[Federal Register Volume 59, Number 135 (Friday, July 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-17257]

[[Page Unknown]]

[Federal Register: July 15, 1994]


[Release No. 34-34348; File No. SR-NASD-93-75]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change Relating to the 
Referral of Matters by Arbitrators for Disciplinary Investigation

July 11, 1994.
    On May 25, 1994, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association'') filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'')\1\ a proposed rule 
change pursuant to Section 19(b)(1) of the Securities Exchange Act of 
1934 (``Act''),\2\ and Rule 19b-4 thereunder.\3\ The proposed rule 
change amends Section 5 of the Code of Arbitration Procedure 
(``Code'')\4\ to specify that arbitrators, at the conclusion of a 
proceeding, may refer matters arising or discovered during the course 
of an arbitration proceeding for disciplinary investigation.

    \1\The NASD initially submitted the proposed rule change on 
December 16, 1993. However, on May 25, 1994, the NASD filed 
Amendment No. 1, which amended and superseded the original rule 
    \2\15 U.S.C. 78s(b)(1)(1988).
    \3\17 CFR 240.19b-4 (1993).
    \4\NASD Manual, Code of Arbitration Procedure, Part I, Section 
5, (CCH)  3705.

    Notice of the proposed rule change, together with the substance of 
the proposal, was provided by issuance of a Commission release 
(Securities Exchange Act Release No. 34146, June 2, 1994) and by 
publication in the Federal Register (59 FR 29647, June 8, 1994). One 
comment letter was received.\5\ This order approves the proposed rule 

    \5\See letter from James F. Fotenos, Esq., Fotenos & Suttle, 
P.C. to Jonathan G. Katz, Secretary, SEC, dated July 1, 1994 
(``Fotenos Letter'').

    In its filing, the NASD stated that potential violations uncovered 
during arbitration hearings should be investigated by the NASD as part 
of its comprehensive regulatory program. While customers who suffer a 
financial loss as a result of misconduct by their registered 
representative may bring arbitration actions, they often do not pursue 
formal complaints with a self-regulatory organization (``SRO'') 
necessary to trigger an investigation of the potential violation. 
Further, while the filing of an arbitration complaint will alert an SRO 
to the existence of a potential violation,\6\ because customer 
complaints in arbitration often do not allege or disclose sufficient 
information to indicate obvious misconduct on the part of a respondent, 
they may not trigger a disciplinary investigation. Indeed, in such 
cases, violations of the securities laws or the NASD's rules may not be 
apparent until an arbitration hearing occurs and the parties testify 
and introduce evidence about the relevant events. The NASD stated in 
its filing that in some cases, it never is made aware of securities law 
violations or violations of the NASD's rules, notwithstanding the fact 
that the financial injury to the customer resulting from the violations 
is the subject of an arbitration proceeding.

    \6\The filing of a customer-initiated arbitration complaint 
against an associated person alleging damages of $10,000 or more 
triggers a requirement of the member or associated person to amend 
the associated person's Form U-4 or U-5, as appropriate. Information 
supplied pursuant to such an amendment will be entered into the 
Central Registration Depository and will also be forwarded to the 
appropriate NASD District office for preliminary investigation.

    The NASD also stated in its filing that it has observed that 
arbitrators seldom refer for disciplinary investigation matters which 
come to their attention during the course of an arbitration proceeding. 
Because the NASD believes that arbitration matters, and the evidentiary 
material related to or produced in such matters, constitute a valuable 
source of information concerning potential violations of the NASD's 
rules and the federal securities laws, it believes that bringing such 
information to the attention of the Association's regulatory staff 
should improve the efficacy of the NASD's regulatory function. The NASD 
stated in its filing that it believes that specifying a mechanism in 
the Code for arbitrators to bring such information to the attention of 
the NASD's regulatory staff for investigation will serve the public 
interest by ensuring that potential violations of the NASD's rules and 
the federal securities laws are not overlooked.
    In addition, the NASD believes that it is important for arbitrators 
to understand that the arbitration process is for the resolution of 
disputes between the securities industry and others, and that there is 
also a regulatory apparatus separate from the arbitration process which 
is designed to address misconduct which affects the public interest and 
the integrity of the financial markets. Thus, to the extent arbitrators 
are aware that they may refer matters, in addition to or in lieu of 
awarding punitive damages as part of awards,\7\ the fairness of the 
arbitration process will be enhanced.

    \7\The NASD, in connection with this rule filing, is not 
expressing any official position with respect to the ability of 
arbitrators to award punitive damages.

    The proposed amendment to Section 5 specifies that if any matter 
comes to the attention of an arbitrator during the course of a 
proceeding the arbitrator may initiate a referral of the matter to the 
Association for disciplinary investigation. The proposed amendment also 
specifies, however, that any such referral should be initiated by an 
arbitrator only after final disposition of the matter through 
settlement or award. Although the NASD is not setting forth a specific 
procedure for such referrals, the NASD stated in its filing that it 
contemplates that arbitrators will direct referrals to the Association 
through the Arbitration Department Staff and the Director of 
    One commenter objected to the proposed rule change on the grounds 
that it would cause arbitrators to believe that they must make 
disciplinary referrals in all instances in which they find for 
claimants alleging that a member firm or associated person has violated 
the NASD's rules or securities laws.\8\ This commenter stated that the 
effect of the proposed rule change would be to compromise the 
independence of arbitrators. The Commission disagrees. The Commission 
notes that the amendment provides that referral of any matter by an 
arbitrator is permissive rather than mandatory. Futher, the Commission 
believes that, because the disciplinary process is intended to address 
misconduct which affects the public interest and the integrity of the 
financial markets, the process is enhanced when the NASD receives 
notice of violations from an important and reliable source of 

    \8\See Fotenos Letter, supra n. 5.

    The Commission finds that the proposed rule change is consistent 
with the provisions of Section 15A(b)(6) of the Act\9\ because it will 
encourage arbitrators to bring information concerning potential 
violations of the Association's rules and the federal securities laws 
to the attention of the NASD's regulatory staff for investigation. 
This, in turn, will serve the public interest by enhancing the ability 
of the NASD's regulatory staff to take disciplinary action against 
perpetrators of conduct adversely affecting the public interest and the 
integrity of financial markets.

    \9\15 U.S.C. 78o-3.

    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the Act, 
that File No. SR-NASD-93-75 be, and hereby is, approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority, 17 CFR 200.30-3(a)(12).
Jonathan G. Katz,
[FR Doc. 94-17257 Filed 7-14-94; 8:45 am]