. Communications Work-

ers, 475 U.S. 643, 649 (1986). The dispute here

does not involve an issue of arbitrability. Rather, as

the court of appeals correctly noted, “[t]he Client

Agreement does not purport to withhold certain issues

from arbitration. In fact, it refers all ‘contro-

vers[ies]’ to arbitration.” Pet. App. 18. The dis-

pute concerns the legal framework governing the

arbitrator’s decision whether punitive damages should

be awarded. Respondents contend that the choice-of-

law clause, properly construed to incorporate the

rule announced in Garrity, disentitled the arbitrator

to award punitive damages under any circumstances.

Possibly the arbitrators in this case could have con-

strued the contract in that manner, although they

did not. But, in any event, that contention concern-

ing the meaning of the contract does not amount to

a contention that petitioners’ punitive damages claims

are non-arbitrable. Cf. AT&T Technologies, 475 U.S.

at 649 (“in deciding whether the parties have agreed

to submit a particular grievance to arbitration, a

court is not to rule on the potential merits of the

underlying claims’).

tract interpretation that the parties have delegated to the

arbitrator.”). As we explain at pages 18-19, infra, questions

concerning the scope of the arbitrator’s authority with respect

to matters conceded to be arbitrable must be distinguished

from issues of arbitrability—i.e., whether a particular claim

is to be resolved by the arbitrator or by a court.

{ndeed, any suggestion that petitioners’ punitive

damages claims are non-arbitrable would .be funda-

mentally at odds with the basic premises underlying

respondents’ legal position. Petitioners initially filed

suit in federal district court, including in their com-

plaint a request for punitive damages. Respondents

then moved to compel arbitration of the entire case,

and the district court granted the motion. Pet. App.

3-4. Referral of the punitive damages claims to the

arbitrators obviously served respondents’ interests,

since the incorporation of New York law into the

parties’ agreement could have posed no conceivable

barrier to a punitive damages award if the issue had

been adjudicated by the district court. Now that the

arbitrators have concluded that the agreement did

not in fact preclude an award of punitive damages,

respondents may not evade that holding on the ground

that the availability of such damages was not an

arbitrable issue after all. Cf. Willoughby Roofing &

Supply Co. v. Kajima Int'l, Inc., 598 F. Supp. F. Supp.

353, 356-359 & n.12 (N.D. Ala. 1984), aff’d, 776 F.2d

269 (11th Cir. 1985).

B. The Arbitrators Did Not Exceed Their Powers In

Awarding Punitive Damages In This Case

For the reasons that follow, the courts below erred

in concluding that the arbitrators had exceeded their

powers in awarding punitive damages on petitioners’

state law claims. In our view, the most persuasive

reading of the agreement between the parties in this

case is that an arbitral award of punitive damages is

permitted where such relief would be available in a

judicial forum. In any event, however, the arbitra-

tors’ construction of the governing contract as per-

mitting punitive damages is surely a reasonable one,

and is entitled to deference under the principles dis-

cussed in Point A, supra. The arbitral award there-

fore should have been confirmed.”*

1. In construing an arbitration agreement within

the coverage of the FAA, as with any other contract,

the parties’ intentions control. Those intentions are

to be determined, however, by reading the agreement

in light of the policies underlying the Act. See,

e.g., Volt Info. Sciences v. Board of Trustees, 489

14 The Due Process Clause imposes two limitations on the

amount of punitive damages that may be awarded in a judicial

proceeding: a substantive ban on punitive damages that are

“grossly excessive,” TXO Production Corp. v. Alliance Re-

sources Corp., 113 S. Ct. 2711, 2718-2719 (1993) (plurality

opinion); id. at 2731 (O’Connor, J., dissenting), and a pro-

cedural requirement that judicial review of the amount of

punitive damages awards be available, see Honda Motor Co.

v. Oberg, 114 S. Ct. 2331, 2335-23842 (1994). By executing an

arbitration agreement governed by the FAA, however, a

party consents to the limitations on judicial review estab-

lished by 9 U.S.C. 10(a); “[i]t trades the procedures and

opportunity for review of the courtroom for the simplicity,

informality, and expedition of arbitration.” Mitsubishi Motors

Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 628

(1985). Enforcement of the parties’ procedural bargain

therefore raises no constitutional concerns.

It is far from clear, moreover, that the judicial review pro-

vided by Section 10(a) is in fact less extensive than the review

required by the Constitution where punitive damages are

awarded by a jury. An arbitrator who awards punitive dam-

ages in an amount that is “grossly excessive” within the mean-

ing of the constitutional limitation recognized in TXO Pro-

duction might well be said to have “exceeded [his] powers”

under 9 U.S.C. 10(a) (4). An arbitrator would also be bound

by any limitations on punitive damages that are imposed by

the law that creates the claim. In the present case, the arbi-

trators awarded compensatory damages of approximately

$160,000 and punitive damages of $400,000. Because respond-

ents do not contest the size of the punitive damages award, the

issue is not presented in this case.

U.S. 468, 475-476 (1989) (“in applying general

state-law principles of contract interpretation to the

interpretation of an arbitration agreement within

the scope of the Act, due regard must be given to the

federal policy favoring arbitration”). The Court has

noted, for example, that in deciding the issue of

arbitrability, “[t]he Arbitration Act establishes that,

as a matter of federal law, any doubts concerning

the scope of arbitrable issues should be resolved in

favor of arbitration.” Moses H. Cone Memorial Hosp.

v. Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983).

Accord Mitsubishi Motors Corp. v. Soler Chrysler-

Plymouth, Inc., 473 U.S. 614, 626 (1985); cf. AT&T

Technologies, 475 U.S. at 650 (“where the [collective

bargaining agreement] contains an arbitration clause,

there is a presumption of arbitrability” with respect

to a particular grievance).

Two aspects of federal policy under the FAA are

of particular relevance here. First, this Court has

repeatedly emphasized that “[b]y agreeing to arbi-

trate a statutory claim, a party does not forgo the

substantive rights afforded by the statute; it only

submits to their resolution in an arbitral, rather

than a judicial, forum.” Gilmer v. Interstate/John-

son Lane Corp., 500 U.S. 20, 26 (1991); Mc-

Mahon, 482 U.S. at 229-230; Mitsubishi, 473 U.S. at

628.° Second, the Court has stressed that the pur-

% The principle that the decision to arbitrate is not a sur-

render of substantive rights that would be available in a

judicial forum also underlies NASD Rule of Fair Practice

21(f) (4). As the Commission’s Approval Order put it, Rule

21(f) (4) “makes clear that the use of arbitration for the

resolution of investor/broker-dealer disputes represents solely

a choice of arbitration as a means of dispute resolution,” not

a decision to surrender “any rights that a party may other-

pose of the FAA “was to reverse the longstanding

judicial hostility to arbitration agreements that had

existed at English common law and had been adopted

by American courts.” Gilmer, 500 U.S. at 24. This

Court has thus explained that “[w]Je are well past

the time when judicial suspicion of the desirability

of arbitration and the competence of arbitral tri-

bunals inhibited the development of arbitration as

an alternative means of dispute resolution.” Jd. at

34 n. 5 (quoting Mitsubishi, 473 U.S. at 628). See

also id. at 30 (noting that generalized attacks on

submitting statutory claims to arbitration “ ‘res[t]

on suspicion of arbitration as a method of weaken-

ing the protections afforded in the substantive law

to would-be complainants,’ and as such, they are ‘far

out of step with our current strong endorsement of

the federal statutes favoring this method of resolving

disputes’”) (quoting Rodriguez De Quijas v. Shear-

son/American Express, Inc., 490 U.S. 477, 481

(1989) ). Accord McMahon, 482 U.S. at 231-234.

For a court, as a basis for vacating an arbitration

award, itself to construe an ambiguous arbitration

agreement as incorporating the rule announced in

Garrity would be contrary to both of the foregoing

principles. The Garrity court reasoned that “[t]he

evil of permitting an arbitrator whose selection is

often restricted or manipulatable by the party in a

superior bargaining position, to award punitive dam-

ages is that it displaces the court and the jury, and

therefore the State, as the engine for imposing a

social sanction.” 353 N.E.2d at 796. As the Seventh

Circuit itself recognized in an opinion subsequent to

its decision in this case, Garrity is based in large

wise have had in a judicial forum.” 1989 Release, 54 Fed.

Reg. at 21,154.

part on the “mistrust of arbitrators” that this Court

has emphatically rejected. See Baravati v. Josepthal,

Lyon & Ross, Inc., 28 F.3d 704, 710-711 (7th Cir.

1994). The necessary consequence of the Garrity

rule, moreover, is that execution of an arbitration

agreement entails not simply consent to an alterna-

tive forum, but a waiver of substantive rights as

well. Insofar as the FAA is concerned, the parties

are assuredly permitted to agree to such constraints

on the arbitrator’s remedial power, just as they are

permitted to fashion an arbitration agreement that

reserves most potential disputes for judicial resolu-

tion. Because such contractual terms run counter to

the premises underlying the FAA, however, they

should not be inferred by the courts absent an un-

ambiguous indication that this was the parties’ intent.

2. For the reasons that follow, no such clear state-

ment is present in this case.

a. The court of appeals asserted that “the parties

agreed to arbitrate all of their controversies under

New York law,” Pet. App. 12, and that “[s]ubmis-

sion to New York law is a general condition upon the

arbitration of all ‘controvers[ies]’ between the par-

ties.” Id. at 13-14. The agreement provides that it

“shall be governed by the laws of the State of New

York,” ic. at 44, and presumably New York law

defines the rights and obligations established by the

contract itself. It is clear, however, that New

York law was not intended to govern every aspect

of all disputes between the parties. Respondents do

not contend, for example, that the arbitrator was

required to apply New York law in ruling on peti-

tioners’ claims under the Securities Exchange Act or

SEC Rule 10b-5. Petitioners also asserted claims

based upon Illinois and Texas statutes, see Pet. App.

4, and neither of the courts below suggested that

those claims were barred by the choice-of-law provi-

sion. Although the agreement was to be “governed”

by the law of New York, it was plainly within the

contemplation of the parties that other sources of law

might be consulted in the process of resolving any

disputes that might arise.

b. In this case, the arbitration agreement not only

contained the New York choice-of-law provision, but

it also provided that arbitration would be conducted

“in accordance with the rules then in effect, of the

[NASD].” Pet. App. 44. The NASD Code of Arbi-

tration Procedure does not restrict the types of relief

an arbitrator may award, but merely refers to “dam-

ages and other relief.” NASD Code of Arbitration

Procedure, Section 41(e) (quoted at Pet. App. 15).

See Gilmer, 500 U.S. at 30 (suggesting that nearly

identical language in New York Stock Exchange

Rules allows a broad range of types of relief);

see also Baravati, 28 F.3d at 710 (“Silence [about

the scope of arbitrators’ powers] implies—given the

tradition of allowing arbitrators flexible remedial

discretion—the absence of categorical limitations.’’).

As the court of appeals in the instant case acknowl-

edged, moreover, the NASD Manual for arbitrators

specifically advises that punitive damages are a

permissible remedy. Pet. App. 15.

The court of appeals acknowledged that the perti-

nent provisions of the Code and Manual are at least

to some extent inconsistent with Garrity. The court

resolved that tension by treating the New York law

provision as the most significant provision in the

agreement and then using it to trump the NASD

rules. There is, in our view, no warrant in the lan-

guage of the contract for concluding that the arbitra-

tors were compelled to adopt that approach. Both the

choice-of-law provision and the provision incorporat-

ing NASD rules identify bodies of law that are to be

relied on in settling disputes between the broker-

dealer and its customers. One provision may not be

read out of the agreement when there is a reasonable

interpretation of the paragraph that accommodates

both.

Indeed, in our view, these provisions are most rea-

sonably harmonized by applying New York law to

determine what substantive rights and obligations

are created by the contract, while applying NASD

rules to resolve questions concerning the conduct of

the arbitral proceedings and the scope of the arbi-

trators’ authority. That reading comports with the

established principles of contract interpretation that

different provisions of an agreement should be read

as consistent with each other if that is reasonably

possible, that an interpretation giving effect to all the

terms is preferred to one which leaves some of no

effect, and that the specific (i.e., NASD rules appli-

cable to arbitration) prevails over the general (i.e.,

the provision referencing New York law). See, ¢.9.,

Restatement (Second) of Contracts § 202(5) & Cmt.

d (reading different provisions as consistent with each

other); id. §203(a) & Cmt. b (giving effect to all

terms) ; id. § 203(c) & Cmt. e (specific over general)

(1981).”

1 Moreover, it is well established that in choosing among

the reasonable meanings of the terms of an agreement, “that

meaning is generally preferred which operates against the

party who supplies the words or from whom a writing other-

wise proceeds.” Restatement (Second) of Contracts § 206.

The contract here is a form agreement drafted by respondents.

In any event, as we have explained (see pages

12-19, supra), the dispositive point is that the task

of harmonizing apparently inconsistent contractual

provisions is the province of the arbitrator rather

than the courts. For the reasons explained in the

preceding paragraph, the arbitrators in this case

acted well within their province.

c. If the agreement in this case had contained no

choice-of-law provision, the arbitrators would presum-

ably have assessed the parties’ rights and obligations

under the contract by reference to the law of some

State, chosen on the basis of its connection to the

parties, the agreement, and the contested transac-

tions. If that State had been New York, however, it

seems clear that the Garrity rule would not have been

applied. State law is preempted “to the extent that

it actually conflicts with federal law—that is, to the

extent that it ‘stands as an obstacle to the accomplish-

ment and execution of the full purposes and objectives

of Congress.’” Volt, 489 U.S. at 477 (quoting Hines

v. Davidowitz, 312 U.S. 52, 67 (1941)).7 The

Garrity rule, which is premised on the mistrust of

arbitrators that the FAA was intended to counteract,

7 For example, the FAA “pre-empts state laws which ‘re-

quire a judicial forum for the resolution of claims which the

contracting parties agreed to resolve by arbitration.’” Volt,

489 U.S. at 478 (quoting Southland Corp. v. Keating, 465

U.S. 1, 10 (1984)); Perry v. Thomas, 482 U.S. 483, 489-490

(1987). Similarly, States may not impose conditions on

arbitration agreements that are not imposed generally on

other types of contracts. Saturn Distribution Corp. v. Wil-

liams, 905 F.2d 719, 723-724 (4th Cir.), cert. denied, 498

U.S. 983 (1990); Securities Industry Assoc. Vv. Connolly, 883

F.2d 1114, 1120 (1st Cir.), cert. denied, 495 U.S. 956 (1990);

Webb v. R. Rowland & Co., 800 F.2d 8038, 806-807 (8th Cir.

1986).

and which treats arbitration as a disfavored forum,

surely stands as an obstacle to the effective imple-

mentation of the congressional purpose. As the Sev-

enth Circuit recently noted, “[s]tate common law

hostile to arbitration is preempted by federal common

law friendly to it.” Baravati, 28 F.3d at 711.

So far as the FAA is concerned, “parties are gen-

erally free to structure their arbitration agreements

as they see fit,” and they may limit by contract such

matters as the issues they will arbitrate or the rules

under which the arbitration will be conducted. Volt,

489 U.S. at 479. The Act therefore would not prevent

the parties from expressly agreeing that punitive

damages would not be awardable in any dispute be-

tween them, or from accomplishing the same result

by inserting explicit contractual language to the effect

that resolution of disputes between the parties “will

be governed by New York law, including the limita-

tion on arbitral power announced in Garrity.” But the

customer agreement here does not expressly say that

punitive damages are not allowed, nor does it ref-

erence the Garrity rule; it says only that New York

law governs. Standing alone, the choice-of-law provi-

sion should not be read to incorporate state law prin-

ciples that would be preempted if New York law ap-

plied of its own force as a result of the State’s connec-

tion to the relevant primary conduct.”

18 This Court’s decision in Volt is not to the contrary. The

arbitration agreement at issue in Volt included a choice-

of-law provision that referenced California law. Because the

California Arbitration Act authorized “a court to stay arbi-

tration pending resolution of related litigation” (489 U.S. at

470), the case had proceeded directly in the state courts,

rather than on review of an arbitral award. The California

Court of Appeal interpreted the choice-of-law provision to in-

corporate California rules of arbitration, including the statu-

d. For the foregoing reasons, the arbitrators in

this case acted well within their province in interpret-

ing the parties’ agreement as not incorporating the

Garrity rule. The courts below therefore erred in

setting aside the award of punitive damages.

tory provision empowering a state trial court to stay arpitra-

tion. Jd. at 471-472. This Court declined to revisit the state

court’s construction of the arbitration agreement, id. at 474-

476, noting that “the interpretation of private contracts is

ordinarily a question of state law, which this Court does not

sit to review.” Jd. at 474. The Court then held that, “assum-

ing the choice-of-law clause meant what the Court of Appeal

found it to mean,” id. at 476, application of the stay provision

was not preempted by the FAA. Id. at 476-479.

Volt does not cast doubt upon our contention that the

agreement in the instant case was permissibly interpreted by

the arbitrators to allow an award of punitive damages. Noth-

ing in Volt suggests that respondents’ construction of the

agreement here is the correct one, much less that an arbitral

award grounded in a contrary reading was properly vacated

by the district court. Moreover, the California procedural

rules at issue in Volt merely provided that the trial court

could coordinate the timing of an arbitration proceeding and

a parallel state court lawsuit involving third parties. This

Court found that incorporation of the California procedural

rules was not inconsistent with the FAA because those rules

were “manifestly designed to encourage resort to the arbitral

process.” 489 U.S. at 476. In contrast to the state procedural

rules applied in that case, the Garrity rule discourages resort

to the arbitral process by depriving plaintiffs of an otherwise

available substantive remedy.

CONCLUSION

The judgment of the court of appeals should be

reversed.

Respectfully submitted.

Drew S. Days, III

Solicitor General

SIMON M. LORNE LAWRENCE G. WALLACE

General Counsel Deputy Solicitor General

PAUL GONSON MALCOLM L. STEWART

Solicitor Assistant to the Solicitor

JACOB H. STILLMAN General

Associate General Counsel

LUCINDA O. MCCONATHY

Assistant General Counsel

SUSAN S. MCDONALD

Special Counsel

MARK PENNINGTON

Special Counsel

Securities and Exchange

Commission

NOVEMBER 1994

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