Ratcheting up the drama surrounding a $9.2 million arbitration award levied against Morgan Keegan & Co. Inc. for securities fraud, an expert witness for the plaintiffs has moved to expunge all references to him in an opinion issued by a federal court that vacated the award, and laid waste to the expert’s reputation in the process.
The expert, Dr. Craig McCann, took the unusual step so he could present evidence that countermands assertions in court’s opinion that he knowingly provided false testimony during the arbitration hearing.
Dr. McCann’s asserts in his Oct. 28 motion that the references in the opinion to his testimony are 1) unnecessary to the court’s decision; 2) unsupported by the record in the case; and 3) legally insufficient under the Federal Arbitration Act.
Withdrawal & Expungement of All References to Dr. McCann
The motion is seeking the withdrawal and expungement of all references to Dr. McCann and his testimony, as well as a statement that the references to Dr. McCann in the court’s prior opinion will have no further force or effect.
FINRA Issued $9.2 Million Award
An arbitration panel of the Financial Industry Regulatory Authority, or FINRA, issued the $9.2 million award to the plaintiffs in October 2010 for fraud in the sale of bond funds. John J. Garrett and seventeen others said that Morgan Keegan had misled them to invest in the funds. The award included compensatory damages, costs, and attorney fees.
The case involves shares of funds issued by Morgan Keegan between 1999 and 2008. The funds invested in both high- and low-risk bonds and mortgages, according to the court’s opinion.
When the housing market collapsed in 2007, the funds lost a lot of value. The manager allocated more capital to risky instruments betting that housing would recover. When it did not, the funds lost more.
Later in 2007, Morgan Keegan did not have the earnings to pay dividends at the expected rate, so it liquidated some positions, paid the dividends and encouraged the claimants to reinvest them, the opinion said.
In 2008, the funds’ assets were sold. Hyperion, the purchaser, said the assets were overvalued and that the dividend payments were unsustainable. The Garrett investors filed their arbitration claims a year later. The hearing started in August 2010, and FINRA issued the award in October of that year.
Morgan Keegan then moved in U.S. District Court for the Southern District of Texas to vacate the award. The Garrett investors opposed the motion to no avail.
After the court vacated the award in late September, Morgan Keegan filed a motion for an award of attorney fees and expenses of close to $200,000 and the Garrett investors appealed the to the 5thU.S. Circuit Court of Appeals.
The vacatur opinion from the district court in Texas stated that the arbitrators did not have power to hear the claims because they were derivative.
A claim is derivative if the plaintiff’s injury is the same as the company’s injury. The opinion said the plaintiffs’ real complaint was that they did not like the internal pricing of the funds, and that Morgan Keegan’s mismanagement caused the funds to lose value.
The Garrett Investors Sue
The Garrett investors sued because they lost money, the opinion said, calling this a “textbook derivative claim,” and as such, outside of the scope of the arbitrators’ power.
The Federal Arbitration Act, or FAA, permits an award to be vacated if the arbitrators exceeded their power, were obviously partial, prejudiced the rights of a party, or based the award on fraud.
In addition to acting beyond the scope of its power, the court said the arbitration panel’s ward should be vacated it was based on the knowingly false testimony of Dr. McCann, who often serves as an expert witness in securities cases. Dr. McCann holds a master’s degree and Ph.D. in economics from University of California Los Angeles, and was employed twice at the Securities and Exchange Commission, among other credentials.
McCann Testimony Causes Inacurate Damages Calculations
The damages calculations were inaccurate because of the testimony, the court said. The opinion labeled the testimony as fraud and stated that Morgan Keegan could not have discovered this fraud before the hearing.
Dr. McCann’s testimony about the internal pricing of the funds, and the fact that this pricing caused the funds to lose more money than that of comparable funds that were priced differently, was the key to the plaintiffs’ success, the opinion said.
McCann’s Motion to Expunge
In his motion to expunge, Dr. McCann first makes the argument that the court’s alternative ruling regarding his testimony was dictum and not necessary to its decision.
The motion points out that the opinion said the arbitration panel did not have the authority to hear the Garrett investors’ derivative claims, and the court had no need to make any alternative finding.
It was therefore irrelevant, unnecessary and inappropriate, the motion says, for the court to state that “even if the panel had power to hear the claims, the award would still have been vacated because it was based on fraudulent testimony.”
Morever, Dr. McCann’s motion contends that the court’s statement that his testimony was fraudulent is not supported by the record and legally insufficient under the FAA.
The standard for fraud under the FAA is high. To allege that an award was procured through fraud, a party must demonstrate that the improper behavior was 1) not discoverable by due diligence before or during the arbitration hearing; 2) materially related to an issue in the arbitration; and 3) established by clear and convincing evidence, the motion says.
Court Concludes False Testimony
The court concluded that Dr. McCann gave knew his testimony was false at the Garrett hearing based on a misunderstanding of the record, the motion says. The court’s opinion stated that, “Dr. McCann admitted in other testimony months after the hearing that he knew at the Morgan Keegan hearing that his testimony was false.”
The excerpt is a reference to Dr. McCann’s testimony in what is identified as the Arispe case in the motion. In a hearing in that case less than two months after the hearing in Garrett, Dr. McCann said he had revised his calculations on the percentages of losses in the funds due to internally priced securities.
However, according to the motion to expunge, the record shows that Dr. McCann said in that hearing that he revised his calculations after the Garrett hearing, not before.
Not only is there no clear and convincing evidence that Dr. McCann knew his testimony was false during the Garrett hearing, his testimony in the Arispe hearing shows just the opposite, the motions says.
The motion reproduced part of the transcript of the Arispe hearing to support its contention that the revision of Dr. McCann’s calculations on the percentages of losses in the funds due to internally priced securities was the result of an honest mistake, not fraud.
In addition, the motion contends that Morgan Keegan could have discovered Dr. McCann’s mistake with the application of ordinary due diligence as it prepared its defense for the arbitration hearing. To make out a claim of fraud, a behavior has to be beyond the reach of due diligence, per the FAA.
Finally, Dr. McCann corrected the mistake without prompting and reported the mistake to Morgan Keegan in September 2010, after the Garrett hearing but before the arbitration panel made its award in October, the motion says.
Morgan Keegan knew that Dr. McCann had changed his report between the Garrett and Arispe hearings, the motion says, because the fact is stated in Morgan Keegan’s own reply brief in the Arispe case.
According to Dr. McCann’s motion, this confirms the absence of any nexus between Dr. McCann’s erroneous testimony at the Garrett hearing and the arbitration award. If the errors were material to the award as is required by the FAA test for fraud, the motion says, surely Morgan Keegan would have brought them to the attention of the Garrett arbitration panel while there was still time.
In its conclusion, the motion states that the court should withdraw all the findings in its opinion regarding Dr. McCann’s testimony, and affirmatively note that the findings “shall have no further force or effect, and provide such other and further relief as would help restore Dr. McCann’s reputation.”
Guiliano Law Group
Nicholas J. Guiliano has over twenty years experience representing investors before the Financial Industry Regulatory Authority, the New York Stock Exchange and before the National Association of Securities Dealers, Office of Dispute Resolution. Over the last twenty years, he has represented more than a thousand investors from all across the United States and from several foreign countries, in claims against stockbroker and broker-dealers for fraud, breach of fiduciary duty, churning or excessive trading, the sale of unsuitable investments, the sale of defective investments, the sale of unregistered securities, and the failure to supervise. He is frequently quoted in the national media on securities and investment related issues, most recently on National Public Radio. He offers his services on purely a contingent fee basis, and is also a member of Public Investors Arbitration Bar Association.
For more information concerning common claims against stockbrokers and investment professionals, please visit us at securitiesarbitrations.com