Court overturns $5 million ruling against Morgan Stanley Tue Sep 18, 2012 5:11pm EDT (Reuters) - A California court overturned a nearly $5 million securities arbitration ruling against Morgan Stanley Smith Barney in a case filed by two brokers who said the company broke promises it made when recruiting them. Judge Lisa Schall of the Superior Court of California in San Diego agreed with Morgan Stanley Smith Barney's arguments that one of three securities arbitrators who heard the case did not disclose ties between some of his family members and the securities industry. Securities industry arbitration rules required the arbitrator to disclose those details, Schall ruled. Among the details that were omitted: The arbitrator's daughter had previously worked in the brokerage industry and also has an account at Morgan Stanley Smith Barney, according to the four-page decision on Monday. Lawyers for Morgan Stanley Smith Barney also argued that the arbitrator's son-in-law was previously his partner at another brokerage firm and was "recruited away" to Morgan Stanley Smith Barney by the same managers involved in the dispute, according to court papers. Morgan Stanley Smith Barney, a unit of Morgan Stanley (MS.N), was formed after the merger of Morgan Stanley's wealth unit and Citigroup Inc's (C.N) Smith Barney. The case is a rare instance of a court overturning, or vacating, an arbitration ruling, according to Jonathan Uretsky, a New York-based securities arbitration lawyer. But that rarely happens, "except in the most egregious of circumstances," Uretsky said. A Financial Industry Regulatory Authority (FINRA) arbitration panel ruled in June that Morgan Stanley Smith Barney must pay $5 million to brokers John Paladino and Todd Vitale, who are still with the firm, for making false promises when recruiting them from rival brokerage UBS (UBSN.VX) (UBS.N). "We are extremely pleased with the court ruling that validates the facts in this matter," said a Morgan Stanley Smith Barney spokeswoman. Lawyers for Paladino and Vitale could not be reached for comment. Disclosure rules for arbitrators help to ensure a fair and impartial hearing for parties. Lawyers for each party typically use the information to help research the backgrounds of arbitrators and decide whether to object to their participation in the case, say lawyers. Morgan Stanley Smith Barney filed its court case against Vitale and Paladino shortly after the FINRA arbitration ruling in June, alleging that Barry Kersh, one of three arbitrators on the panel, did not disclose key details about the links between some of his family members and the brokerage industry, according to court documents the brokerage filed in the case. Those details included that Kersh, who is also a broker for Southwest Securities Inc in San Diego, is the father-in-law of Matthew Childs, a financial adviser for Morgan Stanley in the San Diego area. Kersh and Childs previously worked together at Southwest. Morgan Stanley Smith Barney recruited Childs from Southwest and also tried unsuccessfully to recruit another relative who worked with Kersh, Morgan Stanley Smith Barney said in court documents. People on the Morgan Stanley Smith Barney management team involved in those recruitment efforts were also involved in the case filed by Paladino and Vitale, according to the brokerage. While Judge Schall in California did not address those specific accusations, she rejected arguments made by Vitale's lawyers that Kersh was not required to disclose certain details and that Morgan Stanley Smith Barney knew other details about his family, according to the court decision. Efforts to "impute knowledge" of Kersh's relationships to Morgan Stanley Smith Barney were "unpersuasive and speculative," the judge wrote. Kersh and Childs did not return calls requesting comment. A Morgan Stanley Smith Barney spokeswoman declined comment on Childs' behalf. Reporting by Suzanne Barlyn in New York; editing by Steve Orlofsky and Matthew Lewis