How Changes To The NASD Code Of Arbitration Procedure May Affect Customer Arbitrations

Wednesday, August 1, 2007 - 01:00

When changes to the NASD Code of Arbitration Procedure were announced in April of this year, applicable to claims filed on or after April 16, 2007, the changes brought with them a goal that the NASD's arbitration process would be fundamentally changed into a more transparent, understandable and efficient process. In order to bring these hopes to fruition, the NASD decided to break the code up into three distinct parts: the Customer Code, the Industry Code and the Mediation Code. Also, the new code implements a number of substantive changes, including changes to the manner in which arbitrators are selected, and codifies many informal arbitration practices already taking place. Now, nearly four months after these changes were adopted, the question remains as to whether the NASD's goals of creating an easier, more user-friendly, Code were achieved.

In this article, we address four major changes involving the Customer Code and one proposed change that has divided the claimants' and respondents' bar. Each of these changes will be analyzed in relation to the old code. We will also comment on the new provisions from a practitioner's point of view.

1. New Procedures For Adding Parties To An Ongoing Arbitration

In order to address concerns resulting from the fact that under the old Code newly added parties were precluded from objecting to their inclusion in an ongoing arbitration and they were unable to participate in the panel selection process, the new Code includes detailed procedures for how parties may now be added to pending arbitrations. Per new Rule 12309, rather than parties being able to freely amend their pleadings any time prior to the panel's appointment, parties may now only add new parties to an arbitration without receiving the panel's approval until the arbitrator selection forms are due to the NASD. Anytime after the forms are due, parties must seek leave from the panel before new parties are added to an ongoing arbitration. Further, if a motion to amend the pleadings is filed, the party to be added may oppose the effort.

Under new Rule 12407, while parties added to an arbitration through the panel approval process delineated in Rule 12309 are still unable to participate in the arbitrator selection process, they, like any other party, are permitted to challenge a panel member for cause under the provisions set forth in new Rule 12410. However, if a party is added to an arbitration before the arbitrator selection forms are due, the newly added party must, like any other party, be given an opportunity to rank and strike the proposed arbitrators.

The problem with the old Code procedures applicable to subsequently added parties was their exclusion from the arbitrator selection process. The new Code only rectifies this issue for promptly added respondents. Those added at later points, where delay is engendered either for strategic reasons or as a result of discovery efforts, will continue to be limited to challenges for cause. Later added respondents will continue to be foreclosed from the rights and privileges of participating in the selection of those persons who will decide their fate.

2. Changes To The Arbitrator Selection Process

Arguably, the biggest change in the new Code pertains to the arbitration panel selection process (Rules 12400-12406). Under the Neutral List Selection System ("NLSS"), the NASD now maintains separate rosters of non-public and public arbitrators, as well as a new roster of public arbitrators eligible to serve as panel chairpersons. In arbitrations heard by a single arbitrator, the arbitrator will now be selected from the public arbitrator chairperson roster. For arbitrations heard by a three-person panel, panels are now selected by choosing one individual from each of the three separate rosters (Rule 12402).

With respect to the new procedures for striking and ranking arbitrators, the NLSS now generates lists of eight arbitrators from each of the three arbitrator categories ( i.e. public arbitrators, non-public arbitrators, and public arbitrators who are eligible to be chairpersons). In order to minimize instances where the parties strike all of the proposed arbitrators from the generated lists, the parties may now only strike up to four arbitrators from each list and must rank the remaining arbitrators (Rule 12404).

The new Code's arbitrator striking and ranking procedures represents an important departure from the previous Code's selection procedure. First, by separating out a unique category of chairpersons, it makes it more likely that a qualified chairperson will survive the striking process. Second, it makes it less likely that a surprise panelist will be appointed. Under the old Code, parties could strike any or all of the proposed arbitrators and risk the appointment of a panel partially or wholly selected by the NASD; this is no longer permitted. Parties must now rank at least four of the proposed arbitrators from each of the provided lists. However, it is still conceivable, though less likely, that combining the various party strikes will result in all candidates in a category being striken, in which case NASD will appoint a person not previously identified or subject to preemptory challenges of the parties. As arbitrators eligible for selection may and do include self-acknowledged advocates for claimants and respondents (ie., attorneys and expert witnesses), the possibility that one of these persons may be selected without the right to challenge, other than for cause, remains a shortcoming of the arbitrator selection process. (Rule 12406).

3. Adoption Of The Discovery Guide

Prior to the implementation of the new Code, the parties to a customer arbitration conducted discovery by following the provisions of the Discovery Guide, a guide which provides a framework for the mutual exchange of documents deemed relevant by the NASD, adopts a procedure for the limited use of "Requests for Information," and specifically discourages depositions in customer arbitrations. Now, under the new Code, the procedures outlined in the Discovery Guide are no longer guidelines; they are now codified obligations that the parties in an arbitration must follow (Rules 12505-12510).

The codification of the Discovery Guide advances the positive aspects of early disclosure of presumptively relevant information. Interestingly, the new Code delays the exchange from the old 30 day rule to a new 60 day rule. This extended time period, also applicable to other discovery requests, may serve to prolong the discovery phase of NASD arbitrations. One additional concern resulting from the codification of the Discovery Guide is that the "presumption of relevance" attributed to mandatory production lists may be extremely difficult to overcome and may lead to the forced disclosure of questionable, burdensome material.

4. The Panel's Power To Award Sanctions

As part of the new Code's "get tough" policy, the NASD specifically provides the Panel with authority to sanction, by specifying numerous sanctions available to enforce Code violations, Panel Orders and discovery obligations. (Rules 12212 and 12511). Under the new Code, arbitrators may issue sanctions by awarding, among other things, monetary penalties, evidentiary sanctions, adverse inferences, attorneys' fees, costs and expenses. Further, in situations of material and intentional failures, a panel may dismiss a claim, defense or proceeding with prejudice (Rule 12212).

These sanctions, which under the old Code were not expressly addressed, now give the Panel teeth to enforce the Code's terms. Previously, except in extreme circumstances, Panels were reluctant to issue sanctions. The power to sanction likely is to be felt most in the discovery phase of the proceeding, to rectify situations at times seen in the past where compliance with arbitrator directives often was delayed or ignored. It remains to be seen how arbitrators will use this express power, particularly in situations regarding objections to "presumptively relevant" production lists or other Discovery Guide features now codified in the new Code.

5. Motions Practice

In contrast to the old Code, which was silent as to motions practice, Rule 12503 of the new Code provides a general mechanism for the filing of motions. Specifically, under Rule 12503(a), motions may be made orally or in written form, must include a description of the efforts taken to resolve the issue(s) of the motion, and if written are to be served at least 20 days before a hearing. The opposing party has 10 days to respond (Rule 12503(b)). The Panel Chairperson may hear discovery motions, individually, while all other matters are to be heard by the full Panel.

Dispositive motion practice is a bit uncertain at this point. Although the filing of dispositive motions has become commonplace in NASD proceedings, the Code in both its old and new forms does not expressly provide for such filings. The new Code anticipates such a rule by reserving Rule 12504 for it. However, much controversy has arisen regarding the content of the anticipated rule, leading to its delay and continued consideration. In the summer of 2006, NASD (re-)submitted a proposed rule. While the proposed rule (Rule 12504) acknowledges the practice, it provides that such dispositive motions are "discouraged and may only be granted in extraordinary circumstances." Proposed Rule 12504(a). The controversy surrounding this proposed rule revolves around whether or not to specify what would qualify as an "extraordinary" circumstance to warrant a dispositive motion. Claimants' bar is concerned that such specification invites dispositive motions; respondents' bar decries how limited the universe is for the specified circumstances. Unable to resolve the disagreement, the currently proposed rule remains silent as to what constitutes an extraordinary circumstance.

A dispositive motion rule will be adopted, but it is anticipated that it will be limited. Such a result will be unfortunate, because it will misunderstand the fact that dispositive motion practice, with briefing and oral argument, affords substantive due process to all parties, and it is to the advantage of all parties to have early resolution of challenges to a claim, thereby avoiding unnecessary time and expense in lengthy litigation over resolvable issues. In the interim, generic motion Rule 12503 applies to all motions, including dispositive motions.

The rewrite of the NASD customer arbitration rules is a welcome clarification and amplification of existing procedure and practice. Only time will tell whether the new provisions accomplish the goals of transparency, understandability, and efficiency. Hopefully, practice under the new Code will enhance the fact and perception of fairness to all who participate in NASD arbitrations.

Paul A. Fischer is Chair of the Securities Industry group of Jorden Burt. He regularly defends insurance companies and broker-dealers in individual and class action lawsuits and arbitration proceedings challenging the market conduct and sales practices of these members of the financial services industry. Robin M. Sanders is an Associate and specializes in complex litigation, including class action and ERISA defense. Both Mr. Fischer and Ms. Sanders work in the Washington, DC office of Jorden Burt LLP.

Please email the authors at paf@jordenusa.com or rms@jordenusa.com with questions about this article.