[Federal Register Volume 63, Number 204 (Thursday, October 22, 1998)]
[Notices]
[Pages 56670-56684]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-28321]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40555; File No. SR-NASD-98-48]
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Change and Notice of Filing and Order Granting
Accelerated Approval to Amendment Nos. 3 and 4 to Proposed Rule Change
by the National Association of Securities Dealers, Inc., Relating to
the Selection of Arbitrators in Arbitrations Involving Public Customers
I. Introduction
On July 10, 1998, the National Association of Securities Dealers,
Inc., (``NASD'' or ``association'') through its wholly-owned
subsidiary, NASD Regulation, submtited to the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend Rule 10308 to set forth
new procedures to be used to select arbitrators for arbitrations
involving public customers.\3\ Under the new procedures, NASD
regulation will allow the parties to an arbitration to rank arbitrators
from lists generated primarily using an automated process, providing
parties with a larger role in determining the composition of their
arbitration panels. NASD Regulation also is proposing conforming
changes to Rules 10104, 10309, 10310, 10311, 10312, and 10313. In
addition, NASD Regulation proposes to amend Rule 10315 concerning the
scheduling of the first meeting of the parties and the arbitration
panel to reflect that such meetings usually occur prior to the first
hearing of an arbitration proceeding. Finally, NASD Regulation proposes
to correct in its rules the name of the NASD Regulation committee that
addresses arbitration and related matters, the National Arbitration and
Mediation Committee.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ NASD Regulation filed a proposed rule change to use a
similar list selection process for intra-industry arbitrations (SR-
NASD-98-64), which the Commission is approving on an accelerated
basis simultaneously with this filing.
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The proposed rule change, together with the substance of the
proposal, was published for comment in Securities Exchange Act Release
No. 40261 (July 24, 1998) 63 FR 40761 (July 30, 1998). Three comment
letters were received in response to the proposal.\4\ NASD Regulation
filed Amendment Nos. 3 and 4 to the proposed rule change \5\ on August
14, 1998 and September 4, 1998, respectively. The NASD also responded
to the comment letters.\6\ Below is the text of the proposed rule
change contained in the Amendment Nos. 3 and 4. Proposed new language
is italicized; proposed deletions are in brackets.
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\4\ See letters from Stephen G. Sneeringer, Chairman, Securities
Industry Association (``SIA'') Arbitration Committee, to Jonathan G.
Katz, Secretary, Commission, dated August 19, 1998 (``SIA Letter'');
Scot D. Bernstein (``Bernstein''), Law Offices of Scot D. Bernstein,
to Jonathan G. Katz, Secretary, Commission, dated August 19, 1998
(``Bernstein Letter''); and Richard P. Ryder (``Ryder''), Securities
Arbitration Commentator, to Jonathan G. Katz, Secretary, Commission,
dated September 2, 1998 (``Ryder Letter'').
\5\ Amendment No. 3 amends the definition of ``non-public
arbitrator'' to incorporate the standard terminology ``municipal
securities dealer'' and to add an explicit reference to government
and municipal securities to make clear that employees of banks or
other financial institutions who engage in government or municipal
securities transactions are included in the definition; by
reordering proposed Rule 10308(b)(1) to make it more clear and to
conform it to previously approved amendments to Rule 10308 and Rule
10302; by amending Rule 10308(b)(1) to clarify parties' right to
change the panel composition if they all agree; to clarify in the
rule language what information will be available with regard to the
initial conflict of interest review by NLSS; to clarify in the rule
language that the information on each arbitrator forwarded to the
parties is employment information for a 10 year period and any other
background information; to clarify in the rule language that a
ranking of ``1'' means the most preferred arbitrator; to clarify in
the rule language that when the Director must appoint an unranked
arbitrator the Director will provide the parties Rule 10308(b)(6)
information and the parties shall have the right to object to the
arbitrator as provided in Rule 10308(d)(1); to delete the reference
in the rule to parties acting cooperatively to rank arbitrators; and
to reorder Rule 10312(d), (e), and (f) and to clarify the
information contained in those paragraphs. See letter from John M.
Ramsay, Vice President and Deputy General Counsel, NASD Regulation,
to Katherine A. England, Assistant Director, Market Regulation,
Commission, dated August 14, 1998 (``Amendment No. 3'').
Amendment No.4 amends Rule 10308(c)(5) to state that the
Director must chose one of the public arbitrators as chairperson of
the arbitration panel, subject to certain parameters; amends Rule
10308(c)(3) to eliminate the exception where a Director could
determine not to consolidate a party's rankings with the other
parties if he or she determines that their interests are
``sufficiently divergent;'' amends Rule 10313 to align the time
period with previous revisions to rules 10312 and 10315; to clarify
the effective date of the proposed rule change; and to respond to
the comment letters. See letter from Alden S. Adkins, Senior Vice
President and General Counsel, NASD Regulation, to Katherine A.
England, Assistant Director, Market Regulation, Commission, dated
September 4, 1998 (``Amendment No. 4'').
\6\ See Amendment No. 4 and letter from Alden S. Adkins, Senior
Vice President and General Counsel, NASD Regulation, to Katherine A.
England, Assistant Director, Market Regulation, Commission, dated
September 11, 1998 (``Response Two'').
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10308. Selection of Arbitrators in Customer Disputes
* * * * *
[[Page 56671]]
(a) Definitions
(1) through (3) No change
(4) ``non-public arbitrator''
The term ``non-public arbitrator'' means a person who is otherwise
qualified to serve as an arbitrator and:
(A) is, or within the past three years, was:
(i) associated with a broker or a dealer (including a government
securities broker or dealer or a municipal securities [broker or]
dealer);
(ii) through (iv) No change
(B) through (C) No change
(D) is an employee of a bank or other financial institution and
effects transactions in securities, including government or municipal
securities, and commodities futures or options or supervises or
monitors the compliance with the securities and commodities laws of
employees who engage in such activities.
(5) through (7) No change
(b) Composition of Arbitration Panel; Preparation of Lists for
Mailing to Parties
(1) Composition of Arbitration Panel
(A) Claims of $50,000 or Less [General Rule Regarding Panel
Composition] [(i)]
If the amount of a claim is $50,000 or less, the Director shall
appoint an arbitration panel composed of one public arbitrator, unless
the parties agree [otherwise] to the appointment of a non-public
arbitrator.
(i) If the amount of a claim is $25,000 or less and an arbitrator
appointed to the case requests that a panel of three arbitrators be
appointed, the Director shall appoint an arbitration panel composed of
one non-public arbitrator and two public arbitrators, unless the
parties agree to a different panel composition.
(ii) If the amount of a claim is greater than $25,000 and not more
than $50,000 and a party in its initial filing or an arbitrator
appointed to the case requests that a panel of three arbitrators be
appointed, the Director shall appoint an arbitration panel composed of
one non-public arbitrator and two public arbitrators, unless the
parties agree to a different panel composition.
[(ii) If the amount of a claim is more than $50,000, the Director
shall appoint an arbitration panel composed of one non-public
arbitrator and two public arbitrators, unless the parties agree
otherwise.]
(B) [Special Request] Claims of More than $50,000. If the amount of
a claim is more than $50,000, the Director shall appoint an arbitration
panel composed of one non-public arbitrator and two public arbitrators,
unless the parties agree to a different panel composition.
[If the amount of a claim is greater than $25,000 and not more than
$50,000 and the claimant requests that a panel of three arbitrators be
appointed, the Director shall appoint an arbitration panel composed of
one non-public arbitrator and two public arbitrators, unless the
parties agree otherwise.]
(2) through (3) No change
(4) Preparation of Lists
(A) Except as provided in subparagraph (B) below, the Neutral List
Selection System shall generate the lists of public and non-public
arbitrators on a rotating basis within a designated geographic hearing
site and shall exclude arbitrators based upon conflicts of interest
identified within the Neutral List Selection System database.
(B) No change
(5) No change
(6) Information About Arbitrators
The Director shall send to the parties employment history for each
listed arbitrator for the past 10 years and [any] other background
information [disclosed by the arbitrator under Rule 10312 relating to
personal or financial interests or the existence of a relationship that
gives rise to an appearance of a conflict of interest or bias]. If a
party requests additional information about an arbitrator, the Director
shall send such request to the arbitrator, and shall send the
arbitrator's response to all parties at the same time. When a party
requests additional information, the Director may, but is not required
to, toll the time for the parties to return the ranked lists under
paragraph (c)(2).
(c) Striking, Ranking, and Appointing Arbitrators on Lists
(1) Striking and Ranking Arbitrators
(A) No change
(B) Ranking--Panel of One Arbitrator
Each party shall rank all of the arbitrators remaining on the list
by assigning each arbitrator a different, sequential, numerical ranking
, with a ``1'' rank indicating the party's first choice, a ``2''
indicating the party's second choice, and so on.
(C) Ranking--Panel of Three Arbitrators
Each party shall rank all of the public arbitrators remaining on
the list by assigning each arbitrator a different, sequential,
numerical ranking, with a ``1'' rank indicating the party's first
choice, a ``2'' indicating the party's second choice, and so on. Each
party [and] separately shall rank all of the non-public arbitrators
remaining on the list, using the same procedure.
[(D) Joint Action Permitted
All claimants may act jointly and all respondents, including third-
party respondents, may act jointly to file a single list that reflects
their unanimous agreement as to the striking and ranking of
arbitrators. If multiple claimants or respondents do not act jointly,
the rankings of multiple claimants or respondents will be consolidated
as described in paragraph (b)(3)(A).]
(2) No change
(3) Process of Consolidating Parties' Rankings
[(A) General Rule] The Director shall prepare one or two
consolidated lists of arbitrators, as appropriate under paragraphs
(b)(2) or (b)(3), based upon the parties' numerical rankings. The
arbitrators shall be ranked by adding the rankings of all claimants
together and all respondents together, including third-party
respondents, to produce separate consolidated rankings of the claimants
and the respondents. The Director shall then rank the arbitrators by
adding the consolidated rankings of the claimants, the respondents,
including third-party respondents, and any other party together, to
produce a single consolidated ranking number, excluding arbitrators who
were stricken by any party.
[(B) Exception If the Director determines that the interests of a
party are sufficiently different from the interests of other claimants
or respondents, the Director may determine not to consolidate the
rankings of that party with the rankings of the other claimants or
respondents.]
(4) Appointment of Arbitrators
(A) No change
(B) Discretion to Appoint Arbitrators Not on List
If the number of arbitrators available to serve from the
consolidated list is not sufficient to fill a panel, the Director shall
appoint one or more arbitrators to complete the arbitration panel. [;
provided, however,] U[u]nless the parties agree otherwise, the Director
may not appoint a non-public arbitrator under paragraphs (a)(4)(B) or
(a)(4)(C). The Director shall provide the parties information about the
arbitrator as provided in paragraph (b)(6), and the parties shall have
the right to object to the arbitrator as provided in paragraph (d)(1).
(5) Selecting the Chairperson for the Panel
The parties shall have 15 days from the date the Director sends
notice of the names of the arbitrators to select a chairperson. If the
parties cannot agree, the Director shall appoint [one of the public
arbitrators as the chairperson. Unless all parties agree otherwise, the
Director shall not appoint as the chairperson a public arbitrator who:
(A) is an attorney, accountant, or other
[[Page 56672]]
professional, and (B) has devoted 50% or more of his or her
professional or business activities; within the last two years, to
representing or advising public customers in matters relating to
disputed securities or commodities transactions or similar matters.] a
chairperson from the panel as follows:
(A) The Director shall appoint as the chairperson the public
arbitrator who is the most highly ranked by the parties as long as the
person is not an attorney, accountant, or other professional who has
devoted 50% or more of his or her professional or business activities,
within the last two years, to representing or advising public customers
in matters relating to disputed securities or commodities transactions
or similar matters.
(B) If the most highly ranked public arbitrator is subject to the
exclusion set forth in subparagraph (A), the Director shall appoint as
the chairperson the other public arbitrator, as long as the person also
is not subject to the exclusion set forth in subparagraph (A).
(C) If both public arbitrators are subject to the exclusion set
forth in subparagraph (A), the Director shall appoint as the
chairperson the public arbitrator who is the most highly ranked by the
parties.
(6) No change
(d) Disqualification and Removal of Arbitrator Due to Conflict of
Interest or Bias
(1) through (2) No change
(3) Vacancies Created by Disqualification or Resignation
Prior to the commencement of the earlier of (i) the first
prehearing conference or (ii) the first hearing, [I]if an arbitrator
appointed to an arbitration panel is disqualified or is otherwise
unable or unwilling to serve, [resigns from an arbitration panel,] the
Director shall appoint from the consolidated list of arbitrators the
arbitrator who is the most highly ranked available arbitrator of the
proper classification remaining on the list. If there are no available
arbitrators of the proper classification on the consolidated list, the
Director shall appoint an arbitrator of the proper classification
subject to the limitation set forth in paragraph (c)(4)(B). The
Director shall provide the parties information about the arbitrator as
provided in paragraph (b)(6), and the parties shall have the right to
object to the arbitrator as provided in paragraph (d)(1).
(e) No change
* * * * *
Rule 10312. Disclosures Required of Arbitrators and Director's
Authority To Disqualify
(a) through (c) No change
* * * * *
(d) Prior to the commencement of the earlier of (i) the first
prehearing conference or (ii) the first hearing, the Director may
remove an arbitrator based on information disclosed pursuant to this
Rule.
(e) Prior to the commencement of the earlier of (i) the first
prehearing conference or (ii) the first hearing, t[T]he Director shall
inform the parties to an arbitration proceeding of any information
disclosed to the Director under this Rule unless either the arbitrator
who disclosed the information withdraws [from being considered for
appointment] voluntarily as soon as [and immediately after] the
arbitrator learns of any interest or relationship described in
paragraph (a) that might preclude the arbitrator from rendering an
objective and impartial determination in the proceeding, or the
Director removes the arbitrator.
[(e) Prior to the commencement of the earlier of (i) the first
prehearing conference of (ii) the first hearing, the Director may
remove an arbitrator based on information disclosed pursuant to this
Rule.]
(f) After the commencement of the earlier of (i) the first
prehearing conference or (ii) the first hearing, the Director's
authority to remove an arbitrator from an arbitration panel ceases.
During this period, the Director shall inform the parties of any
information disclosed by an arbitrator under this Rule.
Rule 10313. Disqualification or Other Disability of Arbitrators
In the event that any arbitrator, after the commencement of the
earlier of (i) the first prehearing conference or (ii) the first
hearing [session] but prior to the rendition of the award, should
become disqualified, resign, die, refuse or otherwise be unable to
perform as an arbitrator, the remaining arbitrator(s) shall continue
with the hearing and determination of the controversy, unless such
continuation is objected to by any party within 5 days of notification
of the vacancy on the panel.
II. Background and Description
NASD Regulation developed a rule that provides parties in
arbitration with more input into the selection of arbitrators. Under
the proposal, parties will select their arbitrators from lists provided
by NASD Regulation. In a one-arbitrator panel case, the parties to the
arbitration will be provided a list of public arbitrators, and, in a
three-arbitrator panel case, the parties will be provided a list of
public and a list of non-public arbitrators.\7\ The parties will use
the lists to express numerical preferences for the arbitrators listed
and those rankings will determine the outcome of the arbitrator
selection process, unless all ranked arbitrators decline to serve
because they are unavailable, recuse themselves, or are disqualified
because of conflicts of interest.
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\7\ For ease of reference, the NASD focused the discussion in
this rule filing on of the process of selecting a three-person
arbitration panel.
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The lists of arbitrators will be generated by computer from an
arbitrator database called the Neutral List Selection System
(``NLSS'').\8\ However, the Director of Arbitration (``Director'') also
has the discretion to supplement the NLSS process in response to party
requests.
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\8\ The term ``Neutral List Selection System'' is defined in
proposed Rule 10308(a)(3).
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The proposed rule change is divided into five parts.\9\ Paragraph
(a) contains definitions. Paragraph (b) specifies how lists of public
and non-public arbitrators will be compiled and forwarded to the
parties. Paragraph (c) specifies how the parties indicate their
preferences by numerical rankings and how the Director reconciles the
preferences of the parties, selects the arbitrators, selects the
chairperson if the parties do not make the selection, and, if
necessary, disqualifies an arbitrator before the arbitrator is
appointed. Paragraph (d) describes generally how parties and the
Director may remove a person from serving as an arbitrator if the
person has a conflict of interest or a bias. Paragraph (e) specifies
that the Director has discretionary authority to resolve issues arising
in the administration of the list selection process.
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\9\ The NASD has filed a proposed rule change to apply a similar
list selection process to intra-industry disputes, which the
Commission is approving on an accelerated basis simultaneously with
this filing. See SR-NASD-98-64.
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NASD Regulation amended several other rules in the Rule 10000
Series in order to make the Rule Series 10000 consistent. Proposed
amendments to those rules are discussed at the end of the discussion of
the proposed changes to Rule 10308.
Definitions--Paragraph (a)
Paragraph (a) of Rule 10308 of the proposed rule change contains
seven definitions: ``day,'' ``claimant,'' ``Neutral List Selection
System,'' ``non-public arbitrator,'' ``public arbitrator,''
``respondent'' and ``send.''
[[Page 56673]]
The definition of ``non-public arbitrator'' at paragraph (a)(4)
largely retains the existing definition in the Rule 10000 Series of an
arbitrator who is deemed to be ``from the securities industry,'' but it
adds to that defined term persons employed by banks and other financial
institutions who are engaged in securities activities or in the
supervision of such activities.
The definition of ``public arbitrator'' at paragraph (a)(5) of Rule
10308 also largely retains the existing definition in the Rule 10000
series. The proposed rule change clarifies the securities-related
activities or affiliations that would exclude an arbitrator from the
``public arbitrator'' classification. For example, the proposed rule
change adds that persons employed by banks and other financial
institutions who are engaged in securities activities or in the
supervision of such activities may not be public arbitrators.
``Immediate family member'' is defined in proposed Rule
10308(a)(5)(B) with reference to the person's familial or economic ties
to the person associated with the securities or commodities
industry.\10\ A person who has a close familial, personal, or
economically dependent relationship with an associated person can be
viewed as biased in favor of the securities or commodities industry
even though he or she is not involved directly with the identified
industry.\11\
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\10\ ``Immediate family member'' means:
(i) a family member who shares a home with a person engaged in
the conduct or activities described in paragraphs (a)(4)(A) through
(D);
(ii) a person who receives financial support of more than 50
percent of his or her annual income from a person engaged in the
conduct or activities described in paragraph (a)(4)(A) through (D);
or
(iii) a person who is claimed as a dependent for federal income
tax purposes by a person engaged in the conduct or activities
described in paragraph (a)(4)(A) through (D).
\11\ As under existing rules, a small group of persons will
continue to be excluded from serving as either public or non-public
arbitrators (e.g., spouses and immediate family members of
registered representatives). Excluded by subparagraph (a)(5) from
serving as public arbitrators, such persons are also excluded from
serving under subparagraph (a)(4) as non-public arbitrators because
a non-public arbitrator must have the professional securities
experience (or the related qualifications) listed in subparagraph
(a)(4). For example, unless the spouse of a registered
representative was also employed in the securities or commodities
industry (or engaged in one of the business activities related to
the securities industry), that person might not posses securities
industry experience (or the related qualifications) and therefore
could not serve as a non-public arbitrator. In addition, because of
the marital relationship, the spouse would be excluded from serving
as a public arbitrator.
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The term ``Neutral List Selection System'' defines the new software
program that will implement the proposed list selection rule. NASD
Regulation defines ``Neutral List Selection System'' as ``the software
that maintains the roster of arbitrators and performs various functions
relating to the selection of arbitrators.'' \12\ Among other things,
NLSS will maintain the roster of arbitrators, identify arbitrators as
public or non-public, screen arbitrators for conflicts of interest with
parties, list arbitrators according to geographic hearing sites and, on
occasion, by expertise, and consolidate the numerical rankings that
parties assign to listed arbitrators.
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\12\ Proposed Rule 10308(a)(3).
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Two other terms, ``claimant'' and ``respondent,'' are defined in
paragraph (a) to simplify certain aspects of the rule. Under proposed
Rule 10308(a)(2), if one or more persons files a single claim they will
be treated as one claimant. A parallel definition is proposed for
respondents; one or more persons who file the same answer will be
treated as one respondent.\13\ The Office of Dispute Resolution
(``ODR'') views claimants who file one claim or respondents who file
one answer as generally having sufficiently similar interests in the
outcome of the proceeding to be considered as one party for purposes of
the list selection process.\14\ This approach will simplify
consolidating the parties' preferences for arbitrators described
below.\15\
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\13\ Proposed Rule 10308(a)(6).
\14\ The consolidated process is described in greater detail
below. However, it should be noted that a group of claimants that
does not file a single claim, or, similarly, a group of respondents
that does not file a single answer, does not obtain an advantage in
the consolidation process or in the weighting of their preferences
for arbitrators. For example, if in a case there are two claimants
who are not viewed as one claimant under the rule, and one
respondent, the two claimants' arbitrator rankings will be weighted
as only 50% of the total; the one respondent's arbitrator rankings
be weighted as the other 50%.
\15\ The terms ``day'' and ``send'' are also defined in
paragraph (a).
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Composition of Arbitration Panel; Compilation of Lists of Arbitrators
for Parties' Selection--Paragraph (b)
Proposed Rule 10308(b)(1) states the number of arbitrators that the
Director should appoint to a panel, general panel composition
requirements, and exceptions to those requirements. If the claim is
$50,000 or less, the claim generally will be heard by a single public
arbitrator, unless the parties agree to the appointment of a non-public
arbitrator.\16\ If the claim is more than $50,000, a panel of two
public arbitrators and one non-public arbitrator will hear the dispute,
unless the parties agree to a different panel composition.\17\ Under
proposed paragraph (b)(1)(i), if the claim is $25,000 or less and an
arbitrator appointed to the case requests that a panel of three
arbitrators be appointed, the Director will appoint an arbitration
panel composed of one non-public and two public arbitrators, unless the
parties agree to a different panel composition.\18\
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\16\ See Proposed Rule 10308(b)(1)(A)(i) and Amendment No. 3.
Under proposed paragraph (b)(1)(A)(ii) of Rule 10308, a claimant
with a claim valued greater than $25,000 and not more than $50,000
may request a three-person arbitration panel. Obtaining a three-
person panel under this subparagraph then obligates the parties to
pay hearing session deposit fees for a three-person panel under Rule
10332. An arbitrator appointed to the case may also request a three
arbitrator panel. See Amendment No. 3.
\17\ See Proposed Rule 10308(b)(1)(A)(ii) and Amendment No. 3.
\18\See Amendment No. 3.
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Under proposed paragraphs (b)(2) and (b)(3) of Rule 10308, the
Director will send lists of names of arbitrators for ranking to the
claimant and the respondent. When only one arbitrator will hear the
proceeding, the Director will send the parties one list of public
arbitrators.\19\ When three arbitrators will hear the proceeding, the
Director will send the parties two lists, one containing the names of
public arbitrators and the other containing the names of non-public
arbitrators.\20\ When the parties agree to change the panel
composition, references in the balance of the rule to a panel would be
interpreted accordingly. For example, if the parties agree to a panel
composed of three public arbitrators, under proposed paragraph
(c)(1)(C) the parties would rank a list of public arbitrators only; the
Director would not send the parties a list of non-public arbitrators.
In addition, if the panel composition varies from that provided in
proposed paragraph (b)(1)(A) or (B), NLSS is not capable of processing
all combinations. NLSS can generate the lists and consolidate the
rankings for one-person panel of either public or non-public
classification. For a three-person panel, NLSS can only generate the
lists and consolidate the rankings for a panel composed of one non-
public and two public arbitrators or three non-public arbitrators.\21\
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\19\ Proposed Rule 10308(b)(2).
\20\ Proposed Rule 10308(b)(3).
\21\ Although the parties could agree to changes in panel
composition, NASD Regulation states that experience indicates that
composition changes for disputes involving customers is almost never
requested.
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(i) Director's Minimum Numbers for Lists
Subparagraphs (b)(2) and (b)(3) of proposed Rule 10308 do not set a
fixed ratio of arbitrators or a minimum number of arbitrators that ODR
must
[[Page 56674]]
list. ODR, however, has established the following guidelines. For a
panel of one arbitrator, the Director intends to provide five names of
public arbitrators whenever possible, but not less than three names.
For a panel of three arbitrators, the Director intends to provide lists
that contain up to 10 public arbitrator names and five non-public
arbitrator names; when that is not possible, the Director will provide
a public arbitrator list of not less than six names, and a non-public
arbitrator list of not less than three names. To the extent possible,
NASD Regulation expects that, for a three-person panel, the list of
public arbitrators will contain approximately twice as many names as
the list of non-public arbitrators. The Director's ability to provide
full lists of names will vary and depends on the number of available
arbitrators and the demands on the arbitrator roster. Circumstances may
arise where a small arbitrator roster in a particular hearing location
(for example, Richmond, Va., Norfolk, Va., Alaska, or Hawaii), combined
with a high demand for arbitrators, would prevent the Director from
meeting the objectives.
To address possible arbitrator shortages, NASD Regulation plans to
combine arbitrator rosters from near-by hearing locations. For example,
under proposed paragraph (b)(2), the list to be sent to the parties
should contain, at a minimum, three names of public arbitrators. If,
with one hearing location coded into NLSS, NLSS does not generate the
names of three public arbitrators, the Director will return to NLSS,
add a second hearing location code, and generate a list of public
arbitrators that will include the additional arbitrators. The second
hearing location coded will be one that is geographically close to the
first hearing location code.
(ii) NLSS Functions and Capabilities
Proposed paragraphs (b)(2), (3), and (4) of Rule 10308 together
state the four factors which are used by NLSS to generate the list or
lists of arbitrators by ``selecting'' or ``sorting'' the NLSS database.
The four factors are arbitrator classification, hearing location code,
rotation,\22\ and conflicts of interests \23\ identified within the
NLSS database.\24\
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\22\ The NLSS rotation feature also may be described as a
``first-in-first-out'' feature. For a case that will be heard by one
public arbitrator, the following steps would apply. As an
arbitrator's name rises to the top of the list of all arbitrators
who are, for example, public arbitrators and found in one hearing
location, the arbitrator's name will be generated by NLSS, absent an
identified conflict of interest, on a list for ranking by parties to
an arbitration. Once the arbitrator's name is sent to the parties,
even if the arbitrator is later not appointed an arbitrator for the
panel, NLSS places such arbitrator at the bottom of the computerized
NLSS list. Thus, an arbitrator may be listed, and thereafter rotated
to the bottom of the NLSS list even if: (1) the arbitrator recuses
him or herself; (2) the arbitrator is not ranked highly enough by
the parties to be appointed or the arbitrator was struck; or (3) the
arbitrator is ranked highly enough to serve, is contacted, has no
conflict of interest or bias that would disqualify him, but is
unavailable to serve.
When a three person panel will be appointed, generally two
public arbitrators and one non-public arbitrator are needed. For the
generation of the list of non-public arbitrators and the list of
public arbitrators, the same process would be used. For the
selection of the non-public arbitrators, the first five non-public
arbitrators in the system will be rotated forward for the first
arbitration case. However, if, for example, the case is against Firm
X and the first person that NLSS generates, Arbitrator A51000, is
employed by Firm X, NLSS will not select Arbitrator A51000 but will
skip over him or her and will list the next person classified as a
non-public arbitrator. Arbitrator A51000 will remain at the top of
the internal NLSS rotating list for non-public arbitrators, and the
NLSS will generate his or her name when next requested to produce
the names of non-public arbitrators for a case in the same hearing
location. The process for obtaining the list of public arbitrators
is the same.
\23\ Proposed Rule 10308(b)(4). NLSS can identify only obvious,
disclosed conflicts of interest. For example, NLSS recognizes a
conflict of interest when the member firm that is the respondent is
also the employer of an arbitrator rotating forward in NLSS. NLSS
would not list such a person on a non-public arbitrator list being
generated for that case.
\24\ See Amendment No. 3.
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Under proposed Rule 10308(b)(4)(B), the automated NLSS selection
process that generates the arbitrators may be altered in order to add a
fifth factor, expertise. Expertise has three subcategories: (1) subject
matter expertise (also known as a controversy code); (2) security
expertise (also known as a security code); and (3) case expertise (also
known as a qualification code).
Two of these types of expertise, subject matter expertise and
security expertise, are factors that may be included in the NLSS's
selection or sorting process at the option of a party as provided in
proposed paragraph (b)(4)(B) of Rule 10308.
First, a party may request for listing arbitrators who possess
certain types of subject matter expertise.\25\ The NLSS will add the
additional factor and sort or select for placement on the lists some
arbitrators having the subject matter expertise identified unless such
arbitrators are not available.\26\
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\25\ An arbitrator is deemed to have certain subject matter
expertise if he or she represents on an NASD arbitration intake form
that he or she possesses it. ODR does not verify such
representations.
\26\ NLSS selects based upon the areas of subject matter
expertise that have been coded for the NLSS. If not coded into the
NLSS, ODR does not have the administrative capacity to identify
arbitrators who might possess in-depth knowledge in the desired
subject (e.g., bankruptcy is not a category of expertise identified
in the NLSS; ``churning'' and ``suitability'' are subject matter
categories that are identified.). The areas of subject matter
expertise that are coded in NLSS are those that previously have been
identified in arbitrator disclosure forms. NASD Regulation plans in
the future to update and to amend the designated subject matter
areas. At that time, NASD Regulation will make corollary changes to
NLSS.
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The second subcategory of expertise, security expertise, is also
added to the NLSS selection process at the option of a party. There are
22 security subcategories, listing various types of securities or other
financial instruments (e.g., common stock, municipal bonds, stock index
futures, Ginnie Maes, etc.), and a party may indicate whether expertise
regarding a particular instrument is desired. The same procedure
described above regarding NLSS selection to accommodate the additional
factor of subject matter expertise will apply if a party opts to
include security expertise in the NLSS selection process. If available
in the hearing location, certain arbitrators may be included in the
arbitrator lists generated by NLSS. However, the Director is not
obligated to provide a list that contains one or more names having the
requested security expertise.
The third type of expertise, case expertise, will be a factor in
the NLSS selection process at the option of the Director or at the
request of the parties; the category is very narrow and its use is
primarily to aid in the administration of a case. Case expertise
contains only three subcategories: injunctive relief cases; employment
law cases; and large and complex cases. Only one of the subcategories,
that identifying expertise in large and complex cases, is relevant for
any customer arbitration and is very infrequently utilized.\27\ When
used, the NLSS will search for the names of arbitrators, if such
arbitrators exist, in the appropriate hearing location with expertise
in large and complex cases.
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\27\ The two other types of case expertise, expertise involving
injunctive relief and employment issues, are used only in intra-
industry arbitrations.
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(iii) Conflicts-of-Interest
During the preparation of the arbitrator lists, two types of
conflict-of-interest checks will occur. The first is the check for
conflicts of interests between parties and potential arbitrators that
will be performed as part of the automated NLSS process that was noted
[[Page 56675]]
above.\28\ The second process will be a review for conflicts of
interest performed manually by ODR, which will occur after the NLSS
creates a list of arbitrators, but before the list is finalized. ODR
will perform a review based upon information that each arbitrator
discloses to ODR and, for non-public arbitrators, additional
information found in the Central Registration Depository (``CRD'').
After a review of available information, ODR may remove an arbitrator
based upon such disclosure.\29\ If arbitrators are eliminated during
this process, ODR will replace them by returning to NLSS so that the
minimum number of public arbitrators, and, if applicable, non-public
arbitrators, are on the list or lists that will be mailed to the
parties.
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\28\ See discussion regarding proposed Rule 10308(b)(4)(A) and
Note 23, supra.
\29\ At this stage of the arbitrator appointment process, ODR
staff would not make telephone inquiries.
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After the parties receive the lists, the parties also will have the
ability to review information disclosed by the potential arbitrators to
determine if a conflict of interest exists. Under proposed paragraph
(b)(6) of Rule 10308, for each arbitrator listed, the Director will
provide the parties with the arbitrator's employment history for the
past 10 years and other background information. This information may
help parties to discover a conflict of interest between a party or its
witnesses and the arbitrator listed and permits the parties to make
more informed decisions during the process of ranking and striking the
listed arbitrators. Under paragraph (b)(6), the parties may request
additional information from the arbitrators; any response by an
arbitrator is forwarded to all parties. If a party identifies a
conflict of interest, the party's remedy is to strike the person from
the list, in the process described in greater detail below.\30\
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\30\ Proposed Rule 10308(c)(1)(A).
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(iv) Transmittal to Parties
The Director shall send the lists to all parties approximately 30
days after the respondent's answer is due, or, if there are multiple
respondents, approximately 30 days after the last answer is due. If
there is a third-party claim, the Director shall send the lists
approximately 30 days after the third-party respondent's answer is due
or, if there are multiple third-party respondents, approximately 30
days after the last answer is due.\31\ Under proposed paragraph (a)(7)
of Rule 10308, ``send'' means to send by first class mail, facsimile,
or any other method available and convenient to the parties and the
Director, and the lists and all other transmissions between the parties
and the Director shall be sent using one of these methods.
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\31\ Proposed Rule 10308(b)(5).
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Striking, Ranking, and Appointing Arbitrators--Paragraph (c)
Generally, paragraph (c) of proposed Rule 10308 sets forth the
method by which a party strikes and ranks arbitrators and the
procedures ODR will use to consolidate the parties' preferences and
appoint an arbitration panel. Under paragraph (c), the parties rank the
arbitrators on the list according to the parties' preferences, and
strike arbitrators to remove them from consideration. Proposed
paragraph (c) will implement the most important feature of the list
selection rule, that of allowing a party to exercise significant
influence over the composition of the party's arbitration panel.
(i) Striking and Ranking Arbitrators
Proposed paragraph (c)(1) provides the basic structure for the
parties to exercise their influence in selecting arbitrators for their
arbitration proceeding. First, each claimant and each respondent may
strike any one or more arbitrators from the list (or lists, if there
are two lists) for any reason, including the party's concern that the
arbitrator may have a conflict of interest. Second, the party ranks
each arbitrator remaining on the list by assigning the arbitrator a
different numerical ranking. A ``1'' rank indicates the party's first
choice, a ``2'' indicates the party's second choice, and so on, until
all the arbitrators are ranked.\32\ When a party receives one list of
public arbitrators and one list of non-public arbitrators, the party
must rank arbitrators on each list separately.\33\ As noted above, all
claimants who file a single claim are treated as one claimant; and
similar treatment is accorded to all respondents who file one answer.
Multiple claimants and multiple respondents may act jointly to
determine which arbitrators to strike and how to rank the remaining
arbitrators on the lists in order for persons who are parties to have
their preferences for arbitrators weighed appropriately.\34\
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\32\ This language explaining the ranking was added to the rule
language in proposed Rule 10308(c)(1)(B) and (C). See Amendment No.
3.
\33\ Proposed Rule 10308(c)(1).
\34\ Proposed paragraph (c)(1)(D) of Rule 10308, which addresses
multiple-party concepts, has been deleted because NASD Regulation
believes that it is implicit that parties may act cooperatively to
rank arbitrators. See Amendment No. 3.
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Under proposed paragraph (c)(2), each party's lists of arbitrators
reflecting the party's strikes and rankings must be returned to the
Director not later than twenty days after the Director's letter
communicating the lists was sent. If a party does not timely return the
lists, the Director shall treat the party as having retained all the
arbitrators on the lists and as having no preferences. If the lists are
returned but a party fails to rank an arbitrator on a list, the
Director will assign the arbitrator the next lower ranking after the
lowest-ranked arbitrator on that list. For example, if a party ranks
arbitrators on a list containing ten public arbitrators by striking six
arbitrators and ranking arbitrators A, B, and C, as ``1,'' ``2,'' and
``3,'' respectively, and fails to rank public arbitrator D, ODR will
assign arbitrator D a ranking of ``4.''
If a party fails to rank more than one arbitrator on the same list
or gives two or more arbitrators on the same list the same numerical
ranking, then the Director shall rank the multiple, unranked
arbitrators in the same order of preference that the list originally
generated by NLSS reflected and transmitted to the parties for their
ranking. (When NLSS generates a list, the person listed first is ranked
as high or higher by NLSS selection factors than the person listed
second, third, and so on. Generally, this NLSS ranking is not relevant
because the ranking by the parties is the basis for appointing
arbitrators. NLSS ``ranking'' only becomes relevant when the parties
fail to rank, or improperly rank multiple arbitrators on a list.) \35\
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\35\ In this process, when only the four factors are considered
in the NLSS-list generation process (e.g., arbitrator
classification, hearing location code, rotation, and no identified
conflicts of interest), the person who has taken part in the fewest
list selection processes (i.e., having a higher rotation number)
would be placed higher on the NLSS-generated list than a person who
has participated in more list selection processes. (e.g., P, a
public arbitrator in Richmond, Virginia who has participated in the
list selection process six times would be listed more highly by NLSS
than Z, a public arbitrator from Richmond, Virginia who has
participated in the list selection process seven times, if both were
generated for the same list. Therefore, if a party failed to rank
both P and Z, the Director would refer to the original NLSS-
generated list and rank P more highly than Z.) If additional factors
are introduced, such as subject matter expertise, those persons
having the greatest cluster of desired factors or characteristics
would be listed most highly on the NLSS-generated lists and that
ordering would be used by the Director for the default ``ranking''
process that is used only when the parties fail to rank multiple
arbitrators.
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(ii) Consolidating Parties' Rankings
After the claimant and respondent have returned their lists to the
Director, the Director implements the parties' preferences for
arbitrator selection using the process described in proposed paragraph
(c)(3) of Rule 10308. Under
[[Page 56676]]
proposed paragraph (c)(3), the Director, using the NLSS, creates a
consolidated list of the public arbitrators, and, if non-public
arbitrators are also ranked, a second consolidated list of non-public
arbitrators, using a one or two-step consolidation process.
Since generally all parties who file a single claim are treated as
one claimant and all respondents who file one answer are treated as one
respondent, in most cases, the Director will consolidate the parties'
preferences for arbitrators using a one-step process. The Director will
add the consolidated rankings of the claimant and the respondent to
produce a single consolidated list for the public arbitrators and, if
necessary, a second consolidated list for the non-public
arbitrators.\36\ NLSS performs the consolidation functions.
---------------------------------------------------------------------------
\36\ Proposed Rule 10308(c)(3).
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When there are multiple claimants or respondents, the Director will
use a two-step consolidation process. First, the Director will
consolidate all rankings of the multiple claimants or respondents. For
example, if there are two respondents, R#1 and R#2, the rankings of R#1
and R#2 are added together, resulting in one consolidated respondent
ranking for each listed public arbitrator and a second consolidated
respondent ranking for each listed non-public arbitrator. This first
step in the two-step consolidation process may be avoided by
cooperation. The parties may file a list to which the parties have
jointly agreed. The first step of the consolidation process,
consolidating all the preferences of multiple claimants and,
separately, those of multiple respondents, prevents numerous parties on
the claimant or respondent side of the case from having a greater
influence in the selection of the arbitrators. By consolidating the
rankings of parties on the same side, the process ensures that
claimants' and respondents' choices will have the same weight in the
arbitrator selection process. Second, as previously described, the NLSS
will consolidate the rankings of the claimants and the respondents to
produce a single consolidated list for public arbitrators and, if
necessary, a second list for non-public arbitrators.\37\
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\37\ Proposed Rule 10308(c)(3). The proposed rule also
accommodates the interests of a party added to the case if the party
is added before the Director has consolidated the other parties'
rankings. Proposed Rule 10308(c)(6).
---------------------------------------------------------------------------
NASD Regulation has eliminated the exception to the general rule
for consolidation of all claimants or all respondents, which had stated
that in instances where the Director determines that the interests of a
claimant or a respondent (including a third party respondent) are so
substantially different from the interests of other claimants or
respondents, the Director may determine not to consolidate the
numerical rankings of that party with the numerical rankings of the
other claimants (or with the other respondents, as the case may
be).\38\
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\38\ See Amendment No. 4, deleting proposed Rule 10308(c)(3)(B).
---------------------------------------------------------------------------
Numerical ties between two or more arbitrators during consolidation
will be broken by NLSS by the following principles. First, NLSS will
break a tie during consolidation by preferentially ranking one
arbitrator above another based upon which of the tied arbitrators has a
set of rankings, that, when compared, result in the smallest numerical
difference between the claimant ranking and the respondent ranking. A
second principle that governs tie-breaking within NLSS is that, given
an equal difference in the consolidated ranking, an arbitrator who was
listed higher (as more preferred) on the list as originally generated
by the NLSS and transmitted to the parties will be given a more
preferred or higher ranking in order to break this type of tie.
(iii) Appointing Arbitrators
Proposed Rule 10308(c)(4) states the steps the Director will take
to appoint arbitrators after consolidation occurs. If the arbitration
is to be heard by one public arbitrator, the Director contacts the
public arbitrator ranked highest on the public arbitrator list. If the
Director were required to appoint a three-person arbitration panel, the
Director would contact the next two highest ranked arbitrators to
determine if they were available to serve and, if not disqualified,
would appoint them. If necessary, due to the unavailability or
disqualification of one of the two arbitrators, the Director would then
contact the third highest ranked arbitrator, and invite him or here to
serve. The Director would refer to the second list, generated according
to the same principles, to determine which non-public arbitrator should
be contacted first.
The contact is to determine if the arbitrator is available and,
after provided the issues of the cases and the names of the parties, if
the arbitrator is aware of any conflicts of interest or bias or other
reason that may preclude the arbitrator from rendering an objective and
impartial decision. Based upon the information that the arbitrator has
previously provided, any information provided to the Director under
Rule 10312,\39\ and any information obtained from any other source, the
Director shall determine if the arbitrator should be disqualified. If
the Director determines that the arbitrator should not be disqualified
and that the arbitrator is available, the Director appoints the
arbitrator.\40\
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\39\ Current Rule 10312, also discussed below, requires an
arbitrator to disclose, with respect to a particular case and the
issues, parties, and witnesses in the case, any information which
might preclude the arbitrator from rendering an objective and
impartial determination in the case.
\40\ Proposed Rule 10308(c)(4).
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NASD Regulation will establish a time frame to guide its staff when
a listed arbitrator is contacted but fails to respond to ODR's
inquiries regarding availability and disqualification. For example, if
an arbitrator is telephoned and fails to respond, ODR will eliminate
such arbitrator and contact the next listed arbitrator after an
appropriate period. NASD Regulation undertakes to exercise its
discretion in fairness to the parties waiting for their arbitration
cases to be resolved.
(iv) Selecting a Chairperson
Under the proposal, the Director will notify the parties of the
appointments and request that the parties appoint a chairperson. The
parties may jointly select one of the arbitrators (including the non-
public arbitrator) to be the chairperson of the panel.\41\ If the
parties fail to appoint a chairperson by mutual agreement within 15
days, the Director will appoint the chairperson. The Director will
appoint the public arbitrator most highly ranked by the parties, as
long as that person is not an attorney or other professional who has
devoted 50% or more of his or her professional or business activities,
within the past two years, to representing or advising public customers
in adversarial proceedings concerning disputed securities or
commodities transactions or related matters.\42\ If the most highly
ranked public arbitrator is subject to this exclusion, the Director
shall appoint the other public arbitrator as chairperson, unless that
person is also subject to the same exclusion. If both public
arbitrators are subject to this exclusion, the Director shall appoint
the most highly ranked public arbitrator as chairperson.\43\
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\41\ Proposed Rule 10308(c)(5).
\42\ See Amendment No. 4.
\43\ See Amendment No. 4.
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(v) When the Consolidated List Is Insufficient
Under proposed Rule 10308(c)(4), if the Director is not able to
appoint the
[[Page 56677]]
number of arbitrators needed for the panel using the consolidated list,
the Director may appoint other arbitrators from the NLSS roster as
necessary. If the Director is required to appoint a non-public
arbitrator, the Director may not appoint a non-public arbitrator who
meets the criteria set forth in paragraph (a)(4)(B) or (a)(4)(C),
unless the parties otherwise agree. A non-public arbitrator in proposed
paragraph (a)(4)(B) is one who is retired from the securities or
commodities industry; proposed paragraph (a)(4)(C) describes a non-
public arbitrator who is a professional who devotes 20 percent or more
of his or her professional time to clients who are engaged in any of
the securities or commodities business activities described in
subparagraph (a)(4). The rule requires that the Director choose a non-
public arbitrator who is active and fully involved in the securities or
commodities industry or related industry. When the Director appoints a
non-public arbitrator in this stage of the proceeding, the parties no
longer have the ability to strike.\44\
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\44\ Under the proposal, the Director provides the parties
information about the arbitrator as provided in proposed paragraph
(b)(6). Based upon that information, the parties have the right to
object to the arbitrator as provided in proposed paragraph (d)(1) of
Rule 10308. See Amendment No. 3. This means that although a party
does not have the right to strike an arbitrator appointed under the
process described in proposed (c)4)(B) of Rule 10308, a party
retains the right to request that the Director consider
disqualifying an arbitrator appointed pursuant to proposed Rule
10308(c)(4)(B).
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Arbitrator Disclosures and Removing Arbitrators--Paragraph (d)
Proposed Rule 10308(d)(1) provides a mechanism for the Director to
disqualify an arbitrator after the arbitrator has been appointed by the
Director under proposed paragraph (c)(4). As noted previously, during
the period that a party is reviewing and ranking the lists of
arbitrators (see paragraphs (c) (1) and (2)), a party has an unlimited
right to eliminate a listed arbitrator by striking the arbitrator from
the list, and may do so to eliminate an arbitrator who the party
believes may not be impartial or fair, among other reasons. Proposed
paragraph (d)(1) applies after the parties have exercised this
unlimited right to strike, the arbitrator lists have been consolidated,
the arbitrators have made disclosures to the Director under Rule 10312
regarding the specific parties, issues and witnesses in the case as
discussed below, and the arbitrators have been appointed.\45\
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\45\ As noted above, disqualification issues that arise after
the Director, using NLSS, has begun consolidating parties' preferred
arbitrators, may be addressed by the Director directly as part of
the appointment process described in paragraph (c)(4).
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An arbitrator has a continuing obligation under Rule 10312 of the
Code to disclose to the Director any circumstances that might preclude
the arbitrator from rendering an objective and impartial determination
in an arbitration, including a direct or indirect financial or personal
interest in the outcome of the arbitration, or any existing or past
financial, business, professional, family or social relationships with
a party, counsel, or representative (or, when later identified, a
witness) that might affect impartiality or might reasonably create an
appearance of partiality or bias. Generally, the ODR, in turn, must
disclose to the parties any information the arbitrators provide.
Under paragraph (d)(1), a party or the Director may raise a
disqualification issue, and the Director may disqualify an arbitrator
already appointed. The Director may not make any decision to disqualify
an arbitrator, however, after the commencement of the earlier of two
events: (i) the first prehearing conference or (ii) the first
hearing.\46\ At that point or thereafter, if a party believes that an
arbitrator should be disqualified, the matter must be raised before the
arbitration panel. Vacancies created as a result of a disqualification
or because the arbitrator is otherwise unable to or unwilling to serve
\47\ under proposed paragraph (d)(1), prior to the commencement of the
earlier of 1) the prehearing conference or 2) the first hearing,\48\
are filled by the Director by referring to the appropriate consolidated
list from which the panelists were originally obtained (proposed Rule
10308(d)(3)) or, if there are no persons remaining on the consolidated
list, by a person the Director selects under proposed Rule
10308(c)(4)(B). Under the proposal, the Director provides the parties
information about the replacement arbitrator(s) as provided in proposed
paragraph (b)(6), and the parties have the right to object to that
arbitrator as provided in proposed paragraph (d)(1).\49\
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\46\ Proposed Rule 10308(d)(2).
\47\ See Amendment No. 3.
\48\ See Amendment No. 3.
\49\ See Amendment No. 3.
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Discretionary Authority--Paragraph (e)
Under paragraph (e) of Rule 10308, the Director's authority to
exercise discretionary authority is stated explicitly. In paragraph
(e), the Director has authority to resolve a problem that arises
relating to the appointment of arbitrators or any other procedure under
the rule if (i) the rule does not have an applicable provision, or (ii)
the application of a specific provision in the rule would not result in
a resolution of the underlying problem because the facts and
circumstances are unanticipated or unusual.
Miscellaneous Related Proposed Rule Changes
Proposed Conforming Amendments
NASD Regulation is proposing conforming amendments to Rules 10104,
10309, 10310, 10311, 10312, and 10313.
NASD Regulation proposes to make parallel amendments to Rule 10104
and Rule 10309. NASD Regulation proposes to amend Rule 10104 to reflect
that the specific provisions of proposed Rule 10308, rather than the
general provisions of Rule 10104, regarding the composition and
appointment of arbitration panels, apply to arbitrations involving
public customers. Rule 10104 would not apply to a question regarding
the composition and appointment of such arbitration panels unless none
of the specific provisions in proposed Rule 10308 would be
applicable.\50\ NASD Regulation proposes the same type of amendment to
Rule 10309, a similarly general provision relating to the composition
of arbitration panels.
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\50\ The NASD has stated that Rule 10104 and certain other rules
in the Rule 10000 Series may be amended further or rescinded when a
list selection rule applicable to intra-industry arbitration
proceedings is approved. NASD Regulation has filed a proposed rule
change to apply the NLSS to panel selection in intra-industry
arbitrations, as well as in customer arbitrations (SR-NASD-98-64)
which is being noticed and granted accelerated approval
simultaneously with this rule approval. See Securities Exchange Act
Release No. 40556 (October 14, 1998).
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NASD Regulation proposes to amend Rule 10310 and 10311 to make both
of them inapplicable to proceedings subject to Rule 10308. Under Rule
10310, NASD Regulation notifies parties of arbitrators appointed, and
under Rule 10311, parties have the right to a pre-emptory challenge of
an arbitrator. Because proposed Rule 10308 deals with both types of
procedures, NASD Regulation proposes to amend Rules 10310 and Rule
10311 so that neither will apply to arbitration proceedings involving
public customers.
NASD Regulation is proposing to amend Rule 10312 to make it
consistent with proposed Rule 10308. Both Rules contain provisions
regarding an arbitrator's obligation to disclose information to the
Director and disqualification based upon such disclosure. The proposed
changes to Rule 10312 state explicitly when the Director's authority to
disqualify an arbitrator terminates, and provide an arbitrator the
option to withdraw from
[[Page 56678]]
an arbitration panel prior to disclosure of arbitrator information to
the parties. A final change in Rule 10312 makes the timing of a
disclosure consistent with the parallel provision in proposed Rule
10308. Specifically, under proposed Rule 10312(d), prior to the
commencement of the earlier of 1) the prehearing conference or 2) the
first hearing, the Director may remove an arbitrator based upon Rule
10312 information.\51\ Under proposed Rule 10312(e), in the same time
frame, the Director must disclose any Rule 10312 information to the
parties unless the arbitrator voluntarily withdraws as soon as the
arbitrator learns of any conflict, or the Director removes the
arbitrator.\52\ Finally, under proposed Rule 10312(f), after
commencement of the earlier of the prehearing conference or the first
hearing, the Director shall disclose any Rule 10312 information
disclosed by an arbitrator to the parties.\53\
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\51\ See Amendment No. 3.
\52\ See Amendment No. 3.
\53\ See Amendment No. 3. The Director does not have authority
after this time period to remove an arbitrator.
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The proposed changes to Rule 10313 are necessary because Rule 10313
incorporates by reference certain procedures in Rule 10311. That rule,
if amended, will not apply to arbitrations involving public customers.
Accordingly, NASD Regulation proposes to amend the last sentence of
current Rule 10313 so that, for arbitration proceedings involving
public customers, a party may exercise the right to challenge a
replacement arbitrator within the time remaining prior to the next
scheduled hearing session by notifying the Director in writing of the
challenged arbitrator's name and the basis for such challenge. NASD
Regulations also proposes to amend the first sentence of Rule 10313 to
clarify that if an arbitrator becomes disqualified or otherwise unable
to serve after the start of the earlier of the pre-hearing conference
or first hearing but prior to rendition of an award, the remaining
arbitrator(s) shall continue on, unless a party objects. \54\
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\54\ See Amendment No. 4.
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Proposed Amendments to Rule 10315
In the past, the first formal meeting of the arbitration panel and
the parties generally was the first hearing. As the arbitration process
has evolved, NASD Regulation has encouraged most arbitration panels to
hold prehearing conferences. For most arbitrations currently, the first
formal meeting of the arbitration panel and the parties is a prehearing
telephone conference. NASD Regulation proposes to amend Rule 10315
regarding the scheduling of the first meeting to reflect the current
practice.
NASD Regulation also proposes to amend from eight business days to
15 business days the period that NASD has for giving notice of the
first meeting to the parties and the arbitrators. The period is being
amended to conform to the 15 business day period set forth in Rule
10310, which formerly also was a period of eight business days.
Proposed Amendments to Various Rules to Correctly Identify Committee
Name
The committee of NASD Regulation that addresses arbitration matters
is the National Arbitration and Mediation Committee. NASD Regulation
proposes to amend each rule in which the outdated term ``National
Arbitration Committee'' is used by replacing the outdated term with the
current committee name, the ``National Arbitration and Mediation
Committee.'' \55\
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\55\ See, e.g., Rule 10102, Rule 10103, Rule 10104 referenced
specifically above, Rule 10301, and Rule 10401.
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Date of Effectiveness
The Association intends to make the rule change effective on a date
to be stated in a Notice to Members (``NTM''). Depending on the date of
the Commission's approval, however, the effective date may be less than
30 days following publication of the NTM announcing the Commission's
approval. When effective, the rule changes will apply to any
arbitration case filed with the Association if the Association has not
mailed or otherwise transmitted to the parties a notice stating the
names of the arbitrators appointed to hear the arbitration.
A case will be subject to current Rule 10308 for the purpose of
selecting an arbitration panel, if, before the effective date of the
rule change, the Association identifies the arbitrator (in a case
having one arbitrator) or the three-arbitrator panel (in a case having
three arbitrators) and mails or otherwise transmits a letter or other
written communication to the parties notifying the parties of the names
of the arbitrators. As of the effective date, the newly adopted changes
to all other rules will apply to the case (e.g., amendments to Rule
10104, Rules 10309 through 10313, and Rule 10315), as will those parts
of newly adopted Rule 10308 relating to the actions or functions to be
performed after a panel is appointed (initially) if such actions or
functions can be performed without reference to party ranking of
arbitrators. (See, e.g., proposed Rule 10308(c)(5) regarding selecting
a chairperson. The parties will be allowed by agreement to select a
chairperson; however if the parties did not select a chairperson by
agreement, the Director will exercise authority under newly adopted
Rule 10308(e) in order to select a chairperson because the Director
will not have party rankings of arbitrators to rely upon and, thus,
will not be able to act in accordance with certain provisions of
paragraph (c)(5). A case will be subject to newly adopted Rule 10308
if, as of the rule change effective date, the Association has not
mailed or otherwise transmitted a letter or other written communication
to the parties notifying the parties of the names of the arbitrators
appointed to hear the arbitration. In this instance, the other newly
adopted rule changes will also apply to the case as of the effective
date.
The Association believes that this is the most appropriate approach
to provide the benefits of list selection to the greatest number of
parties as quickly as possible. List selection provides the parties
additional input into the arbitration proceeding; the Association
believes that applying the new process for the appointment of
arbitrators to certain cases filed shortly before the date of
effectiveness will provide the benefits to such parties. Moreover, the
Association does not believe that any party will suffer an unfair
surprise if the list selection rule and the other rule changes are
applied to an arbitration filed prior to the effective date. Finally,
in order to implement the proposed rule change, the Association must
make a number of operational changes. The administrative burdens of
fully implementing the list selection process nationwide are many, and
the Association believes that the benefits of implementing the new
procedures rapidly and system-wide outweigh the benefits, if any,
obtainable from continued use of the old system.
III. Summary of Comments
The three commenters \56\ generally support the proposed rule
change as an
[[Page 56679]]
improvement over the current method for selecting arbitrators, but
suggest improvements to the proposed rule.\57\
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\56\ A fourth comment letter was received on October 6, 1998;
the comment period ended on August 20, 1998. See letter from
Theodore G. Eppenstein (``Eppenstein''), Eppenstein & Eppenstein, to
Jonathan G. Katz, Secretary, Commission, dated October 1, 1998. The
issues raised by this commenter were the same as those raised by
other commenters except for one issue that is not germane to this
proposed rule change and one new issue. Eppenstein argues that the
arbitration panel for customer arbitrations should be composed
exclusively of public arbitrators. The Commission does not believe
that the proposed rule change raises this issue because the
composition of the three member arbitration panel for customer
arbitrations currently is two public members and one non-public
member, and is not substantively amended by this proposed rule
filing. Eppenstein also argues that there should be a mandatory
tolling provision for the time within which the parties have to
respond and submit their arbitrator rankings in the event they wish
to request additional information on the arbitrators. The Commission
believes that the proposed rule change reasonably accommodates the
needs of the parties both by lengthening the time for the parties to
engage in due diligence from the time period in the current rule,
and by specifically providing that the Director may use his or her
discretion to toll the time period for the parties to return their
ranked lists. See proposed Rule 10308(b)(6). The Commission expects
NASD Regulation to monitor the operation of the list selection
process carefully to see whether the proposed time frames operate
appropriately.
\57\ See supra note 4.
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The SIA believes that the Director should have the ability to
remove an arbitrator until after the first pre-hearing conference, up
until the start of the first hearing; the proposed rule states that the
Director can remove an arbitrator up until the commencement of either
the pre-hearing conference or the first hearing.\58\ NASD Regulation
states that it has made changes to Rule 10308(d) and a series of
related rules to reflect this new time frame, in order to reflect a
basic principle that an arbitration is administered and controlled by
the arbitrator or the arbitration panel after the arbitrators have
begun to address the issues that are the subject of the arbitration.
Thus, NASD Regulation believes that as of the beginning of the first
meeting among the parties and the arbitrators, it is no longer
appropriate or consistent with arbitration principles for the
Association to intervene in the arbitration in order to disqualify an
arbitrator.\59\
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\58\ SIA Letter. The SIA believes that the pre-hearing
conference itself could expose some evident bias, or an inability or
unwillingness on the part of the arbitrator to be impartial;
therefore, the Director should retain the ability to remove an
arbitrator until after the pre-hearing conference.
\59\ See Amendment No. 4.
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The SIA also believes that the NASD should reexamine the rationale
behind the automatic exclusion of any immediate family member of
registered representatives or others who work in the securities
industry from serving as public or non-public arbitrators.\60\ The SIA
argues that there is no reason that a spouse or dependent child of a
securities industry professional should be presumptively adjudged to be
incapable of being a capable, effective and impartial arbitrator. In
addition, the SIA argues that the mechanics of the list selection
method make the parties' attorneys able to deal with any perceived
problems or biases, by either ranking such candidates low on their list
or not ranking them at all. The SIA does not believe that the NASD, at
a time when it is trying to expand and more fully train its arbitrator
pool, should collectively eliminate an entire category of arbitrators
based upon a perceived bias.\61\ NASD Regulation responds that the
exclusion of ``immediate family member'' from classification as public
arbitrators is a practical, realistic view of how such persons should
be classified, and reflects how most claimants would view such persons.
NASD Regulation believes that if such persons were classified as public
arbitrators, and then their background information (including a
description of their relationship to a spouse or family member engaged
in securities activities) was distributed to the parties, most
claimants would routinely strike those people or request that the
Director disqualify them. NASD Regulation also states that this would
only benefit a small group of people desiring to serve as arbitrators,
while creating a perception of unfairness, raising costs, an increasing
delays.\62\
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\60\SIA Letter.
\61\ Scot D. Bernstein (``Bernstein'') argues that the 50%
support standard used to classify a person as an immediate family
member'' of a person generally engaged in the securities industry
should be lowered to 10%, effectively broadening this group of
persons. See Bernstein Letter. NASD Regulation responds that it
believes the 50% standard is generally appropriate, and also notes
that a person who falls below the 50% standard may be excluded later
in the arbitration selection process by a party who strikes him or
her or by the Director during a conflict of interest review. See
Amendment No. 4.
\62\ See Amendment No. 4.
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Bernstein argues that the size of the list of arbitrators given to
the parties should be larger and that the number of strikes allowed
each party should be smaller.\63\ He argues that unlimited strikes,
combined with a small list, will lead to either party being able to
void a list simply by striking everyone on the list, which would give
the selection authority back to the NAD.\64\ Similarly, Richard P.
Ryder (``Ryder''), does not believe that the proposed rule change will
actually result in most arbitrators being selected by the parties
themselves, but that administrative appointments will occur in a
substantial number of cases because too few candidates will remain
after the parties have struck the nominees on the list.\65\
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\63\ Bernstein suggests lists that provide no less than twelve
public arbitrators and six non-public arbitrators.
\64\ See Bernstein Letter.
\65\ See Ryder Letter.
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NASD Regulation, although recognizing this fear, believes that the
rule should be implemented as proposed and monitored to see how often
the Director must appoint arbitrators not previously reviewed and
ranked by the parties to a panel because one or both parties have
struck every arbitrator listed.\66\ NASD Regulation will revist the
issue of limiting the number of strikes if the Director appoints
unranked arbitrators frequently because of the parties exercising their
unlimited strike rights. NASD Regulation believes that the current
proposed number of arbitrators on each list provides a sufficiently
large number of arbitrator choices and provides a standard that will
generally be attainable.\67\
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\66\ See Amendment No. 4.
\67\ Id.
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Bernstein argues that there should be a second round of list
selection with a larger list if the first round fails, in order to fill
any vacancies. He argues that this is more in line with the Task
Force's recommendation and closer to the goals of allowing parties to
choose their arbitrators and keeping the NASD out of the selection
process.\68\ He also argues that the NASD's concerns over the cost of a
second round of list selection should be disregarded as well, in part
because the costs are small compared to the savings that mandatory
arbitration affords the member firms. Ryder suggests that instead of
having only one round of selection, NASD Regulation should give the
parties the choice between having one round and a default to staff
appointment (but within the same time frame as proposed in the rule) or
a second round approach but with a shorter time limit within which the
parties must respond to the lists; this shorter time frame would result
in more arbitrators being freed up more quickly for other simultaneous
proceedings.\69\ Ryder also suggests staggering first round lists in a
locale where there are simultaneous cases, by allowing NASD Regulation
more time to generate and send lists to parties in other cases. NASD
Regulation could then take arbitrators rejected by the first
arbitration and put them back into the pool for other cases. In any
event, Ryder suggests that the Commission require the NASD to keep
statistics on how often administrative appointments occur under the
proposed system, and that the NASD should explore a practical, flexible
solution to the limited
[[Page 56680]]
supply objection to a second round list selection.
---------------------------------------------------------------------------
\68\ Bernstein argues that the NASD's concern about a limited
number of arbitrators related to the large caseload is not a reason
to not have a second round of selection. He states that the same
number of arbitrators will be appointed to a case regardless of how
they are chosen, and that the size of the available pool of
arbitrators will not be affected if a second round were implemented
because those arbitrators not chosen would simply rotate to the
bottom of the list.
\69\ See Ryder Letter.
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NASD Regulation responds that they will not impose a second round
at this time because of the scarcity of arbitrators in certain
locations, the substantially greater costs, and the significant delays
in empaneling an arbitrator or an arbitration panel.\70\ However, after
the NASD has had some experience administering the rule, it will
reconsider whether to add an additional round of list selection.\71\
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\70\ See Amendment No. 4 and Response Two.
\71\ Id.
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Bernstein objected to the procedure in the proposal for selecting a
chairperson, and suggests that the highest-ranked public arbitrator
selected by the parties be the chairperson. In addition, Bernstein
argues that advocates for public investors should not be excluded from
serving as chair of the arbitration panel, and that a rule that
disqualifies advocates for public investors from chairing arbitration
panels is inconsistent with investor protection.\72\ In response, NASD
Regulation amended proposed Rule 10308(c)(5) to provide that the
Director will appoint the highest ranked pubic arbitrator, unless that
person represents or advises customers in matters relating to the
securities or commodities industry for fifty percent of his or her
time, in which case the Director would appoint the other public
arbitrator. If both public arbitrators are subject to the exclusion,
the Director will appoint the highest ranked public arbitrator.\73\
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\72\ Bernstein argues that attorneys who represent public
investors are not subject to the same financial pressure on their
decisions as are representatives of industry participants, yet an
attorney who derives 19% of his or her income from representing
industry participants is allowed to chair a panel under the proposed
rule.
\73\ See supra notes 42 and 43 and accompanying text, and
Amendment No. 4.
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Bernstein also argues that some of the descriptive text in the
proposed rule filing regarding the administration of ODR should be
included in the rule language so that the NASD's interpretations cannot
be changed without Commission approval.\74\ NASD Regulation argues that
is has stated the basic operational aspects of the rule in the rule
text and it is not appropriate to describe all of the operational
details relating to the NLSS software in the rule text or in the rule
filing because to do so would make the rule very unclear and confusing
to all but a few readers.\75\ However, the Association has described in
general and clear terms those aspects of the NLSS that are essential
functions of the proposed list selection rule.
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\74\ See Bernstein Letter. For example, he argues that: 1) the
standards for exclusion from serving as an arbitrator based upon
conflicts of interest as a function of current employment should be
included in the rule (and that both current and former employment
should be a basis for exclusion); 2) the standards that apply to a
Director's rulings on for cause challenges should be included in
proposed Rule 10308(d)(1); 3) the method of operation of the list
selection software and the selection rules that will be used when
that software cannot be used, should be a matter of public record
and should be stated in the rule; 4) the standards for all
determinations made by the software (geographic proximity, conflicts
of interests, subject matter expertise, ranking and rotation) should
be included in the rule; 5) the number of arbitrators required to be
on a list should be a part of the rule; 6) the arithmetic method
that the NASD will use to consolidate the rankings of parties on the
same side should be explained in the text and in the rule; 7) the
standards for what would constitute ``sufficiently divergent'' when
a Director can decline to consolidate rankings of parties when their
interests diverge sufficiently should be explained in detail; 8) the
standards for when the NASD manually performs a conflict of interest
check should be made public; 9) the time that prospective
arbitrators will have to respond to the NASD's call should be
specified in the rule; and the NASD should be obligated to attempt
to reach a selected arbitrator at all available telephone and
facsimile numbers for that arbitrator in the NASD's database; and
10) the rule should state that the NASD and its staff shall not
communicate with the proposed arbitrators or otherwise operate in
such a manner as to influence the outcome of the selection process.
\75\ See Amendment No. 4.
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NASD Regulation states that the arithmetic method will be used for
consolidating rankings was explained in a detailed, multi-part example.
The Association does not believe that the rule text would be clearer by
incorporating examples of calculations in the text. In addition, the
Association has explained in detail in the rule filing its aspirations
regarding providing parties with a certain number of listed
arbitrators, and declines to provide an exact minimum number of
arbitrators in the proposed rule because the number of available
arbitrators varies from place to place.
In response to Bernstein's suggestion that under proposed Rule
10308 the Association should address conflicts that may arise based
upon the past employment of an arbitrator or a party, as well as
conflicts-of-interest based upon current employment, NASD Regulation
points out that the rule filing indicates that the initial conflict-of-
interest review performed by NLSS is limited to readily apparent
conflicts of interest,\76\ but that there are subsequent checks
performed by the Director that include all possible relationships,
including past employment that allow the Director to determine whether
an arbitrator has a conflict of interest and should not be appointed or
must be disqualified after appointment.\77\ The Association also
declines to state in proposed Rule 10308 a standard by which the
Director will judge claims of an arbitrator's conflict of interest,
arguing that the Director applies the facts as presented to assess
whether a bias or a conflict of interest is present or may be present,
and that the present Code does not contain an express standard.\78\
Also, NASD Regulation states that it would inappropriately limit the
ability of the Association staff to administer cases to specify how the
Association must attempt to communicate with a listed arbitrator to
determine if the arbitrator is available to serve on a panel.
Generally, however, the Association intends to contact the arbitrators
by telephone.\79\
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\76\ Such as whether the arbitrator is currently employed by, or
currently has a securities account with, the respondent.
\77\ See Amendment No. 4.
\78\ The Association's treatment of divergent interests (among
respondents or claimants) is previously addressed, supra note 38 and
related text.
\79\ See Amendment No. 4.
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Bernstein asks how many strikes are allocated to each party when
there is more than one party on a side and their bankings are
consolidated. Bernstein also argues that the proposed rule should
require the NASD to publish, on its website and possibly in hard-copy
form for each case in which a list of arbitrators is proposed, the
following information: date; geographic location; case number; and
names of arbitrators included in the list of lists of proposed
arbitrators. He argues that this is necessary in order for the public
to be able to verify that the rotation required by the rule is
occurring. NASD Regulation declines to publish the arbitrators names in
the rotation because its would create an enormous administrative
burden. In addition, NASD Regulation states that the NLSS and new list
selection process are subject to review internally by the Audit
Committee,\80\ and to SEC oversight.\81\
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\80\ NASD Regulation states that the Audit committee is
comprised of independent Governors of the NASD Board of Governors.
\81\ See Amendment No. 4.
---------------------------------------------------------------------------
Bernstein argues that the reference in proposed Rule 10308(c)(4)(A)
to the Directors' ability to disqualify arbitrators should cross-
reference all provisions under which disqualification may occur, and as
previously argued, should contain the standards for disqualification.
NASD Regulation responds that the Director, the staff, and all NASD
arbitrators must look to and follow ``The Arbitrators Manual'' and
``Code of Ethics for Arbitrators in Commercial Disputes'' (``Code of
Ethics''), regarding the arbitrator's duty to disclose conflicts of
interest, the appearance of bias, the assessment of challenges relating
to an arbitrator's
[[Page 56681]]
opinion or bias, business or personal relationships, previous or
current involvement with a party or witness, or financial interests,
and an arbitrator's ethical responsibilities to determine issues of
disqualification and withdrawal.\82\ NASD Regulation states that every
arbitrator must review and understand ``The Arbitrator's Manual'' and
the Code of Ethnics as part of mandatory arbitrator training, and any
time that the Director must resolve a disqualification issue, the
Director will refer to these provisions.\83\
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\82\ ``The Arbitrator's Manual,'' (Oct. 1996 ed.), pp. 2-6, App.
A. The Code of Ethics was developed jointly by the American Bar and
American Arbitrator Association. See Amendment No. 4.
\83\ See Amendment No. 4.
---------------------------------------------------------------------------
Bernstein also proposes that proposed Rules 10308(d)(2) and
10312(f) should state that after the Director's authority to disqualify
an arbitrator has ceased, the panel still has that authority, as
consistent with the descriptive text of the proposal.\84\ NASD
Regulation declines to make the amendments because the manner in which
disqualification and withdrawal issues are treated is set forth in
``The Arbitrator's Manual'' and the Code of Ethics. At all times,
including the period when the Director's authority to disqualify an
arbitrator has ended, an arbitrator must consult ``The Arbitrator's
Manual'' and the Code of Ethics, Canon II, regarding the arbitrator's
duty to disclose conflicts of interest, issues of bias, and his or her
ethical responsibilities to determine if withdrawal as an arbitrator is
required. Under Cannon II. E., of the Code of Ethics, an arbitrator
``should withdraw'' if requested to do so by all the parties because of
alleged partiality or bias. If requested to withdraw for such reasons
by less than all of the parties, the arbitrator ``should withdraw''
unless ``the arbitrator, after carefully considering the matter,
determines that the reason for the challenge is not substantial, and
that he or she can nevertheless act and decide the case impartially and
fairly, and that withdrawal would cause unfair delay or expense to
another party or would be contrary to the ends of justice.'' The
Association stated that its experience is that arbitrators apply the
Code of Ethics more rigorously than a strict reading requires.\85\
---------------------------------------------------------------------------
\84\ In addition, Bernstein argues that the standards for
removal in such cases should be the same as those that apply to for-
cause challenges, and that the arbitrator against whom the challenge
or recusal motion is made should not be permitted to participate in
any vote or other decision regarding that issue.
\85\ See Amendment No. 4.
---------------------------------------------------------------------------
Bernstein believes that due diligence and expertise concerning
Ponzi schemes and other illegal securities or transactions should be
included as an identified area of subject matter expertise. He also
believes that limited partnerships should be included in the list of
``various types of securities or other financial instruments'' in which
an arbitrator may have expertise. NASD Regulation notes that the topic
of due diligence is too broad and vague to be entered into NLSS as a
subject matter category, and that ``underwriting'' is currently a
subject matter expertise category. Also, NASD Regulation wishes to
defer receiving proposals to expand the various types of expertise
until a later date.
Finally, Bernstein argues that proposed Rule 10313, which currently
provides for no challenge other than a for-cause challenge to
replacement arbitrators, should allow for a peremptory challenge of the
replacement arbitrator because the industry, which is requiring the
public to ``give up the right to a judge and jury and come instead to
the industry's forum,'' should prevent the appearance of
impropriety.\86\ NASD Regulation responds that this change is
consistent with the other provisions of proposed Rule 10308. Thus,
although the parties are provided an unlimited right to strike an
arbitrator in the early stages of a proceeding, generally, under the
new procedures, when an arbitrator is appointed later in the preceding,
the parties may challenge the arbitrator for cause only. The
Association agrees with Bernstein's suggestion that the replacement
arbitrator the Director appoints should be obtained from an NLSS-
derived ``list of one.'' To replace an arbitrator under Rule 10313, and
in the other instances where the Director must appoint an arbitrator
not previously ranked by the parties (see, e.g., paragraphs (c)(4)(B)
and (d)(3) of proposed Rule 10308), the Director will return to the
NLSS and obtain a ``list of one,'' using the primary factors previously
input into NLSS to generate the list of arbitrators first sent to the
parties. The association does not believe it is necessary to specify in
proposed Rule 10308 and proposed Rule 10313 that the Director will use
NLSS in this manner to perform these rule functions.\87\
---------------------------------------------------------------------------
\86\ Bernstein also adds that the rule should specify that the
replacement arbitrator will be a ``list of one'' selected by the
computer (ie. the next arbitrator in the rotation).
\87\ See Amendment No. 4.
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IV. Discussion
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities association, and, in
particular, with the requirements of Section 15A(b)(6),\88\ which
require, among other things, that the Association's rules must be
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, and, in general, to
protect investors and the public interests.\89\ Specifically, the
Commission believes that allowing parties greater input into the
selection of the arbitrators to hear their cases will help ensure a
more fair and neutral arbitration process.
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\88\ 15 U.S.C. 78o-3.
\89\ In approving this rule, the Commission notes that it has
considered the proposed rule's impact on efficiency, competition,
and capital formation. 15 U.S.C. 78c(f).
---------------------------------------------------------------------------
The Commission believes that the NASD's list selection procedures
and methodology, as proposed, provide for the protection of investors
in the selection of arbitrators and will benefit all users of the
arbitration program. The Commission believes that the computerized
generation of the lists of arbitrators should help ensure greater
confidence in the fairness and neutrality in the selection of the
arbitrators, while at the same time allowing the Director the
flexibility to supplement the NLSS process if necessary.\90\ The
Commission notes that the arbitrators will be selected by the computer
using a rotation method, rather than on a random basis,\91\ so that all
arbitrators are placed on a selection list with the same
regularity.\92\ The Commission also notes that the NLSS is designed to
sort arbitrators based on certain factors that should help ensure a
neutral list of arbitrators who will be better suited to the particular
arbitration. The NLSS sorts arbitrators based on whether an arbitrators
is public or non-public, and based on hearing location, rotation, and
whether any clear conflict of interest exists between a party and
potential arbitrators. In addition, NLSS can also sort arbitrators by
subject matter expertise, security expertise, and case expertise. The
Commission believes that the subject matter, security, and case
expertise categories are a reasonable
[[Page 56682]]
attempt at this time to ``personalize'' an individual arbitration, and
that it is not necessary for the NASD to expand upon them as it begins
to implement its selection process.
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\90\ At the request of a party, the Director can add a procedure
that is outside the NLSS capability, but that may legitimately be
considered in the selection of an arbitration panel.
\91\ See Notice Release.
\92\ The NASD states that the random selection method does not
always produce perfect randomness, which could lead to some
arbitrators being chosen more often than others over time.
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The Commission believes that the list selection method provides
adequate measures to identify potential or actual conflicts of interest
between a party and an arbitrator, both prior to compilation of the
list and selection of the arbitrators, and once an arbitrator or an
arbitration panel is selected. The NLSS performs two conflict-of-
interest checks. First, the NLSS checks for any obvious, disclosed
conflict of interest between parties and potential arbitrators that can
be identified in the NLSS database while generating the list, such as
when the respondent member firm is also the employer of an arbitrator
in NLSS.\93\ Second, ODR will perform a manual conflict of interest
review after the list is created but before it is finalized and sent to
the parties.\94\ The Commission believes that checking for conflicts of
interest before the list is forwarded to the parties will likely
eliminate arbitrators that would have been struck by a party later, and
will result in those arbitrators being replaced (through the NLSS)
before the lists are sent to the parties, which should help avoid
limiting the parties' choices at the selection stage. While reviewing
the lists, parties can review any information on the arbitrators that
ODR has in its possession, including employment history for the past
ten years, in order to make their own determination as to conflict of
interest concerns, and may request additional information from the
arbitrators under Rule 10312(b)(6). In addition, once the parties have
ranked the arbitrators and the lists have been consolidated into one
list, the Director performs another determination as to whether to
disqualify an arbitrator.\95\ If the arbitrator is not disqualified,
and is available, the Director appoints the arbitrator.
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\93\ The Commission does not believe it is necessary for the
NASD to include in the rule language the standards for exclusion
from serving as an arbitrator based upon conflicts of interest as a
function of current employment, or that the standards for the manual
conflict of interest review need to be included in the rule language
or made public. NASD Regulation has stated the basic operational
aspects of the rule in the rule language and the rule filing. The
addition of more detail to the text may be confusing.
\94\ The Commission notes, in response to a comment, that even
though the initial conflict of interest review performed by NLSS is
limited to readily apparent conflicts of interest (such as current
employment), the subsequent manual checks include a wider range of
possible relationships, including past employment. See Amendment No.
4.
\95\ The Director contacts each arbitrator to determine if he or
she is available to serve. At this time, the Director will provide
the arbitrator with the issues of the case and the names of the
parties, and determine whether the arbitrator is aware of any
conflict of interest or bias or other reason that may preclude the
arbitrator from rendering an objective and impartial decision. Based
upon the information previously provided by the arbitrator, any
information provided under Rule 10312, and any information from any
other source, the Director determines if the arbitrator should be
disqualified. The Commission does not believe it is necessary for
the NASD to specify in the rule language a response time for each
arbitrator contacted, or that the NASD should be obligated to
attempt to reach a selected arbitrator at all available telephone
and facsimile numbers for that arbitrator. The Commission also does
not believe it is necessary for NASD Regulation to specify how it
shall communicate with proposed arbitrators to determine if they are
available to serve.
---------------------------------------------------------------------------
The Commission also finds that the conflict of interest safeguards
in place after a panel is appointed are adequate to help protect
investor interests by providing that any new information on the
arbitrators that may lead to a conflict of interest is disclosed to the
parties, unless the arbitrator is removed or resigns. Each arbitrator
has a continuing obligation under Rule 10312 to disclose any
circumstances that might preclude the arbitrator from rendering an
impartial and objective determination to the Director, who has the
ability to remove an arbitrator up until the start of the earlier of
the the pre-hearing conference or the first hearing.\96\ After this
point, a party must raise a disqualification matter with the
arbitration panel.\97\ Finally, the Director must disclose information
about a replacement arbitrator appointed by the Director to the
parties, who can object to the arbitrator, at which time the Director
can decide to disqualify the arbitrator. To replace an arbitrator (and
in other instances where the Director must appoint an unranked
arbitrator), the Director will return to the NLSS to obtain a ``list of
one,'' using the primary factors previously input into NLSS to generate
the initial list of arbitrators sent to the parties.\98\ The Commission
notes that the Director and all arbitrators must review and abide by
``The Arbitrators Manual'' and the Code of Ethics regarding the
arbitrator's duty to disclose conflicts of interest, the appearance of
bias, the assessment of challenges relating to an arbitrator's opinion
or bias, business or personal relationships, previous or current
involvement with a party or a witness, or financial interests, and an
arbitrator's ethical responsibilities to determine issues of
disqualification or withdrawal.\99\
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\96\ The Director must disclose this information to the parties
unless the Director disqualifies the arbitrator or the arbitrator
voluntarily withdraws. After the commencement of the earlier of the
pre-hearing conference or the first hearing, the Director must
disclose any new information on the arbitrators to the parties.
The Commission does not believe it is necessary for the NASD to
include in the rule text the standards that apply to a Director's
ruling on a for-cause challenge to an arbitrator already appointed,
because the Director applies the facts of each situation as
presented, based upon the Code of Ethics developed by the American
Bar Association and American Arbitration Association, to assess
whether a conflict exists or may exist. The Commission also notes
that the present Code does not contain a more express standard.
\97\ The Commission believes it is reasonable to limit the
Director's authority to remove an arbitrator after the commencement
of the earlier of the pre-hearing conference or the first hearing,
to reduce party concerns about NASD Regulation's influence over
particular cases, and because it is reasonable for the arbitration
to be administered and controlled by the arbitrators once the
arbitrators have begun to address the issues in the arbitration.
Accordingly, it is reasonable for NASD Regulation to decide that,
based upon NASD Regulation's characterization of its past experience
with arbitrator recusals, it is no longer appropriate for the
Director to be able to remove an arbitrator after the earlier of the
pre-hearing conference or the first hearing. The Commission does not
believe it is necessary for the NASD to state more explicity the
procedures to disqualify an arbitrator in the rule text because the
manner in which disqualification and withdrawal issues are treated
is addressed in the Code of Ethics and ``The Arbitrators Manual.''
See supra note 82 and accompanying text.
\98\ See Amendment No. 4.
\99\ See Amendment No. 4.
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In addition, the Commission believes that the proposed rule change
provides for sufficient public representation on each arbitration panel
by requiring a majority of public arbitrators on each arbitration
panel, unless all of the parties agree to a differenct panel
composition. The Commission notes that the NASD staff classifies
arbitrators as public or non-public based on the information it
receives for that arbitrator.\100\ The Commission also believes that
the method for selecting a chairperson when the parties do not agree is
reasonable. In response to a comment, NASD Regulation amended the
process to provide that the Director will first attempt to appoint the
highest ranked public arbitrator on the panel as the chairperson.\101\
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\100\ The Commission believes that the NASD's definition of
``immediate family member'' as a person who receives more than 50%
of his or her annual income from a person generally engaged in the
securities industry and its exclusion of such persons from serving
as public arbitrators is a reasonable view of how such persons
should be classified, so as to guard against any perceived bias or
conflict of interest.
\101\ See Amendment No. 4. The Director will chose the highest
ranked public arbitrator unless that arbitrator meets the exclusion
for representing certain investor interests, in which case the
Director will appoint the other public arbitrator as chairperson. If
both public arbitrators are subject to the exclusion, the Director
will appoint the highest ranked public arbitrator as chairperson.
See supra noted 42 and 43 and accompanying text.
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[[Page 56683]]
The Commission believes that the ODR's guideline \102\ for the
minimum number of arbitrators on each list forwarded to the parties is
reasonable to provide a pool of arbitrators for the parties to choose
from to select an arbitration panel. The Commission notes that, for a
three arbitrator panel, NASD Regulation has undertaken to provide a
public list that contains at least two times as many names as the non-
public list, to the extent feasible. In addition, to address possible
arbitrator shortages, the Director can combine arbitrators from nearby
hearing locations when necessary.\103\ The Commission recognizes that
there are times when the parties will strike all the names on a list
and notes that one commenter expressed a concern with the number of
arbitrators on each list, but believes that it is not necessary at this
time to require a larger list of arbitration. The Commission notes that
requiring a larger number of arbitrators on the list might not be
feasible, given the limited number of arbitrators. The Commission also
notes that NASD Regulation has stated it will monitor how often the
Director must appoint unranked arbitrators because one or both parties
have struck all the names on the list.
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\102\See supra Background and Description Section. The
guidelines state that for one arbitrator, NASD Regulation should
supply a public list with 3 to 5 arbitrators. For a three arbitrator
panel, the NASD should supply a public list with 6 to 10 arbitrator
names, and a non-public list with 3 to 5 arbitrator names.
\103\ The Commission believes it is reasonable not to specify a
minimum number of arbitrators in the actual rule text because the
number arbitrators varies from place to place, and notes that NASD
Regulation has explained its guidelines in the proposed rule change.
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The Commission also believes it is reasonable to allow each party
unlimited strikes because this should allow parties greater control in
choosing the composition of the arbitration panel, and reducing the
number of strikes could limit a party's ability to strike an arbitrator
he or she does not want on the panel. The Commission recognized the
possibility that a respondent and/or respondents acting together could
use the unlimited strikes to strike all the arbitrators from the list,
resulting in the Director choosing the panel.\104\ However, the
Commission believes it is reasonable at this time to implement the
proposed rule change as proposed, with the number of arbitrators
suggested and unlimited strikes, and notes that NASD Regulation states
it will reevaluate the issue of limiting the number of strikes if it
finds that the Director appoints unranked arbitrators too frequently
due to the parties' exercise of their unlimited strike rights.
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\104\ See Bernstein Letter. The Commission also believes that
the process for ranking arbitrators when the parties fail to rank
them, or improperly rank multiple arbitrators, is reasonable.
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The Commission also finds that a one-round list selection method
(as opposed to a two-round procedure as suggested by commenters) is
reasonable and consistent with the Act in that it supports the goals of
arbitration as a less expensive and less time-consuming method of
resolving disputes, while at the same time providing a process by which
parties have greater control over the selection of arbitrators. The
Commission notes that although NASD Regulation initially considered a
two-round, two-list selection method, it concluded that the operational
burdens of administering such a process, especially given the limited
number of arbitrators relative to the large caseload, would be too
great. Also, NASD Regulation was concerned that a two-round, two-list
selection method would significantly delay the empaneling of the
arbitrators and would be too costly. The Commission also stresses that
NASD Regulation will reconsider whether to add an additional round of
list selection after it has gained some experience in administering the
rule.
The Commission believes it is reasonable to consolidate all
claimants' rankings, and all respondents' rankings, whether through all
the claimants (or respondents) jointly ranking arbitrators and
submitting one set of rankings, or the Director, using the NLSS,
creating a consolidated list for each side. The Commission notes that
the consolidation gives claimants and respondents equal weight in the
rankings when the two sides are subsequently consolidated. The
Commission also notes that in response to a comment that proposed Rule
10308(c)(3)(B) may have provided certain parties the potential to
unfairly weight the arbitration panel, NASD Regulation amended proposed
Rule 10308(c)(3) to eliminate the Director's ability to determine not
to consolidate the rankings of a claimant (or respondent) with the
rankings of the other claimants (or respondents) if he or she
determined there interests were sufficiently divergent.\105\ Also, the
Commission finds that the methodology for consolidating claimants' and
respondents' rankings to create one list for public and one for non-
public (if necessary), and for appointing arbitrators from that list,
is reasonable.\106\
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\105\ See Amendment No. 4.
\106\The Commission finds that NASD Regulation adequately
explained in detail and with examples the method that will be used
to consolidate rankings, both on each side and them both sides
together, and that it is not necessary to include examples of
calculations in the rule text.
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In summary, the Commission notes that list selection is a new
process designed to allow parties greater control over the selection of
their arbitrators, and that there were different approaches that the
NASD could have taken to obtain this goal. The Commission believes that
the NASD has created reasonable procedures for implementing the new
process that should give investors and other parties more input into
the selection of the arbitration panel and which are consistent with
the Act.\107\ The Commission also believes the NASD has stated the
basic operational principles in the rule language.
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\107\ The Commission also finds the changes to related rules to
conform those rules to the proposed changes to Rule 10308
reasonable.
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The Commission finds good cause to approve Amendment Nos. 3 and 4
to the proposed rule change prior to the thirtieth day after the date
of publication of notice of filing thereof in the Federal Register.
Specifically, Amendment No. 3 amends the actual rule language to
clarify and strengthen the proposed rule change by, in part, amending
the definition of ``non-public arbitrator'' to incorporate standard
terminology and to add an explicit reference to government and
municipal securities; by re-ordering proposed Rule 10308(b)(1) to make
it more clear and to conform it to previously approved amendments to
Rule 10308 and Rule 10302; by amending Rule 10308(b)(1) to clarify a
party's right to change the panel composition if they all agree; to
clarify in the rule language what information will be available with
regard to the initial conflict of interest review by NLSS; to clarify
in the rule language that the information on each arbitrator forwarded
to the parties is employment information for a 10 year period and any
other background information; to clarify in the rule language that a
ranking of ``1'' means the most preferred arbitrator; to clarify in the
rule language that when the Director must appoint an unranked
arbitrator the Director will provide the parties (b)(6) information and
the parties shall have the right to object to the arbitrator as
provided in (d)(1); and to delete the reference in the rule to parties
acting cooperatively to rank arbitrators, since that ability is
implicit.
Similarly, Amendment No. 4 also amends the proposed rule change in
response to comments received to strengthen the proposal by providing
generally for the highest ranked public
[[Page 56684]]
arbitrator to be the chairperson of the panel, to eliminate the
exception to consolidation of parties' rankings for parties with
``sufficiently divergent'' interests, and to amend the time frame in
proposed Rule 10313 to align it with the time frames set forth in
proposed Rule 10312 and 10315. Accordingly, because the changes in
Amendment Nos. 3 and 4 are technical in nature and serve to clarify and
strengthen the proposal, the Commission believes that it is consistent
with Section 15A(b)(6) of the Act to approve Amendment Nos. 3 and 4 to
the proposal on an accelerated basis.
Interested persons are invited to submit written data, views, and
arguments concerning Amendment Nos. 3 and 4 to the rule proposal,
including whether the amendments are consistent with the Act. Persons
making written submissions should file six copies thereof with the
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW.,
Washington, DC 20549. 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 also will be available for
inspection and copying at the principal office of the NASD. All
submissions should refer to File No. SR-NASD-98-48 and should be
submitted by November 12, 1998.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\108\ that the proposed rule change (SR-NASD-98-48), including
Amendment Nos. 3 and 4 on an accelerated basis, is approved.
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\108\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\109\
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\109\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-28321 Filed 10-21-98; 8:45 am]
BILLING CODE 8010-01-M
