Claiming bias, subprime exec appeals arbitration

The chief executive of a subprime lender who lost a $65 million lawsuit against Merrill Lynch & Co. Inc. is demanding another bite at the apple. Steven Holder, the chief executive of ECC Capital Corp. of Irvine, Calif., sued New York-based Merrill in January 2007, claiming that the firm repeatedly told him that it could hedge his $100 million ECC stock position. Instead, because of an alleged series of missteps at the firm, hedging strategies were never implemented and he claimed that he lost $65 million on his ECC holdings as a result. Documents produced in court by Mr. Holder show that at least one of his Merrill brokers, Mark Sear, a high-net-worth broker based in Los Angeles, was frustrated that the firm couldn't get the hedges accomplished. In a May 2006 e-mail, Mr. Sear wrote that ECC was too illiquid and too low in price to hedge with traditional vehicles such as collars or exchange funds. At Mr. Holder's suggestion, the firm then looked at shorting a basket of mortgage-backed securities through a credit default swap. Merrill's swaps desk put together a structure for him, but after several false starts and refusals, the firm ultimately wouldn't approve him for the swap. In May of this year, Mr. Sear, who reportedly manages some $7 billion in assets, left Merrill to set up his own advisory firm (InvestmentNews, June 16). In June, after 17 days of hearings, an arbitration panel of the Financial Industry Regulatory Authority Inc. of New York and Washington rejected all Mr. Holder's claims without explanation and ordered him to pay half the $43,000 in forum fees. He thinks that he was denied justice, and last month asked a federal court in California to vacate the arbitration finding. The arbitrators' decision was "completely irrational" and the result of "evident partiality" of the panel against Mr. Holder, one of his lawyers, Theodore Cohen, a partner at Spolin Silverman & Cohen LLP in Santa Monica, Calif., said in a court filing. "Finra is traditionally an unfavorable forum" for plaintiffs, Mr. Cohen said in an interview. But overturning an arbitration award is no easy feat. "Courts give arbitrators great deference," said Theodore Eppenstein, senior partner at Eppenstein & Eppenstein in New York, which represents investors. An appellant has to show arbitrator misconduct or a failure to follow the law or disclose significant conflicts, he said. A hearing should be held in the next few weeks on Mr. Holder's motion to overturn the decision, Mr. Cohen said. How quickly judges rule on such appeals depends on the facts of the case, Mr. Eppenstein said. Despite the long odds, Mr. Cohen thinks his client has a shot. Mr. Holder cites a laundry list of alleged misdeeds by the arbitrators who heard the case. He claims that the industry arbitrator on the three-person panel was biased, and may have improperly deliberated with a public panelist without the chairman present, before the case was decided. After they lost the arbitration, Mr. Holder's lawyers had all the panelists investigated. In a court filing, Mr. Cohen claimed that the industry arbitrator, James Duncan, a lawyer in Montrose, Calif., who is also registered as a broker with Finance 500 Inc. of Irvine, Calif., asked biased questions and was afraid to punish Merrill for fear of being blacklisted from future cases. Mr. Duncan didn't return calls seeking comment. For its part, Merrill disputes the allegations raised in the appeal. "We said when it was filed that the underlying case was frivolous and filed in bad faith and now that the claimant has lost, he's resorted to an appeal that is equally without merit," Merrill spokesman Mark Herr wrote in an e-mail.

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Merrill marketed itself as an expert in handling concentrated stock positions and led Mr. Holder to believe that the firm could complete the credit default swap, Mr. Cohen said. "Merrill Lynch had a duty to ... make a clear communication to the client" as to whether they could do the swap, he added. "Merrill certainly can handle" stock hedges, said Robert Gordon, chief executive at Twenty-First Securities Corp. in New York, which uses hedging strategies for high-net-worth clients. But smaller stocks such as ECC, which raised $354 million in its 2005 initial public offering, are difficult to short, he said. "There's no question that Merrill knows how to do these things," Mr. Cohen said. "They just didn't bring those skills to bear." Mr. Holder was apparently bearish on real estate at the time: He shorted homebuilding stocks as well as Google Inc. of Mountain View, Calif., in 2004 and 2005 through Merrill — and lost $8.5 million doing it. Those losses weren't part of his claim. ECC has since been restructured into a mortgage finance real estate investment trust. Mr. Holder continues to run the company, which is being liquidated. E-mail Dan Jamieson at djamieson@investmentnews.com.