[Federal Register: December 3, 2004 (Volume 69, Number 232)]
[Notices]
[Page 70293-70296]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr03de04-92]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-50713; File No. SR-NASD-98-74]
Self-Regulatory Organizations; Order Granting Approval to
Proposed Rule Change as Amended and Notice of Filing and Order Granting
Accelerated Approval to Amendment No. 5 by the National Association of
Securities Dealers, Inc., Regarding NASD Rule 3110(f) Governing
Predispute Arbitration Agreements With Customers
November 22, 2004.
I. Introduction
On October 6, 1998, the National Association of Securities Dealers
(``NASD'') filed with the Securities and Exchange Commission
(``Commission'' or ``SEC'') a proposed rule change pursuant to section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule
19b-4 thereunder to amend NASD Rule 3110(f) governing predispute
arbitration agreements.\2\ Notice of the proposal, as amended by
Amendment Nos. 1 and 2, was published in the Federal Register on
November 29, 1999.\3\ The Commission received two comment letters on
the proposed rule change.\4\ On April 30, 2002, NASD submitted a
Response to Comments and Amendment No. 3 to the proposed rule change.
On August 22, 2003, NASD filed Amendment No. 4 to the proposal, which
replaced in its entirety the prior filings and amendments, except for
the Response to Comments contained in Amendment No. 3. Notice of the
proposal, as amended by Amendment Nos. 3 and 4, was published in the
Federal Register on September 12, 2003.\5\ The Commission received 24
comment letters on Amendment Nos. 3 and 4.\6\ On January 9, 2004, NASD
submitted a Response to Comments and Amendment No. 5 to the proposed
rule change.\7\ This order approves the proposed rule change, grants
accelerated approval to Amendment No. 5, and solicits comments from
interested persons on Amendment No. 5.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Release No. 34-42160 (November 19, 1999), 64 FR 66681
(November 29, 1999).
\4\ See letters from Barry D. Estell, dated December 15, 1999
(``Estell Letter''), and John J. Miller, dated December 27, 1999
(``Miller Letter'').
\5\ See Release No. 34-48444 (September 4, 2003), 68 FR 53762
(September 12, 2003).
\6\ See letters from Al Van Kampen, Rohde & Van Kampen, dated
October 11, 2003; Barbara Black and Jill I. Gross, Pace Investor
Rights Project, Pace University School of Law, dated October 2, 2003
(``Pace Letter''); Carl J. Carlson, Carlson & Fabish, P.S., dated
October 5, 2003; Daniel A. Ball, Selzer, Gurvitch, Rabin, Obecny,
dated October 3, 2003; Don K. Leufven, dated October 9, 2003; Donald
G. McGrath, McGrath & Polvino, PLLC, dated October 3, 2003; H.
Douglas Powell, Fishkind & Associates, Inc., dated October 6, 2003;
Herb Pounds, Herbert E. Pounds, Jr., P.C., dated October 6, 2003; J.
Pat Sadler, Public Investors' Arbitration Bar Association, dated
October 2, 2003; Jeffrey A. Feldman, Esquire, dated October 6, 2003;
John Miller, Law Office of John L. Miller, P.C., dated October 5,
2003; Jorge A. Lopez, Esquire, Jorge A. Lopez, P.A., dated October
5, 2003; Kari S. Turigliatto, Mutual Service Corporation, dated
October 8, 2003; Kenneth A. Martyn, Attorney at Law, dated October
8, 2003; Laurence S. Schultz, Driggers, Schultz & Herbst, P.C.,
dated October 3, 2003; Lenny Steiner, dated October 4, 2003;
Madelaine Eppenstein and Theodore G. Eppenstein, Eppenstein and
Eppenstein, dated October 3, 2003; Ralph A. Lambiase, North American
Securities Administrators Association, Inc., dated October 3, 2003;
Richard M. Layne, Layne & Lewis LLP, dated October 2, 2003; Robert
S. Banks, Jr., Banks Law Office, P.C., dated October 3, 2003;
Rosemary J. Shockman, Shockman Law Office, P.C., dated October 2,
2003; Scott C. Iigenfritz, Johnson, Pope, Bokor, Ruppel & Burns,
P.A., dated October 16, 2003; Steve Buchwalter, Law Offices of Steve
A. Buchwalter, P.C., dated October 3, 2003; and Tracy Pride
Stoneman, Tracy Pride Stoneman, P.C., dated October 3, 2003.
\7\ See letter from Kosha Dalal, Assistant General Counsel,
NASD, to Katherine A. England, Assistant Director, Division of
Market Regulation, SEC, dated January 9, 2004 (``Amendment No. 5'').
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II. Description of the Proposal
A. Background
1. Purpose and General Description of Proposal
The proposed rule change is intended to increase the disclosure
required in predispute arbitration agreements. Many broker-dealers
require that customers seeking to open accounts, particularly margin
and option accounts or accounts with a checking or money market
feature, agree in writing to arbitrate disputes concerning the account,
typically in an SRO-sponsored forum. These agreements, called
``predispute arbitration agreements,'' are generally part of the non-
negotiated customer agreement drafted by the firm.
To ensure that customers are advised about what they are agreeing
to when they sign predispute arbitration agreements, NASD Rule 3110(f)
requires that such agreements contain highlighted disclosure about
differences between arbitration and litigation, including notice that
by agreeing to arbitrate their disputes, customers may be waiving
certain rights that would be available in court. NASD Rule 3110(f) also
requires that the agreement itself be highlighted, and that a copy of
the agreement be given to the customer and acknowledged by the customer
in writing.
Despite these precautions, investor representatives have expressed
concern that many customers who sign predispute arbitration agreements
still do not understand adequately what they are agreeing to.
Customers' perceptions of unfairness are heightened by the fact that,
in order to open an account, they are forced to agree to SRO-sponsored
arbitration.
Consequently, the Arbitration Task Force, chaired by David Ruder
(formerly Chairman of the SEC and a former NASD Board member),
recommended in its 1996 report, Securities Arbitration Reform: Report
of the Arbitration Policy Task Force to the Board of Governors,
National Association of Securities Dealers, Inc. (``Ruder Task Force
Report''), that members be required to provide more disclosure about
arbitration to customers who sign predispute arbitration agreements,
and that the use of certain provisions that limit rights and remedies
be restricted.
Thus, NASD proposes to amend NASD Rule 3110(f) regarding predispute
arbitration agreements (i) to require additional disclosure in
predispute arbitration agreements about the arbitration process,
including possible limits on eligibility of claims; (ii) to require
member firms to provide certain information regarding arbitration and
predispute arbitration agreements to customers upon request; (iii) to
provide explicitly that the rules of the arbitration forum in which the
claim is filed are incorporated into the predispute arbitration
agreement; and (iv) to require members seeking to compel arbitration of
claims initiated in court to arbitrate all of the claims contained in
the complaint if the customer so requests.
2. General Comments on the Proposed Rule Change
In 1999, the Commission received two comment letters on the
proposal, as amended by Amendment Nos. 1 and 2.\8\ In 2003, the
Commission received 24 comment letters on the proposal, as amended by
Amendment Nos. 3 and 4.\9\ Several commenters applauded the proposed
rule change as an effort to help investors understand the consequences
of signing predispute arbitration agreements. The majority of
commenters, however, opposed Proposed Rule 3110(f)(4)(B), relating to
[[Page 70294]]
the use of choice-of-law provisions. In response to these comments,
NASD is amending the proposed rule change to withdraw Proposed Rule
3110(f)(4)(B), for the reasons explained below in Section II.
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\8\ See Estell Letter and Miller Letter, supra note 4.
\9\ See supra note 6.
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F. Restrictions on Provisions That Limit Rights and Remedies
Finally, one commenter criticized the proposed rule change for not
permitting customers to opt out of predispute arbitration agreements in
cases involving securities fraud, and for failing to eliminate the
requirement that one non-public arbitrator serve on three-arbitrator
panels, as required by NASD Rule 10308.\10\ NASD responded that these
concerns, while noted, are outside the scope of the proposed rule
filing.
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\10\ See letter from Madelaine Eppenstein and Theodore G.
Eppenstein, Eppenstein and Eppenstein, dated October 3, 2003.
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B. Required Disclosure and Notice of Possible Restrictions on
Eligibility
Currently, disclosure language about the differences between
litigation and arbitration must be included in predispute arbitration
agreements.\11\ NASD proposes to clarify existing disclosures and to
require new disclosure that (i) the rules of some arbitration forums
may impose time limits for bringing claims in arbitration; and (ii) in
some cases, claims that are ineligible for arbitration may be brought
in court.\12\
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\11\ See NASD Rule 3110(f)(1).
\12\ See Proposed Rule 3110(f)(1)(F). In a companion rule filing
approved by the Commission today, NASD is amending its rule
pertaining to time limits for bringing claims in arbitration (NASD
Rule 10304), to provide explicitly that arbitrators, rather than the
courts, determine the eligibility of claims, and that a party
requesting dismissal of a claim on eligibility grounds in an NASD
forum agrees that the party that filed the dismissed claim may
withdraw all related claims without prejudice and may pursue all of
the claims in court. See Release No. 34-50714 (November 22, 2004)
(order approving amendments to Rule 10304).
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Under the proposal, members would be required to add the new
disclosure requirements to all new customer account agreements
containing predispute arbitration agreements as of the effective date
of the rule. Accordingly, the proposed rule would not require members
to replace existing agreements with current customers.\13\
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\13\ See Proposed Rule 3110(f)(7).
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C. Incorporation of Arbitration Forum Rules
The proposal provides that the rules of the arbitration forum in
which a claim is brought, and any amendments thereto, are incorporated
into the parties' agreement and are enforceable, as are other
provisions of the arbitration contract.\14\ This provision should
ensure that the rules of a forum apply to cases brought in that forum
and eliminate the need to execute new agreements each time a forum
changes its rules. Accordingly, if a customer files a complaint in an
NASD arbitration forum, NASD's arbitration rules would apply in all
respects to the agreement.
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\14\ See Proposed Rule 3110(f)(1)(G).
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D. Acknowledgement of Predispute Arbitration Clause
NASD Rule 3110(f) currently requires that (i) predispute
arbitration agreements contain a highlighted statement indicating that
the agreement contains an arbitration clause and specifying at what
page and paragraph the arbitration clause is located; and (ii) a copy
of the predispute arbitration agreement be provided to the customer,
who must acknowledge receipt of the agreement in writing, either on the
agreement itself or on a separate document. Proposed Rule 3110(f)(2)(B)
would amend the current rule to require that delivery and customer
acknowledgement of the agreement take place at the time of signing.
E. Requirement That Members Provide Copies of Customer Agreements and
Information Regarding Arbitration Forums to Customers Upon Request:
Proposal and Comments Received
Proposed Rule 3110(f)(3)(A) would require members, within ten days
of receiving a customer request, either to provide the customer with a
copy of any predispute arbitration agreement clause or agreement that
the customer had signed, or inform the customer that the member does
not have a copy of the agreement.\15\ In addition, the proposal would
require that, upon request of a customer, a member must provide the
customer with the names of, and information on how to contact or obtain
the rules of, all arbitration forums in which a claim may be filed
under the agreement.\16\
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\15\ See Proposed Rule 3110(f)(3)(A).
\16\ See Proposed Rule 3110(f)(3)(B).
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One commenter interpreted the phrase ``or inform the customer that
the member does not have a copy thereof'' in Proposed Rule (f)(3)(A) to
refer to a situation in which there is no predispute arbitration
agreement between the customer and firm.\17\ NASD stated that, in fact,
Proposed Rule 3110(f)(3)(A) is intended to address a situation in which
a customer agreement or predispute arbitration agreement has been
executed, but the firm is for some reason unwilling or unable to
produce a copy to the customer. Current Rule 3110(f)(3) requires that
copies of any predispute arbitration agreement be given to the
customer, who must acknowledge receipt thereof. NASD has become aware,
however, that members generally provide copies of such agreements at
the time the agreement is signed, but sometimes refuse or are unable to
do so after a dispute has arisen. Thus, Proposed Rule 3110(f)(A)(3)
requires members to produce customer account or predispute arbitration
agreements upon the request of the customer. NASD expects that members
will retain such agreements, as required by NASD rules. However, if for
some reason, whether through an act of nature, human error, or
otherwise, a member is unable to comply with the customer's request,
NASD proposes to require members to inform the customer of that fact,
rather than simply failing to respond to the customer's request.
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\17\ See Pace Letter supra note 6.
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F. Restrictions on Provisions That Limit Rights and Remedies
Proposed Rule 3110(f)(4)(A) clarifies the prohibition against
provisions in predispute arbitration agreements that limit rights or
remedies, including provisions that would circumvent NASD's eligibility
rule proposal, as amended.\18\ In particular, the proposal would
provide that predispute arbitration agreements may not include any
condition that would: (i) Limit or contradict the rules of any self-
regulatory organization (``SRO''); (ii) limit the ability of a party to
file any claim in arbitration; (iii) limit the ability of a party to
file any claim in court permitted to be filed in court under the rules
of the forums in which a claim may be filed under the agreement; or
(iv) limit the ability of arbitrators to make any award.\19\
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\18\ See supra note 12.
\19\ See Proposed Rule 3110(f)(4)(A).
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NASD initially proposed to amend Rule 3110(f)(4) to include
paragraph (f)(4)(B), which would state that no choice-of-law provision
would be enforceable unless there is a significant contact or
relationship between the law selected and either the transaction at
issue or one or more of the parties. NASD had proposed paragraph
(f)(4)(B) in response to the recommendation of the Ruder Task Force
Report and with the purpose of protecting investors from the use of
arbitrary choice of law provisions. This would make explicit NASD's
interpretation of current Rule 3110(f)(4) to require that, when
predispute arbitration agreements between members and customers
[[Page 70295]]
include a choice-of-law provision, there must be ``an appropriate
contact or relationship between the transaction at issue or the parties
and the law selected.'' \20\ As explained more fully below, however,
NASD has withdrawn proposed paragraph (f)(4)(B) in response to
comments, but continues to caution its members against overreaching in
choice of law provisions.
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\20\ NASD Notice to Members 95-85 (October 16, 1995); see also
NASD Notice to Members 95-16.
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Although one commenter generally supported proposed paragraph
3110(f)(4)(B),\21\ the overwhelming majority of commenters opposed it
as potentially harmful to investors. A majority of the commenters
argued that, because relevant case law regarding choice-of-law
provisions in predispute arbitration agreements has evolved
considerably in the five years since the proposed rule change was
filed, proposed paragraph (f)(4)(B) could be interpreted to endorse
choice-of-law clauses that may not be enforceable under applicable
state law. Two commenters suggested that members might use paragraph
(f)(4)(B) to legitimize choice-of-law clauses that would override the
protection of customers' home state blue sky laws.\22\ Given the strong
opposition of most commenters and the fact that such adverse
consequences were not intended by NASD, NASD is withdrawing proposed
paragraph (f)(4)(B). However, by doing so, NASD is not implying that
members may include arbitrary choice-of-law provisions in predispute
arbitration agreements with customers. As it has in the past, NASD will
continue to interpret NASD Rule 3110(f) to require that, if a choice-
of-law provision is used, there must be an adequate nexus between the
law chosen and the transaction or parties at issue in accordance with
NASD Notices to Members 95-85 and 95-16.\23\
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\21\ See Pace Letter, supra note 6.
\22\ See Estell Letter and Miller Letter, supra note 4.
\23\ See supra note 20.
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G. Non-Bifurcation Provision
NASD proposes to require members seeking to compel arbitration of
claims filed in court to agree to arbitrate all of the claims contained
in the complaint if the customer requests, even if some of the claims
would be ineligible for arbitration under the eligibility rule.\24\
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\24\ See Proposed Rule 3110(f)(5).
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In a companion filing, NASD proposes to provide that by requesting
dismissal of a claim on eligibility grounds in the NASD forum, the
requesting party is agreeing that the party that filed the dismissed
claim may withdraw all related claims without prejudice and may pursue
all of the claims in court.\25\ NASD represents that this provision
would protect parties against involuntary bifurcation of claims.\26\
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\25\ See supra note 12.
\26\ Id. [FEDREG][VOL]*[/VOL][NO]*[/NO][DATE]*[/
DATE][NOTICES][NOTICE][PREAMB][AGENCY]*[/AGENCY][SUBJECT]*[/SUBJECT]
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H. Effective Date Provisions
The proposed amendments to NASD Rule 3110(f) would require various
changes to the customer agreements used by NASD member firms. In order
to provide enough time for firms to modify customer agreements, the
proposed rule change would take effect 90 days after NASD publishes a
Notice to Members to announce Commission approval of the proposal.
Moreover, NASD would issue such Notice to Members within 60 days of
publication of the Commission's approval of the proposed rule change in
the Federal Register.
The proposed amendments to NASD Rule 3110(f) would also provide
that agreements signed before the effective date of the rule, as
amended, would be subject to the provisions of NASD Rule 3110(f) in
effect at the time the agreement was signed, except with regard to the
provisions of subparagraph (f)(3) of the proposed rule change.\27\
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\27\ See Proposed Rule 3110(f)(7).
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III. Discussion and Commission Findings
Currently, NASD Rule 3110(f) requires that predispute arbitration
agreements contain highlighted disclosure about differences between
arbitration and litigation, including notice that by agreeing to
arbitrate their disputes, customers may be waiving certain rights that
would be available in court. Further, NASD Rule 3110(f) provides that
its members must highlight the agreement and provide a copy of the
agreement to the customer, which the customer acknowledges in writing.
The Commission notes that despite the disclosure requirements under
the current rule, NASD has determined that there are continuing
concerns about whether customers who become parties to predispute
arbitration agreements adequately understand the terms of the
agreement. NASD has concluded that it is necessary to require its
members to provide more disclosure about arbitration to customers who
sign predispute arbitration agreements, and that the use of certain
provisions that limit rights and remedies should be restricted.\28\
Accordingly, NASD submitted the proposed amendments to NASD Rule
3110(f) to address these concerns.
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\28\ In formulating its proposal, NASD referred to the work of
its Arbitration Policy Task Force, chaired by David Ruder. See supra
text 0, 1. Purpose and General Description of Proposal.
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The Commission believes that the proposal should provide customers
with clearer and enhanced disclosure regarding the terms of predispute
arbitration agreements. The Commission believes that the proposed rule
change incorporates important protections into the text of the
arbitration agreement itself, including the rules of the SRO in which
the arbitration takes place. This will permit better guidance to the
parties, arbitrators, and the courts. Moreover, the proposed
requirement that a member either provide a customer with the predispute
arbitration agreement or inform the customer that the member does not
have a copy within ten days, as well as provide the customer with
information on how to obtain the rules of the arbitration forums in
which a claim may be filed under the agreement, should help to protect
investors and facilitate the dispute resolution process.
The Commission also notes that the proposal provides that if the
member seeks to compel arbitration of claims, the member must agree to
arbitrate all of the claims contained in the complaint if the customer
requests. The Commission believes that the proposed rule change should
benefit investors by preventing customers from being forced to
bifurcate their claims. The proposed rule change, together with Rule
10304, as amended, addresses the concern that parties would be forced
to litigate in two forums; limits the potential litigation strategies
that could escalate the costs of and thereby impede dispute resolution;
and eliminates the particular litigation strategy, never contemplated
under NASD rules, of so-called ``election of remedies,'' which
foreclosed some investors' access to justice altogether. ?>
Finally, the Commission notes the concerns raised by commenters
regarding the proposed choice-of-law provision.\29\ The Commission,
believes that NASD's response in withdrawing paragraph 3110(f)(4)(B) is
consistent with the Act, and that that Proposed Rule 3110(f)(4)(A)
achieves an appropriate balance between the interests of investors and
the ability of parties to agree contractually to fair terms that would
govern their
[[Page 70296]]
disputes,\30\ especially as explained in NASD Notice to Members 95-
85.\31\
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\29\ See supra text 0, Restrictions on Provisions that Limit
Rights and Remedies.
\30\ The Supreme Court ruled in 1995 that the choice of law
provision in the customer agreement before the Court did not have
the effect of barring arbitrators from barring punitive damages.
Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995).
Rule 3110(f)(4) explicitly forbids broker-dealers from using any
term of an agreement to limit such relief.
\31\ See supra note 20.
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The Commission notes that NASD will publish a Notice to Members
within 60 days of receiving Commission approval of the proposed rule
change. The effective date of the proposed rule change will be 90 days
after the publication of the Notice to Members.
After careful review, the Commission finds that the proposal is
consistent with the requirements of Section 15A of the Act \32\ and the
rules and regulations thereunder that govern NASD.\33\ In particular,
the Commission finds that the proposal is consistent with Section
15A(b)(6) of the Act \34\ which requires, among other things, that the
rules of an association 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 interest; and are not designed to permit unfair discrimination
among customers, issuers, brokers, or dealers.
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\32\ 15 U.S.C. 78o-3.
\33\ In addition, pursuant to Section 3(f) of the Act, the
Commission has considered the proposed rule's impact on efficiency,
competition, and capital formation. 15 U.S.C. 78c(f).
\34\ 15 U.S.C. 78o-3(b)(6).
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IV. Accelerated Approval of Amendment No. 5
The Commission believes that there is good cause for approving
Amendment No. 5 prior to the 30th day after publication in the Federal
Register. Amendment No. 5 responds to comments by withdrawing Proposed
Rule 3110(f)(4)(B). Accelerated approval of Amendment No. 5 will enable
NASD to announce promptly the final rules, in conjunction with those
being approved today in a companion filing, SR-NASD-2003-101, which
changes would be incorporated by Proposed Rule 3110(f) into any
predispute arbitration agreement governing proceedings held in a NASD
forum. Concurrent approval of Amendment No. 5 and SR-NASD-2003-101 will
lessen member confusion as to the final requirements of both rule
filings, allow their effective dates to be the same, and thereby permit
members to make the necessary changes to comply with them in a timely
fashion.\35\ Based on the above, the Commission finds good cause,
consistent with section 15A(b)(6) and section 19(b)(2) of the Act, for
approving Amendment No. 5 prior to the 30th day after the date of
publication of notice of filing thereof in the Federal Register.
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\35\ The Commission further notes that both rule filings and
amendments thereto have been available since their respective filing
dates on http://www.nasdadr.com.
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V. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning whether proposed Amendment No. 5 is consistent
with the Act. Comments may be submitted by any of the following
methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-NASD-98-74 on the subject line.
Paper Comments
Send paper comments in triplicate to Jonathan G. Katz, Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW., Washington,
DC 20549-0609.
All submissions should refer to File Number SR-NASD-98-74. This
file number should be included on the subject line if e-mail is used.
To help the Commission process and review your comments more
efficiently, please use only one method. The Commission will post all
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
).
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 in the
Commission's Public Reference Section, 450 Fifth Street, NW.,
Washington, DC 20549. Copies of such filing also will be available for
inspection and copying at the principal office of NASD. All comments
received will be posted without change; the Commission does not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly. All
submissions should refer to File Number SR-NASD-98-74 and should be
submitted on or before December 27, 2004.
VI. Conclusion
It is therefore ordered, pursuant to section 19(b)(2) of the
Act,\36\ that the proposed rule change (SR-NASD-98-74), as amended, is
hereby approved, and Amendment No. 5 is approved on an accelerated
basis.
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\36\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\37\
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\37\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E4-3450 Filed 12-2-04; 8:45 am]
BILLING CODE 8010-01-P