02-18566. Self-Regulatory Organizations; Order Approving a Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Situations in Which a Suspended, Terminated, or Otherwise Defunct Member or Associated Person Fails ...

July 17, 2002.

I. Introduction

On February 1, 2002, the National Association of Securities Dealers, Inc. (“NASD”), through its wholly owned subsidiary, NASD Dispute Resolution, Inc. (“NASD Dispute Resolution”), filed with 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 10314 of the NASD Code of Arbitration Procedure (“Code”) to provide default procedures for situations in which a suspended, terminated, or otherwise defunct member or associated person (collectively referred to in this order as “defunct”) fails to answer or participate in an arbitration proceeding, and the claimant nevertheless elects to pursue arbitration. The proposed rule change was published for comment in the Federal Register on May 1, 2002.^[3] The Commission received one comment letter regarding the proposal.^[4] NASD Dispute Resolution filed a response to the comment letter with the Commission on July 3, 2002.^[5] This order approves the proposed rule change.^[6]

II. Description of the Proposed Rule Change

NASD Dispute Resolution is proposing to amend Rule 10314 of the Code to provide an expedited default procedure for certain cases in which a respondent is an associated person whose registration is terminated, revoked, or suspended; a member whose membership has been terminated, suspended, canceled, or revoked; a member that has been expelled from the NASD; or a member that is otherwise defunct. NASD Dispute Resolution represents that the procedures are designed to make it easier for claimants to obtain an award against a defunct party. This award can then be enforced in court. NASD Dispute Resolution states that the proposed rule change would address some concerns discussed in a United States General Accounting Office (“GAO”) report that was issued in June 2000.^[7]

Under the proposed rule change, if a defunct respondent fails to answer the claim in a timely manner, the claimant may elect to proceed under optional default procedures as to that respondent. If there are several claimants, all must agree to use default procedures. The default procedures may be used against one or more defunct respondents while the rest of the initial arbitration proceeds against any remaining respondents.^[8]

If the claimant opts to use default procedures, the case would proceed with a single arbitrator without a hearing. Under the default procedures, the arbitrator would make an award based upon the Statement of Claim and any other material submitted by the claimant. The arbitrator may request additional information from the claimant before rendering an award. In keeping with the streamlined nature of the procedures, neither the claimant nor the single arbitrator would have the option to ask that two additional arbitrators be appointed to decide the case (as is sometimes done in other single-arbitrator cases).

NASD Dispute Resolution states that the procedures have several provisions to safeguard the integrity of the process, such as:

• The claimant may not amend the claim to increase the relief requested after the staff has notified the parties that the claim will proceed under default procedures.
• An arbitrator may not make an award based solely on the non-appearance of a party. The party who appears must present a sufficient basis to support the making of an award in that party's favor.
• The arbitrator may not award damages in an amount greater than the damages requested in the Statement of Claim and may not award any other relief that was not requested in the Statement of Claim.

The proposed rule provides, however, that the default award would have no effect on the non-defaulting parties. The proposed rule would apply to all types of claimants, such as customers, associated persons, or member firms, that are bringing a claim against a suspended or terminated member or associated person.

Finally, if a respondent thought to be defunct belatedly files an answer or otherwise begins to participate after the staff has notified the parties that the claim will proceed under default procedures but before an award has been rendered, the default procedures would be suspended, and the case would proceed under the regular procedures.^[9]

III. Summary of Comments and NASD Dispute Resolution's Response

As noted above, the Commission received one comment letter regarding the original proposal.^[10] NASD Dispute Resolution filed a response to address concerns raised by the comment letter.^[11]

The commenters supported the proposed rule change as beneficial to customers and stated that the default procedures set forth in proposed NASD Rule 10314(e) would provide an alternative so that claimants can expeditiously obtain an award without the necessity of a hearing. However, the commenters proposed two substantive changes to the rule.^[12]

First, the commenters questioned the fairness of paragraph (e)(7) of the proposed rule, which provides that the default procedures are terminated if the respondent files an answer anytime before an award has been rendered. The commenters believe that respondents who do not file an answer until late in the process should not have an absolute right to terminate the default procedure. They suggested that the decision to terminate the default procedure and resume the case under regular procedures should be granted at the discretion of the arbitrator, after giving the claimant an opportunity to respond to the request.^[13]

NASD Dispute Resolution responds that it is appropriate to allow the defaulting respondent to appear and automatically terminate default procedures. NASD Dispute Resolution states that to deny the respondent the right to rejoin the regular proceedings due to a late answer could result in court challenges that might delay the proceeding to the claimant's detriment.^[14] The NASD Dispute Resolution also states that a respondent is unlikely to abuse this provision to fail deliberately to appear and then make a sudden untimely appearance because the respondent would have to rejoin the case where the respondent finds it.^[15] Furthermore, NASD Dispute Resolution states that NASD Rule 10314(b)(2)(C) would provide sufficient deterrent from such abuse because it provides that a respondent who fails to file an answer within 45 calendar days from receipt of service of a claim, unless the time to answer has been extended, “may, in the discretion of the arbitrators, be barred from presenting any matter, arguments, or defenses at the hearing.”

Second, the commenters criticized the proposed rule for not addressing the situation where after filing an answer, the respondent ceases to participate in the hearing because of one of the events described in proposed NASD Rule 10314(e)(1). The commenters suggested that, in this event, the claimant should have the option to convert the proceedings to a default procedure.^[16]

In response, NASD Dispute Resolution states its intention to draft a rule that would cover the majority of situations involving defunct respondents without making it unduly complicated. If it should happen that, after filing an answer, a respondent becomes defunct as defined in proposed NASD Rule 10314(e)(1), the claimant would put on its case, and the panel issue an award. If there are no other respondents, NASD Dispute Resolution states that the matter could be concluded expeditiously and that it may not even be necessary to hold an in-person hearing, which would further reduce hearing session costs to the claimant.^[17]

Although NASD Dispute Resolution does not feel that an amendment to the proposed rule is currently necessary, it states that it would monitor the operation of the rule and consider any further enhancements that may be warranted.

IV. Discussion

After careful review, 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.^[18] In particular, the Commission finds that the proposal is consistent with Section 15A(b)(6) of the Act,^[19] in that it is designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and to protect investors and the public interest.

Specifically, the Commission finds that NASD Dispute Resolution's proposal is designed to protect investors and the public interest by making it faster and less costly for investors and other claimants to proceed and obtain awards against defunct members and associated persons while also providing safeguards to all parties. The Commission also believes that the proposed rule change implements the recommendations in the GAO report concerning unpaid arbitration awards issued in arbitration proceedings in securities industry arbitration forums.

V. Conclusion

For the foregoing reasons, the Commission finds that the proposed rule change is consistent with the requirements of the Act and rules and regulations thereunder.

It is therefore ordered, pursuant to Section 19(b)(2) of the Act,^[20] that the proposed rule change (SR-NASD-2002-15) is approved.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[21]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  See Securities and Exchange Act Release No. 45818 (April 24, 2002), 67 FR 21789.

4.  See letter from Barbara Black, Professor, and Jill I. Gross, Visiting Professor, Pace Law School, to Secretary, Commission, dated May 21, 2002 (“Pace Letter”).

5.  See letter from Jean I. Feeney, Chief Counsel and Associate Vice President, NASD Dispute Resolution, to Florence Harmon, Senior Special Counsel, Division of Market Regulation (“Division”), Commission, dated July 3, 2002 (“NASD Letter”).

6.  The NASD Dispute Resolution represents that the proposal will be effective by October 15, 2002. Telephone conversation between Jean I. Feeney, Chief Counsel and Associate Vice President, NASD Dispute Resolution, and Cyndi Nguyen, Attorney, Division, Commission, on July 8, 2002.

7.  The report is entitled “Securities Arbitration: Actions Needed to Address Problems of Unpaid Awards,” Report No. GAO/GGD-00-115 (June 15, 2000) (“GAO Report”). The report is available online at http://www.gao.gov.

8.  If a case is to be a bifurcated and handled under two different procedures, regular and default, each proceeding will be assigned a separate case number to avoid confusion. Proposed NASD Rule 10314(e) provides that the default award will have no effect on any non-defaulting part.

9.  See NASD Letter, supra note 5.

10.  See Pace Letter, supra note 4.

11.  See NASD Letter, supra note 5.

12.  See Pace Letter, supra note 4.

13.  The commenters suggest that, in making the decision, the arbitrator should take into account the reasons given by the respondent for not filing sooner and the hardship to the claimant of being required to go forward with a hearing. See Pace Letter, supra note 4.

14.  NASD Dispute Resolution made reference to Rule 55(c) of the Federal Rules of Civil Procedure that provides that, for good cause shown, the court may set aside an entry of default and, if a judgment by default has been entered, may likewise set it aside in accordance with Rule 60(b). See NASD Letter, supra note 5.

15.  For example, if a single arbitrator or the panel has already been selected, the respondent would have to accept that choice without input into the selection, subject only to a challenge for cause. Additionally, in multi-party cases, if a prehearing conference or hearing session has been held, the late-appearing respondent is subject to previous determinations unless the respondent successfully moves for relief. See NASD Letter, supra note 5.

16.  See Pace Letter, supra note 4.

17.  See NASD Letter, supra note 5.

18.  In approving this proposal, the Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

19.  15 U.S.C. 78 o-3(b)(6).

20.  15 U.S.C. 78s(b)(2).

21.  17 CFR 200.30-3(a)(12).