Alternative Dispute Resolution
Jul. 24, 2002
N.Y. Exchange Challenges State's Rules For Arbitrators
SAN FRANCISCO - Two stock market groups that arbitrate investor disputes filed suit in federal court Monday against the state Judicial Council, claiming the council's new ethical standards for arbitrators are too burdensome and are preempted by federal rules.
The 19-page lawsuit was filed in U.S. District Court by the high-powered firms of Gibson, Dunn & Crutcher and Milbank, Tweed, Hadley & McCloy on behalf of the New York Stock Exchange and the National Association of Securities Dealers. NASD Dispute Resolution Inc. v. Judicial Council, C02-3486 MJJ.
The 15 comprehensive ethics standards adopted in April by the Judicial Council are the first of their kind in the country. Among other things, they require detailed disclosure of financial relationships with parties involved in a dispute.
Most of the rules prohibiting ex parte communications with the parties and forbidding judges from being used as marketing tools took effect July 1.
To allow time for implementation, mediators will not have to comply with the strict disclosure requirements until January.
Earlier this month, the U.S. Securities and Exchange Commission, which has supervisory jurisdiction to ensure fair and ethical business practices, said securities arbitrations should be exempt from the state's new standards.
The two plaintiffs contend the new state rules are so complex that arbitrators won't take the $400 per day jobs, and brokerages will exploit the rules by challenging awards to investors on grounds that arbitrators failed to meet the more stringent state requirements. The NYSE and NASD say they already require arbitrators to disclose any professional, personal or business conflicts of interest.
The suspension of arbitration panels could create a backlog of unresolved cases within a short time. The NYSE said it has more than 100 cases pending in California, and only half have been assigned arbitrators. Already, about 300 NASD disputes have had the appointment of arbitrators postponed, officials said.
"If self-regulatory organizations were required to implement the California rules, investors and other parties would be saddled with higher costs, a less efficient and streamlined process and a much smaller arbitrator roster from which to select the panelists who will decide their cases," the NASD said in a prepared statement.
Brokerages have long preferred using mandatory arbitration to avoid the courts, and the U.S. Supreme Court has upheld that policy. Three arbitrators usually hear the cases - one from the brokerage industry and two from the public.
Martha Escutia, D-Whittier, chairwoman of the Senate Judiciary Committee, which developed the new law, said the strict rules are needed.
"More than ever, investors who have lost most or all of their life savings in the stock market due to broker-dealer misconduct, who are forced to litigate their claims in a private arbitration forum operated by the stock exchange, must have confidence that the persons ruling on their complaint are truly impartial and free from bias and possible conflicts," she said. "The current rules for NYSE and NASD arbitrations do not provide that basic protection."
Suzanne Wierbinski, Escutia's chief of staff, said the two groups were contacted when the rules were being considered.
"They made no effort to contact the Legislature after the rules were distributed to them," she noted. "All they wanted was an exemption - that's not good enough. We said: 'Tell us how [the rules] are too burdensome,' but all they wanted was an exemption."
Responding to a growing chorus of complaints about arbitration, legislators passed a law in September requiring the Judicial Council, which oversees the state court system, to adopt standards for private arbitrators.
Chief Justice Ronald M. George, who is chairman of the council and is a named defendant, said Monday he couldn't comment on the suit. But he noted the tough, new standards were adopted at the Legislature's direction.
The disclosure requirements, the most controversial of the new rules, generated the most complaints from arbitrators who attended hearings on the issue, with many saying it would be difficult to determine financial or other relationships of an arbitrator's distant relatives.
Responding to those concerns, the proposal was modified to require disclosure involving only an arbitrator's immediate family. Also, arbitrators can submit written declarations that they have disclosed all pertinent relationships to the best of their knowledge.
San Diego securities litigator Jim Krause hasn't had problems with NASD arbitrators but said he thinks the new standards are a good idea.
"I applaud the new rules. I have not observed any firsthand bias, but I still think the laws are a reasonable advancement in arbitration and the NASD should comply," he said.
He disagreed with the plaintiffs that federal laws preempt California's ethics requirements.
"It doesn't mean states can't enact stronger rules if they want higher standards; I don't think the federal rule is in opposition to that," Krause said.
He compared the new rules to an onion: "It's like peeling off an additional layer so you get closer to knowing what the core values and biases are of the people."
Krause said he was intending to file a brokerage case with the NASD but will now go to court.
"Since that forum is no longer available, we'll sue in court," he said.
Donna Domino
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