[Federal Register Volume 64, Number 198 (Thursday, October 14, 1999)]
[Notices]
[Pages 55793-55796]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-26793]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41971; File No. SR-NASD-99-21]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change by the National Association of Securities Dealers, Inc. To
Create a Dispute Resolution Subsidiary
September 30, 1999.
On April 26, 1999, the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association''), through its wholly owned regulatory
subsidiary, NASD Regulation, Inc. (``NASD Regulation''), submitted to
the Securities and Exchange Commission (``Commission''), pursuant to
section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\
and Rule 19b-4 thereunder,\2\ a proposed rule change to create a
dispute resolution subsidiary. The proposed rule change was published
for comment in the Federal Register on June 17, 1999.\3\ The Commission
received one comment letter on the proposal from the Securities
Industry Association (``SIA'').\4\ This order approves the proposal.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 41510 (June 10,
1999), 64 FR 32575.
\4\ Letter from Stephen G. Sneeringer, Chairman of the
Arbitration Committee, SIA, to Jonathan G. Katz, Secretary,
Commission, dated July 8, 1999 (``SIA Letter'').
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I. Description of the Proposal
The Association is proposing (i) to create a dispute resolution
subsidiary, NASD Dispute Resolution, Inc. (``NASD Dispute
Resolution''), to handle dispute resolution programs; (ii) to adopt by-
laws for the subsidiary; and (iii) to make conforming amendments to the
Plan of Allocation and Delegation of Functions by NASD to Subsidiaries
(``Delegation Plan''), the NASD Regulation By-Laws, and the Rules of
the Association.
A. Background
The Association's arbitration and mediation programs were operated
by the NASD Arbitration Department until 1996, when those functions
were moved to NASD Regulation following a corporate reorganization.
This reorganization in part grew out of recommendations of a Select
Committee formed by the NASD and made up of individuals with
significant experience in the securities industry and NASD governance
(``the Rudman Committee'').\5\ The Rudman Committee reviewed the
Association's arbitration and mediation programs from December 1994
through August 1995. The Rudman Report was issued in September 1995.
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\5\ Report of the NASD Select Committee on Structure and
Governance to the NASD Board of Governors (September 1995) (``Rudman
Report'').
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In September 1994, the NASD established the Arbitration Policy Task
Force, headed by David S. Ruder, former Chairman of the SEC (``the
Ruder Task Force''), to study NAD arbitration and recommend
improvements. The Ruder Task Force, composed of eight persons with
various backgrounds in the area of securities arbitration, met from the
Fall of 1994 to January 1996, when its Report was issued.\6\
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\6\ Report of the Arbitration Policy Task force to the Board of
Governors National Association of Securities Dealers, Inc. (January
1996) (``Ruder Report'').
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Both the Rudman Committee and the Ruder Task Force made
recommendations that affected the arbitration program. The Rudman
Committee recommended that the NASD reorganize as a parent corporation
with two relatively autonomous and strong operating subsidiaries,
independent of one another. The resulting enterprise would consist of
NASD, Inc., as parent, The Nasdaq Stock Market, Inc. (``Nasdaq'') as
[[Page 55794]]
one subsidiary to operate Nasdaq, and a new subsidiary, NASD
Regulation, Inc., to regulate the broker-dealer members of the NASD.\7\
The Ruder Report recommended that the dispute resolution program be
housed either in the parent or in NASD Regulation.\8\ The Arbitration
Department was placed in NASD Regulation in early 1996 based on the
recommendation of the Rudman Committee,\9\ and the name of the
department was changed to the Office of Dispute Resolution (``ODR'')
shortly thereafter, to reflect the full range of dispute resolution
mechanisms.
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\7\ Rudman Report at R-8.
\8\ Ruder Report at 151-52.
\9\ Rudman Report at R-8.
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The NASD believes that ODR has established credibility as a neutral
forum that is fair to all parties and has gained acceptance by investor
groups. However, because there are significant differences between the
disciplinary role of NASD Regulation and the sponsorship of a neutral
forum for the resolution of dispute between members, associated
persons, and customers, the NASD believes that creation of a separate
dispute resolution entity will further strengthen the independence and
credibility of its arbitration and mediation functions. A new dispute
resolution subsidiary should benefit from the perception that it is
separate and distinct from other NASD entities. The new subsidiary will
be subject to the same SEC oversight as other parts of the NASD
enterprise, which includes regular inspections by the Commission and
the need to file all by-laws and rule changes with the SEC. In
addition, the new subsidiary will remain subject to inspections by the
General Accounting Office (``GAO''), which performs audits at the
request of Congress.
The NASD proposes to call the new subsidiary NASD Dispute
Resolution, Inc. Together with NASD Regulation, the two subsidiaries
will form the NASD Regulatory and Dispute Resolution Group. Both the
NASD directly, and NASD Regulation, indirectly, will be responsible for
the actions of NASD Dispute Resolution. Because NASD Dispute Resolution
performs its functions through authority delegated by the NASD, the
NASD is responsible for proper performance of such functions.
Indirectly, NASD Regulation will be responsible for enforcing
compliance with decisions rendered by NASD Dispute Resolution
concerning NASD members.\10\
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\10\ See Section A.1.f. of the Delegation Plan.
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Staffing for NASD Dispute Resolution will be the same as ODR,
except for the creation of a President position. Certain additional
executive positions, if necessary, may be created as well. Many
functions of the new subsidiary, such as human resources, legal,
finance, communications, administrative services, and technology will
be shared with the NASD and other subsidiaries to avoid duplication.
The new subsidiary will be charged for the cost of those functions as
it presently is.
Funding for the new subsidiary will be handled in much the same way
as presently handled for ODR, which is not self supporting. Fees
received from parties who use the arbitration and mediation programs
are not sufficient to fund the Office's regular actitivies. Rather, as
a part of NASD Regulation, ODR shares in the revenue stream of the NASD
and its affiliated entities, which includes revenue derived from member
assessments, various fees and charges, disciplinary fines, and other
sources of income. In return, ODR is charged for services that it
receives from the other corporations in the enterprise as described
above. Apart from accounting changes to reflect the new subsidiary's
status, the funding process for the new subsidiary will be the same as
that for ODR. ODR employees will continue in the same positions in the
new subsidiary, and the physical offices will not move.
The NASD proposes a five-person Board for NASD Dispute Resolution,
consisting of three non-industry and two industry directors, as those
terms are defined in Article I of the proposed By-Laws. The Chief
Executive Officer of the NASD will be an ex-officio non-voting member
of the Board. The non-industry directors would include at least two
persons who also are members of the NASD Board of Governors (``NASD
Board''), and an additional person knowledgeable in the dispute
resolution field. At least one of the non-industry directors also will
qualify as a public director, as defined in the By-Laws. One industry
director would be a member of the NASD Board; the other would be the
President of the new subsidiary. The NASD Board would elect the
directors, as is done for the boards of the other subsidiaries.
The procedures currently in place for disciplining members and
associated persons for noncompliance with arbitration awards will be
largely the same. The Code of Arbitration Procedure (``Code''), in IM-
10100, provides that the failure of a member or associated person to
comply with an arbitration award obtained in connection with an
arbitration submitted for disposition pursuant to the procedures
specified by the NASD, other self-regulatory organizations, or the
American Arbitration/Association \11\ may be deemed conduct
inconsistent with just and equitable principles of trade and a
violation of NASD Rule 2110. This language presently applies to awards
obtained in the NASD Regulation forum, because that forum applies rules
and procedures that are ultimately approved by the NASD. This will also
be the case for NASD Dispute Resolution. Enforcement of the Code will
continue to be handled by NASD Regulation.
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\11\ The NASD Regulation Board of Directors recently approved an
amendment to this Interpretive Material that would add, ``or other
dispute resolution forum selected by the parties.'' See Securities
Exchange Act Release No. 41339 (April 28, 1999), 64 FR 23887 (May 4,
1999). This proposal was filed as a non-controversial filing. The
NASD designated May 17, 1999 as the effective date of the proposal.
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As is the case with actions by NASD Regulation, actions by the NASD
Dispute Resolution Board may be referred by that board to the NASD
Board, or reviewed by the NASD Board, as provided in the proposed
amendments to the Delegation Plan.\12\ Thus, the rules of NASD Dispute
Resolution will be the rules of the Association, just as rules approved
currently by the other subsidiaries and subject to NASD Board review
are deemed to be NASD rules. NASD Regulation has formed a working group
with representatives from various departments to ensure a smooth
transition.
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\12\ the Delegation Plan was amended in 1997, together with
related By-Laws changes designed to allow the NASD Board to take
action on its own initiative rather than waiting for a subsidiary to
act on the matter. See Securities Exchange Act Release No. 39326
(Nov. 14, 1997), 62 FR 62385 (Nov. 21, 1997).
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B. Description of Proposed Amendments
The Association proposes to amend the Delegation Plan to add
references to the new subsidiary and to move the arbitration and
mediation functions from NASD Regulation to NASD Dispute Resolution.
Therefore, references to the delegations of authority to the
subsidiaries and the rulemaking decisions of the subsidiaries have been
amended to include references to NASD Dispute Resolution. As is the
case for NASD Regulation and Nasdaq, actions of the new subsidiary
Board will be subject to review by the NASD Board, and rule filings
will be made by the new subsidiary on behalf of the NASD.
The description of the National Arbitration and Mediation Committee
(``NAMC'') in the Delegation Plan has been moved from the section
delegating authority to NASD Regulation to a new NASD Dispute
Resolution section. A
[[Page 55795]]
change has been made in the NAMC member balancing requirement to
provide more flexibility while maintaining at least 50% non-industry
membership. The Delegation Plan currently provides that NAMC membership
shall be equally balanced between industry and non-industry members. It
may be desirable, however, to have an odd number of members on the NAMC
to avoid tie votes. Therefore, the provision has been amended to state
that the NAMC shall have at least 50% non-industry members. This
provides additional flexibility while maintaining a minimum of half
non-industry members, in accordance with the spirit of the Delegation
Plan.
The Association proposes to amend the NASD Regulation By-Laws to
add references to NASD Dispute Resolution in the definitions
sections.\13\
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\13\ The NASD also intends to review the NASD and Nasdaq By-Laws
and other corporate governance documents to identify other
appropriate amendments recognizing the formation of NASD Dispute
Resolution.
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Rule 0120(b) will be amended to clarify that the term
``Association'' collectively means the NASD and its subsidiaries that
are considered part of the self-regulatory organization: that is, the
NASD, NASD Regulation, Nasdaq, and NASD Dispute Resolution.
Rule 10102(a) of the Code of Arbitration procedure will be amended
to clarify that the new NASD Dispute Resolution Board will appoint
members of the NAMC and name its chair. In addition, Rule 10102(a) will
be amended to replace the phrase ``a pool of arbitrators'' with the
more accurate phrase ``rosters of neutrals,'' since the current rosters
include both arbitrators and mediators (collectively referred to as
``neutrals'').
Rule 10102(b) will be amended to conform to current practice, in
which the NAMC recommend to the Board certain rules and procedures to
govern the conduct of arbitration and mediation matters, and does not
unilaterally make such changes. The rule currently authorizes the NAMC
to establish these rules and procedures. In addition, the phrase ``NASD
Dispute Resolution'' has been added before ``Board'' to clarify that
recommendations will be made to that Board. As noted above, actions of
the new subsidiary board will be subject to review by the NASD Board.
Rule 10401 will be amended to replace the phrase ``by the
Association'' with regard to designation of the Director of Mediation
and replace it with ``by the NASD Dispute Resolution Board,'' and to
delete ``Association's'' as a modifier of ``National Arbitration and
Mediation Committee.'' Although the NASD and its subsidiaries are
collectively referred to as the Association for self-regulatory
purposes, the use of ``Association'' in this Rule may cause confusion
in light of the new corporate structure and serves no useful purpose in
the Rule. The term ``of Arbitration'' will be added after one instance
of the word ``Director'' to distinguish it from the Director of
Mediation. In addition, the reference to the ``Board of Governors'' has
been changed to ``NASD Dispute Resolution Board'' to reflect the new
structure.
Rule 10404 will be amended to change the term ``NASD'' to
``Association'' to be more inclusive in this instance because, as
described above, the term ``Association'' refers to the entire self-
regulatory organization including subsidiaries.
The proposed NASD Dispute Resolution By-Laws are modeled after
those of NASD Regulation, with certain modifications, described below,
appropriate to the particular functions of NASD Dispute Resolution. For
example, NASD Dispute Resolution will not require that a committee
other than the NAMC review all rulemaking proposals. Standard
provisions allowing for the appointment of an Executive Committee and a
Finance committee have been included for flexibility, although it is
not immediately expected that such committees will be needed.
Proposed Article IV, Section 4.2 sets the number of Board members
at five to eight although, as stated above, the intention initially is
to have only five Board members. In addition, the Chief Executive
Officer of the NASD will be an ex-officio non-voting member of the
Board. Proposed Section 4.3(a) provides that the number of non-industry
directors shall equal or exceed the number of industry directors plus
the President. This means that the President is treated as an industry
director for this purpose. The other industry director and at least two
of the non-industry directors also will be sitting members of the NASD
Board. This overlapping membership provides stability and uniformity
among the corporations. At least one of the non-industry directors also
will qualify as a public director. The proposed By-Laws define ``Public
Director'' as a director who has no material business relationship with
a broker or dealer or the NASD, NASD Regulation, Nasdaq, or NASD
Dispute Resolution. The By-Laws define ``Non-Industry Director'' as a
director (excluding the President) who is (1) a public director or
public committee member; (2) an officer or employee of an issuer of
securities listed on Nasdaq or Amex, or traded in the over-the-counter
market; or (3) any other individual who would not be an industry
director or industry committee member.
A minor modification was made to the standard terminology in
Section 4.13(h) to clarify that the Board may appoint a non-director to
a committee, because this power is implied but not specifically stated
in the preceding paragraphs of Section 4.13.
II. Comments
The Commission received one comment letter from the SIA,\14\ which
opposed the proposed rule change. The SIA disagreed with (i) the
proposed composition of the NASD Dispute Resolution Board; (ii) the
proposed composition of the NAMC; and (iii) the manner in which fees
will be imposed by NASD Dispute Resolution.
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\14\ See supra, note 4.
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The SIA had three concerns about the composition of the NASD
Dispute Resolution Board. First the SIA stated that industry and non-
industry representation should be equal. Second, the SIA noted that it
is inappropriate to consider the president of NASD Dispute Resolution
as an industry representative. Third, the SIA stated that the proposed
compositional breakdown might permit the NASD Dispute Resolution Board
to be dominated by claimants' lawyers. The SIA recommended that the
Commission exclude from the definition of Non-Industry ``anyone who
provides professional legal services to investor-claimants and whose
revenues in that regard constitute more than 20% of his or her gross
annual revenue.'' \15\
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\15\ SIA Letter at 4.
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Similarly, the SIA expressed concern about the proposed composition
of the NAMC. It stated its position that industry and non-industry
representation on the NAMC should be equal rather than at least 50
percent non-industry. The SIA stated that the ``amorphous concern that
they may be a tie vote * * * does not outweigh the more paramount
concern that the representation on the NAMC be truly balanced between
Industry and Non-Industry representatives.'' \16\
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\16\ SIA Letter at 4-5.
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In addition to the composition of the NAMC and the NASD Dispute
Resolution Board, the SIA commented on the manner in which fees will be
imposed under the proposed rule change. The SIA objected to the
dichotomy between fees affecting members and those affecting non-
members. Under the proposed rule change, the NASD Board must ratify any
rule change adopted by the NASD
[[Page 55796]]
Dispute Resolution Board that imposes fees or other charges on person
or entities other than NASD members. Rule changes that impose fees on
NASD members do not require NASD Board ratification. The SIA stated
that industry participants ``should have the opportunity to participate
in critical decisions that will impact their business and their bottom
line--such as fee increases related to the arbitration system.'' \17\
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\17\ SIA Letter at 5.
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NASD Regulation responded to the SIA's concerns about the proposed
composition of the NASD Dispute Resolution Board, the proposed
composition of the NAMC, and the manner in which fees will be imposed
by NASD Dispute Resolution.\18\ First, with respect to the composition
of the NASD Dispute Resolution Board, NASD Regulation noted that this
proposal is consistent with NASD Regulation's bylaws, which require a
majority of non-industry members on its Board and its President and
Nasdaq's President are also counted as industry participants for
compositional and quorum requirements.\19\ Second, with respect to the
composition of the NAMC, NASD Regulation noted that the NAMC's
recommendations are only advisory and that rule changes and major
policy changes must be presented to the NASD Dispute Resolution Board
for final approval.\20\ Third, with respect to NASD Dispute
Resolution's authority to impose fees on NASD members without prior
review and ratification by the NASD Board, NASD Regulation noted that
fee proposals must be submitted for Commission review and that the NASD
may, on its own initiative, review any action of its subsidiaries.\21\
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\18\ Letter from Jean I. Feeney, Assistant General Counsel, NASD
Regulation, to Richard C. Strasser, Assistant Director, Commission,
dated August 11, 1999.
\19\ Id. at 2.
\20\ Id. at 4.
\21\ Id.
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III. Discussion
The Commission finds that the proposed rule change is consistent
with section 15A(b) of the Act \22\ in general and furthers the
objectives of section 15A(b)(6) \23\ in particular, in that it is
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, and to protect
investors and the public interest.\24\ Specifically, the Commission
believes that separating the dispute resolution role from the
disciplinary role of NASD Regulation will result in a more neutral and
independent forum for the resolution of disputes between members,
associated persons, and customers. The Commission also expects the NASD
to ensure that NASD Dispute Resolution is adequately funded and able to
fulfill its responsibilities.
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\22\ 15 U.S.C. 78o-3(b).
\23\ 15 U.S.C. 78o-3(b)(6).
\24\ In approving this rule, the Commission has considered the
proposed rule's impact on efficiency, competition, and capital
formation. 15 U.S.C. 78c(f).
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In its comment letter, the SIA stated that industry and non-
industry representation on the NASD Dispute Resolution Board and the
NAMC should be equal and that the President of NASD Dispute Resolution
should not be considered an industry representative. The Commission
notes that NASD Dispute Resolution's Board structure is modeled after
NASD Regulation's structure. Nasdaq also requires a majority of non-
industry directors on its Board. Moreover, the Presidents of both NASD
Regulation and Nasdaq are counted as industry participants for board
composition and quorum requirements. The Commission believes that it is
reasonable to extend this structure to NASD Dispute Resolution.
The SIA also stated that the NASD Dispute Resolution Board may
include too many claimants' lawyers, thus permitting domination by a
single NASD Dispute Resolution constituency. The Commission disagrees,
noting that at least two of the non-industry directors will come from
the NASD Board. As characterized by the SIA in its comment letter, the
current non-industry members of the NASD Board are senior executives
from major corporations with no particular affiliation with the
securities industry. Moreover, if NASD Dispute Resolution has a five
member Board, only one non-industry director may be chosen from outside
the NASD Board. While that director should be knowledgeable in the
dispute resolution field, the universe of potential candidates is not
limited to claimants' lawyers. Indeed, it is likely that the remaining
non-industry position would be filled by a practicing arbitrator, a
mediator, or an academic. Accordingly, the Commission does not believe
that there is an undue risk that the NASD Dispute Resolution Board will
be dominated by an single constituency of the new subsidiary.
The SIA also stated that the NASD Board should be required to
ratify rule changes adopted by the NASD Dispute Resolution Board if the
rule change imposes fees or other charges on NASD members as well as
those affecting non-members. The Commission notes that rule changes by
the NASD Regulation and Nasdaq Boards imposing fees or other charges on
NASD members do not require ratification by the NASD Board. The
Commission also notes that fee proposals must be submitted for
Commission review under Rule 19b-4 under the Act. In addition, any
member of the NASD Board may call an action of a subsidiary for review
at the next NASD Board meeting following the subsidiary's action. The
Commission believes these measures provide an adequate safeguard
against unreasonable fees being levied against NASD members.
Finally, the Association represents that funding for the new
subsidiary will be handled in much the same way as funding for ODR was
accomplished. The new subsidiary will share in the revenue stream of
the NASD and its affiliated entities, which includes revenue derived
from member assessments, various fees and charges, disciplinary fines,
and other sources of income. As the new subsidiary is implemented, we
expect the NASD to commit to ensuring that NASD Dispute Resolution
continues to be properly funded to carry out all its responsibilities.
IV. Conclusion
It Is Therefore Ordered, pursuant to section 19(b)(2) of the
Act,\25\ that the proposed rule change (SR-NASD-99-21) is approved.
\25\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\26\
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\26\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-26793 Filed 10-13-99; 8:45 am]
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