    Follow-up Report on Matters Relating to Securities Arbitration
    (11-APR-03, GAO-03-162R).

    Our June 2000 report Securities Arbitration: Actions Needed to
    Address Problem of Unpaid Awards revealed that, although
    investors had won a majority of awards against brokers, a high
    proportion of those awards had not been paid. Nearly all of the
    unpaid awards involved cases decided in the National Association
    of Securities Dealer's (NASD) arbitration program and most
    involved brokers that had left the securities industry. A year
    later we reported on limited data suggesting that the rate of
    unpaid awards had declined. However, we noted that given the
    short time period that the data covered, regulators needed to
    continue monitoring the payment of the awards to determine
    whether additional steps need to be taken. Arbitration attorneys
    and claimants have also expressed concern about the timeliness of
    NASD's updating of arbitrator disclosure information, which can
    be used by the parties in arbitration to judge the competence and
    objectivity of arbitrators, and with NASD's ability to remove
    arbitrators from cases if conflicts arise. In addition,
    arbitration attorneys also expressed concern about the use of
    motions to dismiss and motions for summary judgment to terminate
    NASD-administered arbitration cases. This report responds to
    requests that we review the status of issues relating to
    securities arbitration and award payment. Our objectives were to
    (1) describe NASD's procedures to ensure the timely updating of
    disclosure information that arbitrators provide and NASD's
    procedures for removing arbitrators from cases, (2) provide
    information on the use of motions to dismiss and motions for
    summary judgment in arbitrations, and (3) describe recent changes
    in the rate of unpaid awards and the number of arbitration claims
    filed with NASD.
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-03-162R
        ACCNO:   A06640
      TITLE:     Follow-up Report on Matters Relating to Securities
    Arbitration
         DATE:   04/11/2003
      SUBJECT:   Payments
    	     Securities arbitration
    	     Claims processing
    	     Claims settlement
    	     Information resources management

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    GAO-03-162R

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration

    April 11, 2003 The Honorable John D. Dingell Ranking Minority Member
    Committee on Energy and Commerce House of Representatives

    The Honorable Edward J. Markey Ranking Minority Member Subcommittee on
    Telecommunications

    and the Internet Committee on Energy and Commerce House of Representatives

    Subject: Follow- up Report on Matters Relating to Securities Arbitration
    Our June 2000 report Securities Arbitration: Actions Needed to Address
    Problem of Unpaid Awards revealed that, although investors had won a
    majority of awards against brokers, a high proportion of those awards had
    not been paid. 1 Nearly all of the unpaid awards involved cases decided in
    the National Association of Securities Dealer*s (NASD) arbitration program
    and most involved brokers that had left the securities industry. A year
    later we reported on limited data suggesting that the rate of unpaid
    awards had declined. 2 However, we noted that given the short time period
    that the data covered, regulators needed to continue monitoring the
    payment of the awards to determine whether additional steps need to be
    taken. Arbitration attorneys and claimants have also expressed concern
    about the timeliness of NASD*s updating of arbitrator disclosure
    information, which can be used by the parties in arbitration to judge the
    competence and objectivity of arbitrators, and with NASD*s ability to
    remove arbitrators from cases if conflicts arise. In addition, arbitration
    attorneys also expressed concern about the use of motions to dismiss and
    motions for summary judgment to terminate NASD- administered arbitration
    cases. 3 1 U. S. General Accounting Office, Securities Arbitration:
    Actions Needed to Address Problem of

    Unpaid Awards, GAO/ GGD- 00- 115 (Washington, D. C.: Jun. 15, 2000). 2 U.
    S. General Accounting Office, Evaluation of Steps Taken to Address the
    Problem of Unpaid Arbitration Awards, GAO- 01- 654R (Washington, D. C.:
    Apr. 27, 2001). 3 There are basically two categories of motions for
    prehearing dismissal. Motions to dismiss are based exclusively on the
    allegations of the statement of claim. Motions for summary judgment are
    those that depend, at least in part, on some facts that go beyond those
    allegations.

    United States General Accounting Office Washington, DC 20548

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 2 This report responds to your May 2, 2001, April 15,
    2002, and May 21, 2002, requests

    that we review the status of issues relating to securities arbitration and
    award payment. Our objectives were to (1) describe NASD*s procedures to
    ensure the timely updating of disclosure information that arbitrators
    provide and NASD*s procedures for removing arbitrators from cases, (2)
    provide information on the use of motions to dismiss and motions for
    summary judgment in arbitrations, and (3) describe recent changes in the
    rate of unpaid awards and the number of arbitration claims filed with
    NASD.

    Results in Brief

    NASD has made important changes to its arbitration program procedures,
    specifically in updating and entering arbitrator disclosure information
    and removing arbitrators from cases. To better manage the data entry
    process, in 2001 NASD centralized the arbitrator disclosure information
    function in its New York City offices. NASD also put a reporting form on
    line allowing arbitrators to submit new background information such as
    their education and training, employment, past arbitration experience,
    finances, and conflicts of interest. Also, in 2004 NASD plans to start a
    new computer system that would allow arbitrators to update their own
    records. Since November 2001, when the Securities and Exchange Commission
    (SEC) reported that NASD and SEC had not received any new complaints about
    the currency of arbitrator disclosure information, NASD has received one
    complaint. In addition, NASD has adopted a rule change that gives its
    Director of Arbitration and the President, NASD Dispute Resolution,
    indelegable authority to remove an arbitrator from a case after the
    hearing process has begun based on information not known to the parties
    when the arbitrator was selected. NASD has used this authority in nine
    instances since the change became effective in March 2001.

    Motions to dismiss were filed and granted in NASD- administered
    arbitration cases. Although NASD does not keep track of such motions, in
    2001, for example, we determined that motions to dismiss or motions
    seeking summary judgment were filed in 55, or about 8 percent, of 719
    investor- initiated, NASD- administered cases in which the investors won a
    monetary award. 4 We identified 54 instances in which motions were denied
    and 28 instances in which the motions were granted. 5 NASD rules do not
    prohibit either of the parties in arbitration from filing or the
    arbitrators from granting prehearing motions to dismiss. Further, the
    courts have consistently recognized the authority of arbitrators in NASD
    cases to grant prehearing motions to dismiss. Moreover, an NASD official
    told us that these motions can save time and resources by helping to weed
    out certain cases that, based on the facts set out in the parties*

    4 Securities arbitration cases are categorized as broker- broker,
    employee- broker, and customer- broker cases. Because the customers of
    brokers are generally investors, in this report we refer to the customers
    as investors.

    5 The total number of motions filed exceeded the number of cases because
    many cases involved multiple respondents and multiple filings of motions.
    In some instances in which motions to dismiss were granted, awards were
    still rendered against other parties responding to the claims.

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 3 filings, clearly would not satisfy procedural
    requirements for cases in the arbitration

    forum. However, a member of the Securities Industry Conference on
    Arbitration said that such motions ought to be discouraged because
    discovery and appeal rights in arbitration are limited. In 2001, 236 or
    about 33 percent of the 719 NASD- administered monetary awards on

    claims filed by investors were not fully paid, down from 64 percent not
    fully paid in 1998, as we reported in June 2000. About 55 percent of the
    $100.2 million NASD arbitrators awarded to investors in 2001 was unpaid,
    down from 80 percent of the total $161 million awarded to investors in
    1998. 6 The majority of unpaid awards in both 1998 and 2001 resulted from
    brokers leaving the securities industry. For example, 192 of the 236
    unpaid awards in 2001 involved defunct brokerage firms or individual
    brokers. Since 1998, NASD has introduced award- monitoring procedures that
    are designed to encourage payment. NASD also has introduced procedures for
    investors to avoid the problem of unpaid awards by defunct brokers by
    giving investors more options for handling claims against defunct brokers.
    The noted decline in the rate of award nonpayment also might be related to
    a difference in methodologies used to measure that rate. In 2000, we
    directly surveyed a sample of investors to determine if awards were paid
    in 1998, while for this report we used NASD data based on its monitoring
    of payment for the entire year 2001. The 5,974 arbitration claims that
    investors filed with NASD in 2002 have increased by 64 percent over the
    3,637 claims filed in 2000.

    We recommend that the President, NASD Dispute Resolution, make available
    on NASD*s Web site current statistics showing the frequency with which
    arbitration awards against defunct brokers are not fully paid.

    Background

    The securities industry uses arbitration to resolve disputes among
    industry members, their employees, and individual investors. Arbitration,
    an alternative to suing in court, uses neutral third parties to resolve
    differences between parties to a controversy. Cases involving investors,
    other than relatively small claims, are resolved by a panel of three
    arbitrators. Two are public arbitrators and one is a nonpublic arbitrator
    who brings a greater degree of expertise in the workings of the industry.
    Arbitrators* decisions are final and can be appealed to the courts only
    for narrowly- defined

    reasons such as misconduct, bias, or a manifest disregard of the law on
    the arbitrators* part. Arbitration awards are to be paid within 30 days of
    the date of the award, unless a party seeks a judicial review. SEC
    oversees the arbitration programs administered by securities industry
    self- regulatory organizations (SRO) such as NASD. NASD administers the
    largest SRO arbitration program, for example, its

    6 In 2001, $12 million of the unpaid awards were not due because the
    respondents had requested a hearing, filed for bankruptcy, or filed a
    motion to vacate.

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 4 program accounted for about 90 percent of securities
    arbitration cases in 2000 and

    2001. 7 Investors have a right under NASD (and other SRO) rules to require
    that brokersdealers and individual brokers arbitrate any disputes they may
    have. In addition, most broker- dealers require customers, when opening an
    account, to sign a customer agreement that includes a predispute
    arbitration clause. If a dispute subsequently arises between the investor
    and the broker- dealer, the investor can file an arbitration claim with
    the forum indicated in the predispute agreement and with any SRO of which
    the broker- dealer is a member.

    In an investor- initiated arbitration case, the investor files a statement
    of claim with the designated SRO- sponsored arbitration forum. The forum*s
    director of arbitration serves the statement of claim on the broker-
    dealer or individual broker (called respondents) against whom the claim
    has been brought. The respondent has from 20 to 45 days, depending on the
    forum used, to answer the claim with any defenses and related claims.
    After the filing process, the director of arbitration provides the parties
    with a list of potential arbitrators to hear the dispute. The parties
    indicate their preference and may challenge specific arbitrators on the
    list.

    Once the panel of arbitrators has been selected, the panel conducts
    hearings that may last a day or more depending on the complexity of the
    case. Arbitrators are to render their decisions after the presentation of
    the evidence at the hearings. Arbitrators issue a written *award* at the
    end of a case. The written award is not required to include a reason or
    formal written opinion supporting the award. However, the award is
    required to include a statement setting out certain issues, including the
    basic issues raised and resolved in a case, the amount claimed and
    awarded, and any other, nonmonetary issues resolved.

    New NASD Procedures Address Concerns about Information on Arbitrators and
    Removing Arbitrators from Cases

    NASD has taken steps to improve its procedures for updating arbitrator
    disclosure information and removing arbitrators from cases. The arbitrator
    update improvements included centralizing the process for updating
    arbitrator profiles and making an on- line reporting form available for
    arbitrators to submit new disclosure information. Another change allows
    the President, NASD Dispute Resolution, and its Director of Arbitration to
    remove an arbitrator from a case once the hearing process has begun and
    new information about the arbitrator has been disclosed.

    7 NASD Dispute Resolution facilitates the resolution of monetary,
    business, and employment disputes between investors, securities firms, and
    employees of securities firms, offering both arbitration and mediation
    services.

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 5 NASD Procedures Help Ensure That Arbitrator Disclosure
    Information Is Updated Regularly In selecting individuals to be in its
    pool of potential arbitrators, NASD relies on

    background information that prospective arbitrators provide. This
    information is first entered into the NASD arbitrator information database
    when arbitrators enroll in the program and is to be updated for any new
    information. NASD uses the background information to classify arbitrators
    as *public* or *nonpublic.* 8 The parties in a dispute also use this
    information in deciding whether to accept arbitrators to be assigned to
    their case. NASD arbitrator disclosure reports include information on
    education and training, employment, past arbitration experience, finances,
    and conflicts of interest. The reports also include a narrative section,
    written by the arbitrators, describing their professional duties and
    responsibilities.

    As we reported in November 2000, NASD has taken steps to improve its
    procedures for updating and entering arbitrator disclosure information. 9
    We reported that the new procedures appeared reasonable and were likely to
    reduce the possibility for errors and improve the promptness of data
    entry. The improvements included

    centralizing the process for updating arbitrator profiles in the
    Department of Neutral Management in the New York City offices of NASD*s
    Division of Dispute Resolution, and

    using an on- line reporting form on which arbitrators submit updated
    disclosure information via a NASD dispute resolution program Web site.

    NASD procedures state that all updated arbitrator records, whether
    received on- line or by phone or fax, are to be reviewed by a quality
    control supervisor after they are initially entered. Records of
    arbitrators currently serving on panels are to be updated within 24 hours,
    while updates from nonserving arbitrators can be entered in 3 to 5 days.
    NASD staff are also to monitor and track all entries to arbitrator
    profiles and prepare a biweekly report to department managers on the
    receipt and computer entry of arbitrator updates. For each arbitrator
    submission, the biweekly reports list the date the information was
    received by the Department of Neutral Management and the date computer
    entry of the information was completed. The department manager is to use
    the report to verify the timeliness of the process.

    In November 2001, SEC reported that, after the new procedures were
    implemented, neither SEC nor NASD had received any new complaints
    regarding the arbitrator

    8 A public arbitrator has had no recent association with the securities
    industry whereas a nonpublic arbitrator has had recent or has current
    association with or experience in the securities industry. Public
    arbitrators are used in all investors* cases. In single arbitrator cases
    in which claims are $50,000 or less, the arbitrator is a public
    arbitrator. In cases with three arbitrators in which claims are more than
    $50,000, two of the arbitrators are public arbitrators . 9 U. S. General
    Accounting Office, Procedures for Updating Arbitrator Disclosure
    Information, GAO- 01- 162R (Washington, D. C.: Nov. 9, 2000).

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 6 disclosure records. According to NASD, from November
    2001 through the end of 2002

    it had logged one complaint about an arbitrator failing to update his
    background information. In that case, according to NASD, a party in a
    dispute asked the arbitrator for new information, and the arbitrator sent
    the new information to the party by fax and to NASD by mail. As a result,
    the party received the information before NASD could receive it, update
    its disclosure information database, and make the information available.
    SEC officials said that they did not recall receiving any new complaints
    and SEC has indicated that its inspection staff will continue to monitor
    NASD*s process for updating arbitrator profiles. In 2004, NASD plans to
    use a new computer system that would enable arbitrators to access and
    update their own disclosure records on- line at a NASD Web site.

    New Procedures Make Removing Arbitrators from Cases Easier Effective March
    2001, SEC- approved amendments to NASD*s Code of Arbitration Procedure
    gave the President, NASD Dispute Resolution, and its Director of
    Arbitration indelegable authority to remove an arbitrator at any juncture
    in the arbitration process. These amendments allow for removal of an
    arbitrator from a case after a prehearing conference or a hearing has been
    started, based on new information that was not known to the parties at the
    time of the arbitrator*s appointment but that the arbitrator, pursuant to
    NASD rules, should have disclosed.

    Under the old rule, the director could disqualify an arbitrator from
    serving on a case when information revealed a conflict of interest or bias
    such as a relationship with one of the parties. However, this authority to
    disqualify was limited to the time before the start of the prehearing
    conference or the first hearing. After that point, the parties would have
    needed to make a motion before the arbitration panel asking the arbitrator
    to recuse himself or herself or seek a court action to remove an
    arbitrator from a case. In approving the rule change, SEC noted that the
    change should result in lower litigation expenses for the parties, because
    they would not have to seek judicial intervention to remove an arbitrator.
    SEC also noted that the change would help ensure greater confidence in the
    fairness and neutrality of the administration of arbitration cases.

    According to NASD, after the new rule became effective in March 2001 and
    through the end of 2002, NASD had received 47 requests for the Director of
    Arbitration to exercise the authority to remove an arbitrator. NASD
    reported to us that the Director denied these requests in 38 instances and
    removed an arbitrator in 9 instances.

    Motions to Dismiss Are Used in NASD Arbitrations

    Prehearing motions to dismiss are used in NASD- administered arbitration
    cases. NASD, however, does not centrally track the motions filed in its
    numerous cases. Data that we assembled from 719 investor- initiated, NASD-
    administered monetary arbitration awards in 2001, showed that motions to
    dismiss were filed in 54 cases and a request for summary judgment in one
    case, or in about 8 percent of all the cases. In

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 7 the 54 cases, 124 motions were filed. We identified 42
    instances in which the motions

    were not decided because the claims had been dismissed for other reasons
    or settled by the parties before the case was decided. We identified 54
    instances in which the motions were denied and 28 instances in which the
    motions were granted. The total number of motions filed exceeded the
    number of cases because any one case may involve multiple respondents and
    multiple filings of motions. SEC officials said that some motions to
    dismiss are based on substantive arguments, while others assert practical
    ones, for example, that the wrong party was named or served. The awards
    did not provide enough detail about the motions for us to determine the
    reasons for their being filed.

    NASD arbitration rules do not specifically provide for dismissal motions
    or for motions for summary judgment. However, nothing in the rules
    prohibits the parties from filing motions or precludes panels from
    granting them. NASD rules are consistent with the practice of disposing of
    claims by motion. NASD rules allow prehearing conferences at which the
    presiding person can require the briefing of contested issues and address
    *any other matters which will expedite the arbitration

    cases.* 10 The case law consistently has recognized the authority of
    arbitrators to grant prehearing motions to dismiss. For example, in Warren
    v. Tacher the underlying dispute in the arbitration proceeding involved
    alleged investor losses in a brokerage account. 11 The investors brought a
    claim for arbitration against the broker- dealer that maintained the
    account and the clearing broker- dealer. The clearing broker- dealer moved
    to dismiss all claims on the ground that it had no responsibility to
    claimants. The claimants filed a written response to the motion and the
    arbitration panel held oral argument. The arbitration panel dismissed all
    claims against the clearing brokerdealer. The claimants appealed and
    sought to have the arbitrators* decision vacated on the ground that the
    arbitrators engaged in misconduct and exceeded their powers by dismissing
    the claims against the clearing broker- dealer prior to discovery and an
    evidentiary hearing. The court stated that courts have recognized the
    authority of NASD arbitrators to decide prehearing dismissals for failure
    to state a claim under the NASD Code. 12 The court rejected an argument
    that the arbitrators displayed a *manifest disregard for the law* by their
    determination to dismiss all claims against the clearing broker- dealer.

    10 NASD Code S:10321( d)( 1). General Provisions Governing Pre- Hearing
    Proceedings, Pre- Hearing Conference, (1) Upon the written request of a
    party, an arbitrator, or at the discretion of the Director of Arbitration,
    a prehearing conference shall be scheduled. The presiding person shall
    seek to achieve agreement among the parties on any issue that relates to
    the prehearing process or to the hearing,

    including but not limited to stipulation of facts, identification and
    briefing of contested issues, and any other matters which will expedite
    the arbitrations.

    11 114 F. Supp. 2d 600 (W. D. Ken. 2000). 12 Goldman, Sachs & Co. v. Patel
    (N. Y. L. J. Aug. 18, 1999, p. 23, co. 6) (* Contrary to respondent*s
    assertion, the NASD panel has the power to decide a motion to dismiss a
    claim on legal grounds without holding an evidentiary hearing.*).

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 8 The court in Warren v. Tacher also addressed the issue
    of whether the grant of a

    prehearing motion to dismiss is tantamount to a refusal to hear evidence.
    The court rejected this argument and explained that while the granting of
    a prehearing motion to dismiss usually means that the arbitrator *refused
    to hear evidence,* that, by itself, is insufficient to vacate the award.
    Claimants must also show that the excluded evidence was material to the
    panel*s determination and that the arbitrator*s refusal to hear the
    evidence was so prejudicial that the party was denied fundamental
    fairness. 13 In addition, the court held that a hearing for purposes of
    NASD rules does not

    necessarily mean an evidentiary hearing. The court found that the
    claimants did have a *hearing.* They were given adequate opportunity to
    respond to the clearing agent*s motion to dismiss and they did so.

    The courts have upheld arbitrators granting of dismissal motions in other
    cases. These include dismissal on the grounds of the timeliness of the
    claims, a respondent*s involvement in the matter in controversy, or
    whether the claimant has a private right of action for alleged violation
    of an SRO rule. 14 We have not found any cases that do not recognize
    arbitrators* authority to grant prehearing motions to dismiss. Moreover,
    an NASD official told us that these motions can save time and resources by
    helping to identify certain cases that would not prevail in a hearing on
    the merits. For example, in some cases the parties* pleadings may clearly
    show that the case, or some portion of the case, does not fall within the
    NASD*s procedural rule covering filing time limits, which would send the
    case instead to court. On the other hand, a member of the Securities
    Industry Conference on Arbitration said that motions to dismiss and
    motions of summary judgment ought to be discouraged because discovery and
    appeal rights in arbitration are limited. Another arbitration official
    also said that parties in arbitration deserve the right to be fully and
    fairly heard. Rate of Unpaid Awards Has Decreased,

    but Many Investors Are Not Paid Awards against Defunct Brokers

    Data for 2001 show that the rate of unpaid NASD- administered arbitration
    awards had decreased from the levels we previously reported for 1998. NASD
    procedures for monitoring awards encourage payment by still- active
    brokers. However, defunct brokers continue to not pay awards. The recent
    rise in arbitration claims may result in more investors not being paid
    their awards.

    13 9 U. S. C. S: 10( c); Campbell v. Cantor Fitzgerald & Co., 21 F. Supp.
    2d 341, 344 (S. D. N. Y. 1998). 14 In Howsam v. Dean Witter, 123 S. Ct.
    588 (2002), the United States Supreme Court recently held that arbitrators
    can decide that a claim is ineligible for arbitration under an NASD rule
    that provides that claims submitted a certain time after they arose are
    ineligible. The Court*s decision does not address whether arbitrators
    should make such a decision in response to a motion to dismiss an
    arbitration

    claim. Dean Witter did not file a motion to dismiss the arbitration claim.
    It brought an action in federal court asking the federal court to decide
    that the arbitration claim was untimely.

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 9 Payment Rates Have Improved, but Many Awards Still Are
    Not Fully Paid Although the rate of unpaid arbitration awards has fallen,
    many awards rendered by

    NASD arbitration panels remain unpaid. In 2001 about 55 percent, or $55
    million, of the $100.2 million NASD arbitrators awarded to investors was
    unpaid. However, $12 million of the unpaid awards were not required to be
    paid because the respondents had requested a hearing, filed for
    bankruptcy, or filed a motion to vacate. In our June 2000 report, we
    estimated that about 80 percent of the $161 million awarded to investors
    in 1998, which were primarily NASD- administered awards, was unpaid. In
    that report, we estimated that 64 percent of NASDadministered monetary
    arbitration awards won by investors in 1998 had not been fully paid. Our
    analysis of NASD award payment data for 2001 found that 33 percent of
    awards to investors were unpaid. Of the total of 719 monetary awards that
    investors won in 2001, 236 awards were not fully paid. (Nothing was paid
    on 216 awards and 20 awards were partially paid.)

    In June 2000, we reported that most of the unpaid arbitration awards in
    1998 were against broker- dealer firms and associated persons that had
    left the securities industry. Awards that were not fully paid in 2001 also
    were against such defunct brokers. More specifically, as shown in table 1,
    nonpayment of 192 awards ($ 41 million) in 2001, was attributed to brokers
    that had terminated their NASD membership. In an additional 16 awards,
    NASD suspended firms or individual brokers for failing to pay $2.1 million
    of awards. In 29 awards, $12 million awarded was not paid because the
    respondents had requested a hearing, filed for bankruptcy, or filed a
    motion to vacate the award. 15 15 NASD procedures allow the respondent to
    request a hearing on the matter to consider whether (1) the respondent was
    given notification of the award, (2) the respondent satisfied the award,
    and (3) a

    valid reason exists for the respondent*s failure to comply with the award.

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 10

    Table 1: Number and Amount of Dollars Not Fully Paid by Broker- dealers or
    Individual Brokers with NASD- administered Arbitration Awards against Them
    and Award Nonpayment Status in 2001

    Terminated NASD membership Suspended Requested a

    hearing Filed for bankruptcy

    Filed motion to vacate Total Number of awards not fully paid

    192 16 7 5 17 237 a

    Dollars not paid (in millions)

    $41 $2 $2 $1 $9 $55 Source: NASD (data); GAO (analysis). a The sum of
    these unpaid cases exceeds the 236 unpaid awards because cases with
    multiple respondents can have different outcomes.

    NASD Procedures to Monitor the Payment of Awards Are Designed to Encourage
    Award Payment NASD has put procedures in place for monitoring the payment
    of awards that are designed to encourage award payment. In September 2000,
    NASD began requiring its member broker- dealers to certify that they had
    paid or otherwise complied with an award against them or their associated
    persons within 30 days after the award was served. NASD also began asking
    the claimants who had won awards to notify it if an award had not been
    satisfied within the 30- day period. If an award is not paid, NASD begins
    the process of suspending the license of the broker- dealer firm or the
    individual broker responsible for payment of the award. In 2001, NASD
    suspended one or more of the respondents in 12 cases for failing to pay
    awards. Members and individuals who fail to pay awards cannot apply to
    restore their licenses until an award against them is satisfied.

    Although these procedures may have helped to reduce the rate of unpaid
    awards, the previously discussed reduction in the rate of unpaid awards
    also might reflect differences in the methodologies used to compile the
    data used to calculate the rate. Our June 2000 report was based on data
    that we obtained by surveying a sample of investors that had won
    arbitration awards in 1998. For this report, the rate was calculated from
    data obtained from NASD based on its monitoring of award payment for the
    entire year of 2001. Additionally, arbitration attorneys said that they
    have begun scrutinizing cases more closely to avoid taking cases where
    awards might not be paid, a factor which may also have contributed to a
    reduction in the rate of unpaid awards.

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 11 NASD Has Implemented Changes to Help Address the
    Problem of Unpaid Awards by Failed Broker- Dealers NASD is helping to
    address the problem of unpaid awards by defunct brokers by

    making it easier for investors to seek alternative means of relief or
    obtain a judgment against the broker. These procedures address the problem
    of unpaid awards by defunct brokers, for example, by helping shorten the
    time period for obtaining a court judgment that could be used to seize
    remaining assets of a defunct broker. In April 2001, SEC approved
    amendments to NASD*s Code of Arbitration Procedure, S:10301, effective
    June 2001, that provided that a broker- dealer that has been terminated,
    suspended, or barred from NASD, or that is otherwise defunct cannot
    enforce a predispute arbitration agreement against an investor in NASD*s
    arbitration forum. Also, in June 2001, NASD began to advise claimants in
    writing, at the time they file a claim, of the registration status (for
    example, terminated, out- of- business, bankrupt) of broker- dealers or
    associated persons so that the claimants can evaluate whether to continue
    with the arbitration. In October 2002, a new NASD rule, which SEC approved
    in July 2002, took effect. The rule provides for streamlined default
    proceedings where the terminated or defunct broker- dealer or associated
    person does not answer or appear, but the claimant affirmatively elects to
    pursue the arbitration. Under the streamlined proceedings, an arbitrator
    can make a decision based on the statement of claim and any other material
    submitted by the claimant. In addition, in August 2002, the NASD Board of
    Directors approved a proposed amendment, which was submitted in January
    2003 to SEC for approval, that would strengthen NASD*s authority to
    preclude member broker- dealers from using structural changes, such as
    consolidations or other asset sales and transfers, to avoid meeting their
    arbitration obligations to investors. Also, NASD officials said that
    NASD*s Enforcement Division had started reviewing new arbitration claims
    as they come in as part of an effort to identify potentially troublesome
    members.

    In our June 2000 and April 2001 reports, we discussed proposals made by
    investors* attorneys to address the unpaid award problem such as insurance
    and bonding. In the June 2000 report we recommended that, to the extent
    unpaid awards remain a problem, the SEC*s Chairman should establish a
    process to assess the feasibility of alternative approaches to address the
    problem. In response SEC officials said that after our report was issued
    SEC staff assessed other approaches addressed in the report including
    insurance and bonding. According to the officials, SEC staff met with
    broker- dealer representatives and insurance companies to discuss existing
    brokerdealer insurance and bonding requirements. The officials said that
    after those consultations, the staff concluded that expanding broker-
    dealer insurance and bonding requirements would not be an appropriate
    means of addressing unpaid arbitration awards. Instead, SEC staff
    concluded that the efforts of NASD* which conducts most broker- dealer
    examinations* to institute a procedure of reviewing all arbitration claims
    as they are filed to identify problem brokers early through related
    examinations and as appropriate, enforcement action, would limit the harm
    they cause investors. The officials said that this, as well as other
    initiatives NASD has taken, which are described earlier in this report and
    in our June 2000 and April 2001 reports, should be given time to work.
    SEC*s continuation of the process we

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 12 recommended in June 2000 to assess the feasibility of
    alternative approaches to

    address the problem of unpaid awards by defunct brokers could further
    reduce the incidence of unpaid awards. This process could consider how SEC
    and NASD programs for broker registration, regulation, enforcement, as
    well as arbitration, and other areas as appropriate, can further reduce
    the incidence of unpaid awards.

    In June 2000, we also recommended that the SEC Chairman work with the SROs
    to develop and publicize information to focus investor attention on the
    possibility of unpaid arbitration awards. In response, NASD and SEC made
    information available on their Web sites to caution investors about the
    possibility of having an unpaid award. That information, while helpful,
    does not provide any data to inform investors

    of the scope of the problem or the frequency with which awards are unpaid
    by defunct brokers. Increasing investors* awareness of the scope and
    frequency of the problem may better inform investors that broker- dealers
    that stay in business generally pay awards and help to reduce unpaid
    awards by defunct brokers.

    Recent Increase in Arbitration Claims Suggests That Many Future Awards
    also Might Not Be Paid Arbitration claims have increased sharply, which
    may mean, assuming the rate of unpaid awards remains the same; more
    investors may not be paid. In 2001, 6,926 arbitration claims were filed
    with NASD. In 2002, the number of new cases further increased to 7,709, or
    a 39 percent increase over the 5,565 total claims filed in 2000. In most
    of these cases* 4,849 in 2001 and 5,974 in 2002* investors filed claims
    against their brokers. Through 2002, these investor- initiated cases
    increased by 64 percent from the 3,637 claims filed by investors in 2000.
    NASD officials said that whether this increase in claims will mean more
    unpaid awards depends on the types of brokerdealers any resultant awards
    might be against. For example, if the increase in claims results in more
    awards against large viable broker- dealers that tend to pay awards, the
    number of unpaid awards could decrease.

    NASD officials said that the increase in claims filed was the result of
    changes in the economy. The officials said the downturn in and increased
    volatility of the stock market in 2001, an influx of new inexperienced
    investors during the boom years of the late 1990s, and the overall
    increased number of securities holders contributed to the increase in
    arbitration claims filed. According to NASD, claims alleging broker
    failure to supervise their sales representatives, breach of fiduciary
    duty, misrepresentation, and negligence also had increased.

    Conclusions

    The rule and procedural changes that NASD has adopted to improve the
    arbitrator information update process and its ability to remove
    arbitrators from cases appear reasonable and could improve the
    effectiveness and efficiency of arbitration. These changes could help NASD
    to keep current the information that parties in arbitration use in
    selecting arbitrators and allow for faster and less costly removal of
    arbitrators in cases where there has been an undisclosed conflict of
    interest.

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 13 Motions to dismiss are used, but not with great
    frequency, in NASD arbitrations.

    Arbitration law and codes do not explicitly prohibit the use of these
    motions. Because appeal rights and evidentiary discovery are limited, a
    Securities Industry Conference on Arbitration member said that arbitration
    forums should discourage the granting of these motions. However, NASD
    officials have contended that use of these motions helps to make the
    arbitration process more efficient. Data show that the rate of unpaid
    awards has diminished since our June 2000 report.

    However, continued unpaid awards, regardless of how effective and fair the
    arbitration process may be, could negatively affect investors* confidence
    in arbitration and potentially the securities markets in general. Unpaid
    awards also may discourage attorneys from taking investors* cases. It is
    important that regulators continue to issue a strong message to investors
    about being cautious in choosing their brokers because some brokers will
    never pay for the damage they cause. Moreover, given that continued unpaid
    awards could erode investors* confidence in arbitration, SEC*s Chairman
    should continue the process we recommended in June 2000 to assess the
    feasibility of alternative approaches to address the problem of unpaid
    awards by defunct brokers. This process could consider how SEC and NASD
    programs for broker registration, regulation, enforcement, as well as
    arbitration, and other areas as appropriate, could further reduce the
    incidence of unpaid awards. Further, NASD needs to be concerned about
    unpaid awards, which represent inefficient use of NASD dispute resolution
    program resources and futile efforts by defrauded investors seeking
    restitution. By making data on the frequency with which awards are unpaid
    by defunct brokers publicly available, NASD could better inform investors
    of the possibility of unpaid awards by defunct brokers and increase
    investors* awareness of the scope of the problem. This, in addition, could
    cause investors to be more cautious in choosing their broker and also help
    them decide whether to file an arbitration claim or seek alternative means
    of obtaining relief and avoid unnecessary expenses.

    Recommendation for Executive Action

    We recommend that the President, NASD Dispute Resolution, make available
    on NASD*s Web site current statistics showing the frequency with which
    arbitration awards against defunct brokers are not fully paid.

    Agency Comments and Our Evaluation

    SEC and NASD provided written comments on a draft of this report, which
    are reprinted in enclosures I and II. SEC and NASD also provided technical
    comments, which were incorporated into the final report. SEC agreed with
    the contents of this report and noted that our work demonstrates that NASD
    has developed necessary tools to administer its growing caseload and that
    implementation of our June 2000 recommendations has helped achieve an
    appreciable reduction in the rate of unpaid awards. SEC commented that it
    welcomes our recommendation that NASD make available on its Web site
    current statistics showing the frequency with which arbitration awards
    against defunct brokers are not fully paid. SEC said that this more

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 14 explicit data should help deliver to investors the
    educational message to choose

    investment professionals carefully. SEC noted that SEC staff believe that
    more time is needed to realize the full effects of the steps taken after
    our June 2000 report and that it continues to work with NASD to better
    identify individuals responsible for unpaid awards.

    NASD generally agreed with the contents of this report and provided
    additional information on the various steps it has taken related to its
    addressing the problem of unpaid awards. NASD also noted the dramatic
    improvement in the rate of unpaid awards from our June 2000 report and
    provided updated information on the status of awards we found to be
    unpaid. NASD updated the payment status of awards that were paid after it
    threatened suspension of the member or a motion to vacate was denied or
    which had motions to vacate still pending, which reduced the percent of
    awards unpaid from 55 percent to 53 percent. NASD stated that it would
    consider our recommendation and additional ways to enhance investor
    education about the problems associated with terminated members and the
    payment of awards. NASD commented that it strives to strike a balance
    between disclosing information and not discouraging investors from filing
    valid claims. NASD stated that, with that concern in mind, it will develop
    an approach to enhance the data available to investors to enable them to
    make more informed decisions about whether to pursue a claim. NASD also
    commented that it welcomes the opportunity to participate in a feasibility
    study of alternative solutions to address the problem of unpaid awards
    that we recommended in June 2000.

    We commend SEC and NASD for the efforts they have taken to monitor and
    educate investors about unpaid awards, and provide investors viable
    options when faced with the possibility of unpaid awards. However, the
    extent to which awards are unpaid by defunct brokers shows that unpaid
    awards, even when reduced to 53 percent for 2001, as NASD adjusted it, is
    still a serious problem that can affect investors* confidence in
    arbitration and potentially the securities markets and discourage
    attorneys from taking investors* cases. It is, therefore, important that
    NASD make available to investors current statistics on the frequency with
    which awards are unpaid by defunct brokers and that regulators continue to
    monitor unpaid awards and consider ways of addressing the problem.

    Scope and Methodology

    We analyzed information on NASD procedures for updating arbitrator
    disclosure information and removing arbitrators from cases based on our
    review of NASD*s procedures and interviews of NASD officials. We analyzed
    information on the use of motions in arbitration based on interviews of
    officials of NASD and the Securities Industry Conference on Arbitration.
    We also reviewed arbitration rules of NASD and other forums and federal
    case law regarding the uses of motions to dismiss and motions for summary
    judgment in NASD cases. We then identified the extent to which these
    motions were used in 2001 NASD investor- initiated cases in which monetary
    award decisions were rendered in favor of investors.

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 15 To determine changes in arbitration claims and the
    rate at which awards in investorinitiated

    cases were paid, we analyzed NASD data. Initial testing of the NASD data
    on award payment found errors that could overstate the extent to which
    awards were paid that were significant enough to require further
    verification and correction. We then had NASD correct any errors found and
    then further tested the accuracy of the data. We reviewed a randomly-
    selected sample of 34 cases out of 719 monetary awards in 2001 to verify
    that NASD had documentation showing that the awards were paid. From our
    random sample of 34 awards 1 award was initially listed as paid, but we
    discovered on further review that the award was unpaid, and the respondent
    had filed for bankruptcy. Subsequently, NASD discovered an additional
    award that was mistakenly classified as unpaid. The number and magnitude
    of these data errors are small enough that the data are sufficiently
    reliable for our purposes and should not materially affect the estimates
    of payment rates in this report. Nevertheless, we apprised SEC officials
    of the errors. The officials said that SEC examiners would test the
    accuracy of the award payment data as part of SEC*s routine inspections of
    NASD's dispute resolution program. NASD officials told us that the errors
    resulted from NASD not having a means of tracking the payment status of
    awards. Once an award was granted, NASD gave the case a closed status and
    NASD staff had to manually compile the payment data from documents in case
    files. The NASD officials

    said that NASD has since entered new status codes in its computer system
    for tracking the payment status of awards. They said that they can now
    track different outcomes related to award payment such as receiving a
    broker*s certification that an award was paid or that a broker had filed a
    motion to vacate an award in a court. The officials said that this change
    should minimize the opportunity for compilation errors.

    We conducted our work in Washington, D. C., and New York, N. Y., from
    April 2002 through March 2003, in accordance with generally accepted
    government audit standards.

    As agreed with your offices, unless you publicly announce the contents of
    this report earlier, we plan no further distribution until 30 days from
    the report date. At that time, we will provide copies of this report to
    the Chairman, House Committee on Energy and Commerce; the Chairman,
    Subcommittee on Telecommunications and the Internet, House Committee on
    Energy and Commerce; the Chairman and the Ranking Minority Member, Senate
    Committee on Banking, Housing, and Urban Affairs; and the Chairman and the
    Ranking Minority Member, House Committee on Financial Services. Copies
    also will be provided to the Honorable William H. Donaldson, Chairman,
    SEC; Mr. Robert R. Glauber, Chairman, NASD; and other interested parties.
    In addition, the report will be available at no charge on the GAO Web site
    at http:// www. gao. gov.

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 16 Please call me or Orice M. Williams, Assistant
    Director, at (202) 512- 8678 if you or

    your staff have any questions concerning this report. David Tarosky and
    Sindy Udell also contributed to this report.

    William O. Jenkins Jr. Director, Financial Markets and Community
    Investment Enclosures

    Enclosure I

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 17 Comments from the Securities and Exchange Commission

    Enclosure I

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 18

    Enclosure I

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 19

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 20 Comments from NASD

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 21

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 22

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 23

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 24

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 25

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 26

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 27

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 28

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 29

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 30

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 31

    Enclosure II

    GAO- 03- 162R Follow- up Report on Matters Relating to Securities
    Arbitration Page 32 (250081)

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