New NASD Code of Arbitration for Customer Disputes is Effective

The long-awaited new NASD codes of arbitration became effective April 17, 2007. They are reorganized into three different codes: member-customer disputes, industry disputes and mediation. We will discuss here the code likely to be the most used, i.e. the code for member-customer disputes.

Although the provisions for customer-member disputes were almost totally rewritten in the new rules, there are surprisingly few substantive changes in them. I have, somewhat arbitrarily, broken the more important substantive changes into categories.

Control of the Process. Two of the more important new rules give more control of the arbitration process to the attorneys and parties, and one takes some away, giving it to the Director of Arbitration and the arbitrators.

New Rule 12207 allows the parties by agreement to extend or modify important deadlines, including the deadlines for serving answers, responding to arbitrator selection requirements and motions by opposing parties, and exchanging documents and witness lists in the course of discovery. Under the prior rule, only the Director of Arbitration and/or the arbitrator panel had the authority to extend such deadlines. And new Rule 12601 allows the parties by agreement to require that the hearing be postponed. (If such postponement occurs just prior to the hearing, the parties may be required to pay a significant postponement fee.)

This writer believes that these amendments will benefit claimants (customers) and respondents (broker-dealers and registered representatives) equally, and the process generally, because the parties and their counsel know better what their needs are than do the arbitrators and the Director.

To paraphrase a famous quote, “the SEC and the NASD giveth and the  SEC and NASD taketh away.” New Rule 12512 reduces the control given the parties and their counsel, allowing only arbitrators to issue subpoenas for the production of documents and the appearance of witnesses. Prior to this rule, attorneys for the parties also had the power to issue subpoenas. Undoubtedly this rule change resulted from perceived abuses by attorneys for both sides, though probably most of such abuse was by claimants’ counsel. (An example of such abuse would be subpoenaing executives from the broker-dealer, requiring their attendance, when there is no clear need for their testimony.)

This writer believes that this rule change will hurt customers more than brokers, because claimants have a more frequent need to subpoena otherwise unwilling witnesses. This new rule will also significantly hinder the processing of the cases of both counsel validly needing a subpoena.  More often than not, counsel (for both parties) know which persons to subpoena only relatively shortly prior to the hearing. Under the new rule, subpoenas must be issued sufficiently prior to the hearing

(i) for the subpoena to be forwarded to the NASD and other parties; (ii) for the NASD to process it; and forward it to the arbitrators; (iii) for the arbitrators to set a time to meet about whether to issue the subpoena, and then (iv) to actually meet and decide it and to inform the NASD of heir decision; and (v) for the NASD to then notify the parties of the decision. This could require as much as, say, three or four weeks time, causing a serious hindrance to the party validly seeking the subpoena.

Quality and Effectiveness of the Arbitration Process. A number of the recent amendments are intended to raise the quality and effectiveness of the arbitration system. But they will simultaneously increase the complication and cost of that process.

Perhaps the major such change concerns selection and qualification of the chairpersons of arbitration panels. The chairperson has enormous impact on the hearing. New rule 12400(c) now requires that all chairpersons be attorneys who have served as arbitrators in at least two hearings leading to awards or, if not attorneys, have served as arbitrators through awards in at least three arbitrations.

Theoretically, this new rule allows non-attorneys to become chairpersons after they complete three arbitrations as non-chairpersons. However, because attorneys undoubtedly constitute the most frequent occupation of non-chairperson arbitrators presently, and because to qualify as chair, attorneys need only two, rather than three, completed arbitration hearings, it is clearly most likely that within a short period of time all but a minor proportion of chair-qualified arbitrators will be attorneys.

Not surprisingly, perhaps because I am an attorney, I believe that this amendment will increase the quality of the hearing process, as concerns rulings on the admission of evidence, the order of the hearings, and other process issues. It may also, however, cause technicalities of the court-trial process (e.g., the rules of evidence) to creep back into the arbitration process, notwithstanding it was originally intended that arbitration preclude such technical rules. Clearly this amendment also increases the need for each side to be represented by counsel, and will probably benefit broker-dealers and RRs more than claimants, at least to the extent that it is more frequent for claimants to be unrepresented than brokers and RRs.

Another improvement in the arbitration process is intended, and is likely, from new Rule 12214(c) This new rule provides payment of $200.00 to arbitrators for deciding discovery-related motions without hearing sessions. Prior thereto there was no such payment, which for some arbitrators was likely a significant disincentive to spending sufficient effort on such motions. (Indeed, even the $200.00 honorarium is much less than the average hourly pay for most attorneys, who typically are the deciders of such motions). Again, of course, this will at least slightly increase the cost of the process.

It is arguable that claimants are the more frequent violators of the discovery process, refusing to produce documents, and filing claims which lack sufficient detail, requiring broker-dealer and RR respondents to file more discovery motions. If that is true, it is the brokerage community which will benefit most from this new rule.

Stronger Enforcement of Discovery. And in two other new rules, the NASD seeks to put more “teeth” into the discovery process in arbitration. Prior to these new rules, in its “Discovery Guide” set forth in Notice to Members 99-90, the NASD set forth specific documents, specific types of documents and specific types of information which were expected to be produced to the opposing parties by customers, broker-dealers and RRs, as they prepared their cases for hearing. However, NTM 99-90, was a guide only, and was frequently ignored.

In its new rules 12505-12511, the NASD makes mandatory the discovery procedures set forth in the Discovery Guide. And Rule 12509, specifies that parties may make motions to require other parties to produce documents or information if the non-moving party has failed to comply with the requirements therefor. Further, new Rule 12511 provides serious sanctions when parties fail to respond or frivolously object to producing required documents or information.

It is difficult to speculate whether these changes in discovery rules will benefit customers or broker-dealers more. It can be argued that, because typically broker-dealers have more documents and information, and customers need more documents and information, these tougher requirements of discovery will impact broker-dealers more negatively.

Sanctions for Failure to Comply. New Rule 12212 provides that arbitrators may sanction a party for failure to comply with any provision of the arbitration code or with any order of the Panel. The sanctions allowed are serious: monetary penalties, precluding a party from presenting evidence (probably causing that party to lose), making an adverse inference against the violator, and assessing postponement, forum or attorneys fees against the violator.

The sanctions provided can be very damaging to a violator. It is doubtful to this writer, however, that they will be fully utilized by arbitrators, except for particularly egregious, repetitive violations. It will also be interesting to see whether they will be applied to parties who are not represented by attorneys.

Although it is pure speculation, this writer believes this new rule will, on balance, benefit broker-dealers more than customers.

Authority of Arbitrators to Dismiss Without Hearings. Another new rule clarifies and strengthens the authority of the arbitrators to dismiss a claim or a defense prior to, and without, a hearing on the evidence. New Rule 12700 makes it clear that the arbitrators have the authority to dismiss cases and defenses for egregious refusals to comply with discovery requirements or other orders of the Panel, or for failure of a claimant to file his claim within the six year period of eligibility (which acts as a “statute of limitations”).

This writer believes this rule will benefit broker-dealers significantly more than complaining customers.

Interestingly, the new rules do not address whether the arbitrators may dismiss a customer claim if it fails to state facts sufficient to give the customer a right to some relief (“failure to state a cause of action,” in legalese.). This non-addressing the right will undoubtedly cause claimants to argue that arbitrators may not dismiss such complaints.

CONCLUSION

The new customer dispute arbitration rules will generally improve the logic and organization of the arbitration process, while increasing its cost. This will also benefit those parties whose cases are thoroughly prepared. Because the defenses by broker-dealers are usually more thoroughly prepared-if only because their attorneys are paid by the hour, and customers’ attorneys are more often paid only contingent fees – it is likely the new rules will be of greater benefit to broker-dealers.

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