[Federal Register Volume 64, Number 228 (Monday, November 29, 1999)]
[Notices]
[Pages 66681-66684]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-30836]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42160; File No. SR-NASD-98-74]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to Amendments to NASD Rule 3110(f) Governing Use of Predispute 
Arbitration Agreements With Customers

November 19, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on October 6, 1998, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its wholly-owned subsidiary 
NASD Regulation, Inc. (``NASD Regulation'') filed with the Securities 
and Exchange Commission (``SEC'' or ``Commission'') a proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by NASD Regulation. On May 26, 1999 and July 27, 1999 the 
NASD submitted Amendments No. 1 and 2 to the proposed rule change, 
respectively.\3\ The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter to Katherine A. England, Assistant Director, 
Division of Market Regulation, Commission, from Alden S. Adkins, Sr. 
Vice President and General Counsel, NASD Regulation, dated May 26, 
1999 and letter to Richard C. Strasser, Assistant Director, Division 
of Market Regulation, Commission, from Joan C. Conley, Sr. Vice 
President and Corporate Secretary, NASD Regulation, dated July 26, 
1999.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The NASD is proposing to amend NASD Rule 3110(f) to: require 
additional disclosure in predispute arbitration agreements regarding 
the arbitration process, including possible limits on eligibility of 
claims; require member firms to provide certain information regarding 
arbitration and predispute arbitration agreements to customers upon 
request; and clarify the rule regarding use of choice of law provisions 
in predispute arbitration agreements. Below is the text of the proposed 
rule change. Proposed new language is in italic; proposed deletions are 
in brackets.
* * * * *
RULES OF THE ASSOCIATION
3000. RESPONSIBILITIES RELATING TO ASSOCIATED PERSONS, EMPLOYERS, AND 
OTHERS' EMPLOYEES
3110. BOOKS AND RECORDS
    (f) Requirements When Using Predispute Arbitration Agreements 
[With] for Customer Accounts
    (1) Any predispute arbitration agreement clause shall be 
highlighted and shall be immediately preceded by the following 
[disclosure] language [(printed] in outline form [as set forth herein) 
which shall also be highlighted].
    This agreement contains a predispute arbitration clause. By signing 
an arbitration agreement, the parties agree as follows:
    (A) [Arbitration is final and binding on the parties.] All parties 
to this agreement are giving up the right to sue each other in court, 
including the right to a trial by jury, except as provided by the rules 
of the arbitration forum in which a claim is filed.
    (B) [The parties are waiving their right to seek remedies in court, 
including the right to a jury trial.] Arbitration awards are generally 
final and binding; a party's ability to have a court reverse or modify 
an arbitration award is very limited.
    (C) [Pre-arbitration discovery is generally more limited than and 
different from court proceedings.] The ability of the parties to obtain 
documents, witness statements and other discovery is generally more 
limited in arbitration than in court proceedings.
    (D) [The arbitrators' award is not required to include factual 
findings or legal reasoning and any party's right to appeal or seek 
modification of rulings of the arbitrators is strictly limited.] The 
arbitrators do not have to explain the reason(s) for their award.
    (E) The panel of arbitrators will typically include a minority of 
arbitrators who were or are affiliated with the securities industry.
    (F) The rules of some arbitration forums may impose time limits for 
bringing a claim in arbitration. In some cases, a claim that is 
ineligible for arbitration may be brought in court.
    (G) The rules of the arbitration forum in which the claim is filed, 
and any amendments thereto, shall be incorporated into this agreement.
    (2) (A) [Immediately preceding the signature line,] In any 
agreement containing a predispute arbitration agreement, there shall be 
a highlighted statement immediately preceding any signature line or 
other place for

[[Page 66682]]

indicating agreement [which shall be highlighted] that states that the 
agreement contains a predispute arbitration clause. the statement shall 
also indicate at what page and paragraph the arbitration clause is 
located.
    (B) At the time of signing, a copy of the agreement containing any 
such clause shall be given to the customer who shall acknowledge 
receipt thereof on the agreement or on a separate document.
    (3) [A copy of the agreement containing any such clause shall be 
given to the customer who shall acknowledge receipt thereof on the 
agreement or on a separate document.]
    (A) A member shall provide a customer with a copy of any predispute 
arbitration clause or customer agreement executed between the customer 
and the member, or inform the customer that the member does not have a 
copy thereof, within ten business days of receipt of the customer's 
request.
    (B) Upon request by a customer, a member shall provide the customer 
with the names of, and information on how to contact or obtain the 
rules of, all arbitration forums in which a claim may be filed under 
the agreement.
    (4) [No agreement shall include any condition which limits or 
contradicts the rules of any self-regulatory organization or limits the 
ability of a party to file any claim in arbitration or limits the 
ability of the arbitrators to make any award.]
    (A) No predispute arbitration agreement shall include any condition 
that:
    (i) limits or contradicts the rules of any self-regulatory 
organization;
    (ii) limits the ability of a party to file any claim in 
arbitration;
    (iii) limits the ability of a party to file any claim in court 
permitted to be filed in court under the rules of the forums in which a 
claim may be filed under the agreement;
    (vi) limits the ability of arbitrators to make any award.
    (B) No member may seek to enforce any choice-of-law provision 
unless there is a significant contact or relationship between (i) the 
law selected and (ii) either the transaction at issue or one or more of 
the parties.
    (5) [The requirements of subapragraphs (1) through (4) shall apply 
only to new agreements signed by an existing or new customer of a 
member after September 7, 1989.[ If a customer files a complaint in 
court against a member that contains claims that are subject to 
arbitration pursuant to predispute arbitration agreement between the 
member and the customer, the member may seek to compel arbitration of 
the claim that are subject to arbitration. If the member seeks to 
compel arbitration of such claims, the member must agree to arbitrate 
all of the claims contained in the complaint if the customer so 
requests.
    (6) All agreements shall include a statement that ``No person shall 
bring a putative or certified class action to arbitration, nor seek to 
enforce any predispute arbitration agreement against any person who has 
initiated in court a putative class action; or who is a member of a 
putative class action who has not opted out of the class with respect 
to any claims encompassed by the putative class action until: (i) the 
class certification is denied; or (ii) the class is decertified; or 
(iii) the customer is excluded from the class by the court. Such 
forbearance to enforce an agreement to arbitrate shall not constitute a 
waiver of any rights under this agreement except to the extent stated 
herein.''
    (7) [The requirements of subparagraph (6) shall apply only to a new 
agreements signed by an existing or new customer of a member after 
October 28, 1993.] The provisions of this Rule shall become effective 
on (effective date). Agreements signed by a customer before (effective 
date) are subject to the provisions of this Rule in effect at the time 
the agreement was signed.
    (g)-(h) Unchanged.
* * * * *

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

    In its filing with the Commission, NASD Regulation 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 staements may be examined at the places 
specified in Item IV below. NASD Regulation 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
    The purpose of the proposed rule change is threefold: to require 
additional disclosure in predispute arbitration agreements regarding 
the arbitration process, including possible limits on eligibility of 
claims; to require member firms to provide certain information 
regarding arbitration and predispute arbitration agreements to 
customers upon request; and to clarify the rule regarding use of 
choice-of-law provisions in predispute arbitration agreements.
Background
    Many broker-dealers require that customers seeking to open 
accounts, particularly margin and option accounts or accounts with a 
checking or money market feature, agree in writing to arbitrate 
disputes concerning the account, typically in an SRO-sponsored forum. 
These agreements, called ``predispute arbitration agreements,'' are 
generally part of the non-negotiated customer agreement drafted by the 
firm.
    To ensure that customers are advised about what they are agreeing 
to when they sign predispute arbitration agreements, NASD Conduct Rule 
3110(f) requires that such agreements contain highlighted disclosure 
about the differences between arbitration and litigation, including 
notice that by agreeing to arbitrate their disputes, customers may be 
waiving certain rights that would be available in court. Rule 3110(f) 
also requires that the agreement itself be highlighted, and that a copy 
of the agreement be given to the customer and acknowledged by the 
customer in writing.
    Despite these precautions, investor representatives have expressed 
concern that many customers who sign predispute arbitration agreements 
still do not adequately understand what they are agreeing to. For 
example, some predispute arbitration agreements contain ``choice-of-
law'' provisions that specify that the law of a certain state will 
govern disputes arising out of the agreement. In some cases, the member 
knows that the law of the chosen state may limit the ability of a 
customer to bring a claim or obtain an award, but the customer would 
not be aware of these restrictions from the face of the agreement. By 
signing an agreement that contained a choice-of-law provision, a 
customer might inadvertently waive certain rights and remedies. 
Customers' perceptions of unfairness are heightened by the fact that, 
when customers must sign predispute arbitration agreements in order to 
open accounts, their participation in SRO-sponsored arbitration may be 
involuntary.
    Consequently, in its 1996 report, Securities Arbitration Reform: 
Report of the Arbitration Policy Task Force to the Board of Governors, 
National Association of Securities Dealers, Inc. (``Task Force 
Report''), the Arbitration Task Force, chaired by David Ruder (formerly 
Chairman of the SEC and a

[[Page 66683]]

former NASD Board member), recommended that members be required to 
provide more disclosure about arbitration to customers who sign 
predispute arbitration agreements, and that the use of certain 
provisions that limit rights and remedies be restricted.
    Moreover, the NASD noted in its rule filings concerning the 
proposed eligibility (SR-NASD-97-44) and punitive damages rules (SR-
NASD-97-47) that the NASD would amend Rule 3110(f) to require 
disclosure of the limitations contained in those rules. This rule 
filing amends Rule 3110(f) to provide disclosure of the proposed 
eligibility rules. Simultaneous with this filing, the NASD filed an 
amendment to the punitive damages rule filing to include proposed 
amendments to Rule 3110(f) relating to punitive damages.
Proposed Amendments
Required Disclosure and Notice of Possible Restrictions on Eligibility
    Currently, paragraph (f)(1) of Rule 3110 mandates certain 
disclosure language about the differences between litigation and 
arbitration that must be included in predispute arbitration agreements. 
The proposed amendments would simplify the existing language in some 
existing provisions, and would add new provisions.
    One of the most significant new provisions concerns notice of 
possible limits in some arbitration forums on the time for bringing 
claims. Paragraph (f)(1)(F) would require disclosure that the rules of 
some arbitration forums may impose time limits for bringing claims in 
arbitration, and that, in some cases, claims that are ineligible for 
arbitration may be brought in court. This provision is intended to give 
notice to customers of the NASD's proposed eligibility rule, as well as 
the rules in other forums.
Applicability of Disclosure Requirements to New and Existing Account 
Agreements
    Members would be required to add the new disclosure requirements to 
all new customer account agreements containing predispute arbitration 
agreements as of the effective date of the rule. The proposed rule does 
not require members to replace existing agreements with current 
customers.
Incorporation of Arbitration Forum Rules
    Paragraph (f)(1)(G) would provide that the rules of the arbitration 
forum in which a claim is brought, and any amendments thereto, shall be 
incorporated into the agreement. The purpose of this provision is to 
ensure that the rules of a forum apply to cases brought in that forum, 
and to avoid having to execute new agreements each time a forum changes 
its rules. For example, if a customer filed a complaint in an NASD 
Regulation arbitration forum, the NASD's arbitration rules would apply 
in all respects to the agreement.
Requirement That Members Provide Copies of Customer Agreements and 
Information Regarding Arbitration Forums to Customers Upon Request
    In some cases, customers have complained that they have not been 
able to obtain copies of the predispute arbitration agreements they 
have signed from members in a timely manner, and that they had unequal 
access to information about the respective rules of the arbitration 
forums in which claims may be filed under a given agreement. Under the 
proposed amendments, paragraph (f)(3)(A) would require that, within ten 
days of receiving a request, members must provide a customer with a 
copy of any predispute arbitration agreement clause or agreement that 
the customer had signed, or inform the customer that the member does 
not have a copy of the agreement. In addition, paragraph (f)(3)(B) 
would require that, upon request of a customer, a member must provide 
the customer with the names of, and information on how to contact or 
obtain the rules of, all arbitration forums in which a claim may be 
filed under the agreement.
Restrictions on Provisions That Limit Rights and Remedies
    Much of the criticism of predispute arbitration agreements has 
focused on the use of choice-of-law provisions. A choice-of-law 
provision specifies that the law of a certain state will govern 
disputes arising our of an agreement. In some cases, the law of a state 
might limit the availability of certain remedies, such as punitive 
damages, or the ability of a customer to bring a claim. For example, 
previously under New York law, courts could award punitive damages, but 
arbitrators could not. A customer who agree to arbitrate disputes under 
New York law could inadvertently forfeit the ability to obtain punitive 
damages that might have been available in court. (New York law on this 
subject has begun to shift in favor of arbitrators being able to award 
punitive damages.) Customers have argued that it is unfair for members 
to include provisions in predispute arbitration agreements that limit 
the availability of remedies, particularly when the effects of the 
provisions are not explained in the agreement.
    Currently, Rule 3110(f) prohibits any choice-of-law provision that 
limits or contradicts the rules of any self-regulatory organization, or 
that limits the ability of a party to file any claim in arbitration or 
of arbitrators to make any award. However, the application of this 
provision has not always been consistent or clear. In addition, some 
investors have expressed concern that choice-of-law provisions select 
arbitrary jurisdictions that have no relationship to the customer or 
the transaction at issue.
    To address these concerns, paragraph (f)(4) of the Rule would be 
amended to clarify the prohibition against provisions that limit rights 
or remedies, including provisions that would circumvent the eligibility 
rule. The amendment rule would also state that no choice-of-law 
provision will be enforceable unless there is a significant contact or 
relationship between the law selected and either the transaction at 
issue or the one or more of the parties.
Non-Bifurcation Provision
    The NASD's proposed eligibility rule contains certain provisions 
intended to provide customers with a forum for all of their claims but 
to prevent them from having to bifurcate their claims, that is, from 
being forced to litigate their claims in two forums (court and 
arbitration) at the same time.\4\ NASD Regulation also stated in the 
eligibility rule filing that it would amend Rule 311(f) to include a 
provision prohibiting members from seeking to compel arbitration of 
some but not all of a customer's court-filed claims, in order to 
prevent members from forcing customers to litigate in two forums when 
they filed a complaint in court that contained both eligible and 
ineligible claims. Therefore, NASD Regulation is proposing to add a new 
paragraph (f)(5) to Rule 3110(f) that would require members seeking to 
compel arbitration of claims filed in court to agree to arbitrate all 
of the claims contained in the court-filed complaint, even if some of 
the claims would be ineligible for arbitration under the eligibility 
rule. The purpose of these provisions in the eligibility rule and Rule 
3110(f) is to give the customer

[[Page 66684]]

control over whether claims are bifurcated.
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    \4\ Under the proposed eligibility rule, if the Director of 
Arbitration rules that the claims contained in a complaint are 
ineligible for arbitration because they are based on occurrences or 
events that took place more than six years before the complaint was 
filed, the customer may file the complaint in court. If the Director 
rules that some of the transactions are eligible for arbitration, 
the customer has the option either to pursue the eligible claims in 
arbitration and the ineligible claims in court, or to pursue both 
the eligible and ineligible claims in court.
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Effective Date Provisions
    The proposed amendments to Rule 3110(f) would require various 
changes to the customer agreements used by member firms, including 
adding disclosure of proposed amendments to the NASD's eligibility rule 
contained in a currently-pending rule filing (SR-NASD-97-44). The 
proposed punitive damages rule (SR-NASD-97-47) would also require 
changes to the customer agreements used by member firms. In order to 
prevent multiple amendments to customer agreements as a result of these 
three rule filings, the NASD has determined that these three rule 
filings, if approved, should take effect at the same time. In addition, 
the effective date of the rules must provide enough time for firms to 
modify their customer agreements. Therefore, the proposed amendments to 
Rule 3110(f) and the eligibility rule, and the proposed punitive 
damages rule, will become effective 120 days after final Commission 
action on the last of the three rule filings. The NASD will announce 
the effective date of the rules in a Notice to Members published prior 
to the effective date.
    The proposed amendments to Rule 3110(f) would also provide that 
agreements signed before the effective date of the Rule amended would 
be subject to the provisions of 3110(f) in effect at the time the 
agreement was signed.
Restriction of Rule of Customer Account Agreements
    Some members of the NASD's National Arbitration and Mediation 
Committee (``NAMC'') expressed concern that the rule, which currently 
applies to all predispute arbitration clauses in any agreement between 
member firms and customers, could be construed to apply to agreements 
between a member firm and large institutional clients with whom they 
had face-to-face negotiations over the terms of the agreement. To 
address this concern, the rule would be amended to clarify that it only 
applies to customer accounts and not to other agreements between member 
firms and large institutional clients with whom they had negotiated 
contract terms.
2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act, which 
requires, among other things, that the Association's rules must be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest. The NASD believes that the 
proposed amendments to Rule 3110(f) will serve the public interest by 
providing customers with more complete information about the 
arbitration process.

B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation does not believe that the proposed rule change will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

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

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve such proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. 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-
0609. 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 in 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-98-74 and should 
be submitted by December 20, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\5\
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    \5\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-30836 Filed 11-26-99; 8:45 am]
BILLING CODE 8010-01-M