[Federal Register Volume 63, Number 3 (Tuesday, January 6, 1998)]
[Notices]
[Pages 588-595]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-162]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39487; File No. SR-NASD-97-44]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc. Relating
to the Eligibility of Claims for Arbitration
December 23, 1997.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on June 24,
1997,\1\ the National Association of Securities Dealers, Inc. (``NASD''
or ``Association'') filed with the Securities Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by the self-regulatory
organization. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
---------------------------------------------------------------------------
\1\ The NASD filed Amendment Nos. 1, 2, 3 and 4 to the proposed
rule change on July 15, 1997, July 21, 1997, December 3, 1997, and
December 19, 1997, respectively, the substance of which is
incorporated into the notice. See letters from to Elliot R. Curzon,
Assistant General Counsel, NASD Regulation, to Katherine A. England,
Assistant Director, Market Regulation, Commission, dated July 14,
1997 (``Amendment No. 1''), July 18, 1997 (``Amendment No. 2''), and
December 18, 1997 (``Amendment No. 4''); and letter from Joan C.
Conley, Secretary, NASD Regulation, to Katherine A. England,
Assistant Director, Market Regulation, Commission, dated December 3,
1997 (and attachments) (``Amendment No. 3'').
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
NASD Regulation is proposing to amend Rules 10304, 10307 and 10324
of the NASD's Code of Arbitration Procedure (``Code'') to establish
that all arbitration claims are eligible unless challenged, and to
establish a procedure for challenging the eligibility of claims. Below
is the text of the proposed rule change. Proposed new language is in
italics; proposed deletions are in brackets.
10304. Time Limit on Eligibility of Claims for Arbitration;
Procedures for Determining Eligibility Under This Rule [Time Limitation
Upon Submission]
This rule describes when a claim must be filed in order to be
eligible for arbitration, how and when parties may challenge the
eligibility of claims, and the Director's role in determining
eligibility.
[No dispute, claim, or controversy shall be eligible for submission
to arbitration under this Code where six (6) years have elapsed from
the occurrence
[[Page 589]]
or event giving rise to the act or dispute, claim or controversy. This
Rule shall not extend applicable statutes of limitations, nor shall it
apply to any case which is directed to arbitration by a court of
competent jurisdiction.]
(a) Claims eligible for arbitration and the Director's role in
determining the eligibility of claims.
(1) Any filed claim is eligible for arbitration unless the Director
decides it is ineligible. The Director may decide a claim is ineligible
only if:
(A) a party that is responding to a claim, the responding party,
asks the Director to decide that the claim is ineligible; and
(B) the Director determines that the claim is based on an
occurrence or event that took place 6 years or more before the claim
was filed.
(2) The 6-year eligibility period in paragraph (a)(1)(B) will be
extended only for the length of time that a claim is pending in court.
(The eligibility period will not be extended during any period in which
a responding party fraudulently concealed facts from the claimant.)
(b) Procedures for challenging eligibility and new time periods for
answering and delivering documents.
(1) If a responding party wants the Director to decide whether a
claim is ineligible:
(A) a responding party must serve a written request on the Director
and all the other parties to the arbitration; and
(B) a responding party must serve the written request no later than
30 days after the responding party was served the Statement of Claim.
(Rule 10314(c) explains how to serve a document.)
(2) To oppose the written request, a party must serve a written
response on the Director and all the parties. This written response
must be served no later than 14 days after the party was served the
written request.
(3) The Director will try to determine eligibility issues within 30
days of receiving the written request. The Director will serve the
decision on all the parties.
(4) The Director's determination is final. No party to the
arbitration may seek review of the determination in any forum, in an
action to vacate the arbitration award, or in any other proceeding
(5) If a claimant amends a Statement of Claim filed in arbitration,
a responding party may challenge the eligibility of any new claim in
the amended Statement of Claim.
(6) The parties do not have to file an answer or any other
documents until 45 days after the Director serves the decision on
eligibility.
(c) Challenges to eligibility when a claimant files a claim or
claims in court.
(1) If a court orders a claim to arbitration at the request of the
responding party, then the responding party may not challenge the
claim's eligibility in arbitration.
(2) The responding party may challenge the eligibility of a claim
in arbitration that a claimant initially filed in court when:
(A) the court orders the claim to arbitration and the responding
party did not request the order, or
(B) the claimant moves the claim from court to arbitration without
a court order.
(d) Determinations of eligibility and statutes of limitation.
(1) All statutes of limitation or any other time limitations that
may apply to a claim are extended from the time a Statement of Claim is
filed until 45 days after the Director serves a decision on eligibility
or the Association no longer has jurisdiction over a claim, whichever
is later. The parties agree that they will not assert a statute of
limitations defense in court that is inconsistent with this
subparagraph.
(2) The Director's determination that a claim is eligible or
ineligible does not determine whether a claim was filed later than the
time allowed by a statute of limitations. The parties may still assert
to the arbitrators or the court that has jurisdiction over a claim any
statute of limitations defense that applies to a claim.
(3) A claimant may pursue a claim in court even if a court or the
Director determines the claim is ineligible for arbitration.
(e) Consolidation of eligible and ineligible claims. If the
Director decides that one or more of the claims is not eligible for
arbitration, a customer claimant may:
(1) pursue all of the claims included in the Statement of Claim in
court; or
(2) pursue the eligible claims in arbitration and the ineligible
claims in court.
(f) Definitions.
(1) ``Claim''--For purposes of this Rule, the term ``claim'' means
any dispute or controversy described in a Statement of Claim, including
Counter-claims, Cross-claims, and Third-party claims, for which the
claimant is seeking any form of relief, damages or other remedy.
(2) ``Occurrence or event''--For purposes of this Rule, the term
``occurrence or event'' means:
(A) the date of the transaction upon which the claim is based; or,
(B) if the claim does not arise from a transaction, the date of the
occurrence of the act or omission upon which the claim is based.
* * * * *
10307. Reserved. [Tolling of Time Limitation(s) for the Institution of
Legal Proceedings and Extension of Time Limitation(s) for Submission to
Arbitration]
[(a) Where permitted by applicable law, the time limitations which
would otherwise run or accrue for the institution of legal proceedings
shall be tolled where a duly executed Submission Agreement is filed by
the Claimant(s). The tolling shall continue for such period as the
Association shall retain jurisdiction upon the matter submitted.]
[(b) The six (6) year time limitation upon submission to
arbitration shall not apply when the parties have submitted the
dispute, claim or controversy to a court of competent jurisdiction. The
six (6) year time limitation shall not run for such period as the court
shall retain jurisdiction upon the matter submitted.]
* * * * *
10324. Interpretation of Provisions of Code and Enforcement of
Arbitrator Rulings
[The arbitrators shall be empowered to interpret and determine the
applicability of all provisions under this Code and to take appropriate
action to obtain compliance with any ruling by the arbitrator(s). Such
interpretations and actions to obtain compliance shall be final and
binding upon the parties.] The arbitrators may interpret and apply the
provisions of this Code and take appropriate action to obtain
compliance with any ruling that they make, except as provided in other
provisions of this Code. The interpretations and actions of the
arbitrators to obtain compliance shall be final and binding upon the
parties.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the self-regulatory organization
included statements concerning the purpose of and basis for the
proposed rule change and discussed any comments it received on the
proposed rule change. The text of these statements may be examined at
the places specified in Item IV below. The self-regulatory organization
has prepared summaries, set forth in Sections A, B, and C below, of the
most significant aspects of such statements.
[[Page 590]]
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
Purpose
Background
Origins of the Eligiblilyt Rule. A time limitation on matters
eligible for arbitration has existed in the Code since it was first
adopted in 1968. Originally set at two (2) years, the time limit had
been extended to six years by the time the Rule was added to the
original Uniform Code of Arbitration developed by the Securities
Industry Conference on Arbitration (``SICA'') in 1978. Currently, Rule
10304 of the Code provides, ``No dispute, claim, or controversy shall
be eligible for submission to arbitration under this Code where six (6)
years have elapsed from the occurrence or event giving rise to the act
or dispute, claim or controversy.''
The original purpose of the rule was to prevent aged claims from
being litigated in arbitration. The six-year time limitation was
consistent with the SEC's books and records rule, SEC Rule 17a-4, which
required certain significant broker/dealer records to be retained for
no more than six years, and members may have believed that they would
be disadvantaged if forced to arbitrate claims if records were not
available. Moreover, the securities industry believed that the
inherently equitable nature of arbitration posed a greater risk that
arbitrators might not strictly apply legal defenses such as statutes of
limitation, thereby permitting a customer (investor) to recover in a
case that would have been dismissed had it been brought in court.
Resolving Eligibility Issues. Until about seven or eight years ago,
relatively few cases called for the application of the eligibility
rule; however, as public investor claims relating to limited
partnerships increased in the late 1980s, with many filed more than six
years after the public investor's original purchase, member firm
respondents employed the eligibility limitation of Rule 10304 to avoid
arbitrating those claims.
Member firms's efforts to defeat claims in arbitration on
eligibility grounds have had mixed success because arbitrators tend to
delay eligibility decisions until the hearing on the merits. Member
firms have had greater success when they have taken eligibility issues
to the courts in the form of actions to enjoin the arbitration of a
claim as ineligible, particularly because courts have not applied the
equitable tolling doctrine \2\ to eligibility decisions. The success
has been augmented by an increasing number of courts that have decided
that a predispute arbitration agreement amounts to an election of
remedies barring the claim from being heard in court, when it is
ineligible for arbitration.\3\
---------------------------------------------------------------------------
\2\ Equitable tolling based on fraudulent concealment is a legal
doctrine that permits a plaintiff to pursue a claim after a time
limitation for filing the claim has run out. Under the doctrine,
when it appears that a defendant intentionally hid (fraudulently
concealed) certain facts that would have alerted the plaintiff to
the existence of a legal claim for damages, a court or arbitrator
may determine that, in the interests of equity and fairness, the
running of a time limitation for the filing of a claim should be
tolled (stopped) during the time period when the facts were
concealed.
\3\ Some recent court rulings have held that if a claim
submitted to arbitration under a predispute agreement to arbitrate
is ineligible for arbitration, the claim may not be litigated in
court because the customer (investor) had elected arbitration as the
sole remedy. See Calabria v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 855 F. Supp. 172 (N.D. Tex. 1994); Merrill Lynch, Pierce,
Fenner & Smith, Inc. v. Shelapinsky, No. 93-1553 (E.D. Pa. Mar. 16,
1994); Piccolo v. Faragalli, 1993 WL 331933 (E.D. Pa. Aug. 24,
1993); and, Castellano v. Prudential-Bache Securities, Inc., 1990 WL
87575 (S.D.N.Y. June 19, 1990). Other courts have held there is no
election of remedies. See Smith Barney, Harris Upham & Co. v. St.
Pierre, 1994 WL 11600 (N.D. Ill., Jan. 4, 1994); Prudential
Securities v. LaPlant, 829 F. Supp. 1239 (D. Kan. 1993).
---------------------------------------------------------------------------
As a result, eligibility issues have become the subject of intense
and contentious litigation, both in court and in arbitration, and
member firms and customers (investors) often view the resolution of an
eligibility dispute as the major strategic issue of a case. If a claim
is found to be ineligible for arbitration, it may be either too costly
or difficult for the customer (investor) to pursue in court, or it may
be more susceptible to a statute of limitations defense in court. The
customer (investor) may settle the case for an amount the customer
(investor) believes is less than what could have been recovered in
arbitration in order to avoid the expense of court litigation or the
risk of losing the case. If the case is found to be eligible, the
member firm may be more likely to settle because it believes that the
equitable nature of arbitration renders one of its most valuable
procedural defenses--statutes of limitation--less reliable and
increases the risk of an adverse award.
Tactical maneuvering on the eligibility issue also resulted because
the courts, the Director of Arbitration (``Director''), and the
arbitrators, all have asserted jurisdiction over eligibility issues, or
directed the issue to another forum. Parties attempt to gain an
advantage by filing a claim or a motion in the forum they believe will
produce a favorable ruling. The result is significant confusion about
who should decide eligibility issues. Some courts have held that
eligibility was for the courts to decide; others have held that the
arbitrators could decide the issue.\4\ In some cases, the courts have
declined to decide the issue if the claim was clearly less than six
years old and, instead, deferred to the decision of the Director or the
arbitrators.
---------------------------------------------------------------------------
\4\ The rationale for holding that eligibility is for the courts
to decide, and not the arbitrators, is that the arbitrators only
have jurisdiction to hear claims the parties have agreed to submit
to arbitration and that it is for the courts to determine what the
parties have agreed to arbitrate. See, e.g., Cogswell, Merrill
Lynch, Pierce, Fenner & Smith, Inc., 78 F.3d 474 (10th Cir. 1996);
Edward D. Jones & Co. v. Sorrells, 957 F.2d 509, 514 (7th Cir.
1992). Other courts have held, however, that the parties may agree
to permit the arbitrator to determine if a case is arbitrable. See
PaineWebber Incorporated v. Elahi, 87 F.3d 589 (1st Cir. 1996);
Smith Barney Shearson, Inc. v. Boone, 47 F.3d 750 (5th Cir. 1995).
The Supreme Court's recent decisions in Mastrobuono v. Shearson
Lehman Hutton, 514 U.S. 52, 131 L.Ed.2d 76, 115 S.Ct. 1652 (1996),
and First Options of Chicago, Inc. v. Kaplan, 514 U.S. 938, 131,
L.Ed.2d 985, 115 S.Ct. 1920 (1995), among others, favoring
arbitration and giving full effect to agreements to arbitrate,
suggest that the Supreme Court would resolve the split between the
circuits by affirming agreements that give decisionmakers other than
the courts (e.g., the Director or the arbitrators) the power to
decide eligibility issues.
---------------------------------------------------------------------------
Until recently, the Director would examine arbitration claims to
determine if they were eligible.\5\ If the Director rejected a claim as
clearly ineligible, the customer (investor) could ask a court to compel
arbitration or attempt to litigate the claim in court. If the director
determined that the claim was clearly eligible, the member firm could
ask the arbitrators to reexamine the issue. If the arbitrators
dismissed the claim as ineligible, the customer (investor) could ask a
court to compel arbitration or attempt to litigate the claim in court.
---------------------------------------------------------------------------
\5\ In October 1996, NASD Regulation filed SR-NASD-96-47 with
the SEC setting forth its revised policy that, effective August 1,
1996, the staff of the Office of Dispute Resolution would no longer
make preliminary eligibility determinations and, instead, would
refer eligibility issues to the arbitrators. The SEC published the
proposed rule change for comment in the Federal Register. NASD
Regulation responded to the comments received by the SEC in a letter
from John M. Ramsay to Katherine A. England dated July 1, 1997.
---------------------------------------------------------------------------
Moreover, some courts, arbitrators, and the Director permitted
certain claims to be arbitrated even though they appeared to be based
on events more than six years old under a theory akin to equitable
tolling. Other courts, some arbitrators, and, several years ago, the
Director, applied a ``bright line'' transaction date test holding that
the date of the transaction was determinative of the eligibility of a
claim and that the limit could not be
[[Page 591]]
tolled.\6\ In the last few years (until August 1996, when NASD
Regulation's Office of Dispute Resolution (``Office'') changed the
procedure for deciding eligibility issues and sent them to the
arbitrators for eligibility determinations) the Office has declined the
apply equitable theories tolling as a basis for finding a claim
eligible for arbitration and, instead, has required the basis of a
claim for relief to be a transaction or an act that occurred within six
years of the filing of the claim.
---------------------------------------------------------------------------
\6\ Under either standard, if there were a close question or if
the facts about the eligibility of a claim were unclear, the
Director would refer the decision to the arbitrators.
---------------------------------------------------------------------------
Arbitration Policy Task Force Recommendations. In January 1996, the
NASD's Arbitration Policy Task Force (``Task Force'') released its
report on Securities Arbitration Reform. The Task Force's report
identified eligibility disputes as one of the most important areas for
reforming the arbitration process. The Task Force noted that: (1) The
eligibility rule has resulted in frequent court litigation; (2) the
eligibility rule, as presently written and applied, creates great
uncertainty as to who is to decide eligibility and what the triggering
event should be; (3) when the bright line transaction date test is not
applied, fact intensive inquiry and discovery may be required to
determine whether the claim is eligible for arbitration; and (4) the
eligibility rule creates the potential for a bifurcated process. In
considering its recommendations for resolving the problems with the
eligibility rule, the Task Force was confronted with an apparently
unbridgeable split of opinion. Customers (investors) want to eliminate
the eligibility rule entirely; member firms want to keep the rule and
apply it with a bright line test and no equitable tolling.\7\
---------------------------------------------------------------------------
\7\ The Task Force's specific recommendations were to: (1)
Suspend the eligibility rule for three years (and repeal the rule if
the pilot were successful) and adopt procedures to ensure that
statute of limitations issues would be resolved early in a case; (2)
suspend and repeal the rule prospectively only so that the
eligibility of claims older than six years old at the time the
suspension took effect would still be resolved under the old rule;
(3) direct the arbitrators to resolve statute of limitations issues
based on applicable law and train arbitrators to do so; and (4)
prohibit parties from litigating procedural arbitrability issues in
court until after an award is rendered.
---------------------------------------------------------------------------
From the standpoint of some, the rule is viewed as a burdensome,
unfair impediment preventing customers (investors) from obtaining a
hearing on their claims. The costs and delays involved in resolving
eligibility disputes affect the ability of customers (investors) to
receive complete recovery on their claims. Under some circumstances,
customers (investors) are discouraged or prevented from seeking
recovery for their claims because the costs and delays of litigating
eligibility claims approach or exceed the value of their claims.
Moreover, customers (investors) question the fairness of being forced
into arbitration under a predispute agreement that they are required to
sign as a condition of opening a securities account \8\ and then being
forced to litigate the eligibility of their claim. This circumstance
appears especially unfair to customers (investors) who find themselves
out of arbitration, but also barred from court under the election of
remedies doctrine.
---------------------------------------------------------------------------
\8\ Not all member firms include predispute arbitration clauses
in their new account agreements; however, such clauses are the
industry norm.
---------------------------------------------------------------------------
One byproduct of eligibility decisions is that if one of several
claims filed in arbitration is found to be ineligible, the customer
(investor) would be forced to litigate the ineligible claim in court
and pursue arbitration of the remaining claims. The cost of litigating
claims in two forums may preclude the customer (investor) from pursuing
some of the claims. Indeed, the customer (investor) may find that it is
uneconomical to pursue any of the claims if some must be litigated in
arbitration and others litigated in court.
Some member firms argue that the original reason for the rule still
prevails; members should not be forced to arbitrate claims if the
records relating to the claim may no longer exist because the SEC's
rules do not require them to keep the records. In addition, some argue
that with the increasing mobility of associated persons in the
securities industry, the individuals responsible for the actions
alleged by customers (investors) often are no longer employed by the
respondent member firm if the claim is filed many years later, making
obtaining witnesses and information in aid of the defense increasingly
difficult as time passes. Member firms also argue that arbitrators are
not strictly bound to apply statutes of limitation \9\ and, therefore,
often allow customers (investors) to assert and recover for claims that
would be barred if brought in court. Finally, respondents argue that
the resulting uncertainty about arbitrator application of statutes of
limitation makes analyzing the risks of litigating a claim much more
difficult and makes decisions about disposing of records much riskier.
---------------------------------------------------------------------------
\9\ If the arbitrators err or refuse to apply a statute of
limitation in the same manner as would a court, it is extremely
difficult for respondents to overturn the decision because the
standard of review for an arbitration award is much more limited
than the standard of review on appeal from a court decision.
---------------------------------------------------------------------------
Consideration of Task Force Recommendations by NASD Regulation.
NASD Regulation, through its National Arbitration and Mediation
Committee, and in consultation with SICA, considered the Task Force's
recommendations at length. NASD Regulation initially developed proposed
rule changes designed to give effect to the Task Force's
recommendations and consulted with SICA, the Public Investors
Arbitration Bar Association (``PIABA''), the Securities Industry
Association (``SIA''), the staff of the SEC, and others about the
efficacy of the proposals.\10\
---------------------------------------------------------------------------
\10\ As a member of SICA, NASD Regulation participated in
considering several proposals to amend the eligibility rule advanced
by other members of SICA. One proposed eligibility rule was adopted
by SICA; however, upon further review, NASD Regulation became
concerned about a number of unresolved issues and determined not to
adopt the SICA rule language. Nevertheless, NASD Regulation has
considered the concerns of SICA and its members in developing its
proposed rule. While SICA has not adopted NASD Regulation's proposed
rule, and some SICA members have indicated they are not in favor of
the proposed rule, NASD Regulation believes that the proposed rule
adequately addresses the issues raised by SICA and others.
---------------------------------------------------------------------------
The Task Force recommended suspending the eligibility rule for
three years as a pilot and, ultimately, repealing it. The Task Force
also proposed adopting procedures to ensure that statute of limitations
issues would be resolved early in a case and directing the arbitrators
to resolve statute of limitations issues based on applicable law.
Finally, the Task Force recommended prohibiting parties from litigating
procedural arbitrability issues in court until after an award was
rendered. The recommendations generated significant opposition.
First, customers (investors) objected that if the rule was
reinstated after three years, customers (investors) who filed their
claims after the rule was reinstated might have their claims dismissed
as ineligible while those who filed identical claims before the change
would not. Customers (investors) also argued that it was unfair to
repeal the eligibility rule only temporarily while permanently adopting
a rule capping punitive damages.\11\ Member firms argued that repealing
the rule either temporarily or permanently would eventually expose them
to very old claims and they would be unable to predict or manage the
risks of such claims.
---------------------------------------------------------------------------
\11\ The Task Force recommended adopting a rule permitting
punitive damages with a cap, but did not recommend a pilot period
for the punitive damages rule.
---------------------------------------------------------------------------
[[Page 592]]
Second, customers (investors) and member firms believed that
adopting a prehearing procedure for resolving statute of limitation
issues would add unnecessary burdens and delays, and would aggravate
the current trend toward formalization of arbitration proceedings. They
also argued that requiring arbitrators to resolve statue of limitations
issues on the basis of applicable law would create a contractual
limitation on the authority of the arbitrator to decide these issues
and make it easier to overturn an arbitration award, because the losing
party would have to show only that the arbitrator exceeded the
contractual limitation by failing to apply the law rigorously. The
usual, more onerous, standard of review that would apply in the absence
of a contractual limitation established in the rule would be that the
arbitrators so imperfectly exercised their powers by manifestly
disregarding the law that a valid award was not rendered.\12\
---------------------------------------------------------------------------
\12\ See Federal Arbitration Act, 9 U.S.C. 10(d).
---------------------------------------------------------------------------
Finally, some customers (investors) argued that permitting
eligibility decisions to be reviewed after an award undermines
certainty and finality of arbitration awards. Member firms argued that
prohibiting review of eligibility decisions until after an award would
cause both sides to expend resources litigating a claim that might
ultimately be dismissed. Both customers (investors) and member firms
agreed that eligibility decisions should occur early in a case and
should be final, but member firms wanted the decisions to be
immediately reviewable in court.
As a result of these concerns, NASD Regulation ultimately
determined not to adopt the Task Force's recommendations concerning the
eligibility rule. NASD Regulation concluded that repealing the rule
could create more problems for both customers (investors) and member
firms than were solved and that the original purpose for the rule
remained valid. Also, the Task Force's recommendations, in the opinion
of some, would ultimately work as a greater disadvantage to public
investor claimants than to members and associated persons.
Consequently, the proposed amendments reestablish the gatekeeping
function and eliminate the aspects of the current rule that may be
unfair to public investors.
In addition, NASD Regulation believes that the proposed rule
addresses the concerns of customers (investors) and enhances the
hallmarks of arbitration as an efficient, cost-effective, fair method
of resolving disputes. Under the proposed rule, customers (investors)
will be assured that their claims will be heard either in court or in
arbitration, and that they will not be subjected to repeated, costly,
time-consuming, and indeterminate battles over the eligibility of their
claim for arbitration. First, by presuming that all filed claims are
eligible for arbitration, the proposed rule eliminates the need for
customers (investors) to fight their way in to arbitration if that is
where they want to have their claims adjudicated. Second, by providing
that the Director is the sole and final arbiter of eligibility issues,
the parties will know in advance that they will not be engaged in a
lengthy, indeterminate, multi-forum fight. Finally, by preventing the
potentially costly and involuntary bifurcation of eligible and
ineligible claims, the proposed rule will provide customers (investors)
with a single forum (either court or arbitration) for the resolution of
their disputes. Accordingly, NASD Regulation is proposing to amend the
eligibility rule to provide a clear, quick, and final mechanism to
resolve eligibility issues, prevent bifurcation of claims, and permit
customers (investors) to pursue ineligible claims in court (and in
arbitration under some circumstances).
Description of Proposed Rule
The proposed rule, which applies to all claims (public investor-
member and intra-industry) filed in arbitration, the provisions of
which are described in more detail below, would:
(1) Retain the current six-year eligibility rule but establish that
all filed claims are eligible unless successfully challenged; (2)
establish a bright line transaction date test for eligibility (i.e., it
would preclude the application of the equitable tolling doctrine) and
permit separate claims for non-transaction-based occurrences; (3) give
investor claimants the option, in the face of a successful eligibility
challenge, to consolidate their ineligible and eligible claims in court
to avoid bifurcation; and (4) establish that an ineligible claim is not
barred from court under the election of remedies doctrine. In the same
manner that other provisions of the Code supersede the terms of a
predispute arbitration agreement,\13\ the proposed changes to Rule
10304 will supersede provisions in any existing or future arbitration
agreements between members and others on issues relating to eligibility
and statutes of limitations.
---------------------------------------------------------------------------
\13\ See Rule 3110(f) of the NASD's Conduct Rules.
---------------------------------------------------------------------------
The proposed rule has been drafted using the ``plain English''
principles of written communication that the Commission has encouraged.
NASD Regulation believes the proposed rule will be easier for all
arbitration participants to understand, most notably participants who
represent themselves (pro se parties). Unlike the NASD's Conduct Rules,
which are mainly referred to and applied by member firms, their
compliance offices, and their attorneys, the Code of Arbitration
Procedure is often used by pro se parties who are not attorneys and who
by seeking arbitration are usually coming into contact with the dispute
resolution process for the first time.\14\ In such circumstances, plain
English rules are particularly important.
---------------------------------------------------------------------------
\14\ NASD Regulation estimates that as many as one-third of all
claims filed involve a pro se party. See Securities Arbitration
Commentator, Vol. VIII, No. 9 (February 1997). The number of pro se
parties is much higher for smaller claims; more than three-quarters
of claims involving $10,000 or less involved pro se claimants. Id.
---------------------------------------------------------------------------
Eligibility Determinations. Paragraph (a)(1) provides that a claim
filed with NASD Regulation's Office of Dispute Resolution (``Office'')
is eligible for submission to arbitration unless the Director
determines that the claim is ineligible. A determination by the
Director can occur only if a respondent challenges a claim as
ineligible, triggering the Director's action. The Director cannot act
in the absence of a challenge. Moreover, in the absence of a challenge,
and in contrast to the current rule, the proposed rule does not operate
in any manner to preclude the arbitration of a claim. Thus, the rule
fundamentally alters the legal effect and procedure surrounding
eligibility by changing it from a substantive jurisdictional time
limitation on the dispute that could be arbitrated to a presumption
that all claims are eligible. The proposed rule establishes that all
claims are eligible for arbitration unless the Director decides
otherwise and it removes the courts and the arbitrators from any role
in determining the eligibility of a claim.\15\ Consequently, the
proposed rule will eliminate much of the delay and uncertainty that has
surrounded the resolution of eligibility issues.
---------------------------------------------------------------------------
\15\ NASD Regulation is also proposing to amend Rule 10324 of
the Code to clarify that the arbitrators have no power to decide
eligibility issues under the proposed amendments to Rule 10304.
---------------------------------------------------------------------------
Bright Line Standard for Eligibility Determination. Once a
responding party has requested an eligibility determination, the
Director, to decide that a claim is ineligible under paragraph
(a)(1)(B) of the proposed rule, must find that the claim is based on an
occurrence or event that took place more than six years before the
claim was filed. The term ``occurrence or event'' is
[[Page 593]]
defined in paragraph (f)(2) of the proposed rule to mean either the
transaction date or, if no transaction is involved, the date of the act
or occurrence which is the subject of the claim. This provision and the
definition are intended to establish that the six-year limitation in
the proposed rule is a ``bright line.''
Further, under paragraph (a)(2), the six-year limitation period
cannot be extended or ``tolled'' even if the claimant alleges that the
respondent fraudulently concealed the facts that would have alerted the
claimant to the existence of a claim. For example, if the customer's
claim is for losses from the purchase of a limited partnership from a
member in 1987, the claim will be ineligible for arbitration even if
the member continued to send account statements to the claimant that
showed the investment to be worth more than that current market value.
If, however, the customer's claim is for losses suffered from the
misrepresentations contained in the account statements sent less than
six years before the claim was filed, the claim would be eligible for
arbitration.
If the claim is based on an act or occurrence other than a
transaction, the six-year period will run from the date of the act or
occurrence. This point can be illustrated with the above-described
example, assuming the following facts: (1) The claimant asked the
member about the value of the limited partnership in 1992; (2) the
member misrepresented the value to the claimant; (3) the claimant
alleges that the misrepresentation caused the claimant not to sell the
security; and (4) the claimant asks for damages for the difference
between what the member represented as the actual value of the security
at the time and the value at the time the claim is filed. A claim under
these facts would be based on the misrepresentation made in 1992, not
the original purchase in 1987, and thus would be eligible for
arbitration.
While fraudulent concealment will not extend the eligibility
period, proposed paragraph (a)(2) provides that if the claimant files a
claim in court that is eventually moved to arbitration, either
voluntarily or by court order, the six-year period will be tolled for
as long as the claim remains in court. For example, if the claimant
files a claim in court five years and eleven months after the claim
arose and the court ordered the claim to arbitration six months later,
the claim will be eligible for arbitration.
Procedure for Challenging Eligibility. Under paragraph (b) of the
proposed rule, a respondent (called a ``responding party'' in the
proposed rule) who wants to challenge the eligibility of a claim must
serve a request on the Director and all the other parties no later than
thirty calendar days after receiving the Statement of Claim. A claimant
who wants to oppose the respondent's request must serve a response on
the Director and all other parties no later than fourteen days after
receiving the respondent's request. The Director will attempt to
determine the eligibility of the claim within thirty days after
receiving the respondent's request.
This requirement is intended to force eligibility issues to be
raised, responded to, and decided early in a proceeding. Because of an
early eligibility determination, parties will know early in the process
whether a claim is eligible and will be able to decide where and how to
litigate their claims, pursuant to the options provided by other
provisions of the proposed rule.
If a claimant amends a Statement of Claim, under paragraph (b)(5) a
respondent may challenge the eligibility of any new claim. This
provision is intended to prevent respondents from being foreclosed from
challenging a new claim after the time to challenge the initial claim
has expired. Under this provision, if a claimant adds a new transaction
to the claim, the respondent will have the opportunity to challenge the
eligibility of the new claim. For example, if a claimant alleges that
the respondent misrepresented certain facts to the claimant related to
the sale of security A and purchase of security B five years before the
claim was filed, that claim would be eligible. But if the claimant then
amended the Statement of Claim to ask for damages relating to the
original purchase of security A ten years before the claim was filed,
the respondent could challenge the eligibility of that claim insofar as
it is related to the purchase. This provision is not intended, however,
to prevent or discourage a claimant from including or adding facts to
the Statement of Claim that relate to events more than six years before
the claim was filed if the facts are relevant to the claim. Because
eligibility determinations belong exclusively to the Director under the
proposed rule, any decision about what constitutes a new claim will
necessarily be a part of that decision and also will belong exclusively
to the Director.
Paragraph (b)(6) also provides that the parties need not file an
answer or other documents that may be required by the Code until forty-
five days after the Director serves an eligibility decision. This
provision delays the start of the proceedings until decisions about the
eligibility of a claim are made, and permits the parties sufficient
time to consider how to proceed according to the various options
provided by the proposed rule.
Finality of Director's Decision. Paragraph (b)(4) of the proposed
rule provides that the Director's determination of eligibility issues
is final and that the parties are prohibited from seeking review of the
decision in any forum, in any action to vacate the arbitration award,
or in any other proceeding. This provision is intended to establish
conclusively that eligibility issues are gatekeeping issues only,
internal to the Association's forum, and not a jurisdictional matter
that would prevent arbitration of a claim. Providing finality on
eligibility decisions early in the process will substantially reduce
the expense, time, and uncertainty currently associated with
eligibility determinations. Under this provision, parties cannot ask
the arbitrators to revisit the Director's eligibility decision; nor can
they ask to court to overturn it, either immediately or after the
award. Thus, the current practice of seeking an injunction or writ of
mandate to prevent or force the arbitration of an eligible or
ineligible claim will be prohibited. Likewise, neither customers
(investors) nor member firms may ask a court, in an action subsequent
to an award, to reconsider the Director's eligibility decision.
NASD Regulation also is considering amending its rules (Rule 10106
and IM-10100 of the Code) to clarify its authority to discipline
members and associated persons who attempt to seek review of
eligibility decision. Under the plan being considered, if a member or
associated person raises an eligibility issue in a motion to vacate an
award or in an action to compel or bar an arbitration proceeding (or
with the arbitrators, even though such an action is precluded by this
rule), such persons may be subject to disciplinary action. While NASD
Regulation does not have jurisdiction over non-members, members and
associated persons should be able to use the plain language of the rule
and any descriptive provisions contained herein to oppose any attempt
by non-member parties to litigate eligibility rules.
Bifurcation. In considering how to draft a rule that would retain
the six-year eligibility period yet permit parties to litigate
ineligible claims in court, many participants in the drafting process
became concerned that the eligible and ineligible claims of public
investors might be bifurcated between arbitration and court. As noted
above, the cost of litigating claims in two forums may preclude
customers (investors) from pursuing some or all of
[[Page 594]]
their claims in either forum. Accordingly, the proposed rule will not
require customers (investors) to bifurcate their ineligible and
eligible claims in different forums. If the Director determines that
some of a customer's (investor's) claims are ineligible, paragraph (e)
of the proposed rule gives the customer (investor) the option either to
pursue the eligible claims in arbitration and the ineligible claims in
court, thereby permitting customers (investors) to voluntarily
bifurcate the claims,\16\ or to consolidate all of the claims in court.
---------------------------------------------------------------------------
\16\ Paragraph (d)(2) does not force a customer (investor) to
litigate ineligible claims in court if the customer (investor)
determines to arbitrate eligible claims. Rather, the customer
(investor) could choose to abandon any ineligible claims.
---------------------------------------------------------------------------
NASD Regulation is also concerned that if a customer (investor)
files an action in court, members may attempt to bifurcate claims by
selectively compelling only some of the claims to arbitration. In order
to prevent such actions, NASD Regulation will be amending Rule 3110(f)
to, among other things, require predispute arbitration agreements to
include a provision prohibiting members from seeking to compel only
some of a customer's court-filed claims.\17\
---------------------------------------------------------------------------
\17\ As noted in part 6 of this rule filing, the amendments to
Rule 10304 proposed herein will not take effect until the SEC
approves yet-to-be-filed amendments to Rule 3110 (f) of the NASD's
Conduct Rules governing the provisions of predispute arbitration
agreements.
---------------------------------------------------------------------------
In addition, NASD Regulation is aware that some members may view
the proposed rule change as limiting their ability to defend against a
customer's court-filed action. Accordingly, NASD Regulation notes that
it will not be a violation of this proposed rule if a member asks a
court to dismiss some of a customer's court-filed claims on statute of
limitations grounds prior to asking the court to compel arbitration.
NASD Regulation believes that permitting members to seek such
dismissals is consistent with the goal of judicial economy. There is no
reason to force a member to seek to compel arbitration of a claim that
could otherwise be dismissed by the court upon the application of the
appropriate statute of limitation.
Paragraph (c) of the proposed rule provides that if the member firm
asks that court to compel the arbitration of the claims, the member
firm will be barred from challenging the eligibility of those claims
once they reach arbitration. However, if the customer (investor) moves
the claims to arbitration either by voluntarily withdrawing them and
refiling in arbitration or by asking the court to order the claims to
arbitration, or the court on its own motion orders the claims to
arbitration, the member firm may challenge the eligibility of the
claims once they reach arbitration.
The intended effect of these provisions is to give the customer
(investor) control over whether claims are bifurcated. Member firms
will be required to choose whether to challenge the eligibility of a
claim in arbitration, recognizing that they may be forced to litigate
eligible claims in court as a result of their challenge. Similarly, if
a customer (investor) files an action in court first, member firms, in
deciding whether to compel arbitration, will have to choose whether
they want to litigate all of the claims in court or all of the claims
in arbitration. If they choose to compel arbitration, they must seek to
compel arbitration of all of the customers' (investors') claims,
including claims that may be ineligible, and they will be precluded
from challenging the eligibility of the claims once they reach
arbitration.
Statutes of Limitation Defenses. Paragraph (d) of the proposed rule
tolls any applicable statutes of limitation from the time the claim is
filed in arbitration until forty-five days after the Director serves a
decision on eligibility. For example, if the statute of limitations on
a particular case would have run out the day after a claim was filed in
arbitration, the statute will be tolled from the time the claim is
filed. If the claim is eligible for arbitration and remains in
arbitration, there is no statute of limitations defense because the
claim was filed in time. If, however, the Director decides the claim is
ineligible, the customer (investor) has forty-five days after the
decision is served to refile the claim in court before the statute of
limitations begins to run again.
In addition, the proposed rule provides that ``the parties agree
that they will not assert a statute of limitations defense that is
inconsistent with [the tolling provision].'' While NASD Regulation
believes that all of the provisions of the Code are part of the
``agreement to arbitrate'' between the parties, it is especially
important to preserve statute of limitation defenses for parties who
are subject to the procedures specified in this rule. Therefore, the
provision has been phrased as an express agreement between the parties
and precludes the parties from asserting the defense in a manner that
is inconsistent with the tolling provisions of this rule. NASD
Regulation would regard a violation of this provision to be a violation
of Rule 2110 of the NASD's Conduct Rules because it would violate and
express agreement between the parties and, therefore, would be
inconsistent with high standards of commercial honor and just and
equitable principles of trade.
Finally, paragraph (d) provides that an eligibility decision does
not affect the application of a statute of limitations to a claim. This
provision is intended to establish clearly the difference between
eligibility and statutes of limitation, a distinction that has
occasionally been overlooked by courts, arbitrators, and other
participants. Thus, even if a claim is found to be eligible for
arbitration after a challenge under the proposed rule (i.e., it was
filed less than six years after the transaction), it may have been
filed after an applicable statute of limitations have expired (e.g., it
was filed more than three years after the transaction and, therefore,
too late under the absolute three-year limitation on claims under
Section 10(b) of the Securities Exchange Act of 1934). Therefore, the
arbitrators could dismiss the claim. Similarly, if a claim is found to
be ineligible for arbitration and then is filed in court, it may have
been filed in court within the time required by the applicable statute
of limitations.
Election of remedies. As noted in the background discussion above,
some courts have held under the current rule that, if a claim is
ineligible for arbitration, the customer (investor) may not pursue the
claim in court. The rationale for these decisions is that, by agreeing
to arbitration, customers (investors) have ``elected'' arbitration as
their sole remedy for resolving their disputes. NASD Regulation
believes that this result may be unfair to public investors
particularly because they often are required to arbitrate through
predispute agreements in account opening documents. Paragraph (d) of
the proposed rule provides that a customer (investor) may pursue a
claim in court even if the Director or a court decides the claim is not
eligible for arbitration, thereby eliminating the effect of the
election of remedies doctrine.
Elimination of Other Tolling Provisions. Finally, NASD Regulation
is proposing to repeal Rule 10307 to eliminate the tolling provisions
contained therein. The tolling provisions in Rule 10307 are now
contained in provisions of the amendments to Rule 10304.
NASD Regulations notes, however, that users of the arbitration
forum should be aware that, with the elimination of Rule 10307(a), the
filing of an executed Submission Agreement will no longer be sufficient
to toll a statute of limitations. Under the proposed amendments to Rule
10304,
[[Page 595]]
only the filing of a Statement of Claim will toll a statute of
limitations.
Effectiveness of Proposed Rule Change. NASD Regulation plans to
make the proposed rule change effective thirty days after SEC
approval.\18\
---------------------------------------------------------------------------
\18\ NASD Regulation consents to an extension of the time
periods specified in Section (19)(b)(2) of the Act until the SEC is
prepared to approve NASD Regulation's yet-to-be-filed rule filing
proposing to amend Rule 3310(f) to revise the requirements for
customer predispute arbitration agreements used by members. NASD
Regulation intends to amend the rules governing customer predispute
arbitration agreements to give effect to the eligibility rule
proposed herein and the punitive damages rule proposed in SR-NASD-
97-47. The purpose of the extension is to permit the SEC to act
simultaneously on this rule filing, the yet-to-be-filed rule filing
proposing to amend Rule 3310(f), and the punitive damages rule
proposed in SR-NASD-97-47.
---------------------------------------------------------------------------
2. Statutory Basis
NASD Regulation believes that the proposed rule change is
consistent with the provisions of Section 15A(b)(6) of the Act \19\
because it will eliminate many of the substantive and procedural issues
that have cause eligibility issues to interfere with the fair,
efficient, and cost effective resolution of disputes, and will improve
the arbitration process for the benefit of public investors, broker/
dealer members, and associated person who are the user of the process.
---------------------------------------------------------------------------
\19\ U.S.C. 78o-3.
---------------------------------------------------------------------------
B. Self-Regulatory Organization's Statement on Burden on Competition
The NASD does not believe that the proposed rule change will impose
any inappropriate burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
No written comments were either solicited or received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the publication of this notice in the Federal
Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents,\20\ the Commission
will:
---------------------------------------------------------------------------
\20\ See supra note 18.
---------------------------------------------------------------------------
(A) By order approve the proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
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 at 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-97-44 and should
be submitted by January 27, 1998.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-162 Filed 1-5-98; 8:45 am]
BILLING CODE 8010-01-M
