[Federal Register Volume 68, Number 247 (Wednesday, December 24, 2003)]
[Notices]
[Pages 74667-74673]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-31646]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48933; File No. SR-NASD-2002-168]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc; Order Granting Approval of Proposed Rule Change and 
Amendment No. 1, Thereto, and Notice of Filing and Order Granting 
Accelerated Approval to Amendment No. 2, Thereto, Relating to Proposed 
NASD Rule 2130 Concerning the Expungement of Customer Dispute 
Information From the Central Registration Depository System

December 16, 2003.

I. Introduction and Description of the Proposal

    On November 19, 2002, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities 
and Exchange Commission (``SEC'' or ``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 that would: (1) 
Require all directives to expunge customer dispute information from the 
Central Registration Depository (``CRD'or ``CRD system'') to be 
confirmed by or ordered by a court of competent jurisdiction; (2) 
require member firms and associated persons seeking expungement to name 
NASD as an additional party in any judicial proceeding seeking 
expungement relief or confirming an arbitration award containing 
expungement relief; and (3) permit member firms and associated persons 
to ask NASD to waive the requirement to name NASD as a party on the 
basis that the expungement order meets at least one of the standards 
for expungement articulated in the proposed rule.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    On January 28, 2003, NASD submitted Amendment No. 1 to the proposed 
rule change.\3\ The proposed rule change, as amended, was published for 
comment in the Federal Register on March 10, 2003.\4\ The Commission 
received 28 comments on the proposal from a wide range of sources. The 
NASD responded to these comments by amending the filing on September 
11, 2003.\5\ This order approves the proposed rule change, as amended 
by Amendment No. 1. In addition, the Commission is publishing a notice 
to solicit comment on and is simultaneously approving, on an 
accelerated basis, Amendment No. 2 to the proposal. Below is the text 
of the proposed rule change, as amended by Amendment No. 2. Deletions 
of the proposed rule text, which was published in the Notice, appear in 
[brackets]; proposed rule language to be added by Amendment No. 2 
appears in italics.
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    \3\ See letter, dated January 28, 2003, from Patrice M. 
Gliniecki, Vice President and Deputy General Counsel, NASD, to 
Katherine A. England, Assistant Director, Division of Market 
Regulation, Commission (``Amendment No. 1'').
    \4\ See Securities Exchange Act Release No. 47435 (March 4, 
2003), 68 FR 11435 (``Notice'').
    \5\ See letter from Shirley H. Weiss, Associate General Counsel, 
Office of the General Counsel, NASD, to Jonathan G. Katz, Secretary, 
Commission (September 11, 2003) (``Amendment No. 2''). In Amendment 
No. 2, the NASD made certain changes to its proposed rule text in 
response to comments received by the Commission in connection with 
the filing. The Amendment No. 2 rule text changes are published in 
their entirety and discussed at length below.
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* * * * *

[[Page 74668]]

2130. Obtaining an Order of Expungement of Customer Dispute Information 
From the Central Registration Depository (CRD System)
    (a) Members or associated persons seeking to expunge information 
from the CRD system arising from disputes with [public] customers must 
obtain an order from a court of competent jurisdiction directing such 
expungement or confirming an arbitration award containing expungement 
relief.
    (b) Members or associated persons petitioning a court for 
expungement relief or seeking judicial confirmation of an arbitration 
award containing expungement relief must name NASD as an additional 
party and serve NASD with all appropriate documents unless this 
requirement is waived pursuant to subparagraph (1) or (2) below.
    (1) Upon request, NASD may waive the obligation to name NASD as a 
party if NASD determines that the expungement relief is based on 
affirmative judicial or arbitral findings that:
    (A) the claim, allegation, or information is [without factual 
basis] factually impossible or clearly erroneous;
    (B) the [complaint fails to state a claim upon which relief can be 
granted or is frivolous] registered person was not involved in the 
alleged investment-related sales practice violation, forgery, theft, 
misappropriation, or conversion of funds; or
    (C) the [information contained in the CRD system is defamatory in 
nature] claim, allegation, or information is false.
    (2) If the expungement relief is based on judicial or arbitral 
findings other than those described above, NASD, in its sole discretion 
and under extraordinary circumstances, also may waive the obligation to 
name NASD as a party if it determines that:
    (A) the expungement relief and accompanying findings on which it is 
based are meritorious; and
    (B) the expungement would have no material adverse effect on 
investor protection, the integrity of the CRD system, or regulatory 
requirements.
    (c) For purposes of this rule, the terms ``sales practice 
violation,'' ``investment-related,'' and ``involved'' shall have the 
meanings set forth in the Uniform Application for Securities Industry 
Registration of Transfer (``Form U4'') in effect at the time of 
issuance of the subject expungement order.
* * * * *

II. Summary of Comments and Response to Comments

A. Comments Received

    As stated above, the Commission received 28 comments from a variety 
of sources.\6\ The majority of comments received were in favor of the 
NASD putting a rule in place on this topic, but had a variety of 
suggestions as to how to make the proposed rule text more effective. 
The arguments put forth in the comments are summarized as follows.
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    \6\ See Letter to Margaret H. McFarland, Deputy Secretary, 
Commission, from Charles W. Austin, Jr., Executive Vice-President, 
Public Investors Arbitration Bar Association (March 28, 2003) 
(``PIABA Comment); letter to Secretary, Commission, from Joel A. 
Goodman and Stephen Krosschell, Goodman & Nekvasil, P.A. (March 29, 
2003) (``G&N Comment''); electronic mail (``e-mail'') to Secretary, 
Commission, from Barry D. Estell (March 28, 2003) (``Estell 
Comment''); letter to Secretary, Commission, from C. Thomas Mason 
III (March 31, 2003) (``Mason Comment''); letter to Jonathan G. 
Katz, Secretary, Commission, from Stuart J. Kaswell, Senior Vice 
President and General Counsel, Securities Industry Association 
(March 31, 2003) (``SIA Comment''); e-mail to Commission Rule 
Comments from Steven M. Sherman (March 31, 2003) (``Sherman 
Comment''); e-mail to Commission Rule Comments from Alan L. Sachs 
(March 28, 2003) (``Sachs Comment''); e-mail to Commission Rule 
Comments from Helen Mangano (March 28, 2003) (``Mangano Comment''); 
e-mail to Commission Rule Comments from John J. Miller (March 30, 
2003) (``Miller Comment''); letter to Jonathan G. Katz, Secretary, 
Commission, from Gerald S. Siegmyer, Siegmyer, Oshman & Geddie, 
L.L.P. (April 7, 2003) (``SO&G Comment''); letter to Commission from 
Donald G. McGrath, McGrath & Polvino, PLLC (March 27, 2003) (``M&P 
Comment''); letter to Commission from A. Daniel Woska, Woska & 
Hasbrook (March 31, 2003) (``W&H Comment''); letter to Jonathan G. 
Katz, Secretary, Commission, from Dan Jamieson (April 25, 2003) 
(``Jamieson Comment''); letter to Commission from Kenneth R. Hyman, 
President, Partnervest Securities, Inc. (May 19, 2003) 
(``Partnervest Comment''); e-mail to Commission from Steven K. 
McGinnis (May 19, 2003) (``McGinnis Comment''); letter to Commission 
from Robert L. Hicks, President, Finance 500 (May 19, 2003) 
(``Finance 500 Comment''); e-mail to Commission Rule Comments from 
Robert Eastmann (June 3, 2003) (``Eastmann Comment''); letter to 
Margaret H. McFarland, Deputy Secretary, Commission, from Deborah 
Bortner, North American Securities Administrators Association CRD 
Steering Committee Co-Chair and Washington State Director of 
Securities (June 4, 2003) (``NASAA Comment''); e-mail to Commission 
Rule Comments from Tammy McQuade (June 7, 2003) (``McQuade 
Comment''); e-mail to Commission Rule Comments from Fired Broker 
(June 9, 2003) (``Fired Broker Comment''); e-mail to Commission Rule 
Comments from Mike Marchetta (June 10, 2003) (``Marchetta 
Comment''); e-mail to Commission Rule Comments from David Macias 
(June 10, 2003) (``Macias Comment''); e-mail to Commission Rule 
Comments from djs (June 10, 2003) (``djs Comment''); 23 
substantially identical form letters to Commission from John 
Schooler, President, WFP Securities (May 21, 2003) (``Form Letter 
Comment''); e-mail to Commission Rule Comments from Richard Lavoice 
(July 29, 2003) (``Lavoice Comment''); e-mail to Commission Rule 
Comments from Steve Kus (July 2, 2003) (``Kus Comment''); e-mail to 
Commission Rule Comments from David Haburjak (July 8, 2003) 
(``Haburjak Comment''); and e-mail to Commission Rule Comments from 
Jim Aldendifer (October 12, 2003) (``Aldendifer Comment'').
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    Argument #1--The criteria adopted with respect to when the NASD 
will waive its involvement at the court confirmation level should be 
the criteria used by arbitrators for granting expungement. In short, 
rather than simply the criteria for NASD joining the court confirmation 
proceeding, the standards should be applied directly to arbitrators 
through the NASD's Code of Arbitration Procedures.\7\
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    \7\ See PIABA Comment and Mason Comment.
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    Argument #2--Member firms and associated persons will be in a 
position to ``buy clean records'' through an arbitration award 
containing unwarranted expungement criteria that includes one of the 
three standards proposed.\8\
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    \8\ See PIABA Comment; G&N Comment; Estell Comment; Mason 
Comment; SO&G Comment; W&H Comment; and Jamieson Comment.
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    Argument #3--The standard for proving a defamation claim varies by 
jurisdiction and, in conjunction with the proposed standard language 
invoking defamation principles, the result will be confusion as to 
which law should be applied.\9\
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    \9\ See PIABA Comment.
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    Argument #4--An absolute or partial privilege exists for defamation 
claims that arise out of quasi-judicial proceedings (e.g., arbitration) 
in most jurisdictions, but not all. Thus, confusion could result from 
the lack of uniformity in this regard.\10\
    Argument #5--Extensive collateral litigation will be required to 
resolve which jurisdiction's defamation standard should apply.\11\
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    \10\ See PIABA Comment; G&N Comment; Mason Comment; Mangano 
Comment; and SO&G Comment.
    \11\ See PIABA Comment.
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    Argument #6--The proposal will cause a ``chilling effect.'' 
Investors will be disinclined to bring any arbitration claims because 
of the near certainty that members and associated persons will raise 
defamation as a defense and counterclaim.\12\
    Argument #7--The proposal will result in a ``dispositive motions 
practice.'' The formal pleading requirements established by the 
proposal will give rise to an expensive and legally complex motions 
practice (thus defeating the main goal of arbitration--informal and 
inexpensive conflict resolution).\13\
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    \12\ See PIABA Comment; G&N Comment; Estell Comment; Mason 
Comment; Sachs Comment; Mangano Comment; Miller Comment; SO&G 
Comment; M&P Comment; and W&H Comment.
    \13\ See PIABA Comment; G&N Comment; Estell Comment; Mason 
Comment; Sachs Comment; Mangano Comment; Miller Comment; SO&G 
Comment; M&P Comment; and W&H Comment.

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[[Page 74669]]

    Argument #8--NASD Rule 2110 (``just and equitable principles of 
trade'') should be strengthened to prevent the use of unwarranted 
criteria for expungement or a new rule should be adopted that states 
that a member may not seek expungement unless one of the standards is 
met.\14\
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    \14\ See PIABA Comment; G&N Comment; and NASAA Comment.
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    Argument #9--Expungements generally will increase because of the 
additional criteria and such an increase is clearly detrimental to 
investors.\15\
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    \15\ See G&N Comment and SO&G Comment.
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    Argument #10--A conflict will be created in cases when it is in the 
investor's interest to settle (through an arbitration award containing 
expungement criteria), but the investor's counsel will be averse to 
admitting to have filed a claim warranting expungement (e.g., a 
defamatory claim).\16\
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    \16\ See G&N Comment.
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    Argument #11--Pro se investors will be unable to meet the 
heightened formal pleading requirements established by the proposed 
standards.\17\
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    \17\ See G&N Comment.
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    Argument #12--The status quo is not unfair and altering the status 
quo would place member and associated records in a privileged class 
relative to other classes of public records (i.e., civil actions are 
not expungeable from the public record).\18\
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    \18\ See Estell Comment; Sherman Comment; Mangano Comment; 
Miller Comment; and M&P Comment.
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    Argument #13--The court confirmation process will be an 
insufficient safeguard relative to the added expungement criteria, 
because the NASD does not have the resources to put forth serious 
opposition to expungements at the court confirmation level.\19\
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    \19\ See G&N Comment; Estell Comment; Mason Comment; Jamieson 
Comment.
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    Argument #14--CRD information is considered to be part of the 
states' books and records. NASAA and the states currently insist that 
only ``factually impossible'' claims are expungeable and, thus, an 
expansion of the expungement criteria would conflict with the states' 
books and records laws.\20\
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    \20\ See Estell Comment; Mason Comment; and Sherman Comment.
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    Argument #15--Investors already view the NASD arbitration process 
with suspicion and adding criteria for expungement will serve to 
exacerbate this perception.\21\
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    \21\ See Estell Comment; Sherman Comment; and Mangano Comment.
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    Argument #16--The integrity of the CRD will be negatively affected 
by the proposal.\22\
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    \22\ See Mason Comment; Sachs Comment; SO&G Comment; M&P 
Comment; and W&H Comment.
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    Argument #17--The court confirmation process is still too 
burdensome on members and associated persons and this burden should be 
eased, rather than increased.\23\
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    \23\ See SIA Comment.
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    Argument #18--The proposal evidences a general lack of respect for 
arbitrators. Moreover, it will undermine the integrity of arbitrators 
by limiting their decision-making ability.\24\
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    \24\ See SIA Comment; Jamieson Comment; Partnervest Comment; 
McGinnis Comment; Finance 500 Comment; and Form Letter Comment.
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    Argument #19--The proposal should not be acted upon in isolation, 
instead it should be combined with NASD NtM 02-74 regarding expanding 
the amount of information that brokers must report, generally.\25\
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    \25\ See SIA Comment and Jamieson Comment.
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    Argument #20--The proposal would automatically convert the NASD 
into an adversary of members at the court confirmation level. 
Furthermore, the proposal will create a systemic prejudice on the part 
of NASDR against members.\26\
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    \26\ See Partnervest Comment; McGinnis Comment; Finance 500 
Comment; and Form Letter Comment.
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    Argument #21--The court confirmation process will require a 
rehearing of the issues and recalling of witnesses. Such rehearing and 
recalling will not only be inefficient, but could result in the 
confirming court making different findings from those made in the 
underlying arbitration proceeding. This could create confusion as to 
the status of the underlying arbitration decision.\27\
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    \27\ See SIA Comment; Partnervest Comment; McGinnis Comment; 
Finance 500 Comment; and Form Letter Comment.
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    Argument #22--The current system of disclosing unproven allegations 
is inequitable and making it more difficult for members and associated 
persons to remove such allegations from their CRD records is ``doubly 
unfair.'' \28\
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    \28\ See Eastmann Comment; McQuade Comment; Fired Broker 
Comment; Marchetta Comment; Macias Comment; djs Comment; LaVoice 
Comment; Kus Comment; Haburjak Comment; and Aldendifer Comment.
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B. Amendment No. 2

    In Amendment No. 2, the NASD addressed a number of the comments 
received by the Commission in response to the publication of the notice 
in the Federal Register. As noted above, some commenters expressed 
concern that the mere existence of an NASD rule governing expungement 
could encourage registered persons to seek expungements and make 
expungement easier to obtain. NASD noted its belief that this is not a 
legitimate concern. NASD stated that these commenters may not have 
considered the fact that NASD currently expunges information from the 
CRD system when ordered to do so by a court of competent jurisdiction, 
and that court-ordered expungements currently are not subject to any 
NASD limitations or standards.\29\ Under the 1999 moratorium, 
registered persons seeking expungement relief need only obtain a court 
order to expunge or court confirmation of an arbitration award granting 
expungement relief. Under the proposed rule, NASD stressed that it will 
have the opportunity to review the basis for expungement and to oppose 
an expungement in court unless there is a specific finding that the 
expungement meets one of the prescribed standards.
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    \29\ NASD has, since the inception of the CRD system, executed 
expungements involving customer dispute information based on a court 
order or (since the imposition of the moratorium in 1999 on 
expungements based solely on arbitration awards) court confirmation 
of an arbitration award directing expungement. These court orders 
included expungement relief granted in cases involving both 
settlements and hearings on the merits.
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    In Amendment No. 2, NASD discussed a concern raised by commenters 
that arbitrators should have sole authority and complete discretion to 
order expungement. They suggested that NASD's and the States' proposed 
role in the court confirmation process would undermine arbitrators' 
credibility. In response, NASD argued that, to the contrary, the 
critical element in the proposal is NASD's reliance on fact finders, 
especially arbitrators, to find that the expungement relief is based on 
one of the standards in the proposed rule. Also of note, NASD stated in 
Amendment No. 2 that NASD Dispute Resolution will provide training to 
arbitrators regarding the standards for expungement that will trigger 
the NASD waiver of opposition. Under proposed Rule 2130, NASD asserted 
that it will rely on arbitrators' findings and waive participation in 
the court confirmation process if arbitrators have appropriately 
awarded expungement.
    Other commenters contended that the proposed procedures will be 
economically prohibitive. In response, NASD recognized that the 
additional step of naming NASD as a party may involve additional costs. 
In an effort to minimize costs to the parties, NASD may waive 
participation in the court confirmation process before filing with the 
court if the parties give NASD a copy of the award to review and the

[[Page 74670]]

arbitrators have ordered expungement based on one of the standards in 
the rule. NASD noted the belief that the availability of this waiver 
process should limit any additional costs to the parties.
    The NASD also spoke to whether the proposed rule will discourage 
settlements, since the parties will no longer have total control over 
whether information about the arbitration will be expunged. NASD 
admitted that it is unable to predict the ultimate effect of the 
proposed rule on settlements. Further, NASD noted that compliance with 
the proposed rule may have the effect of decreasing the number of 
settlements that are reached. Currently, it is possible that 
respondents may agree to pay damages as a quid pro quo for expungement 
and obtain court confirmation of the expungement. NASD believes that 
the proposed rule will reduce, if not eliminate, the risk of expunging 
information that is critical to investor protection and regulatory 
interests as a condition in settlement negotiations. NASD asserted that 
the potential dampening effect on settlements must be weighed against 
the integrity of the information in the CRD system, and the ability of 
public investors and regulators to examine the entirety of a registered 
person's record, with the limited exceptions as proposed.
    A number of comments received expressed the concern that members 
and associated persons will be able to ``buy clean records'' by 
inserting terms into arbitration settlements that match the standards 
established under the proposed rule. NASD responded to this concern in 
Amendment No. 2 by asserting that the ``affirmative determination'' 
requirement imposed on arbitrators should foil attempts to ``buy a 
clean record.'' Under the proposed standard, dismissal of a claim alone 
would not be a sufficient basis for ordering expungement. NASD states 
that its arbitrator training materials will make clear that an 
expungement order must be premised on an affirmative determination by 
the arbitrator that the respondent was not involved in the alleged 
investment-related sales practice violation, forgery, theft, 
misappropriation, or conversion of funds. Without such an affirmative 
finding, NASD would have no basis under this standard to waive its 
obligation to be named as a party in the court confirmation process.
    Commenters expressed concern that the ``complaint fails to state a 
claim upon which relief can be granted'' standard, which parallels a 
motion to dismiss made in federal court, could be interpreted to 
authorize arbitrators to grant such motions in arbitration. In 
response, NASD modified in Amendment No. 2 the language describing the 
standards under which NASD may waive participation in the court 
confirmation process. Currently, there is no provision in the Code of 
Arbitration Procedure that either permits or prohibits motions. NASD 
did not intend for the proposed rule to have any effect on the 
authority of arbitrators to grant or deny motions to dismiss a claim 
before a hearing on the merits. Therefore, through Amendment No. 2, 
NASD eliminated the ``complaint fails to state a claim upon which 
relief can be granted'' standard and replaced it with a more objective 
standard based on CRD reporting requirements. Specifically, Amendment 
No. 2 proposed a standard that would require an affirmative arbitral or 
judicial finding that the registered person was not involved in the 
alleged investment-related sales practice violation, forgery, theft, 
misappropriation, or conversion of funds. Such a finding, NASD argued, 
would be consistent with the registered representative reporting ``No'' 
answers to current Question 14I(1) of the Uniform Application for 
Securities Industry Registration or Transfer (``Form U-4''). Should 
arbitrators make the required finding, NASD argued, no logical basis 
would exist for reporting the underlying complaint and other 
information on an individual's CRD record. NASD stated its belief that 
this revised standard eliminates any unintended implications for the 
arbitration process, while preserving the intended substantive effect 
of the standard.
    Commenters were also concerned that the ``defamatory in nature'' 
standard would encourage respondents to counterclaim for defamation and 
require claimants to defend such claims, thereby creating undue burdens 
on public investors in the arbitration process. Some commenters 
correctly noted that claims in arbitration are privileged and therefore 
immune from suit. In response, NASD stated that it believes the 
proposed rule should not substantially affect either the substance or 
procedure of an arbitration proceeding and should not place any undue 
burden on claimants in the arbitration process. Thus, to avoid the 
possibility that the proposed standard might result in additional 
counterclaims for defamation, NASD replaced it in Amendment No. 2 with 
a requirement that the arbitrator or adjudicator make a finding that 
the claim, allegation, or information is ``false.''
    Some commenters expressed the concern that the ``without factual 
basis'' standard is overly vague. In response, NASD replaced the 
``without factual basis'' standard with a ``factual impossibility or 
clearly erroneous'' standard. NASD asserted that this standard has a 
clear meaning to regulators and public investors and was favored by a 
number of commenters. This standard, NASD believes, would enable an 
individual who has been erroneously named in an arbitration, because he 
or she was not even employed by the member firm during the relevant 
time, to obtain expungement of a dismissed complaint.
    Some commenters suggested that the burden of complying with the 
three proposed standards should be placed squarely upon the NASD's 
members. Such a rule would require that NASD members only seek 
expungement of data from the CRD system, if such data fits within one 
of the three standards. NASD noted that it does not believe such an 
approach is necessary to achieve the objectives of the proposed rule. 
Federal and state courts, that are fully informed about the investor 
protection and regulatory implications of a proposed expungement order, 
NASD argued, should be trusted to make the proper decision.
    Other commenters put forth the argument that the burden of 
complying with the three proposed standards should be applied to 
arbitrators directly through the NASD's Code of Arbitration Procedure. 
NASD argued that imposing substantive requirements on arbitrators via 
the Code of Arbitration Procedure would be inappropriate. NASD stated 
that in no other instance does the Code of Arbitration Procedure impose 
limitations on arbitrators' ability to decide a legal issue. NASD 
asserted that arbitrators will know the standards for expungement 
relief under proposed Rule 2130, because they will have received 
appropriate training, and members and associated persons will know that 
arbitrators will only grant expungement relief based on those 
standards. Therefore, NASD stressed that, although the proposed rule 
does not place any specific obligations on arbitrators or respondents, 
all parties and arbitrators will be aware of the standards under which 
expungement relief should be granted.
    As discussed above, under proposed Rule 2130, NASD will participate 
in the court confirmation proceeding and oppose confirmation of the 
expungement portion of the arbitration award if the expungement order 
does not meet one of the specified criteria. Some commenters asserted 
that NASD

[[Page 74671]]

will be unable to present sufficient opposition to expungement attempts 
at the court confirmation level. NASD responded in Amendment No. 2 by 
stating that these comments were without merit or supporting evidence. 
NASD noted that it is committed to enforcing the proposed rule, as 
amended, and that it has an obligation as a self-regulatory 
organization to fulfill all of its regulatory obligations. Furthermore, 
NASD stressed that it will be subject to Commission oversight in its 
administration of the proposed rule. As a further means to ensure that 
the court is made aware of the investor protection and regulatory 
implications of an expungement, NASD noted that states will be able to 
intervene if they have concerns regarding whether investor protection 
or regulatory issues have been fairly considered by the NASD.\30\
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    \30\ NASD represented to the Commission that it is in the 
process of establishing a notice procedure, whereby the state(s) in 
which a member or associated person is registered would be notified 
when that member or associated person seeks a waiver of NASD 
involvement in the court confirmation level. To the extent that the 
state(s) wishes to intervene, it could so petition the court. 
Telephone conference between Shirley H. Weiss, Associate General 
Counsel, Office of General Counsel, NASD, and Christopher B. Stone, 
Special Counsel, Division of Market Regulation, Commission (October 
17, 2003).
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    The NASD also discussed on the effective date of the proposed rule 
in Amendment No. 2. NASD stated that, following Commission approval of 
proposed Rule 2130, it will announce the approval of the Rule in a NtM, 
which also will announce the effective date of Rule 2130. According to 
NASD, the NtM will announce that the requirements of Rule 2130 will 
apply to all arbitrations or civil lawsuits filed on or after the 
effective date. NASD noted that all requests to expunge customer 
dispute information from the CRD system arising from arbitrations or 
civil lawsuits filed before the effective date of the rule, including 
any settlements arising therefrom, will continue to be subject to the 
terms of the moratorium in effect as of January 19, 1999.

III. Discussion and Commission's Findings

    The Commission has carefully reviewed the proposed rule change, as 
amended, the comments, and the NASD's response thereto, and finds that 
the proposed rule change, as amended, is consistent with the Act and 
the rules and regulations promulgated thereunder applicable to a 
national securities association,\31\ and, in particular, with the 
requirements of section 15A \32\ of the Act. Specifically, the 
Commission finds that approval of the proposed rule change is 
consistent with section 15A(b)(6) \33\ of the Act because it is 
designed to promote just and equitable principles of trade, and, in 
general, to protect investors and the public interest. The Commission 
finds that the proposed rule change, as amended, is reasonably designed 
to accomplish these ends by allowing fact finders and the NASD to 
consider all competing interests before directing or granting 
expungement of customer dispute information from the CRD.
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    \31\ 15 U.S.C. 78f(b). In approving this proposal, the 
Commission has considered the proposed rule's impact on efficiency, 
competition and capital formation. 15 U.S.C. 78c(f).
    \32\ 15 U.S.C. 78o-3.
    \33\ 15 U.S.C. 78o-3(b)(6).
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    Moreover, the Commission, pursuant to section 19(b)(2) \34\ of the 
Act, finds good cause for approving Amendment No. 2 prior to the 30th 
day after the date of publication of notice thereof in the Federal 
Register. As discussed below, the Commission believes that the NASD has 
responded to the concerns raised by the commenters and has struck a 
fair and reasonable balance between the burden that the proposed rule 
change will impose upon member firms and associated persons and the 
benefit that the proposed rule change will bestow upon investors, 
generally. To the extent that the NASD's Amendment No. 2 has not 
specifically addressed any arguments raised, the Commission is not 
persuaded by these arguments. The Commission believes that the proposal 
is a clear improvement over the current system for the expungement of 
information from the CRD system and believes that it should be put into 
place as soon as practicable to ensure that investors and regulators 
have access to more accurate information through the CRD system.
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    \34\ 15 U.S.C. 78s(b)(2).
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    With respect to Argument Nos. 1-9, 11, 13, and 18 discussed above, 
the Commission believes that the NASD has sufficiently responded in 
Amendment No. 2. Specifically, with respect to Argument Nos. 1 and 8, 
the Commission believes that the NASD has sufficiently justified its 
application of the standards in question to the NASD's waiver or non-
waiver of involvement at the court confirmation level. Argument Nos. 1 
and 8 assert that the standards should be applied to arbitrators 
through the Code of Arbitration Procedure and to NASD members seeking 
expungement, respectively. The Commission agrees with the NASD that 
standards will be most effectively applied at the waiver juncture. In 
no other instance in the NASD's Code of Arbitration Procedure are 
arbitrators bound by substantive restrictions on how they decide an 
arbitration case. Moreover, as the NASD notes in Amendment No. 2, 
arbitrators will be aware of the standards that will be utilized with 
respect to the NASD's waiver of involvement, and, thus, arbitrators 
will indirectly consider them. NASD notes in Amendment No. 2 that the 
standards should not be applied to members directly, because federal 
and state courts are more than able to make the proper decisions with 
respect to arbitration award confirmation. The Commission agrees with 
this analysis, and also believes that the potential involvement of the 
NASD at the court confirmation level will provide greater safeguards 
than simple application of the rule to members.
    With respect to Argument No. 2, concerning the ``buying of clean 
records,'' the Commission is satisfied that the NASD's requirement that 
an ``affirmative'' determination be made by an arbitrator will provide 
sufficient regulatory protection. In the initial proposed rule filing, 
the NASD's proposal simply required that a finding be made by an 
arbitrator that matched one of the proposed standards. In response to 
this, commenters expressed the concern that members and associated 
persons would be able to negotiate for the inclusion of a finding in 
the arbitration settlement that matched one of the requisite standards. 
By requiring an ``affirmative determination'' on the part of the 
arbitrator that one of the standards was met, the NASD asserted that 
this concern and the ability of members and associated persons to ``buy 
clean records'' will be greatly reduced. The Commission agrees with the 
NASD's analysis in this regard.
    Argument Nos. 3-6 and 10 all relate to the potential problems that 
could be caused by the NASD's use of the word ``defamation'' in one of 
the three standards for waiver. In response to these arguments, the 
NASD proposed replacing the phrase ``information contained in the CRD 
system is defamatory in nature'' with ``claim, allegation, or 
information is false.'' The Commission believes that this change 
sufficiently addresses Argument Nos. 3-6 and is satisfied that the new 
proposed language should achieve the NASD's goal in this respect (i.e., 
ensuring that the CRD system contains accurate information).
    Argument Nos. 7 and 11 are concerned with the proposed rule leading 
to a formal dispositive motions practice at the arbitration level. The 
Commission believes that the NASD has

[[Page 74672]]

sufficiently responded to this argument through Amendment No. 2. As 
discussed at length above, the initial proposed rule text included 
language that tracked Federal practice pleading requirements. Such 
language, the commenters argued, could lead to a complex, lengthy, and 
expensive dispositive motions practice. By removing this potentially 
problematic language in Amendment No. 2, the Commission believes that 
the NASD has responded sufficiently to these concerns.
    With respect to Argument No. 9, concerning the NASD's proposed rule 
text itself leading to an increase in expungements, the NASD disagreed. 
The Commission agrees with the NASD in that the proposed rule is 
clearly an improvement over the current expungement system in which 
there are no parameters placed on expungements being incorporated into 
arbitration awards.
    With respect to Argument No. 13, concerning the NASD's inability to 
present serious opposition to expungement requests at the court 
confirmation level, the NASD provided some comfort. In Amendment No. 2, 
the NASD stressed that it is a federally registered self-regulatory 
organization that is required by the federal securities laws to enforce 
its rules.\35\ Moreover, to the extent it fails in that regard, it must 
answer to the Commission. The Commission acknowledges that the extent 
to which the proposed rule will ultimately require the NASD to contest 
expungements at the court confirmation level cannot be divined. The 
Commission believes, however, that the proposal is an improvement over 
the current system for expungement. To the extent that the NASD's 
responsibilities at the court confirmation level ever became untenable, 
the Commission would expect the NASD to approach the Commission with a 
proposed rule change or in some way seek to alter the process to ensure 
that the NASD fulfills its self-regulatory obligations.
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    \35\ See Section 19(g) of the Act, 15 U.S.C. 78s(g).
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    With respect to Argument No. 18, concerning the proposal's lack of 
respect for the arbitration process, the NASD responded in Amendment 
No. 2. The NASD noted that, rather than indicating a lack of respect 
for arbitration, the proposal demonstrates that the NASD is prepared to 
rely heavily on the fact-finding ability of arbitrators. Once an 
arbitrator makes an ``affirmative determination'' that one of the 
standards has been met, the NASD will waive its involvement at the 
court confirmation level. The Commission believes that the proposal 
strikes the appropriate balance between providing arbitrators with 
sufficient flexibility in addressing issues, while at the same time 
placing appropriate parameters on the type of information that is 
potentially expungeable from the CRD system.
    While Amendment No. 2 does not directly address Argument Nos. 12, 
14-17, and 19-22, the Commission is not otherwise persuaded by these 
arguments. The Commission believes that the proposal strikes the 
appropriate balance between permitting members and associated persons 
to remove information from the CRD system that holds no regulatory 
value, while at the same time preserving information on the CRD system 
that is valuable to investors and regulators.
    With respect to Argument No. 12, concerning the proposal's 
establishment of a privileged class of public records, the Commission 
is unconvinced. The Commission believes that, notwithstanding the state 
``public record'' status of data in the CRD system, such data is 
expungeable under certain circumstances. Indeed, a process for the 
expungement of data from the CRD system has been in place since the 
establishment of the CRD system. The Commission also is not persuaded 
by this ``states'' rights' argument and notes that NASAA itself did not 
make this argument to the Commission.
    With respect to Argument No. 14, concerning the rule's potential 
conflict with the states' books and records rules, the Commission is 
not persuaded. NASAA works closely with the NASD in the operation and 
enhancement of the CRD system. To the extent this is a valid concern of 
the states, the Commission would have expected NASAA to have raised 
this point. In fact, NASAA submitted a detailed comment letter on the 
proposal and did not raise this concern.
    With respect to Argument Nos. 15 and 16, concerning a worsening of 
the already poor perception that investors have of the NASD arbitration 
process and of the integrity of CRD data, the Commission is not 
persuaded. These arguments appear to rely on the assumption that 
adopting explicit criteria for expungement will make expungement 
easier, compromise the process for expungement, and, ultimately, 
degrade the CRD system. As discussed at length above, the Commission 
believes that the proposal will have the opposite effect. Specifically, 
the Commission believes it will strengthen the expungement process, by 
ensuring that only information that is not valuable to regulators and 
investors is expunged from the CRD system.
    Argument Nos. 17 and 20-22 ostensibly relate to maintaining the 
accuracy of data that appears in the CRD system. Specifically, by 
making it more difficult to expunge information, the arguments aver, 
members and associated persons will be less likely and less able to 
expunge inaccurate information from the system--ultimately, degrading 
the system. The Commission appreciates these arguments and agrees that 
expungement of inaccurate information from the CRD system is crucial to 
the system's value. Further to that point, the Commission would clearly 
be opposed to any proposed rule that would place an unfair burden upon 
members and associated persons seeking to expunge inaccurate 
information from the system. The Commission, however, does not believe 
that the proposal will make expungement of appropriate information from 
the system overly or unfairly difficult. To the extent a member or 
associated person seeks to expunge appropriate information, the NASD 
should waive involvement at the court confirmation level. In such a 
circumstance, the process should function not unlike how it currently 
functions and should not require a significant rehearing of the issues 
and/or recalling of witnesses. The Commission believes that the 
proposal has been structured in such a way that the potential for 
divergent findings at the court confirmation level and the arbitration 
level has been minimized. In sum, the Commission believes that the 
proposal addresses the serious Commission concern that valuable 
information is being expunged from the CRD system through arbitration 
settlements that include negotiated expungement instructions.
    Finally, with respect to Argument No. 19, asserting that the 
proposal should be acted upon in conjunction with NASD NtM 02-74, the 
Commission does not agree. The NASD is a registered national securities 
association and is owed a certain degree of latitude with respect to 
how it carries out its self-regulatory responsibilities. The Commission 
believes that the decision to file this proposal separately from the 
proposal that will follow from NtM 02-74 is the type of self-regulatory 
decision that the NASD has discretion to make. Moreover, NtM 02-74 has 
not yet been filed by the NASD and the Commission does not believe it 
would be in the interests of investors to delay the Commission's action 
on the instant proposal.

[[Page 74673]]

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 2, including whether the amendment 
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. Comments 
may also be submitted electronically at the following e-mail address: 
[email protected]. All comment letters should refer to File No. SR-
NASD-2002-168. This file number should be included on the subject line 
if e-mail is used. To help the Commission process and review your 
comments more efficiently, comments should be sent in hardcopy or by e-
mail but not by both methods. 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-2002-168 and should be 
submitted by January 14, 2004.

V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\36\ that the proposed rule change (SR-NASD-2002-168), as modified 
by Amendment No. 1, be, and it hereby is, approved, and that Amendment 
No. 2 be, and hereby is, approved on an accelerated basis. As discussed 
above, the NASD will announce the effective date of this proposed rule 
change through a NtM to be circulated as soon as possible after the 
publication of this approval order in the Federal Register.
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    \36\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\37\
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    \37\ 17 CFR 200.30-2(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-31646 Filed 12-23-03; 8:45 am]
BILLING CODE 8010-01-P