[Federal Register Volume 68, Number 177 (Friday, September 12, 2003)]
[Notices]
[Pages 53762-53766]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-23224]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48444; File No. SR-NASD-98-74]


Self-Regulatory Organizations; Notice of Filing of Amendment Nos. 
3 and 4 to a Proposed Rule Change by the National Association of 
Securities Dealers, Inc. Relating to NASD Rule 3110(f) Governing Use of 
Predispute Arbitration Agreements With Customers

September 4, 2003.
    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 August 22, 2003, the National Association of Securities Dealers, 
Inc. (``NASD''), filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') Amendment No. 4 to a proposed rule change 
as described in Items I, II, and III below, which Items have been 
prepared by NASD. Notice of the proposal, as amended by Amendment Nos. 
1 and 2, was published in the Federal Register on November 29, 1999.\3\ 
The Commission received two comment letters on the proposal.\4\ On 
April 30, 2002, NASD submitted a response to comments and Amendment No. 
3 to the proposed rule change.\5\ The Commission is publishing this 
notice to solicit comments on the proposed rule change, as amended.
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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. 42160 (November 19, 
1999), 64 FR 66681.
    \4\ See letters from Barry D. Estell, dated December 15, 1999 
(``Estell Letter''), and John J. Miller, dated December 27, 1999 
(``Miller Letter'').
    \5\ See letter from Sarah J. Williams, Office of General 
Counsel, NASD Regulation, Inc., to Katherine A. England, Assistant 
Director, Division of Market Regulation, Commission, dated April 30, 
2002 (``Amendment No. 3''). In Amendment No. 3, NASD responded to 
comments and changed the effective date provision of the proposal.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD proposes to amend NASD Rule 3110(f) to: require additional 
disclosure

[[Page 53763]]

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. In Amendment No. 4, NASD proposes to 
change the effective date of the proposed rule change to be 90 days 
following publication of a Notice to Members announcing approval by the 
Commission of the proposed rule change; NASD will issue such Notice to 
Members within 60 days of Commission approval. Below is the text of the 
proposed rule change. Proposed new language is in italics; 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 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;
    (iv) 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 subparagraphs (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 a predispute arbitration agreement between the 
member and the customer, the member may seek to compel arbitration of 
the claims 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 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). The provisions of subparagraph (3) shall apply to 
all members as of the effective date of this Rule regardless of when 
the customer agreement in question was executed. Otherwise, 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.
* * * * *

[[Page 53764]]

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 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. NASD 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.

Procedural History of Rule Filing

    In 1997, NASD filed three separate rule filings with the Commission 
relating to predispute arbitration agreements. The first rule filing 
related to the eligibility of claims for arbitration, the second rule 
filing proposed a cap on punitive damages in arbitration disputes,\6\ 
and the third, SR-NASD-98-74 (this rule filing) related to increased 
disclosure with respect to predispute arbitration agreements.\7\ In 
July 1999, the effective date provisions of the three rule filings were 
linked to avoid the cost to firms, and the potential confusion to 
customers, of requiring multiple amendments to customer agreements in a 
relatively short period of time.
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    \6\ On June 24, 1997, NASD submitted a proposed rule change 
concerning the eligibility of claims for arbitration (``Eligibility 
Rule Filing''). See Securities Exchange Act Release No. 39487 
(December 23, 1997), 63 FR 588 (January 6, 1998) (SR-NASD-97-44). On 
July 7, 1997, NASD submitted a proposal to cap punitive damages in 
arbitration disputes (``Punitive Damages Rule Filing''). See 
Securities Exchange Act Release No. 39371 (November 26, 1997), 62 FR 
64428 (December 5, 1997) (SR-NASD-97-47). The Eligibility Rule 
Filing was withdrawn on December 17, 2002, and the Punitive Damages 
Rule Filing was withdrawn on May 9, 2003.
    \7\ This proposal, SR-NASD-98-74, was initially filed with the 
Commission on October 6, 1998. On May 26, 1999, NASD submitted 
Amendment No. 1 to delete provisions from the proposed rule change 
relating to punitive damages so that all such provisions could be 
separately considered in connection with the Punitive Damages Rule 
Filing. On July 27, 1999, NASD submitted Amendment No. 2 to clarify 
the proposed rule language regarding permissible limitations in 
predispute arbitration agreements, and changed the effective date of 
the proposed rule change to coincide with the Eligibility Rule 
Filing and Punitive Damages Rule Filing then pending before the 
Commission (SR-NASD-97-44 and SR-NASD-97-47).
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    On November 19, 1999 the Commission published the proposed rule 
change for comment in the Federal Register.\8\ This Notice incorporated 
Amendment Nos. 1 and 2 to the proposed rule change. The Commission 
received two comment letters on the proposed rule change.\9\ On April 
30, 2002, NASD submitted a Response to Comments and Amendment No. 3 to 
the proposed rule change.
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    \8\ See supra note.
    \9\ See supra note.
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    NASD subsequently withdrew the Eligibility Rule Filing on December 
17, 2002, and the Punitive Damages Rule Filing on May 9, 2003. As a 
result, NASD is proposing to revise the effective date of SR-NASD-98-74 
so that the proposed rule change may proceed.

Background

    The proposed rule change is intended to increase the disclosure 
required in predispute arbitration agreements. 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 a self-regulatory organization (``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 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 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.

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 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 NASD Rule 10304 relating to eligibility of 
claims submitted to arbitration, as well as the rules in other forums.

[[Page 53765]]

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 
arbitration forum, 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 out 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 agreed 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 SRO, 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 amended rule would also state that no choice-of-law provision 
would be enforceable unless there is a significant contact or 
relationship between the law selected and either the transaction at 
issue or one or more of the parties.
    In response to the Federal Register publication of SR-NASD-98-74 in 
November, 1999,\10\ two commenters expressed the view that the laws of 
the state in which the customer resides should apply in arbitration 
disputes.\11\ NASD believes that it should not dictate to the parties 
of a predispute arbitration agreement the law that would govern their 
agreement. NASD believes the approach taken by the proposed rule change 
effectively balances the rights of parties to contractually agree on 
the law that will govern their disputes with the concerns expressed by 
customers regarding choice-of-law provisions in predispute arbitration 
agreements.
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    \10\ See supra note.
    \11\ See Estell Letter and Miller Letter, supra note.
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Non-Bifurcation Provision

    NASD is proposing to amend Rule 3110(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.\12\ Therefore, NASD is proposing to add a new paragraph (f)(5) 
to Rule 3110 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 Rule 3110(f) is to give the customer 
control over whether claims are bifurcated.
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    \12\ In June 2003, NASD filed proposed amendments to Rule 10304 
relating to time limits for the submission of claims to arbitration. 
The proposed rule change seeks to amend Rule 10304 to provide that 
by requesting dismissal of a claim on eligibility grounds in the 
NASD forum, the requesting party is agreeing that the claimant may 
withdraw all related claims without prejudice and may pursue all of 
the claims in court. The proposed provision seeks to protect parties 
against involuntary bifurcation of claims. The filing is currently 
pending with the Commission. See Securities Exchange Act Release No. 
48225 (July 25, 2003), 68 FR 45299 (August 1, 2003) (SR-NASD-2003-
101).
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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. In order to 
provide enough time for firms to modify customer agreements, NASD has 
determined that this rule filing, if approved, should take effect 90 
days after publication of a Notice to Members announcing Commission 
approval of the proposed rule change. NASD would issue the Notice to 
Members within 60 days of receiving Commission approval.
    The proposed amendments to Rule 3110(f) would also provide that 
agreements signed before the effective date of the Rule as amended 
would be subject to the provisions of 3110(f) in effect at the time the 
agreement was signed.

Restriction of Rule to Customer Account Agreements

    Some members of NASD's National Arbitration and Mediation Committee 
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

[[Page 53766]]

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 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 NASD'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 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 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 Amendment Nos. 3 and 4, including whether the 
proposed rule change, as amended, 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 NASD. All submissions 
should refer to File No. SR-NASD-98-74 and should be submitted by 
October 3, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-23224 Filed 9-11-03; 8:45 am]
BILLING CODE 8010-01-P