Petition for Writ of Certiorari — Greenberg v. Bear, Stearns & Co.

@) 2

00 699 0CI 3028

No.

——OFFICE OF THE CLERK

In The

Supreme Court of the Anited States

HOWARD GREENBERG,

Petitioner,

V.

BEAR, STEARNS & CO.,

BEAR STEARNS & CO., INC.,

BEAR STEARNS SECURITIES CORP.,

Respondents.

On Petition For Writ Or CERTIORARI

To Tue Unitep States Court OF APPEALS

For Tue SeEconp Circuit

PETITION FOR WRIT OF CERTIORARI

LESLIE TRAGER

Counsel of Record

MORLEY AND TRAGER

230 PARK AVENUE

New York, NY 10169

(212) 684-2210

Counsel for Petitioner

BECKER GALLAGHER LEGAL PUBLISHING, INC.,

CINCINNATI, OHIO 800-890-5001

QUESTIONS PRESENTED

What shall be the standard for reviewing cases arising

under the federal securities acts in order to insure that

rights under the securities laws are recognized in an

arbitration?

If manifest disregard of the law is to be standard, was

the Second Circuit correct in holding that the

arbitrators had not manifestly disregarded the law by:

a.

not imputing knowledge of the admittedly

fraudulent scheme to respondent Bear Stearns

when the undisputed evidence showed that

Bear Stearns management admitted reading the

first and second sentences of the one applicable

paragraph on page 2 of a prospectus but could

not “recall” reading the third sentence which

would have admittedly informed Bear Stearns

of the fraudulent scheme?

not imposing liability upon Bear Stearns

pursuant to Section 12a(1) of the Securities Act

of 1933 for failing to send a prospectus on an

underwriting?

PARTIES TO THE PROCEEDING

Petitioner

Howard Greenberg

Petitioner is an individual and has no corporate

affiliations.

Respondents

Bear Stearns & Co.

Bear Stearns & Co., Inc. |

Bear Stearns Securities Corp. \

TABLE OF CONTENTS

Page

QUESTIONS PRESENTED ..............ce20. i

PARTIES TO THE PROCEEDING ............. ii

py Rk ety)» ne iii

TABLE OF AUTHORITIES .................. iV

OT a da da 6's yaw ace isan’ a k's l

eh oo a a al a ta cg w'e bao OK Go ke l

STATUTES AND REGULATIONS

SW VGsas Vases OE EBRD CASE 2... ww ccc ccc 2

STATEMENT OF THECASE ................ 5

REASONS FOR GRANTING THE WRIT ......... 9

hole in ay G4 -br a oes lala é ace 20

APPENDIX

Appendix A

2™ Circuit Opinion, 8/7/00 .............. la

Appendix B

District Court Memorandum Opinion

I Es G's’ 0 a ow 4. G60 s'w a 0 08 15a

ill

TABLE OF AUTHORITIES

Cases

Page

Chasins v. Smith Barney & Co., Inc.,

438 F.2d 1167 (2d Cir. 1970)............. 16

Cowen & Co. v. Anderson,

76 N.Y.2d 318, 558 N.E.2d 27 (1990) ........ 12

DeBruyne v. Equitable Life Assurance Society of the

United States,

920 F.2d 457, 466 n.18 (7" Cir. 1990)....... 15

DiRussa v. Dean Witter Reynolds, Inc.,

wih we bo fe os re 10

Dodds v. Cigna Securities, Inc.,

12 F.3d 346, 351 (2d Cir. 1993)

cert. den. 511 U.S. 1019, 114 S.Ct. 1401 ..... 15

Ettinger v. Merrill Lynch Pierce Finner and Smith,

835 F.2d 1031, 1036 (3d Cir. 1987) ........ 16

Garrity v. McCaskey,

612 A.2d 742, 747-48 (Conn. 1992) ........ 13

Grandon v. Merrill Lynch Pierce Finner and Smith,

147 F.3d 184, 189, 190 (2d Cir. 1998)....... 16

Gulf Coast Funds Workers Union v. Exxon Co.,

991 F.2d 244 (5" Cir.) cert. den. 510 U.S. 965,

See es ee 6 ok oe oA a eee 10

iV

Halligan v. Piper Jaffe, Inc.,

148 F.3d 197 (2d Cir. 1998)

cert. den. 526 U.S. 1034, 119 S.Ct. 1286 ....10

In re Carte Blanche (Singapore) PTE, Ltd.,

888 F.2d 260, 267 (2d Cir. 1989) .......... 10

Koke v. Stifel, Nicolaus & Co., Inc.,

620 F.2d 1340, 1344 (8" Cir. 1980) ........ 15

Montes v. Shearson Lehman Bros. .,

138 F398 1006019" Ce TOOPP oo og ev cca 10

Myers v. Finkle,

950 F.2d 165, 167 (4" Cir. 1991) .......... 15

Rodriguez de Quijas v. Shearson/American Express, Inc.,

490 U.S. 477, 109 S.Ct. 1917 (1989)........ 11

S.E.C. v. Jakubowski,

150 F.3d 675, 681, 682 (7" Cir. 1998)....... 15

S.E.C. v. United States Environmental Inc.,

155 F.3d 107, 111 (2d Cir. 1998),

cert. den. sub nom. Romano v.

S.E.C., 526 U.S. 1111, 119 S.Ct. 1755

CE ok Oa eae eee es ee 5, 14

Shearson/American Express v. McMahon,

482 U.S. 220, 232 107 S.Ct 2332,

SED 26 ac kas oe eee 9,11

Wilko v. Swan,

346 U.S. 427, 435, 436, 74 S.Ct. 182 (1953) .. 11

708 F.2d 1511, 1518 (10" Cir. 1983)........ 15

RULES, STATUES AND ORDINANCES

IS U.S.C. Section T7GQOM A) ow cc ccc ccc cee 3,17

yee, Bp: 8, | Pree rrr err sane 4,17

Be Un © RPE. x50 3 widen ss fox ne wea ee l

Rule 10b-5, 17 CFR § 240.10b-5 ............. 2, 16

Section 10(b) of the Securities Exchange Act of 1934,

ie es S ee ee eee eee » F

Section 12(a)(1) of the 1933 Securities Act,

15 U.S.C. Section 77l(ay(1) ........ 1, 3, 8, 18

te Gg: 8 rere yer yr l

pk Pe re res ir oe ee 11

LAW REVIEWS AND MISCELLANEOUS

Black, The Core Institutions that Support Strong

Securities Markets, 55 Business Lawyer 1565

See, AMG, TOGD.. 0. 6 6 en's beens aaeee seein 19

Gary Weiss, Did Bear Stearns Ignore A Stock Swindle,

Business Week, Nov. 23, 1998, at 162 ........... 19

Gregory and Schneider, Securities Arbitration:

A Need for Continued Reform, 17 Nova L.R.

bec Mr Tt. Pee errr re ee oe ee 12, 13

Gretchen Morgenson, Testimony Implicates Bear

Stearns, N.Y. Times Jan. 30, 1999, atB-l1 ........ 19

vi

Levin, The Role of Substantive Law in Business

Arbitration and the Importance of Volition,

35 American Business L.J. 105, 149 (Fall 1997) ... 9, 10

Loss & Seligman, Fundamentals of Securities Regulation

) SS PPreeeerrrrererrr ire 18

Poser, Judicial Review of Arbitration Awards:

Manifest Disregard of the Law, 64 Brooklyn

L.R. 471, 500, Summer 1998 ........... 10, 11, 12

Public Investors Arbitration Bar Association,

Evident Partiality Study (prelim) ...........6++.:. 12

OPINIONS BELOW

The opinions of the Second Circuit, 220 F.3d 22, and

the district court are reprinted in the appendix commencing at

page la.

JURISDICTION

Petitioner filed a petition in the United States District

Court, Southern District of New York alleging that the

arbitrators at the NASD had disregarded the securities laws to

wit: the Securities Exchange Act of 1934, Section 10(b) and

the Securities Act of 1933, Section 12(a)(1) and asking that

the award be vacated. Jurisdiction existed because federal

questions were raised by the petition pursuant to 28 U.S.C. §

1331.

The District Court denied petitioner’s claims

(Appendix, p. 15a) and petitioner appealed to the Court of

Appeals for the Second Circuit. On August 7, 2000, the

decision of the District Court was affirmed. The Second

Circuit held that the federal courts had jurisdiction over the

petition to vacate the arbitration award because federal

jurisdiction will “lie if the ultimate disposition of the matter

by the federal court ‘necessarily depends on resolution of a

substantial question of federal law’” and that the petitioner

here complains “in good faith that the award was rendered in

manifest disregard of federal law....” (pp. 7a and 9a of

appendix).

Pursuant to Supreme Court Rule 13.1, this petition has

been filed within 90 days of the Second Circuit Opinion and

is, therefore, timely. This Court has jurisdiction pursuant to

28 U.S.C. § 1254(1).

STATUTES AND REGULATIONS

INVOLVED IN THIS CASE

Section 10(b) of the Securities Exchange Act of 1934,

15 U.S.C. § 78j(b):

“It shall be unlawful for any person,

directly or indirectly, by the use of any means

or instrumentality of interstate commerce or of

the mails, or of any facility of any national

securities exchange -

(b) To use or employ, in connection

with the purchase or sale of any security

registered on a national securities exchange or

any security not so _ registered, any

manipulative or deceptive device or

contrivance in contravention of such rules and

regulations as the Commission may prescribe

as necessary or appropriate in the public

interest or for the protection of investors.”

Rule 10b-5, 17 CFR § 240. 10b-5:

“It shall be unlawful for any person

directly or indirectly, by the use of any means

or instrumentality of interstate commerce, or

of the mails or of any facility of any national

securities exchange,

(a) To employ any device, scheme, or

artifice to defraud.

(b) To make any untrue statement of a

material fact or to omit to state a material fact

2

necessary in order to make the statements

made, in the light of the circumstances under

which they were made, not misleading, or

(c) To engage in any fact, practice, or

course of business which operates or would

operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any

security.”

Securities Act of 1933, 15 U.S.C. 77e(b)(1):

“It shall be unlawful for any person,

directly or indirectly --

(1) to make use of any means or

instruments of transportation. or

communication in interstate commerce or of

the mails to carry or transmit any prospectus .

relating to any security with respect to which

a registration statement has been filed under

this subchapter, unless such prospectus meets

the requirements of section 77} of this title.”

Securities Exchange Act of 1933, Section 12(a)(1), 15

U.S.C. 77l(a)(1):

“(a) In general

Any person who --

(1) offers or sells a security in violation

of section 77e of this title

* * *

shall be liable, subject to subsection (b) of this

section, to the person purchasing such security

from him, who may sue either at law or in

equity in any court of competent jurisdiction,

to recover the consideration paid for such

security with interest thereon, less the amount

of any income received thereon, upon the

tender of such security, or for damages if he

no longer owns the security.”

17 CFR § 230.174(d):

“(d) If (1) the registration statement

relates to the security of an issuer that is not

subject, immediately prior to the time of filing

the registration statement, to the reporting

requirements of section 13 or 15(d) of the

Securities Exchange Act of 1934, and (2) as of

the offering date, the security is listed on a

registered national securities exchange or

authorized for inclusion in an electronic inter-

dealer quotation system sponsored and

governed by the rules of a registered securities

association, no prospectus need be delivered

after the expiration of twenty-five calendar

days after the offering date. For purposes of

this provision, the term offering date refers to

the later of the effective date of the registration

statement or the first date on which the

secui ity was bona fide offered to the public.”

4

STATEMENT OF THE CASE

The undisputed evidence at the arbitration showed that

a Bear Stearns’ senior officer had read the first two sentences

of the one applicable paragraph found at page 2 of a

prospectus, but could not “recall” reading the third and fifth

sentences of this one paragraph. The latter two sentences

would have informed Bear Stearns beyond per adventure of

doubt that Bear Stearns would be engaging in major fraud if

it did the proposed underwriting. Petitioner claimed that

knowledge of these sentences under these circumstances must

be imputed to Bear Stearns. The Second Circuit’s sole

Statement with respect to this read:

“The petitioner argues that Bear Stearns

should be deemed to have knowledge of the

fraud because it had the necessary information

before it, but it is by no means clear that the

doctrine of imputed knowledge applies in this

context.” (Appendix p. 12a)

No cases, authority or reasoning were given to support this.

The Second Circuit agreed that “knowing participation in a

fraudulent scheme may render a participant liable under

Section 10(b)” citing $.E.C. v. United States Environmental

Inc., 155 F.3d 107, 111 (2d Cir. 1998), cert. den. sub nom.

Romano v. S.E.C., 526 U.S. 1111, 119 S.Ct. 1755 (1999).

The undisputed facts showed the following: In August,

1996, Bear Stearns was requested by its introducing broker,

Sterling Foster, for whom it cleared, to clear an underwriting

of a most unusual sort in which Sterling Foster would sell 2.4

million shares of common stock of a company short after the

initial offering by another firm of a separate 1.1 million

shares and cover that 2.4 million short sale with stock from

5

inside selling shareholders. Concededly, the sale of stock

from insiders constituted an underwriting. Thus, Bear Stearns

knew in August, 1996 that there would be an underwriting in

which stock of the inside shareholders would be sold

immediately after the initial offering. Prompt covering was

necessary in order to prevent Bear Stearns from being

exposed to the unlimited risk of a short sale - that the price

would rise above the sale price.

Bear Stearns’ associate managing director requested

and received a preliminary prospectus, which insofar as this

matter is concerned was identical to the final prospectus.

Page 2 of this preliminary prospectus contained the only

paragraph relevant in the prospectus to the issuance of the

inside selling shareholders’ shares. This paragraph read as

follows:

"Also, the registration statement of which this

Prospectus forms a part covers the offering of

2,400,000 shares of Common _ Stock,

2,000,000 Class A Warrants and 2,000,000

shares of Common Stock underlying Class A

Warrants owned by certain affiliated and non-

affiliated persons, hereinafter collectively

referred to as the ‘Selling Securityholders'.

The Company will not receive any of the

proceeds on the sale of the securities by the

Selling Securityholders. The securities held by

the Selling Securityholders may be sold

commencing 12 months from the date of this

Prospectus, subject to earlier release at the sole

discretion of Patterson Travis, Inc., the

representative (the ‘Representative') of the

underwriters of this offer (the 'Underwriters').

The Representative may release the securities

6

held by the Selling Securityholders at any time

after all securities subject to the Over-

Allotment Option have been sold or such

‘option has expired. The Representative has no

agreements or understandings with any of the

Selling Securityholders with respect to release

of the securities prior to the respective periods

and has no present intention of releasing any

or all of such securities prior to such periods."

(emphasis added)

For clarity, the first three sentences have been done in

different type.

This associate managing director admitted reading the

first two sentences but couldn’t recall reading the third

sentence, which clearly says that these insider shares can be

sold only after 12 months from the date of the prospectus (the

initial offering). The fifth sentence says that there are “no

agreements or understandings” to release the securities prior

to that 12-month period. Thus, these statements (the lockup)

directly contradicted the information represented to this

associate managing director that there would be a sale of these

securities immediately following the IPO.

This same one paragraph was delivered to the

managing director and number 2 person at the Bear Stearns

clearing operation and to a Bear Stearns’ attorney who then

prepared a separate guaranty agreement by Sterling Foster’s

President directly relating to this sale by the inside selling

shareholders. But the number 2 managing director testified

that he too couldn’t “recall” anything about a lockup. The

attorney, though requested to testify by petitioner, was not

directed to testify by the arbitrators.

For this very fraud, the officers of Sterling Foster pled

guilty to criminal securities fraud charges while this

arbitration was pending and this fact was brought to the

attention of the arbitrators.

Petitioner lost approximately half a million dollars on

this fraudulent scheme under which Sterling Foster, clearing

through Bear Stearns, distributed not the 1.1 million shares

set forth in the prospectus, but three times that number or 3.5

million shares.

Sterling Foster paid $3.25 for these insider shares and

sold to the public at prices ranging from $13.25 to over $15

per share for a 400% profit of approximately $24 million.

The public lost approximately $50 million.

In addition, Bear Stearns, as the clearing agent for

Sterling Foster, handled the payment to the insiders on behalf

of Sterling Foster and mailed confirmations to Sterling

Foster’s customers. It is illegal under the Securities Act of

1933 to mail a confirmation within 25 days of an underwriting

without also mailing to the customer a prospectus. Failure to

do so allows rescission under Section 12(a)(1) of the

Securities Act of 1933. No prospectus, however, was mailed

to the customers.

The confirmations mailed by Bear Stearns stated that

Sterling Foster made a market in the relevant stock. It did not

disclose that in fact these transactions were part of an

underwriting, not market making, nor that Sterling Foster

made a 400% profit. Admittedly, Bear Stearns knew that this

was an underwriting.

Thus, this fraudulent transaction was handled by Bear

Stearns as though the securities laws did not exist. Yet, the

8

a

NASD arbitrators found in favor of Bear Stearns by

dismissing at the end of petitioner’s case. No reasons were

Stated.

The Court of Appeals held that such disregard of the

securities acts did not constitute “manifest disregard” of the

securities acts and, therefore, upheld the arbitrators.

REASONS FOR GRANTING THE WRIT

This Court in Shearson/American Express _ v.

McMahon, 482 U.S. 220, 232 107 S.Ct. 2332, 2340 (1987),

in holding that claims under the 1934 Securities Act could be

arbitrated, held:

“[{A]lthough judicial scrutiny of arbitration

awards necessarily is limited, such review is

sufficient to insure that arbitrators comply with

the requirements of the statute.”

This is a promise which to date has not been kept.

Today, the courts virtually always defer to the arbitrators

even where the undisputed facts demonstrate violations of the

securities acts as a matter of law. While some courts claim to

review arbitration awards for “manifest disregard of the law”,

as One Commentator stated:

“The current formulation of manifest disregard

of the law certainly lacks potency. Indeed,

one must question whether it actually affords

any protection beyond that provided in the

arbitration statutes.... Manifest disregard of

the law remains an illusive concept that can be

understood better in terms of what it is not,

rather than what it is.” Levin, The Role of

9

Substantive Law in Business Arbitration and

the Importance of Volition, 35 American

Business L.J. 105, 149 (Fall 1997).

Indeed, the “manifest disregard” standard is applied

by the courts not just to federal statutory claims, but to non-

Statutory cases, as well. See In re Carte Blanche (Singapore)

PTE, Ltd., 888 F.2d 260, 267 (2d Cir. 1989). It is applied

to those who have truly voluntarily agreed to arbitration and

to those where industry-wide, and virtually universal practice,

forces the weaker party into an industry-controlled arbitration.

It is the latter case which prevails in the securities industry

today. As Levin, supra, points out, it is unfair to treat those

who truly voluntarily give up their rights to go to court for

arbitration the same as those who did not and for the latter

“there must be additional emphasis... on providing awards in

accordance with law.” (Id. at 174).

The Fifth Circuit does not even recognize the vague

concept of manifest disregard. Gulf Coast Funds Workers

Union v. Exxon Co., 991 F.2d 244 (5™ Cir.) cert. den. 510

U.S. 965, 114 S.Ct. 441 (1993). The 11" Circuit applied it

reluctantly only when respondent’s attorney urged the

arbitrators to disregard statutory law. Montes v. Shearson

Lehman Bros., 128 F.3d 1456 (11" Cir. 1997). Indeed, one

commentator compared the Second Circuit case of Halligan v.

Piper Jaffe, Inc., 148 F.3d 197 (2d Cir. 1998) cert. den. 526

U.S. 1034, 119 S.Ct. 1286, to DiRussa v. Dean Witter

Reynolds, Inc., 121 F.3d 818 (2d Cir. 1997) and noted

that “the Halligan court did not clearly identify the law that it

believed the arbitrators disregarded” and that Halligan

involved a far more complex area of the law than DiRussa.

Poser, Judicial Review of Arbitration Awards: Manifest

Disregard of the Law, 64 Brooklyn L. Rev. 471, 479,

Summer 1998. Yet, the court in DiRussa did not overturn the

10

arbitrators’ refusal to award attorneys’ fees to the victorious

plaintiff under Title VII, to which the claimant was Clearly

entitled. This commentator called for a standard in which an

award will be vacated “if the arbitrators deny a claimant

Statutory rights to which he or she is entitled.” Poser, id. at

514.

Prior to Rodriguez de Quijas v. Shearson/American

Express, Inc., 490 U.S. 477, 109 S.Ct. 1917 (1989) and

Shearson/American Express v. McMahon, 482 U.S. 220, 107

S.Ct. 2332 (1987) pre-dispute agreements to arbitrate claims

under the securities acts were invalid because the “power to

vacate an award is limited” and “the provisions of the

Securities Act... effectiveness in application is lessened in

arbitration as compared to judicial proceedings.” Wilko v.

Swan, 346 U.S. 427, 435, 436, 74 S.Ct. 182 (1953).

In overruling Wilko, this Court held:

“Our conclusion is _ reinforced by our

assessment that resort to the arbitration process

does not inherently undermine any of the

substantive rights afforded to petitioner under

the Securities Act.” Odriguez de Quijas at

490 U.S. 485, 486.

But today, that confidence is in doubt and this Court

has not ruled how in fact rights under the securities acts are

to be protected. Protecting such rights is particularly

important where the

“NASD pool of arbitrators tends to be

composed largely of retired persons and full-

time professional arbitrators... who... may be

subject to subtle pressures if a significant

portion of their livelihood depends on that

11

activity...[{for] if an arbitrator decides too

many cases adversely to brokerage firms, he or

she is likely to be challenged peremptorily by

brokerage firms in future cases.” Poser,

Judicial Review of Arbitration Awards:

Manifest Disregard of the Law, 64 Brooklyn

L.R. 471, 500, Summer 1998.

This is not simply a commentator’s hypothetical fears,

for a study by the Public Investors Arbitration Bar

Association (PIABA Evident Partiality Study [prelim]) showed

that even after Prudential-Bache Securities had been found by

the SEC to have violated the anti-fraud statutes and had a fine

of $10 million imposed by the SEC, $5 million by the NASD,

$27.5 million by the states and agreed to a restitution fund of

$336 million, in 29 out of 69 cases (43%) arbitrators from the

Pacific Stock Exchange found against the investor in cases

involving claims against Prudential-Bache arising out of the

same fraudulent transactions. In all cases, the arbitrators who

found against the investors were either professional arbitrators

or were formerly associated with the securities industry.

Indeed, the securities industry itself recognizes that the

SRO controlled arbitration forums such as the NASD favor

the industry because when the courts allowed customer

arbitrations to be brought before the American Arbitration

Association through the so-called AMEX window, the

American Stock Exchange immediately changed its

constitution to prevent customers from using a non-SRO

controlled forum. See Cowen & Co. v. Anderson, 76 N.Y .2d

318, 558 N.E.2d 27 (1990); Gregory and Schneider,

Securities Arbitration: A Need for Continued Reform, 17 Nova

L.R. 1223, 1243 (1993).

12

In such a setting, it is particularly important that the

rights of investors under the Federal Securities Acts be

protected by effective judicial review. As Gregory and

Schneider, supra, stated:

“If the Supreme Court has removed the

investor’s judicial remedy, the arbitration

substituted for it should be fashioned in such a

manner that the remedy is meaningful.”

XXX

The fairness of our judicial systems is

predicated on openness, impartiality and

appellate review. Securities arbitration in its

current repute fails in these important

aspects.” (id. at 1250).

The Connecticut Supreme Court stated:

“Judicial approval of arbitration decisions that

So egregiously depart from established law that

they border on the irrational would undermine

society's confidence in the legitimacy of the

arbitration process.” Garrity v. McCaskey,

612 A.2d 742, 747-48 (Conn. 1992).

Here, the undisputed facts demonstrate an irrational

decision, upheld only by stretching the concept of rationality

beyond the breaking point. Thus, the case at bar presents the

general question as to what the standard of review should be

for arbitration of securities act cases. The second question

sets forth some of the precise issues of law ignored by the

arbitrators under the securities acts.

13

In this case, the facts are simple and undisputed. Bear

Stearns received a proposed prospectus which had one

relevant paragraph on page 2. This paragraph and page was

read, or sent to at least three people to read, who focused on

that paragraph - an associate managing director, an attorney

who drafted a special, guarantee agreement by Sterling

Foster’s President for the transaction, and the number 2

person at the clearing arm of Bear Stearns. Anyone reading

the third sentence in that paragraph would immediately know

that there was a massive fraud being perpetrated for that

paragraph represented that there was a lockup of the 2.4

million shares of the inside selling security holders for one

year whereas Bear Stearns knew and understood that those

shares were to be sold immediately upon the initial public

offering.

As the Second Circuit recognized,

“Knowing participation in a fraudulent scheme

may render a participant liable under § 10(b).

See S.E.C. v. U.S. Envtl., Inc., 155 F.3d

107, 111 (2d Cir. 1998) cert. denied sub nom.

Romano v. S.E.C., 119 S.Ct. 1755 (1999).”

(Appendix p. 12a)

The associate managing director admitted to reading

the first two sentences in that one paragraph. “Not recalling”

to have read the third sentence of that one paragraph in these

circumstances would be laughed out of court if this case had

been before a federal court. Yet, that is precisely what

managing director Keith Brigley admitted.

Virtually every circuit has held that knowledge of the

facts contained in a document in one’s hand should be

imputed to that person or entity in circumstances far less

14

likely to have given such person actual knowledge than here

where there was only one relevant paragraph upon which at

least three senior officers focused. See e.g. Dodds v. Cigna

Securities, Inc., 12 F.3d 346, 351 (2d Cir. 1993) cert. den.

511 U.S. 1019, 114.S.Ct. 1401, in which a woman with a 10"

grade education who allegedly did not understand a prospectus

was held not to be excused because “the means of knowledge

are the same thing in effect as knowledge itself.” Zobrist v.

Coal-X, Inc., 708 F.2d 1511, 1518 (10" Cir. 1983);

DeBruyne v. Equitable Life Assurance Society of the United

States, 920 F.2d 457, 466 n.18 (7" Cir. 1990); Koke v. Stifel

Nicolaus & Co., Inc., 620 F.2d 1340, 1344 (8" Cir. 1980);

Myers v. Finkle, 950 F.2d 165, 167 (4" Cir. 1991). While

those cases involved inexperienced claimants, that is no

reason not to apply it to more knowledgeable insiders who are

experienced in Wall Street matters. As the 7" Circuit held in

S.E.C. v. Jakubowski, 150 F.3d 675, 681, 682 (7" Cir.

1998), in upholding summary judgment against the defendant:

“Over and over again, we say that people

claiming to be victims of securities fraud may

not claim to rely on oral statements incon-

sistent with written documents (even tedious

prospectuses) available to them... That is no

less true when the person claiming ignorance

of the writing made rather than received mis-

statements....”

Indeed, it is most perverse to apply the rule of imputed

knowledge to some inexperienced, uneducated person and yet

not to apply it to people, such as those at Bear Stearns, who

were no mere Clerks, but a lawyer and senior management.

Yet, arbitrators, under the ruling of this case, are allowed to

make such a perverse ruling.

- 15

Thus, applying this vague standard of “manifest

disregard”, the Second Circuit held, without citation or

reasoning:

“[I]t is by no means clear that the doctrine of

imputed knowledge applies in this context.”

(Appendix p. 12a)

This Court should grant review to determine whether

there should be applicable standards to vacate such an

apparently irrational arbitration decision.

A similar indulgence was made with respect to the

arbitrators’ discretion as to the false confirmations. The

confirmations sent failed to disclose either that the sales to

petitioner were on an underwriting or the fact that a 400%

profit had been made. Rather, the confirmations represented

that a market-making transaction had taken place. Not

disclosing critical facts in a confirmation such as the existence

of an underwriting or excessive profit, here 400%, has been

consistently held violative of Rule 10(b). Chasins v. Smith

Barney & Co., Inc., 438 F.2d 1167 (2d Cir. 1970); Ettinger

v. Merrill Lynch Pierce Finner and Smith, 835 F.2d 1031,

1036 (3d Cir. 1987); Grandon v. Merrill Lynch Pierce Finner

and Smith, 147 F.3d 184, 189, 190 (2d Cir. 1998), holding:

“There exists an implied representation that

broker-dealers charge their customers

securities prices that are reasonably related to

the prices charged in an open and competitive

market....A broker-dealer commits fraud (in

violation of § 10(b) and Rule 10b-5) by

charging customers excessive markups without

proper disclosure.”

16

Yet, the Second Circuit concluded that:

“But the arbitrators could have concluded that

the language was not actually false, since

Sterling Foster, in fact, was a market maker in

ML Direct securities at the time, although not

for all transactions.” (Appendix p. 13a)

In other words because Sterling Foster sometimes makes a

market in that security, it is okay not to disclose the

underwriting because those other transactions did not involve

an underwriting. This excuse surely stretches the law beyond

the breaking point.

As to the 400% profit, the court allowed the

arbitrators to find that Bear Stearns was “unaware of an

introducing broker’s undisclosed and excessive profit”

(Appendix p. 13a). But the undisputed facts are that one of

Bear Stearns’ managing directors was aware that Sterling

Foster had sold shares with closing prices at $15.25 and

$15.50, and that same managing director had received shares

from the inside selling shareholders with directions to pay

these inside selling shareholders certain fixed amounts.

Simple arithmetic dividing the number of shares received into

the amount paid would easily disclose the 400% profit (e.g.

Special Equities delivered 1,000,080 shares with instructions

to pay Special Equities $3,510,000, a little over $3 a share).

Yet, the arbitrators were allowed to find that Bear Stearns was

“unaware” and the Second Circuit did not discuss imputed

knowledge requirements.

With respect to the Securities Act of 1933, there can

be no dispute that 15 U.S.C. Section 77e(b)(1) and CFR §

230.174(d) make it unlawful to send a confirmation within the

first 25 days of an underwriting without sending the

17

prospectus. Loss & Seligman, Fundamentals of Securities

Regulation 3 Ed., p. 94 “[A] full prospectus must precede or

accompany delivery [of securities] or confirmation, whichever

first occurs....” Thus, sending a confirmation when Bear

Stearns admittedly knew that there was an underwriting

without sending a prospectus violated the basic rule of law of

the Securities Act of 1933.

Section 12(a)(1) of the 1933 Securities Act, 15 U.S.C.

Section 771(a)(1) provides the remedy for such violation -

rescission. The Second Circuit said with respect to this:

[N]othing in the [clearing] agreement between

Bear Stearns and Sterling Foster

unambiguously shifted the burden of

complying with this requirement onto Bear

Stearns.” (Appendix p. 13a)

One must ask, since Bear Stearns clearly had the obligation to

send confirmations for Sterling Foster’s trades, who was

supposed to send the prospectus, if not Bear Stearns? Most

importantly, if Bear Stearns felt that it was not required to

send the prospectus, it had no right to knowingly send out

illegal confirmations for those trades and blithely assume that

some other person perhaps is sending out the prospectus.

There was no evidence that Bear Stearns even asked who was

sending out the prospectus for the underwriting when it

should have known, as a matter of absolute, basic securities

law, that for Bear Stearns to send confirmations without that

prospectus was a violation of the Securities Act of 1933.

It is submitted that the arbitrators in effect allowed

Bear Stearns to violate the Securities Acts of 1933 and 1934

with impunity. These blatant violations have been sanctioned

by the courts as not being in manifest disregard of the law.

18

Under this standard, as applied, it is clear that the petitioner

was not given the basic protections to which he was entitled

under the securities acts.

The securities industry is one of the most important in

the United States. Confidence in the securities industry is

essential. To maintain such confidence, it is necessary to

impose liability for violation of the laws governing the

securities industry. See: Black, The Core Institutions that

Support Strong Securities Markets, 55 Business Lawyer 1565,

1568, August, 2000. Today, most customer disputes must be

handled in arbitration because of the virtually universal use of

the pre-dispute agreement with all customers. Thus, it is

necessary to maintain the effectiveness of the securities laws

through arbitration.

As previously noted, the NASD certainly cannot be

perceived as an unbiased forum because so many of its

arbitrators continually sit and make their living off of

arbitration and may not want to give decisions that might

alienate brokerages, which may subject them to being

peremptorily challenged in future cases. That the facts in this

case raise serious questions of public concern is demonstrated

by the numerous newspaper reports regarding this matter.

See e.g. Gretchen Morgenson, Testimony Implicates Bear

Stearns, N.Y. Times, Jan. 30, 1999, at B 1; Gary Weiss, Did

Bear Stearns Ignore A Stock Swindle, Business Week, Nov.

23, 1998, at 162. And Mr. Michael Harrington, who, at the

time of these events, was in charge of the Bear Stearns

Clearing Division, has since been forced to resign from Bear

Stearns over a matter not related to the Sterling Foster fraud

and has been barred by the SEC from the securities industry.

Thus, if charges of fraud in violation of the securities

acts are to be handled through industry appointed panels,

19

pursuant to pre-arbitration agreements, then this Court must

determine a method for the courts to review arbitrations so

that the basic rights under the securities laws are in fact

protected.

CONCLUSION

This Court should, therefore, grant the writ of

certiorari to determine the standards under which public

customers of securities firms can receive the protections to

which they are entitled under the securities acts.

Dated: New York, New York

October 25, 2000

Respectfully submitted,

MORLEY AND TRAGER

By:

Leslie Trager (LT-8995)

Attorneys for Petitioner

230 Park Avenue

New York, New York 10169

- (212) 684-2210

20

APPENDIX A

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

[Filed August 7, 2000}

No. 99-9041

HOWARD GREENBERG,

Petitioner-Appellant,

¥.

BEAR, STEARNS & CO., INC.,

and BEAR, STEARNS

SECURITIES CORP.,

)

)

)

)

- )

BEAR, STEARNS & CO., )

)

)

)

Respondents-Appellees. )

)

Before: OAKES, WALKER, and KEITH,” Circuit Judges.

Appeal from the judgment of the United States District

Court for the Southern District of New York (John S. Martin,

Jr., District Judge), denying the motion by the petitioner-

appellant to vacate an arbitration award.

* The Honorable Damon J. Keith of the United States Court of

Appeals for the Sixth Circuit, sitting by designation.

la

Court of Appeals Opinion - 8/7/00

Affirmed.

OPINION

JOHN M. WALKER, JR., Circuit Judge:

Petitioner-appellant Howard Greenberg appeals from

the August 25, 1999 judgment of the United States District

Court for the Southern District of New York (John S. Martin,

Jr., District Judge), denying his petition to vacate an

arbitration award that dismissed his securities fraud claims

against respondents-appellees Bear, Stearns & Co., Inc., and

Bear, Stearns Securities Corp. (collectively, “Bear Stearns”).

On appeal, Greenberg argues that the district court’s judgment

should be reversed and the arbitration award against him

vacated because the arbitrators manifestly disregarded federal

law in rendering the award. Bear Stearns responds that there

was no basis for federal subject matter jurisdiction in this case

and that, in any event, the arbitral award easily withstands

review.

This appeal squarely presents the question of whether

and under what circumstances federal courts have jurisdiction

to hear motions to vacate arbitration awards. We conclude

that the district court had jurisdiction in this case because

Greenberg challenged the award primarily on the grounds of

manifest disregard of federal law. Nevertheless, Greenberg

has not met the very stringent burden of demonstrating the

sort of manifest disregard required to vacate the award.

Therefore, we affirm the judgment of the district court.

2a

Court of Appeals Opinion - 8/7/00

BACKGROUND

At the time of the events underlying Greenberg’s

claim, Bear Stearns (a “clearing broker”) provided securities

Clearing services to Greenberg’s primary broker, Sterling

Foster (an “introducing broker”). According to Greenberg,

Bear Stearns violated federal and state securities laws because

it knew of and participated in a fraudulent scheme perpetrated

by Sterling Foster; sent false and misleading confirmations in

connection with this scheme; and failed to send out a required

Prospectus. We briefly discuss the facts and allegations

pertinent to the appeal.

In 1996, Sterling Foster organized the initial public

offering (“IPO”) for a company called ML Direct. Under an

agreement between Bear Stearns and Sterling Foster, the latter

requested permission from the former to underwrite this sale.

According to Sterling Foster’s plan, ML Direct would make

a public sale of 1.1 million shares, and Sterling Foster would

sell short an additional 2.3 million shares, to be covered by

Shares it would obtain from existing shareholders. This

scheme was fraudulent, alleged the plaintiff, because the

prospectus distributed to purchasers of ML Direct stock Stated

that shares from the selling shareholders were subject to a

lock-up agreement for 12 months and that there were “no

agreements or understandings . . . with respect to release of

the securities prior to [this time].” Bear Stearns employees

admitted having seen the prospectus, but did not recall

reading the sentences about the lock-up. Bear Stearns agreed

to clear the transaction.

In September 1996, the IPO and stock sales proceeded

as planned. Sterling Foster allegedly reaped an enormous

3a

Court of Appeals Opinion - 8/7/00

profit at the expense of the selling shareholders by selling

shares short and purchasing shares from those shareholders at

a significantly lower price. Bear Stearns sent out

confirmations to purchasers of ML Direct stock that stated:

“Your broker makes a market in this security and acted as

principal.” The confirmations did not disclose Sterling

Foster’s short sales or its large profit, nor was a prospectus

sent to those who purchased shares.

In May 1997, the petitioner filed a claim with the

National Association of Security Dealers (“NASD”) against

Bear Stearns alleging, among other things, fraud and market

manipulation in connection with Bear Stearns’s provision of

securities clearing services to Sterling Foster. A panel of

three arbitrators heard arguments and testimony through

extensive briefing and seven days of hearings. The arbitrators

first dismissed Greenberg’s claim based on Bear Stearns’s

purported failure to send him a prospectus and thereafter

dismissed his remaining claims. On March 9, 1999, the

arbitrators issued a written award confirming their decision to

dismiss.

On January 18, 1999, Greenberg moved in federal

district court to vacate the award on the basis that it “violated

public policy and manifestly disregarded the law.” In an

opinion and award dated August 23, 1999, the district court

denied the motion on the grounds that the petitioner had failed

to demonstrate manifest disregard of the law in the arbitrators’

treatment of his claims. This appeal followed.

4a

Court of Appeals Opinion - 8/7/00

DISCUSSION

I. Federal Jurisdiction

The principal question presented in this appeal is

whether the district court had federal question jurisdiction

over Greenberg’s motion to vacate the arbitration award.

Jurisdiction would plainly lie if, among other things, the

parties were diverse, see 28 U.S.C. § 1332, the claim arose

in admiralty, see 28 U.S.C. § 1333, or the dispute concerned

the interpretation of a collective bargaining agreement, see 29

U.S.C. § 185(a). Cf. Drexel Burnham Lambert. Inc. v.

Valenzuela Bock, 696 F. Supp. 957, 964-65 (S.D.N.Y. 1988)

(Leval, J.) (listing some circumstances under which federal

courts plainly have jurisdiction to hear a petition to compel

arbitration). However, we must decide whether and under

what circumstances a federal court may entertain a motion to

vacate an award where, as in this case, alternative bases for

jurisdiction are absent. We conclude that: (1) the fact that

the arbitration itself concerns issues of federal law does not,

on its own, confer subject matter jurisdiction on a federal

district court to review the award; but (2) federal jurisdiction

may lie where the petitioner seeks to vacate the award

primarily on the ground of manifest disregard of federal law.

Federal courts have jurisdiction over “all civil actions

arising under the . . . laws . . . of the United States.” 28

U.S.C. § 1331. Federal question jurisdiction exists where a

well-pleaded complaint “establishes either that federal law

creates the cause of action or that the plaintiff’s right to relief

necessarily depends on resolution of a substantial question of

federal law.” Franchise Tax Bd. v. Construction Laborers

Vacation Trust, 463 U.S. 1, 27-28 (1983).

Sa

Court of Appeals Opinion - 8/7/00

Federal law plainly does not create the cause of action

in this case. Greenberg filed his petition under § 10 of the

Federal Arbitration Act (“FAA”), which authorizes “the

United States court in and for the district wherein the

[arbitration] award was made” to “make an order vacating the

award” under certain circumstances. 9 U.S.C. § 10(a).

However, it is well-settled that the FAA does not confer

subject matter jurisdiction on the federal courts even though

it creates federal substantive law. See Southland Corp. v.

Keating, 465 U.S. 1, 16 n.9 (1984); Moses H. Cone Mem.

Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 25 n.32 (1983).

Therefore, federal question jurisdiction does not arise simply

because a petitioner brings a claim under § 10 of the FAA;

there must be “an independent basis of jurisdiction” before

district courts may entertain petitions to vacate. Harry

fi inti a icati ‘l

Union, Local 261, 912 F.2d 608, 611 (2d Cir. 1990).

Simply raising federal-law claims in the underlying

arbitration is insufficient to supply this “independent basis.”

In the context of a motion to compel arbitration under § 4 of

the FAA, see 9 U.S.C. § 4, we have specifically held that

there is no federal subject matter jurisdiction “merely because

the underlying claim raises a federal question.”

Westmoreland Capital Corp. v. Findlay, 100 F.3d 263, 268

(2d Cir. 1996). Petitions to compel arbitration “must be

brought in state court unless some other basis for federal

jurisdiction exists, such as diversity of citizenship or assertion

of a claim in admiralty.” Id. Language in § 4 seemingly

authorizing the federal courts to hear such petitions “is not

intended to confer jurisdiction, but should instead be read as

a response to the antiquated common law principle that an

agreement to arbitrate would oust the federal courts of

6a

Court of Appeals Opinion - 8/7/00

jurisdiction.” Id. at 267-68 (citing Valenzuela Bock, 696 F.

Supp. at 961-62).

The holding in Westmoreland logically extends to

motions to vacate an arbitration award under § 10 of FAA.

Indeed, we implied as much in Westmoreland itself, see 100

F.3d at 268, and other courts have explicitly so held, see,

e.g., Kasap v. Folger Nolan Fleming & Douglas, Inc., 166

F.3d 1243, 1247 (D.C. Cir. 1999); Ford v. Hamilton

Invests., Inc., 29 F.3d 255, 257-58 (6th Cir. 1994); Lipton v.

Shearson, 934 F. Supp. 638, 639 (S.D.N.Y. 1996);

Magninelli v. Smith Barney, Inc., No. 98 Civ. 8986, 1999

WL 615096, at *1 (S.D.N.Y. Aug. 12, 1999). As with a

motion under § 4, the only federal rights that a motion under

§ 10 necessarily implicates are those created by the FAA

itself, which rights do not give rise to federal question

jurisdiction. In both contexts, there is no necessary link

between the requested relief and the character of the

underlying dispute. For example, a petition to compel

arbitration because the dispute falls within the scope of an

arbitration clause, or to vacate an award because the

arbitrators exceeded their powers under that clause, will turn

on the interpretation of the clause, regardless of whether the

actual dispute implicates any federal laws. Accordingly, the

fact that the arbitration concerns issues of federal law does

not, standing alone, confer subject matter jurisdiction on a

federal district court to review the arbitral award.

Nevertheless, federal jurisdiction may still lie if the

ultimate disposition of the matter by the federal court

“necessarily depends on resolution of a substantial question of

federal law.” Barbara v. New York Stock Exch., Inc., 99

F.3d 49, 54 (2d Cir. 1996) (internal quotation marks omitted).

7a

Court of Appeals Opinion - 8/7/00

Thus we must decide whether the petition in this case to

vacate an arbitral award presents a substantial question of

federal law.

“[I]n determining federal question jurisdiction, courts

must make principled, pragmatic distinctions, engaging in a

selective process which picks the substantial causes out of the

web and lays the other ones aside.” Id. (internal quotation

marks omitted). “[E]xamining only those allegations which

are properly raised in a well-pleaded complaint, we look to

the nature of the federal question raised in the claim to see if

it is sufficiently substantial to warrant federal jurisdiction.”

Greenblatt v. Delta Plumbing & Heating Corp., 68 F.3d 561,

570 (2d Cir. 1995) (internal quotation marks omitted). The

greater the federal interest at stake, the more likely it is that

federal jurisdiction will be found. See West 14th St.

Commercial Corp. v. 5 West 14th Owners Corp., 815 F.2d

188, 193 (2d Cir. 1987) (citing Merrell Dow Pharmaceuticals

Inc. v. Thompson, 478 U.S. 804, 814 n.12 (1986)).

In our view, under these standards, whether or not a

petition to vacate under § 10 raises a substantial federal

question turns on the ground for the petitioner’s challenge to

the award. The FAA and federal case law supply various

bases for review of an arbitral award. Section 10 itself lists

several grounds, including fraud in procuring the award;

corruption, partiality, or prejudicial misconduct on the part of

the arbitrators; abuse of power; and failure to render “a

mutual, final, and definite award.” 9 U.S.C. § 10(a).

Judicial interpretation has added additional grounds, such that

awards may be vacated under limited circumstances where the

arbitrators manifestly disregarded the law, see DiRussa v.

Dean Witter Reynolds Inc., 121 F.3d 818, 821 (2d Cir.

8a

es

Court of Appeals Opinion - 8/7/00

1997), or where enforcement would violate a “well defined

and dominant public policy,” IBEW Local 97 v. Niagara

Mohawk Power Corp., 143 F.3d 704, 717 (2d Cir. 1998)

(internal quotation marks omitted).

We hold that where, as here, the petitioner complains

principally and in good faith that the award was rendered in

manifest disregard of federal law, a substantial federal

question is presented and the federal courts have jurisdiction

to entertain the petition. In contrast to grounds of review that

concern the arbitration process itself -- such as corruption or

abuse of power -- review for manifest disregard of federal law

necessarily requires the reviewing court to do two things:

first, determine what the federal law is, and second,

determine whether the arbitrator’s decision manifestly

disregarded that law. This process so immerses the federal

court in questions of federal law and their proper application

that federal question subject matter jurisdiction is present.

Where the arbitrators’ alleged manifest disregard of

federal law forms a key part of the petitioner’s complaint

about the award, the federal questions thereby presented are

substantial enough to support federal jurisdiction. First,

although review for manifest disregard is “severely limited,”

DiRussa, 121 F.3d at 821, if engaging in such review is

essentially all that is required of the reviewing court, it is

plain that federal questions will predominate. Second, there

is a clear federal interest in resolving these questions. While

federal claims may appropriately be resolved through

arbitration, the federal courts have a strong interest in

ensuring that arbitrators interpret and apply federal law

properly, even if within a wide range of tolerance. Cf.

Shearson/Am. Express Inc. v. McMahon, 482 U.S. 220, 232

9a

Court of Appeals Opinion - 8/7/00

(1987) (“[A]lthough judicial scrutiny of arbitration awards

necessarily is limited, such review is sufficient to ensure that

arbitrators comply with the requirements of the statute.”).

Indeed, as Judge Leval observed, this interest “would seem to

be far greater” than the federal interest implicated by a

petition to compel arbitration under § 4 -- that is, the “interest

in seeing that the claims be arbitrated” in the first place.

Valenzuela Bock, 696 F. Supp. at 963.

We note that, by and large, the rulings of other courts

are not inconsistent. Many courts have found the simple

presence of federal claims in the arbitration itself insufficient

as an independent basis-for federal jurisdiction. These cases,

however, generally did not involve a petition to vacate on the

grounds of manifest disregard of federal law in the arbitrators’

resolution of the underlying federal claims. But_see

Manginelli, 1999 WL 615096, at *2 (holding that the “limited

application and interpretation of federal law” required to rule

on a petition to vacate an award on the grounds of manifest

disregard is insufficient to “provide an independent basis for

federal jurisdiction”). Instead, the petitioners challenged

arbitration awards on grounds that plainly did not require

resolution of a uniquely federal issue, including perjury, see

Kasap, 166 F.3d at 1245; “alleged misdeeds of the

arbitrators,” Baltin v. Alaron Trading Corp., 128 F.3d 1466,

1472 (11th Cir. 1997); “fraud, corruption, undue means,

evident partiality, and failure to consider pertinent and

materiai evidence,” Minor v. Prudential Sec., Inc., 94 F.3d

1103, 1105-06 (7th Cir. 1996); and manifest disregard of state

law, see Ford, 29 F.3d at 258; Lipton, 934 F. Supp. at 639.

The Seventh Circuit acknowledged that the federal courts

might have jurisdiction if the motion to vacate involved, on its

face, “the resolution of [the petitioner’s] federal claims or

10a

Court of Appeals Opinion - 8/7/00

some question of federal law.” Minor, 94 F.3d at 1106. But

see Kasap, 166 F.3d at 1247 (suggesting that review for fraud

under § 10 implicates federal law but that this is insufficient

to support federal jurisdiction). Where the petitioner seeks

vacatur chiefly on the ground of manifest disregard of federal

law, a federal question is plainly presented.

In this case, if it were not for the claim that vacatur is

warranted because federal law was manifestly disregarded, we

would find no jurisdiction. The simple fact that the

underlying arbitration implicated federal questions would not

be enough. But because the petition alleges primarily that the

award was rendered in manifest disregard of the federal laws

underpinning these claims, federal question jurisdiction is

present.

Accordingly, the district court had jurisdiction to

consider Greenberg’s petition, and this appeal is properly

before us. We turn now to the merits.

II. Review of the Award for Manifest Disregard of the

Law

The district court held that the petitioner had failed to

demonstrate that the arbitral award was rendered in manifest

disregard of the law. Review for manifest disregard is

“severely limited.” DiRussa, 121 F.3d at 821. In order to

vacate an award on these grounds, a reviewing court must

find “both that (1) the arbitrators knew of a governing legal

principle yet refused to apply it or ignored it altogether, and

(2) the law ignored by the arbitrators was well defined,

explicit, and clearly applicable to the case.” Id. (internal

quotation marks and alterations omitted). The party seeking

lla

Court of Appeals Opinion - 8/7/00

vacatur of the award bears the burden of showing manifest

disregard under these _ standards. See Willemijn

Houdstermaatschappij, BV v. Standard Microsystems Corp.,

103 F.3d 9, 12 (2d Cir. 1997). A district court’s application

of the manifest disregard standard is a legal determination that

we review de novo. See id.

The petitioner has failed to meet this very stringent

burden with respect to any of his claims against Bear Stearns.

First, Greenberg argues that the arbitrators manifestly

disregarded federal law in denying his claim that Bear Stearns

knew about Sterling Foster’s fraudulent scheme and is

therefore liable under § 10(b) of the Securities Exchange Act.

Knowing participation in a fraudulent scheme may render a

participant liable under § 10(b). See S.E.C. v. United States

Envtl., Inc., 155 F.3d 107, 111 (2d Cir. 1998), cert. denied

sub nom. Romano v. S.E.C., 119 S. Ct. 1755 (1999). In this

case, however, Bear Stearns employees testified that they did

not know about Sterling Foster’s fraud, and thus the

arbitrators could reasonably have concluded that Bear Stearns

lacked the knowledge required for § 10(b) liability. The

petitioner argues that Bear Stearns should be deemed to have

knowledge of the fraud because it had the necessary

information before it, but it is by no means clear that the

doctrine of imputed knowledge applies in this context.

Second, according to Greenberg, Bear Stearns violated

federal securities law by sending knowingly false

confirmations. The confirmations were allegedly misleading

because, while they made certain disclosures, they failed to

reveal that the transaction was an underwriting, not a market

sale, and that Sterling Foster was reaping a 400% profit from

the scheme. But the arbitrators could have concluded that the

12a

Court of Appeals Opinion - 8/7/00

language was not actually false, since Sterling Foster, in fact,

was a market maker in ML Direct securities at the time,

although not for all transactions. In addition, there is no well-

settled law imposing a duty upon a clearing broker, who is

unaware of an introducing broker’s undisclosed and excessive

profit, to inquire into the matter and then inform the latter’s

customers of such self-dealing.

Third, Greenberg contends that Bear Stearns failed to

comply with 17 C.F.R. § 230.174, which requires delivery of

a prospectus in connection with the sale of newly issued

securities. But the regulation imposes this requirement only

on underwriters and dealers, not on clearing brokers, and

nothing in the agreement between Bear Stearns and Sterling

Foster unambiguously shifted the burden of complying with

this requirement onto Bear Stearns.

Finally, Greenberg asserts that Bear Stearns should be

held liable as an aider and abetter under New York law

because it participated in the fraudulent scheme and provided

substantial assistance to Sterling Foster. See S & K Sales Co.

v. Nike, Inc., 816 F.2d 843, 847-48 (2d Cir. 1987).

However, there was ample basis for the arbitrators to

conclude that Bear Stearns’s participation was insufficient to

constitute substantial assistance. “(T]he simple providing of

normal clearing services to a primary broker who is acting in

violation of the law does not make out a case of aiding and

abetting against the clearing broker.” Stander v. Financial

Clearing & Servs. Corp., 730 F. Supp. 1282, 1286

(S.D.N.Y. 1990); cf. Edwards & Hanly v. Wells Fargo Sec.

Clearance Corp., 602 F.2d 478, 484 (2d Cir. 1979) (clearing

brokers owe no separate duty to customers of an introducing

broker).

13a

Court of Appeals Opinion - 8/7/00

In sum, the arbitrators did not ignore or refuse to

apply well-defined and clearly applicable law in rejecting any

of the appellant’s claims in such a way that would amount to

manifest disregard.

CONCLUSION

For the foregoing reasons, we hold that: (1) where, as

here, a § 10 petitioner complains principally and in good faith

that an arbitration award was rendered in manifest disregard

of federal law, the federal courts have jurisdiction to entertain

the petition; and (2) the district court in this case properly

rejected the petitioner’s claim for failure to demonstrate that

the arbitrators had manifestly disregarded the law in their

treatment of his securities claims. We have considered the

petitioner's other arguments and find them to be without

merit. Accordingly, we affirm the judgment of the district

court.

l4a

APPENDIX B

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF NEW YORK

[Dated August 23, 1999]

No. 99 Civ. 358 (JSM)

HOWARD GREENBERG ,

Petitioner,

iP

BEAR STEARNS & CO., INC.

and BEAR STEARNS

SECURITIES CORP.,

)

)

)

)

)

)

)

)

Respondents. )

)

MEMORANDUM OPINION AND ORDER

JOHN S. MARTIN, Jr., District Judge:

This case is before the Court on a petition to vacate an

arbitral award dismissing all of petitioner’s claims.

Bear Stearns served as the clearing broker for Sterling

Foster, a now-defunct brokerage house whose President,

Adam Lieberman, pled guilty in this District to securities

fraud charges. One of the fraud schemes Sterling Foster

carried out involved the fraudulent sale of shares of ML

15a

District Court Memorandum Opinion & Order - 8/23/99

Direct, a company whose stock offering Sterling Foster

underwrote. Sterling Foster sold shares of ML Direct short

and then released into the market ML Direct shares that were

supposed to be “locked up.” The flood of ML Direct shares

on the market caused the share price to drop, and petitioner

Howard Greenberg, who bought 29,000 shares in September

1996, lost the value of his investment.

An NASD arbitration panel heard petitioner’s claim

over seven days and dismissed all his claims at the end of the

arbitration. Petitioner seeks to have the arbitral award

overturned because it is in manifest disregard of the law.

Wilko v. Swan, 346 U.S. 427, 436-437, 74 S.Ct. 182, 187

(1953) rev’d on other grounds Rodriguez de Quijas v.

Shearson/American Express Inc., 490 U.S. 477, 109 S.Ct.

1917 (1989); Carte Blanche (Singapore) Pte., Ltd. v. Carte

Blanche Int’l, Ltd., 888 F.2d 260, 265 (2d Cir. 1989).

Review of an arbitral decision for manifest disregard

of the law is “severely limited.” DiRussa v. Dean Witter

Reynolds Inc., 121 F.3d 818, 821 (2d Cir. 1997) (citations

omitted). To modify or vacate an award, a court must find

both that (1) the arbitrators knew of a governing legal

principle yet refused to apply it or ignored it altogether, and

(2) the law ignored by the arbitrators was well defined,

explicit and clearly applicable to the case. Id. (citations and

quotations omitted). A court may also modify or vacate an

award if there is “strong evidence” contrary to the findings of

the panel and the panel has not provided an explanation of its

decision. Halligan v. Piper Jafray Inc., 148 F.3d 197, 204

(2d Cir. 1998).

l6a

District Court Memorandum Opinion & Order - 8/23/99

Petitioner first claims that the arbitrators incorrectly

denied his claims that Bear Stearns knew, as a matter of fact

and law, of the premature sale of restricted ML Direct

securities. The panel heard testimony from the three Bear

Stearns employees who possessed sections of the ML Direct

prospectus prior to the sales in question. Each testified that

they did not know that certain ML Direct shares were subject

to a lock-up provision. The arbitrators credited the testimony

of these employees and rejected Greenberg’s contention that

Bear Stearns knew but ignored the premature sale of restricted

securities. The Court will not second-guess the credibility

findings of the arbitral panel and will not disturb the panel’s

findings that Bear Stearns lacked knowledge of Sterling

Foster’s fraud scheme.

Petitioner’s legal argument rests upon cases that

impose a “duty to read” upon parties to a contract. Dodds v.

Cigna Securities, 12 F.3d 346, 351 (2d. Cir. 1993); see Wood

v. Carpenter, 101 U.S. 135, 143 (1879) (“The means of

knowledge are the same thing as knowledge itself.”). While

it is true that in some circumstances the law will preclude a

party from asserting that he was unaware of the terms of a

contract he signed or a document he read, there is no general

rule that one who may once have had possession of a

document can not thereafter deny knowledge of something

contained therein. The concept of imputed knowledge seeking

to avoid the obligation of a contract by denying knowledge of

its terms at the time it was signed, or situations where a party

asserting a claim of fraud denies knowledge facts set forth in

a document that he was given to review in the course of the

transaction at issue. The “duty to read” cases did not require

the arbitrators to find that the parties engaged in fraudulent

conduct by applying an irrebuttable presumption that a party

17a

District Court Memorandum Opinion & Order - 8/23/99

must have known a fact contained in a document he once

possessed. Accordingly, the proposition that Bear Stearns

knew, as a matter of law, that Sterling Foster was engaged in

fraud is not a governing legal principle that the panel failed to

apply. Halligan, 148 F.3d at 202.

Petitioner’s second contention is that Bear Stearns

participated in the Sterling Foster fraud scheme through its

underwriting work. Petitioner submitted the following

evidence to support his claim of collusion between Bear

Stearns and Sterling Foster: Richard Harriton, a high ranking

Bear Stearns official, personally granted Sterling Foster

permission to clear its sales of ML Direct securities through

Bear Stearns; Harriton required Sterling Foster to deposit $3

million with Bear Stearns to cover its trades and required

Sterling Foster’s chairman Adam Lieberman to assume

personal liability for any money owed Bear Stearns as a result

of clearing activities; Bear Stearns employees expressed

concern amongst themselves regarding their credit exposure

in clearing ML Direct shares and Bear Stearns made a profit

on clearing the trades.

The arbitrator’s decision that this evidence is

insufficient to establish Bear Stearns’ complicity in the

Sterling Foster scheme does not reflect a manifest disregard

of the evidence or the law.

First, clearing brokers do not owe a separate duty to

the customers of an introducing broker. Edwards and Hanly

v. Wells Fargo Securities, 602 F.2d 478, 484 (2d Cir. 1979);

Dillon v. Militano, 731 F.Supp. 634, 636 (S.D.N.Y. 1990).

Petitioner’s recourse for Sterling Foster’s fraud lies with

Sterling Foster, not the clearing house.

18a

District Court Memorandum Opinion & Order - 8/23/99

Second, the arbitrators heard evidence that the conduct

complained of is within the normal course of business for a

clearing house when clearing transactions for an underwriting |

introducing broker. The evidence presented to the arbitrators

is not so biased as to allow the Court to vacate the arbitrator’s

Own assessment of this evidence.

Lastly, the conduct described to the arbitrators was not

fraudulent. See Ross v. Bolton, 1989 WL 80428 aff'd 904

F.2d 819, 824 (2d Cir. 1990).

Petitioner also asserted to the panel that Bear Stearns

knowingly participated in Sterling Foster’s breach of fiduciary

duties in violation of New York law. See S & K Sales v.

Nike Inc., 816 F.2d 843, 847-848 (2d Cir. 1987). As

discussed above, the panel apparently declined to credit

petitioner’s contention that Bear Stearns knew of the Sterling

Foster fraud. The panel’s obvious conclusion that Bear

Stearns employees did not have scienter as to the 10(b) claims

also negates petitioner’s state law claim of knowing collusion.

Petitioner also complains that the arbitrators neglected

the law and evidence regarding Bear Stearns’s obligation to

send prospectuses in accordance with Rule 174 of the

Securities Act of 1933. Petitioner cannot contest that 17

C.F.R. § 230.174 imposes upon a dealer or underwriter the

obligation to send a prospectus under certain circumstances.

Bear Stearns is not liable for any failure to send a prospectus

to petitioner absent evidence -that Bear Stearns assumed

responsibility for this underwriting function. The arbitrators

reviewed the agreement between Bear Stearns and Sterling

Foster and found insufficient evidence to impose this

obligation upon Bear Stearns. Petitioner has failed to

19a

District Court Memorandum Opinion & Order - 8/23/99

establish that this decision was in violation of law or against

the weight of the evidence presented to the panel. Rather,

petitioner asks the Court to review the panel’s legal findings

de novo and to substitute its interpretation of the evidence for

that of the panel. Such review, however, would be beyond

the scope of review of an arbitral decision.

Lastly, petitioner objects to the panel’s finding that the

legend Bear Stearns printed on trade confirmation tickets was

neither false, misleading nor in violation of SEC Rule 10b-10.

see 17 C.F.R. § 240.10b-10(a) (2).

The trade confirmation tickets petitioner received

stated “Your broker makes a [market] in this security, and

acted as principal.” See Pet. Exh. L. Petitioner first claims

that the legend is misleading because it implies that he

purchased ML Direct securities in a market transaction and

not from an underwriter. While this may be a reasonable

inference, the panel apparently decided that the legend was

not misleading because it was true. The fact that an

introducing broker makes a market in a given security does

not lead to the sole conclusion that every transaction with that

broker is a market transaction.

Petitioner's second point concerning trade

confirmations concerns the 400% profit Sterling Foster made

on fraudulent sales of ML Direct stock. Petitioner relies on

S.E.C. v. First Jersey Securities, 101 F.3d 1450, 1472 (2d

Cir. 1996) to suggest that Bear Stearns owed him a duty to

inform him of Sterling Foster’s outrageous profit. This

argument is without merit because the defendant in First

Jersey was a broker-dealer that manipulated customers by

misleading its own sales force. The legal duty of a broker-

20a

District Court Memorandum Opinion & Order - 8/23/99

dealer to notify purchasers of its own self dealing cannot be

imposed upon Bear Stearns, a clearing broker that the panel

found was unaware of Sterling Foster’s fraud.

For the foregoing reasons the petition to overturn the |

arbitral award is denied. The Clerk of Court is instructed to

close this case.

SO ORDERED.

Dated: New York, New York

August 23, 1999

/s/

JOHN S. MARTIN, JR., U.S.D.J.

2la