[Federal Register Volume 67, Number 192 (Thursday, October 3, 2002)]
[Notices]
[Pages 62085-62088]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-25104]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46562; File No. SR-NASD-2002-126]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by National 
Association of Securities Dealers, Inc. To Require Industry Parties in 
Arbitration To Waive Application of Contested California Arbitrator 
Disclosure Standards, Upon the Request of Customers and Associated 
Persons With Claims of Statutory Employment Discrimination, for a Six-
Month Pilot Period

September 26, 2002.
    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 September 23, 2002, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I and II, below, which Items have been prepared by NASD. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons. For the reasons described 
below, the Commission is granting accelerated approval to the proposed 
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing to amend IM-10100 to require industry parties in 
arbitration to waive application of contested California arbitrator 
disclosure standards, upon the request

[[Page 62086]]

of customers that have waived the application of these standards (and, 
in industry cases, upon the request of associated persons with claims 
of statutory employment discrimination that have waived the application 
of these standards), for a six-month pilot period. Below is the text of 
the proposed rule change. Proposed new language is in italics; proposed 
deletions are in [brackets].
* * * * *

IM-10100. Failure To Act Under Provisions of Code of Arbitration 
Procedure

    It may be deemed conduct inconsistent with just and equitable 
principles of trade and a violation of Rule 2110 for a member or a 
person associated with a member to:
    (a)-(e) No change.
    (f) fail to waive the California Rules of Court, Division VI of the 
Appendix, entitled, ``Ethics Standards for Neutral Arbitrators in 
Contractual Arbitration'' (the ``California Standards''), if all the 
parties in the case who are customers have waived application of the 
California Standards in that case; or
    (g) fail to waive the California Standards, if all the parties in 
the case who are associated persons with a claim alleging employment 
discrimination, including a sexual harassment claim, in violation of a 
statute have waived application of the California Standards in that 
case.
* * * * *

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 included statements 
concerning the purpose of and basis for the proposed rule change.\3\ 
The text of these statements may be examined at the places specified in 
Item III below. NASD has prepared summaries, set forth in Sections A, 
B, and C below, of the most significant aspects of such statements.
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    \3\ The discussion in this section represents the NASD's views 
on the situation in California, and does not in any way represent a 
Commission position on this issue.
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A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    NASD's foremost interest is to serve investors who bring their 
claims to the NASD by providing a fair, efficient arbitration forum at 
a modest cost. To this end, NASD spent several months trying to resolve 
the issues created by the recent California Rules of Court, Division VI 
of the Appendix, entitled, ``Ethics Standards for Neutral Arbitrators 
in Contractual Arbitration'' (the ``California Standards''), which are 
described in more detail below. Only as a last resort, when it became 
clear that NASD could not resolve these issues consistent with 
providing a fair and efficient national forum, did NASD, along with the 
New York Stock Exchange (``NYSE''), conclude that NASD should cease 
appointing arbitrators in California and institute litigation.\4\
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    \4\ See Motion for Declaratory Judgment, NASD Dispute 
Resolution, Inc. and New York Stock Exchange, Inc. v. Judicial 
Council of California, filed in the United States District Court for 
the Northern District of California, No. C 02 3486 SBA (July 22, 
2002), available on the NASD Web site at: http://www.nasdadr.com/pdf-text/072202_ca_complaint.pdf.
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    NASD and NYSE have filed a joint complaint in federal court for 
declaratory relief \5\ in which they contend the California Standards 
cannot lawfully be applied to NASD and NYSE (both registered as self-
regulatory organizations (``SROs'') with the SEC under the Act) and 
their arbitrators because the California Standards are preempted by 
federal law and are inapplicable to SROs under state law.\6\ Pursuant 
to the parties' agreement, the court directed expedited proceedings.
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    \5\ As noted above, NASD and NYSE filed a lawsuit on July 22, 
2002, seeking a declaratory judgment that the Standards that went 
into effect in California on July 1, 2002 do not apply to 
arbitrations conducted by NASD or the NYSE as a matter of federal 
law. The suit has three legal bases: that securities regulation is 
part of a pervasive system of federal regulation and state efforts 
to regulate SRO-administered arbitration are impermissible; that 
California's rules are preempted by the Federal Arbitration Act, as 
interpreted by the United States Supreme Court; and that the 
California rules improperly expanded on the definition of neutral 
arbitrator as provided in California statutory law. The parties to 
the litigation have entered into a stipulation for the court to 
adjudicate the case on an expedited basis.
    \6\ On September 19, 2002, the SEC sought leave of the court to 
file a friend of the court (``amicus curiae'') brief in which it 
contended that the California Standards are preempted by federal 
law. Brief of the Securities and Exchange Commission, Amicus Curiae, 
in Support of Plaintiffs' Motion for Declaratory Judgment, NASD 
Dispute Resolution, Inc. and New York Stock Exchange, Inc. v. 
Judicial Council of California, No. C 02 3486 SBA (N.D. Cal.). The 
brief is available on the SEC Web site at: http://www.sec.gov/litigation/briefs/nasddispute.pdf.
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    While waiting for the Court's guidance on this issue, NASD and NYSE 
announced that they were temporarily postponing the appointment of 
arbitrators for new arbitration cases in California until their 
concerns over the new rules governing the arbitration process in that 
state were addressed. Since appointments stopped on July 1, 2002, 
approximately five hundred NASD and NYSE California cases have been 
affected. In an effort to keep cases moving, NASD and NYSE have offered 
California parties several alternatives, enumerated below.
    On September 5, 2002, the Chairmen of NASD and NYSE received a 
request from Harvey L. Pitt, Chairman of the SEC, to further expedite 
processing of arbitration claims involving California parties. In 
response, NASD Chairman Robert R. Glauber stated that NASD would work 
closely with SEC staff to develop interim steps to process California 
cases. Having done so, NASD now proposes implementation of a six-month 
pilot amendment to IM-10100 that will require all parties that are 
member firms or associated persons to waive the California Standards if 
all the parties in the case who are customers or associated persons 
with a statutory employment discrimination claim \7\ have waived 
application of the California Standards in that case. Under such a 
waiver, the case would proceed in California under the existing NASD 
Code, which already contains extensive disclosure requirements and 
provisions for challenging arbitrators with potential conflicts of 
interest.
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    \7\ The amendment will require members to waive the Standards 
not only at the request of customers that have waived, but also in 
industry cases in which the parties who are associated persons with 
claims of statutory employment discrimination have waived, since 
such claims already are subject to special procedures in arbitration 
(see NASD Rule 10201(b) and the NASD Rule 10210 Series).
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    NASD will notify parties (and their representatives, if any) who 
currently are awaiting the appointment of arbitrators in California of 
the terms of this new rule upon its approval by the Commission, and 
will provide them with the waiver forms.

Background

    On July 1, California introduced new rules governing the 
arbitration process in that state. The rules were designed to address 
conflicts of interest in private arbitration forums that are not part 
of a federal regulatory system overseen on a uniform, national basis by 
the SEC. The NASD and NYSE not-for-profit, highly regulated dispute 
resolution programs have in place appropriate conflict of interest 
rules.
    The California Standards put extreme and unnecessary disclosure 
burdens on individuals who serve on NASD arbitration panels and already 
meet stringent disclosure rules. The extensive record-keeping 
requirements for arbitrators, coupled with potential liability for even 
inadvertent violations of the California Standards, led NASD to

[[Page 62087]]

conclude that, if NASD were required to implement the California rules, 
investors and other parties would be saddled with higher costs, a less 
efficient and streamlined process, and a much smaller arbitrator roster 
from which to select the panelists who will decide their cases. Under 
the California Standards, even inadvertent non-disclosure of immaterial 
relationships is a basis for removal of an arbitrator and vacatur of an 
award. The California Standards remove from the alternative dispute 
resolution administrator the power to decide contested challenges to 
arbitrators, instead vesting this authority unilaterally in any party 
to the arbitration. As currently drafted, the California Standards 
would allow a party unilaterally to challenge and remove one arbitrator 
after another, thus destroying any notion of arbitral finality and 
closure. Accordingly, both NASD and NYSE filed extensive comments when 
the rules were proposed in February 2002, followed by meetings between 
NASD and NYSE officials and Judicial Council and Legislative staff. 
Despite these efforts, the California Standards were promulgated 
without addressing the fundamental concerns expressed by NASD and the 
NYSE. As a result, both forums announced in July 2002 that they were 
postponing the appointment of arbitrators for new arbitration cases in 
California until this matter could be resolved.

Measures Previously Implemented

    NASD has taken several steps to help investors deal with the delay 
in California cases. Specifically, NASD announced that it would provide 
venue changes for arbitration cases and absorb the extra administrative 
costs associated with the change of venue, use non-California 
arbitrators when appropriate, and waive its administrative fees for 
NASD-sponsored mediations. To accommodate cases being heard outside of 
California, NASD added Reno, Nevada as a new hearing location to the 
existing sites in Portland, Oregon; Seattle, Washington; Phoenix, 
Arizona; and Las Vegas, Nevada. On September 3, 2002, NASD further 
enhanced the venue selection for investors by announcing that cases 
would be moved outside of California at the request of an investor; 
member firm acquiescence is no longer required.
    To educate parties about these measures, NASD posted on its Web 
site specific guidance announcing and elaborating on these steps. 
Importantly, NASD also advised that investors who believe they have 
disputes with their brokers should not delay in filing their cases with 
an SRO forum because of statutes of limitations. NASD also advised that 
NASD is still processing California cases as they are filed up to the 
point of sending out lists of arbitrators (or appointing arbitrators, 
in cases that had already passed the list selection stage). NASD 
announced that the 660 California cases that had already been paneled 
prior to July 1, 2002 would continue in the normal course.
    Finally, to accommodate investors with exigent circumstances (e.g., 
elderly investors or investors with infirmities), NASD has paneled 
cases at the request of the investor or the investor's representative 
in situations where both the investor and the broker/dealer have agreed 
in writing to waive the California standards.

Proposed Rule Change

    In its ongoing efforts to accommodate California parties in its 
forum, NASD is taking additional steps to resume paneling of California 
cases while the litigation between California and the NASD and NYSE 
continues. The proposed rule will require industry parties to waive the 
California Standards in all cases in which all the parties in the case 
who are customers (or, in industry cases, who are associated persons 
with claims of statutory employment discrimination) agree to waive 
application of the Standards. Under such a waiver, the case would 
proceed in California under the existing NASD Code, which already 
contains extensive disclosure requirements and provisions for 
challenging arbitrators with potential conflicts of interest.
    Starting immediately, NASD will resume issuing lists of proposed 
arbitrators in California cases from which the parties select their 
panels under the current Neutral List Selection System (NLSS). Once the 
proposed rule is effective, NASD will send letters to investors and 
associated persons with claims of statutory employment discrimination, 
giving them the option of waiving the California Standards and 
providing them with waiver forms. NASD is taking other steps to inform 
investors of how they can move their arbitration cases forward under 
this situation. NASD staff members have spoken with numerous investors 
and other parties, and their representatives, and will continue to do 
so, as well as sending written material and posting information to its 
Web site.
    At the same time, NASD will notify industry parties in all pending 
California cases that they must waive the California Standards where 
the investor agrees to a waiver (or associated person, in the 
circumstances described above). Industry parties in such cases will be 
required to execute waiver agreements; however, their failure to do so 
will not stop the cases from moving forward \8\ and the failure to sign 
as required by the proposed rule change will be referred for 
disciplinary action.
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    \8\ In these situations, the NASD will treat the industry 
parties as having waived the California standards.
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    Where all parties waive the California Standards as provided in the 
proposed rule change, NASD will immediately commence the arbitrator 
appointment process using the NASD Code of Arbitration Procedure 
guidelines regarding arbitrator disclosure, and not the California 
Standards. This opportunity will apply to those cases where NASD is 
ready to appoint arbitrators based on lists already executed by the 
parties, and those cases where there is a vacancy in a previously 
appointed panel.
    NASD requests that the rule change become effective on September 
30, 2002, for a six-month pilot period.\9\
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    \9\ If the outcome of the lawsuit is that the California 
Standards do not apply to NASD arbitration, waivers would no longer 
be necessary. Cases in which arbitrators were appointed pursuant to 
waivers would continue to their conclusion. If the lawsuit has not 
concluded at the expiration of the six-month pilot period, NASD may 
request an extension.
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2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\10\ 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. NASD believes that expediting the appointment 
of arbitrators under the proposed waiver, at the request of customers 
(and, in industry cases, associated persons with claims of statutory 
employment discrimination), will allow those parties to exercise their 
contractual rights to proceed in arbitration in California, 
notwithstanding the confusion caused by the disputed California 
Standards.
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    \10\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD 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.

[[Page 62088]]

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

    Written comments were neither solicited nor received.

III. 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, NW, Washington, DC 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-2002-126 and 
should be submitted by October 24, 2002.

IV. Commission's Findings and Order Granting Accelerated Approval of 
the Proposed Rule Change

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities association, 
and, in particular, the requirements of Section 15A of the Act.\11\ 
Specifically, the Commission finds that the proposal is consistent with 
Section 15A(b)(6) of the Act, which requires that the rules be designed 
to promote just and equitable principles of trade, as well as to remove 
impediments to and perfect the mechanism of a free and open market, 
and, in general, to protect investors and the public interest.\12\ The 
Commission further finds good cause for approving the proposed rule 
change prior to the 30th day after the date of publication of notice 
thereof in the Federal Register. Accelerated approval is necessary to 
protect investors in that the rules are designed to help address the 
backlog of cases created by the confusion over the new California 
standards, are designed to provide them with a mechanism to help 
resolve their disputes with broker-dealers in a more expedited manner, 
and are designed to help ensure the certainty and finality of 
arbitration awards. Additionally, the proposed rule change will become 
effective as a pilot program for six months, from September 30, 2002 to 
March 30, 2003, during which time the Commission and NASD will monitor 
the status of the previously discussed litigation.
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    \11\ 15 U.S.C. 78o-3.
    \12\ 15 U.S.C. 78o-3(b)(6).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (SR-NASD-2002-126) is hereby 
approved on an accelerated basis.
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    \13\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-25104 Filed 10-2-02; 8:45 am]
BILLING CODE 8010-01-P