[Federal Register Volume 62, Number 131 (Wednesday, July 9, 1997)]
[Notices]
[Pages 36858-36860]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-17939]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38807; File No. SR-NASD-97-40]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the National Association of 
Securities Dealers, Incorporated Amending the Surcharge on Members 
Named as Respondents in Arbitration Proceedings

July 1, 1997.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on June 13, 
1997, the National Association of Securities Dealers, Incorporated 
(``NASD'' or ``Association'') filed with the Securities and Exchange 
Commission (``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the self-
regulatory organization. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD Regulation is proposing to amend Rule 10333 of the NASD's Code 
of Arbitration Procedure (``Code'') to increase the member surcharge on 
arbitration matters and to further graduate the rate of member 
surcharges to reflect more closely the costs associated with resolving 
controversies involving varying amounts in dispute.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
Background and Introduction
    In January 1996, the NASD's Arbitration Policy Task Force (``Task 
Force'') released its report on Securities Arbitration Reform. The Task 
Force's report made numerous recommendations to improve the arbitration 
process. Some of the recommendations, such as early appointment of 
arbitrators and selection of arbitrators by a list selection method, 
involve significant changes in the way NASD Regulation's Office of 
Dispute Resolution (``Office'') administers arbitration cases and their 
implementation will result in significant increases in cost. Other 
recommendations, including increased arbitrator compensation, also 
involve significant increases in cost.
    Since the report was released, NASD Regulation has been engaged in 
a major effort to implement the numerous Task Force recommendations. In 
addition, the Office has other initiatives underway to improve the 
arbitration process, such as improving case processing and 
administration by, among other things, upgrading its computerized case 
tracking system and hiring additional staff. Finally, the growth rate 
in NASD Regulation's arbitration case load over the last ten years, and 
the increasing length and complexity of arbitration cases, are 
generating additional cost pressures on the Office in its continuing 
efforts to meet the needs of users of the dispute resolution 
service.\1\
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    \1\ The number of cases filed with NASD Regulation's Office of 
Dispute Resolution in the first three months of 1997 is up 15 
percent over the same period in 1996. The number of cases filed has 
risen from 2,886 in 1987 to an estimated 6,356 for 1997 based on the 
number filed in the first three months, a 120 percent increase.
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    Operating Costs. The Office's arbitration service has never been 
self-funding. The revenues generated from filing and hearing session 
fees and, more recently, the member surcharge, have never covered more 
than approximately 70 percent of the arbitration service's operating 
costs. Originally a voluntary program that handled a few hundred cases 
each year, the arbitration service now handles more than 6,000 cases 
annually. Since its inception, the NASD has subsidized a large portion 
of the cost out of revenue obtained from members through the general 
assessment on member income. As the number of cases has grown and the 
cost and complexity of arbitration proceedings have increased, NASD 
Regulation has sought to increase the fees charged to the users of the 
service and to reduce the general assessment subsidy in order to shift 
the costs of the program to the service users.
    Among its recent initiatives, the Office also has begun to appoint 
arbitrators earlier in the process, one of the Task Force's 
recommendations. In addition, list selection of arbitrators will be 
implemented in 1998 (subject to SEC approval), and updating the 
Office's arbitration case tracking system is in progress. The costs of 
these initiatives and others are increasing operating expenses 
significantly. For example, in 1996, the costs of the dispute 
resolution program exceeded revenue by $11.3 million. The revenue 
shortfall is expected to reach $20.0 million in 1997, a 77 percent 
increase. After incorporating planned increases in arbitrator 
compensation, the revenue shortfall is projected to be $25.0 million in 
1998, a 121 percent increase over 1996.\2\
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    \2\ See Exhibit 2 to the rule filing.

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[[Page 36859]]

Development of Proposed Fee Increases
    As a result of the continuing growth of the program and the 
operating losses, NASD Regulation determined that changes to the 
funding mechanisms were necessary. In order to ensure that the changes 
were appropriate to the goals of the program and fair to its users, 
NASD Regulation established guidelines for fee increases and analyzed 
the program to identify the cost of each service.\3\ In addition, to 
support a shift in the source of member financial support from general 
assessment revenue to user fees, NASD Regulation identified the member 
users of the program.
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    \3\ The NASD Regulation Board of Directors formed a Subcommittee 
on Arbitration Fees to examine the current revenue, cost and fee 
structure and recommend changes. The Subcommittee was composed of 
three public members (James E. Burton, CalPERS; Bonnie Guiton Hill, 
Times-Mirror Corp.; and William S. Lapp, Esq., Lapp, Laurie, Libra, 
Abramson & Thomson, board member of the Public Investors Arbitration 
Bar Association and member of NASD Regulation's National Arbitration 
and Mediation Committee (NAMC) and three securities industry members 
(Raymond E. Wooldridge, Southwest Securities Group, Inc., NAMC 
member and Chairman of NAMC's Finance Subcommittee, and former 
member of NASD Regulation's Board of Directors; Philip S. Cottone, 
Rutherford, Brown & Catherwood, Inc., Chairman of NAMC and former 
member of NASD Regulation's Board of Directors; and O. Ray Vass, 
Merrill, Lynch, Pierce, Fenner & Smith, Inc., member of NASD 
Regulation's Membership Committee).
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    Guidelines for Proposed Fee Increases. In developing the proposed 
rule change, NASD Regulation identified several important principles to 
guide its decisions on the appropriate fees for the arbitration service 
it provides:
     The current ratio of public investor fees to member fees 
should remain the same. Currently public investors pay approximately 26 
percent of the arbitration service fees and members pay 74 percent.
     The fees should not create a financial barrier to prevent 
a public investor from seeking arbitration. The maximum fee charged to 
public investors should not exceed the direct costs of providing the 
service.
     The cost for a public investor to file a case in 
arbitration (the filing fee plus hearing session deposit fee) should 
not exceed the cost to the member named in the arbitration (the member 
surcharge).
    The revenue contribution plan should, to the extent possible, 
impose costs on member firms and associated persons who use the 
program.
     Any fee increases should be allocated to reducing the 
revenue shortfall for the arbitration service alone. Additional fee 
increases to cover revenue shortfalls for other dispute resolution 
programs and indirect operating costs may be developed in the future.
    Member-Users of Dispute Resolution Services. In addition, 1996 case 
volume was analyzed to obtain a profile of the users of arbitration 
services and to project the impact of future fee changes upon member 
firms. This analysis revealed that only 753 firms (14 percent) out of 
approximately 5,500 NASD member firms used arbitration services. Of 
these 753 firms, 88 firms (12 percent) accounted for over 50 percent of 
the case volume. Each of these 88 firms reported revenues in excess of 
$100 million on their FOCUS filings. In contrast, firms that reported 
revenues of less than $500,000 accounted for only 9 percent of NASD 
member firms and represented less than 3 percent of the total projected 
case load. Thus, a small number of large firms are involved in more 
than 50 percent of all arbitration cases. NASD Regulation considers 
these firms to be the primary and most frequent member users of the 
service and, therefore, believes it is appropriate for any fee changes 
to shift member costs from general revenues to these member users. The 
proposed rule changes, including the changes to the member surcharge 
proposed in another rule filing, accomplish this goal.
General Description of Proposed Fee Increases
    In view of the foregoing, and in conjunction with proposed 
increases in filing fees and hearing session deposits as set forth in a 
separate rule filing, \4\ NASD Regulation is proposing to amend the 
surcharge assessed on members who are named as respondents in 
arbitration proceedings \5\ to fund implementation of the Task Force's 
recommendations and other initiatives to improve the arbitration 
services administered by the Office. The changes, taken together, will 
maintain the current ratio of funding of the arbitration services 
between customers and members while limiting the increases in filing 
fees and hearing deposits for customers. This will continue to 
encourage the use of the arbitration service while limiting the cost to 
the users of the program to an amount less than the direct costs of 
providing the service.
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    \4\ The NASD also submitted a proposed rule change to amend 
Rules 10205 and 10332, fees and hearing session deposits for 
disputes between public investors and members and between members or 
associated persons and other members or associated persons.
    \5\ The member surcharge is also imposed on members where an 
associated person of the member is named; however, there is only one 
surcharge imposed on each member in each case.
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    NASD Regulation estimates that the combination of increases in 
member fees will generate $8.4 million in additional revenues (71 
percent of total additional revenues to be generated by all fee changes 
proposed in this and other filings). Overall, NASD Regulation expects 
that all of the proposed fee changes on both members and public 
investors will generate approximately $12 million in additional 
revenue. Even with this additional revenue, the Office will continue to 
incur operating losses of more than $13 million.\6\
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    \6\ See Exhibit 3 to the rule filing.
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Proposed Increases in Member Surcharge
    NASD is proposing to amend the surcharge schedule to add brackets 
\7\ and substantially increase the surcharge for the upper brackets. 
Under the current rule there are five brackets with surcharges from 
$100 to $500. Under the proposed new schedule there will be 12 brackets 
with surcharges starting at $150 for cases of $2,500 or less, up to 
$3,600 for cases exceeding $10,000,000. The addition of the new 
brackets and the graduation of the surcharge from the smallest case to 
the largest will cause the members' share of the costs of the 
arbitration service to be assessed upon the members who actually use 
the process in proportion to their financial involvement and exposure 
in the process.
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    \7\ Fees are based on the amount in dispute; a range of amounts 
in dispute (e.g., $50,000.01 to $100,000) to which a particular fee 
applies is referred to as a bracket.
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    The proposed rule change also replaces ``Arbitration Department'' 
with ``Director of Arbitration'' in Rule 10333(a) of the Code. In 
addition, the proposed rule change adds section (c) to Rule 10333 of 
the Code to state that if the dispute, claim, or controversy does not 
involve, disclose, or specify a money claim, the surcharge shall be 
$1,200 or such greater or lesser amount as the Director of Arbitration 
or the panel of arbitrators may require, but cannot exceed the maximum 
amount in the schedule.
    NASD Regulation intends to make the proposed rule change effective 
on July 1, 1997.
2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(5) of the Act \8\ in 
that the proposed rule change provides for the equitable allocation of 
reasonable charges among members using the Association's arbitration 
facility because it further

[[Page 36860]]

graduates the fee schedules and requires member firm users to absorb a 
reasonable share of the costs of operating the arbitration service.
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    \8\ 15 U.S.C. 78o-3.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe the proposed rule change will impose any 
burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    No written comments were solicited or received with respect to the 
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The proposed rule change has become effective upon filing pursuant 
to Section 19(b)(3)(A) of the Act and subparagraph (e) of Rule 19b-4 
thereunder, in that the proposal constitutes a change to a fee which 
the NASD imposes on its members. At any time within 60 days of the 
filing of such proposed rule change, the Commission may summarily 
abrogate such rule change if it appears to the Commission that such 
action is necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes of 
the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying at the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-97-40 and should 
be submitted by July 30, 1997.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-17939 Filed 7-8-97; 8:45 am]
BILLING CODE 8010-01-M