By Don Philbin In this week’s The New Yorker, one of my favorite writers explores how “optimistic overconfidence” contributed to the quick downfall of the mighty Bear Stearns. Malcolm Gladwell, author of Blink, The Tipping Point, and Outliers, chronicles the meteoric rise of Jimmy Cayne, copier salesman turned professional bridge player turned investment banker, to the top of Bear Stearns. A student of history, Gladwell uses the British-led invasion of Gallipoli, Turkey to develop his premise – “as we grow older and more experienced, we overrate the accuracy of our judgments.” Despite a 10:1 troop advantage over the Turks for two days after an amphibious landing en route to Russia, British troops used that window to bath by the hundreds in the bright blue bay while their commander lounged offshore aboard a command ship. Ultimately, the Turks massed their troops and the battle was a spectacular defeat for the British, with high casualties on both sides. This “placid, prudent, elderly English gentleman” commander had undertaken a large-scale landing without a formal plan of operations, with half the recommended number of troops, and without howitzers, trench mortars, or grenades. The British had little experience with amphibious landings, yet this commander was willing to “wing it” based on his other experiences.Those other experiences ultimately did not help him adapt to the new terrain. Back in New York, Gladwell caricatures Cayne as a bluffer’s bluffer. Professional bridge led him to his second wife and to an interview with a high-placed executive at Bear Stearns. During the interview, bridge came up and Cayne was cocksure of his ability. Since bridge and the business of Wall Street are contests between teams, each of which competes over a “contract,” the Bear executive brought Cayne on. Since Cayne was a bridge master, he surmised that he would be proficient in banking too. Like the British commander, he was a good bluffer until the tide went out and he could not adapt to the new terrain. Bear Stearns was riding high in 2003 as other banks suffered that recession and Cayne rhetorically ask a Times reporter, “so you have to ask yourself, What can we do better? And I just can’t decide what that might be.” His (over)confidence continued to the end – Cayne played an inordinate amount of golf in Bear’s final months. Gladwell uses these examples to highlight what psychologists have been teaching us about optimistic overconfidence for years. Investment banking, like law to a certain extent, is a confidence game. The best bluffer is not the one who pretends she is stronger than she really is; it’s the one who actually believes herself to be stronger than she really is. The players who actually believe it are not as likely to give up subtle messages undercutting their perceived confidence. In the end, Bear Stearns failed because its transaction counterparties no longer believed its bluff. In litigation, forests are laid bare discovering ways to undercut overconfident assessments. But, as I wrote in The One Minute Manager Prepares for Mediation: A Multidisciplinary Approach to Negotiation Preparation, published at 13 Harvard Negotiation Law Review 249 (2008), we are all overconfident to different degrees – it’s the Lake Wobegon effect. In experiments, subjects take a less aggressive bargaining position with “dapper” dressers, think they can control computer-simulated stock markets that simply follow a program, discount small probabilities, assume luck runs in their favor, and distort unattractive consequences. Over 80% of interviewed entrepreneurs described their chances of success as 70% or better, and 33% described them as “certain.” That compares with a five-year survival rate for new firms around 33%. Couples about to be married estimated their chances of later divorcing at zero, even though most know that the divorce rate is between 40% and 50%. Negotiators in final arbitrations overestimated the chance that their offer would be chosen by 15%. Surveys find the Lake Wobegon above-average effect across demographics – college professors, high school students, truck and taxi drivers, and even negotiators. Although most negotiators believe that they are more “fair” than average; in specific mediations they tend to overestimate their trial alternatives. Advocates naturally focus attention on case assets while under-appreciating weaker issues. Myopically focusing on the strengths of a case blurs our focus on less favorable points. Focusing tightly on the merits of the case also increases the risk of undervaluing the transaction costs associated with continuing to trial. If we are all imbibed with varying degrees of confidence and that confidence opens a spread between the bid and ask prices of homes, cars, and lawsuits, how can we systemically account for that bias and other psychological barriers to efficient deals? Third-parties inject a different dimension. We take more aggressive bargaining positions with those we dislike or oppose us. In fact, a Cold War experiment quantified the magnitude of the reactive devaluation bias we have to an opponent’s offer. Soviet leader Gorbachev made a proposal to reduce nuclear warheads by one-half, followed by further reductions over time. Researchers attributed the proposal to President Reagan, a group of unknown strategists, and to Gorbachev himself. The surprise was not that the group reacted differently to the same proposal depending on its source, but the wide range of difference. When attributed to the U.S. President, 90% reacted favorably. That dropped only marginally when attributed to the third-party (80%), but in half (44%) when attributed to the Soviet leader. Mediation systemically reduces optimistic overconfidence and reactive devaluation. After a cathartic telling of their story, parties often move to a hard-headed look at whether their alternatives to a negotiated deal realistically best the offer on the table.The trick is to develop those future scenarios iteratively, without losing the party acclimating to a different altitude.“What if” questioning and graphical representations of various alternatives move parties from an emotional look-back at historical events to a problem-solving look at future options. The other side may really be Darth Vader. But the question is, how does that fact change future options? Mediators can build on the […]

Last week, the Global Arbitration Review published an interesting article about a recent case, ReliaStar Life Ins. Co, of N.Y. v. EMC Nat’l Life Co., No. 07-0828 (2nd Cir. Apr. 9, 2009). As previously blogged here, in ReliaStar, the Second Circuit held that inclusion in an arbitration agreement of a broad statement that each party will bear the expenses of its own arbitrator and attorney’s fees, does not deprive the arbitration panel of authority to award those expenses as a sanction against a party whom the panel determines failed to arbitrate in “good faith.” The court explained that an arbitrators’ finding of “bad faith” gives rise to an exception to the general rule that each party bears their own expenses. Thus, the arbitration panel did not exceed its authority in awarding attorney’s and arbitrator’s fees. The article quotes attorney Philip J. Loree, Jr., co-founder of our LinkedIn Commercial and Industry Arbitration and Mediation Group and contributor to this blog: Writing shortly after the appeal court’s decision, Philip Loree Jr of New York firm Loree & Loree, said the court had “violated New York contract interpretation rules.” He said that, according to New York law, “to ascertain whether a contract is ambiguous, courts are required to focus on what is said, not what is omitted.” “Given that the pre-eminent purpose of the Federal Arbitration Act is to enforce the parties’ arbitration agreement as written, this case may be one of those rare Second Circuit decisions that warrant rehearing and reversal en banc,” he added. Find the article (subscription only) here: ‘Bad Faith’ Costs Decision Upheld, Global Arbitration Review, July 13, 2009. Also, read Phillip J. Loree, Jr. summary here, critique here, and recent mention of the case here. Technorati Tags: arbitration, ADR, law, Second Circuit, attorney’s fees, arbitrator’s fees, ReliaStar

The Supreme Court of Texas held that a court abused its discretion by permitting discovery instead of deciding a motion to compel arbitration. In re Houston Pipe Line Co., __S.W.3d __ (Texas 2009) (No. 08-0800) involves a gas purchase agreement between Houston Pipe Line Company, L.P. and O’Connor & Hewitt, Ltd. The agreement was based on the Houston Ship Channel Price Index (the “Index”) and contained the following arbitration clause: Except for matters within the jurisdiction of the Railroad Commission of Texas, any and all claims, demands, causes of action, disputes, controversies, and other matters in question arising out of or relating to this Agreement, any of its provisions, or the relationship between the Parties created by this Agreement . . . shall be resolved by binding arbitration pursuant to the Federal Arbitration Act. . . .If a Party refuses to . . . arbitrate, the other Party may seek to compel arbitration in either federal or state court. . . .The final hearing shall be conducted within 60 days of the selection of the third arbitrator. . . [and] shall not exceed 10 business days. A few years later, O’Connor sued Houston Pipe Line claiming manipulation of the Index, which, according to O’Connor, caused the company to receive lower payments for the gas purchased under the contract. Houston Pipe Line moved to compel arbitration. O’Connor challenged the motion arguing that “it would be impossible to identify all potential defendants and to complete damages calculations within the sixty days allotted for discovery as set out in the arbitration provision.” Instead of ruling on the motion, the trial court ordered discovery to determine: (1) if additional defendants could invoke the arbitration clause, (2) whether the claims fell within the scope of the arbitration clause, and (3) if the discovered time limits on the agreement where jurisdictional. Houston Pipe Line appealed and the Court of Appeals refused to issue writ. The Texas Supreme Court now decides whether the trial court abused its discretion by permitting discovery on damage calculations and other potential defendants, instead of ruling on the motion to compel arbitration. Citing Buckeye Check Cashing, Inc. v. Cardegna, 546 U.S. 440 (2006), the court stated that “[w]hen a party disputes the scope of the arbitration provision or raises a defense to the provision, the trial court, not the arbitrator must decide the issues.” Pre-arbitration discovery is authorized under the Texas Arbitration Act, the court noted, when a court lacks sufficient information on the scope of the arbitration provision, and therefore, cannot make a decision on the motion to compel arbitration. However, the court concluded that this is not the case because determinations of liability must be answered by the arbitrator. The court pointed out that a party cannot avoid arbitration by merely alleging that there may be other potential defendants. Accordingly, the court directed the trial court to vacate the discovery order and rule on the motion to compel arbitration. Technorati Tags: arbitration, ADR, law

To follow up on our post of last week and as reported by the ADR Prof Blog and Professor Ross Runkel’s Law Memo Arbitration Blog, the National Arbitration Forum (“NAF”) announced that is settling its lawsuit with Minnesota’s Attorney General and agrees to step aside from the credit card and consumer debt arbitration business. Lory Swanson released this statement today: National Arbitration Forum Barred From Credit Card And Consumer Arbitrations Under Agreement With Attorney General Swanson: Swanson Also Wants Congress to Ban “Fine Print” Forced Arbitration Clauses. On a related note, the U.S. Congress hearing blogged here is scheduled for Wednesday, July 22. AG Lori Swanson and Michael Kelly, National Arbitration Forum COO are invited to testify at the hearing. Related Posts: Big Arbitration Firm Pulls Our of Credit Card Business, Business Week, July 19, 2009 An AG’s Quick Victory: Arbitration Forum Exits Credit Dispute Business, ABA Journal, July 20, 2009 In Settlement, Arbitration Company Agree to Largely Step Aside, Wall Street Journal, July 20, 2009.