Orrick Employment Law Ticker


November 2003

In keeping with our tradition of providing practical and results-oriented representation for our many clients in the financial services industry, we are pleased to present this issue of the Employment Law Ticker. This is the only publication dedicated to keeping in-house counsel and senior human resources executives informed on the most important developments and trends in employment law in this industry. If you would like your colleagues to be included on our electronic distribution list, have comments about the publication, would like a copy of a case profiled in an article, or would like us to address a specific topic in the future, please contact Ticker editors, Robert Whitman (212-506-5257) or Michael Delikat (212-506-5230).

In This Issue:


Disloyal Investment Banker Required to Forfeit Compensation

An investment banker whose actions demonstrated a pattern of disloyalty toward his employer must forfeit all compensation he earned during the period of disloyalty, according to a recent Second Circuit decision applying New York's longstanding but obscure "faithless servant" doctrine.

In a lengthy opinion describing a complex series of transactions, the court held that banker Rohit Phansalkar breached his duties of loyalty and good faith to Andersen Weinroth & Co. by failing to disclose remuneration he received from clients in the form of stock options and directorships. Phansalkar v. Andersen Weinroth & Co., 344 F.3d 184 (2d Cir. 2003).

Under the "faithless servant" doctrine, "[o]ne who owes a duty of fidelity to a principal and who is faithless in the performance of his services is generally disentitled to recover his compensation, whether commissions or salary." No specific intent to defraud is necessary, and it "does not make any difference that the services were beneficial to the principal, or that the principal suffered no provable damage as a result of the breach of fidelity by the agent. "

The key issue before the court was whether Phansalkar's disloyal actions required him to forfeit all compensation he earned during the period of disloyalty or only the compensation resulting from the disloyal acts themselves. The court held that the "faithless servant" doctrine required forfeiture of all compensation beginning October 1999, when Phansalkar received but did not report a grant of stock options from a client.

The court stated: "This forfeiture is required because there was no agreement for Phansalkar's compensation to be determined on a task-by-task basis for tasks he personally performed." Instead, his employment agreement "calls for general compensation, and does not limit compensation to specific amounts paid for the completion of specific tasks. "

Because Phansalkar is a federal court decision construing New York law, and in an area that the court acknowledged had little case law development and some ambiguity, is it possible that New York courts could reach a different result in subsequent cases. The decision also contains no discussion of the New York Labor Law and its well established rule against forfeitures of earned wages.

Orrick's Employment Law Department has particular expertise  on the issues in this case and has obtained several precedent-setting decisions in litigation involving non-compete, non-solicitation, and other post-employment restrictions. 

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Arbitration Panel Reinstates Record Punitive Damages Award

The NASD Arbitration Panel in Sawtelle v. Waddell & Reed has done what it was asked by a New York appellate court: reconsider the $25 million punitive damages award to former broker Stephen Sawtelle. Its decision: Sawtelle should still get the money.

According to a decision issued September 4, 2003, the Panel reinstated its original punitive damages award, believed to be the largest amount ever awarded in an NASD arbitration. The New York court vacated the award after holding that it was excessive in comparison to the amount of damages Sawtelle actually suffered, but remanded the issue to the original arbitration panel for reconsideration in light of the principles articulated by the court. Sawtelle v. Waddell & Reed, Inc., 304 A.D.2d 103, 754 N.Y.S.2d 264 (1st Dep't 2003).

Despite that explicit judicial guidance, the Panel found that Sawtelle should get the $25 million based on Waddell's "reprehensible conduct." It ruled that the firm "conducted a horrible campaign of deception, defamation and persecution" against Sawtelle, including rerouting client letters and phone calls and telling clients that Sawtelle was untrustworthy and may have been involved in criminal activities. The Panel made no explicit response to the court's concerns with the large award.

The Panel's decision will not be the last word in this long-running dispute. The decision is already back in front of the New York Supreme Court, and will undoubtedly return to the Appellate Division for review again. Sawtelle is represented by Jeff Liddle.

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Update on California Arbitrator Standards

SEC Approves Extension of Waiver Program

Effective September 30, 2003, the SEC approved extensions of the NASD and NYSE pilot programs requiring industry parties in arbitrations to waive the application of California arbitrator standards upon request of a customer or associated person. The programs are now extended through March 31, 2004.

The programs were initiated in response to amendments to the ethical standards for California arbitrators promulgated by the Judicial Council of California. The NASD and NYSE are united in their opposition to these standards, which require arbitrators to provide extensive disclosures concerning their financial and personal relationships. In response, the organizations commenced litigation against the California Judicial Council seeking an exemption from the standards. In order to allow arbitrations to proceed in California during the pendency of this litigation, however, the organizations instituted the waiver requirement pilot programs.

In addition to extending the application of the programs, the NASD has amended its program in several respects. For example, the NASD program was expanded to apply to all customer claims or claims brought by an associated person, as opposed to only employment discrimination claims. Additionally, the NASD clarified that the application of the waiver requirement is intended to include terminated members and associated persons.

Developments in the Courts

One California appellate court recently refused to compel arbitration where one party would not waive the California standards, unless an out-of-state hearing was appropriate under the agreement. In Alan v. Superior Court, 111 Cal. App. 4th 217 (2003), the court held that the forum-selection provision of the arbitration agreement, under which the parties agreed to arbitrate before the NASD, was an integral part of the agreement and must be enforced. Because the NASD refused to arbitrate in California without a waiver of the California standards, the court held that the agreement would fail, and the case should be tried in state court, unless the agreement allowed for an out-of-state arbitration proceeding. The court then remanded the issue of whether an out-of-state proceeding was appropriate. A petition for review of this case by the California Supreme Court has been filed.

A more recent California appellate decision, Rodriguez v. Morgan Stanley, 2003 WL 22089385 (Cal. Ct. App. Sept. 10, 2003), held that an arbitration agreement is not rendered unenforceable by the NASD and NYSE's refusal to require their arbitrators to comply with the California standards. The agreement at issue, the court said, was not facially illegal since the NASD and NYSE have promulgated rules to avoid conflict with the California standards (i.e., waiving the standards or hearing the dispute out of state). The fact that a contract has the effect of waiving a statutory protection, the court concluded, does not render that contract illegal.

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California Governor Vetoes Bill Precluding Compulsory Arbitration of FEHA Claims

In his last days in office, lame-duck Governor Gray Davis vetoed an arbitration bill, AB 1715, that was passed by the California legislature earlier this year. The bill would have invalidated agreements requiring employees to arbitrate claims relating to employment practices covered by the California's Fair Employment and Housing Act ("FEHA") as a condition of employment or continued employment. The bill would also have deemed any harassment, discharge or refusal to hire on the ground that an employee or potential employee refuses to sign an arbitration agreement to be an "unlawful employment practice."

Governor Davis vetoed a similar arbitration bill last year. Davis's stated reason for the current veto was that such a bill would harm businesses.

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Developments in the English Courts

Reflecting an increased litigiousness among employees in England, two tribunals have recently issued decisions in high-profile cases adverse to financial services firms.

Secretive Bonus Process

In Barton v. Investec Henderson Crosthwaite Securities Ltd., England's Employment Appeal Tribunal ruled that an investment bank's secretive and discretionary bonus practices, combined with an apparent disparity between the bonuses paid to the female claimant and her male counterparts, shifted the burden of proof to the bank to establish that the disparity was not the result of sex discrimination.

The claimant was a female research analyst with 23 years' experience. In the spring of 2001, she received a bonus of £300,000 in addition to her salary of £150,000. She challenged the disparity between her bonus compensation and that received by two similarly situated males, one who received a bonus of £1 million and one whose bonus was £600,000. In defense of the bonus differentials, the bank claimed that she generated only £3.2 million in revenue, compared to £5.3 million and £10 million for the males.

Testimony indicated that the bank's Chairman was "very much the key figure in the setting of salaries and other benefits and bonuses." The bank did not produce any documents relating to its bonus-determination process, and there were indications it had failed to comply with its discovery obligations.
A London Employment Tribunal deciding the case observed that bonus-setting at the bank was "a rough and ready process, not a precise science" and not "a paper based exercise." It also detected an "underlying philosophy of avoiding precision and written material to prevent giving individuals the material on which they could challenge their bonuses." It nonetheless held in September 2002 that the differences in the bonuses identified by the claimant were not based on sex.

The Employment Appeal Tribunal reversed. While much of its decision consists of a detailed discussion of the statutory scheme governing claims of sex discrimination, the Tribunal also made clear its disdain for the secretive bonus-setting process employed at the bank:

This Court would certainly wish to make it clear that no Tribunal should be seen to condone a City bonus culture involving secrecy and/or lack of transparency because of the potentially large amounts involved, as a reason for avoiding equal pay obligations.

It therefore held that the lower tribunal "could, and indeed should," have drawn inferences against the bank, and that "the burden of proof was placed upon the Respondents to prove that sex was not a reason for the less favourable treatment in relation to the bonus setting."

Abusive Work Environment

The court in the closely watched case of Horkulak v. Cantor Fitzgerald International awarded £912,000 in damages to a former executive of Cantor Fitzgerald who alleged constructive discharge based on a pattern of abusive treatment by his boss.

Steven Horkulak was a broker in interest rate derivatives who later moved into managerial roles. He alleged that he was forced to resign by the treatment he received from Lee Amaitis, President and CEO of Cantor Fitzgerald International Group. In its defense, the firm admitted that Amaitis raised his voice and used words that "might be regarded as extreme in polite conversation," but said that such words "were common currency" between him and Horkulak. It also argued that, while Amaitis occasionally banged his desk, he did so in a non-violent and non-threatening manner.

In ruling in Horkulak's favor, the court recognized the stressful working environment at the firm:

Brokers have to negotiate deals over the telephone in the space of a few minutes. They deal in very large sums of money. If deals go wrong the financial consequences can be severe. It is a tough market place where quick thinking, firm determination and risk taking are essential attributes for a successful career. Employees are regarded as "producers," but the only product is money.

Nonetheless, it stated that the law "recognise[s] an employment contract as engaging obligations in connection with the self esteem and dignity of the employee" and noted the "obvious tension" between that principle "and the currency of the language in evidence in this case."

The court found that Amaitis's language consisted of "foul and abusive expressions and swear words." It then concluded that Amaitis "is a dictatorial manager and executive" who "issues staccato instructions, raises his voice, shouts, expects instant responses and is quick to criticise where he perceives failings or faults. He regularly employs strong, foul language and swear words and expressions containing expletives."

Such conduct, the court said, "breached the implied term of trust and confidence in the claimant's contract of employment." Amaitis "displayed neither balance not fairness in the criticisms he levelled at the claimant," and the frequency of the abuse "did not santitise its effect."

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Ninth Circuit Scraps Duffield

The full Ninth Circuit has expressly overruled Duffield v. Robertson Stephens & Co., 144 F.3d 1182 (9th Cir. 1998), and held that employers may require employees to arbitrate Title VII claims as a condition of employment. The decision, EEOC v. Luce, Forward, Hamilton & Scripps, 345 F.3d 742 (9th Cir. 2003) (en banc), puts the Ninth Circuit in line with every other federal appellate court that has addressed the issue.

In the original Luce, Forward decision, 303 F.3d 994 (9th Cir. 2002), a three-judge panel held that Duffield, which precluded mandatory arbitration of Title VII claims, had been implicitly overruled by the Supreme Court's decision in Circuit City Stores v. Adams, 532 U.S. 105 (2001). Although none of the parties requested en banc review, the full Ninth Circuit, at the request of a group of Members of Congress opposed to mandatory arbitration of employment claims, withdrew the panel's decision and ordered the case reheard. 319 F.3d 1091 (9th Cir. 2003).

Examining the Civil Rights Act of 1991, the court concluded that Duffield erred in interpreting the Act to preclude mandatory arbitration of Title VII claims. The court noted that the text of the Act encourages arbitration and contains no express prohibitory language. The court also declined to give weight to the Act's legislative history, noting that the pertinent provisions of the statute were "clear and unambiguous."

The court did leave one key issue unresolved. The EEOC contended that Luce, Forward engaged in unlawful retaliation when it withdrew a job offer based on the prospective employee's refusal to sign its pre-dispute arbitration agreement. Although the panel decision rejected that argument, the en banc court remanded the issue to the district court for further consideration. Nonetheless, the court strongly suggested its disagreement with the EEOC's position, stating: "[I]t would appear that, if an employer can compel its employees to submit all claims arising out of their employment to arbitration, no retaliation would be involved in an employer's exercise of such right, because an employee opposing such a practice would not be engaged in any protected activity."

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FLSA "Collective Action" Subject to NASD Arbitration

A Florida federal court has ruled that a "collective action" for unpaid overtime compensation under the Fair Labor Standards Act ("FLSA") is subject to mandatory arbitration, notwithstanding NYSE, NASD, and AMEX rules prohibiting the arbitration of class actions.

In Chapman v. Lehman Brothers, Inc., 2003 WL 22053459 (S.D. Fla. Aug. 26, 2003), Judge K. Michael Moore held that the rules promulgated by Self-Regulatory Organizations prohibiting the arbitration of class actions do not apply to FLSA collective actions, given the distinct differences between the two procedures. Federal Rule of Civil Procedure 23 does not apply to "collective actions" under Section 16(b) of the FLSA.

Before commencing employment with Lehman Brothers, the plaintiff in Chapman signed both a form U-4 and an employment application in which she agreed to arbitrate any disputes arising out of her employment. She later sued under the FLSA for the alleged failure to pay overtime to sales assistants, wire operators, cashiers and other clerical staff. Lehman Brothers moved to compel arbitration. In response, the plaintiff argued that arbitration could not be compelled because the arbitration rules of the NASD, NYSE, and AMEX prohibited the arbitration of class actions.

Judge Moore disagreed. He held that the SROs' rules did not encompass collective actions. In particular, he noted that class actions automatically include as plaintiffs all persons within the description of the class, while plaintiffs in collective actions must "opt into" the class. Judge Moore also noted that the SROs had frequently amended their arbitration rules to specify the types of claims subject (and not subject) to arbitration, but had nowhere mentioned collective actions under Rule 16(b). Given these facts and the strong federal policy in favor of arbitration, the court held that the rules precluding arbitration of class actions should be narrowly construed and did not encompass collective actions.

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© 2003, Orrick, Herrington & Sutcliffe LLP

The Employment Law Ticker is distributed periodically without charge to labor and employment professionals. The Ticker reports on significant developments in labor and employment law affecting the financial services industry. For more information on this and other employment law subjects, visit out Web site at www.orrick.com

The contents of this publication are for informational purposes only and are not meant and should not be construed to be legal advice. No responsibility is assumed for errors made in the publishing process.

For more information about any information contained herein, please contact:

Mike Delikat (mdelikat@orrick.com) in New York at 212-506-5230

Rob Whitman (rwhitman@orrick.com) in New York at 212-506-5257