Litigation: NASD Proposes Modified Arbitration Rules

|||Litigation: NASD Proposes Modified Arbitration Rules

Litigation: NASD Proposes Modified Arbitration Rules

May 2006

This month, the National Association of Securities Dealers (NASD) filed with the Securities and Exchange Commission (SEC) changes to its Code of Arbitration Procedure.  The changes are intended to simplify and reorganize the language/rules.

The proposal makes the following changes:

  1. Divides the current Code into three separate codes: the Customer Code, the Industry Code, and the Mediation Code (Each of these different processes are described below.) The NASD believes that this restructuring of the rules does not substantively alter them, but is intended to make the rules easier to understand.
  2. The NASD would keep a separate roster of chairperson-qualified arbitrators.  In three-person arbitrations, the chairperson would be selected in the same manner and at the same time that the other panel members are selected.  The chair-person list would also be used to select the single arbitrator in smaller matters (less than $50,000 in dispute), unless the parties agree otherwise.
  3. Parties would receive a list of eight names from each of the three rosters (instead of the current ten names for both public arbitrator positions and five names for the non-public arbitrator position).  Parties will be allowed to strike up to four names from each roster, and rank the remaining names (instead of the current unlimited strikes).

Unlike other arbitrations, NASD arbitration awards are publicly available.  This includes past awards rendered by each arbitrator, which can be reviewed by parties when selecting an arbitration panel.  Potential arbitrators also are required to disclose past employment, past or current business, personal or client relationships with any party, and to complete a lengthy disclosure checklist.

A Primer on NASD Arbitrations

The NASD is the world’s leading private-sector provider of financial regulatory services.  Almost every securities firm in the country is a member of this not-for-profit organization.  The NASD registers member firms, establishes rules that govern conduct, examines for compliance, and disciplines those that are not following the rules.

Starting in the mid 1980s, most brokerage firms began incorporating binding arbitration into their agreements.  Now, practically all customer complaints involving NASD members are resolved through binding arbitration operated through the NASD.  Around sixty percent of all claims are resolved through mediation or through direct contact of the parties before arbitration.  Over the past five years, approximately 55 percent of NASD claims that are decided through arbitration resulted in awards to the plaintiff.  Through settlements and awards, approximately three-quarters of investors who bring an arbitration complaint receive some compensation.

Most complaints against NASD members relate to the following:

  1. Unsuitable transactions – The recommendation of or placement into securities that is inappropriate in light of the investor’s age, financial situation, investment objective, and/or investment experience.
  2. Unauthorized transactions – When broker discretionary control has not been granted, the purchase or sale of securities without permission.
  3. Churning – Excessive trading for the purpose of generating commissions.  This most frequently happens when a discretionary account exists in which the broker has complete control over the account.
  4. Misrepresentation – Failing to disclose material facts, such as the risks involved, the fees involved, and company financial information.

In addition to disputes between brokers and their customers (which comprise around 80% of claims), the NASD also conducts arbitrations between:

  1. Broker-dealers – These include trading disputes, employee raiding allegations, and contract breaches.
  2. NASD member firms and their employees – These include the typical disputes that one might expect from the employment relationship, including contract disputes, compensation disagreements, discrimination claims, and wrongful termination.

NASD arbitrations are similar to other arbitrations.  A telephonic pre-hearing conference will address scheduling and discovery issues.  NASD discovery is generally limited, and depositions are rare.  A pre-hearing exchange of exhibits and witnesses will occur.  Because many NASD arbitrators are not lawyers, lawyers need to be clear when presenting legal issues to these non-lawyers.

Fulcrum Inquiry is a Registered Investment Advisory firm.  We assist clients address financial, accounting and damages analysis issues.

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