California's arbitration tussle with the NASD and NYSE has gone from bad to worse. Now, SEC Chairman Harvey Pitt has jumped into the fray. In an unprecedented move, he has ordered the self-regulatory organizations to empanel arbitrators to start handling the cases against brokers that have been piling up while the NASD and NYSE fight new California rules about arbitration.
As Registered Rep. reported in last month's issue, the state passed legislation requiring additional disclosures about business and family ties of arbitrators who handle cases in a variety of industries. The NASD and NYSE cried foul and sued the California Judicial Council to stop the new rules, saying that only the SEC has authority to impose rules on securities legislation. That left approximately 600 arbitration cases in limbo.
In a letter dated Sept. 5, 2002, to NYSE Chairman Richard Grasso and NASD Chairman Robert Glauber, Pitt told the self-regulatory organizations — in fairly strong language — that they'd have to appoint arbitrators.
“However inappropriate you may believe the California legislation to be,” Pitt wrote, “there is absolutely no justification for requiring individuals either to go out of state to obtain a hearing they have an absolute right to have or otherwise forgo their rights in arbitration.”
Both agencies, while complying with Pitt's request, are nonetheless going ahead with their lawsuit. An SEC spokesman confirmed that this is the first time in the agency's 68-year history that the SEC chairman had to order arbitrators to be appointed in a particular case.
For their part, the agencies have said that despite complying with Pitt's request, they believe they should be exempted from the California disclosure rules because they are under the umbrella of the SEC's oversight and federal law, which preempts separate state regulation.
The SROs have filed for a declaratory judgment that the new disclosure standards are inapplicable to them, based on the SEC oversight and federal preemption arguments. California argues that its disclosure laws should be used across the country. A hearing on the request for a declaratory judgment was scheduled for Sept. 24 in U.S. District Court, to be heard by Judge Sandra Armstrong. A ruling is expected sometime during October.
But it doesn't end there. No matter which party wins, securities experts predict the loser will file an immediate appeal with the U.S. 9th Circuit Court of Appeals. That federal appellate court, which also sits in San Francisco, has had the most decisions reversed by the U.S. Supreme Court. At best, there are more headaches — at worse, expect migraines.
“Can every state in the union, with political elections on the horizon, come up with all kinds of standards for arbitrations to play to the electorate?” says Constantine Katsoris, a Fordham University professor who was one of the original members of the Securities Industry Conference on Arbitration. “How can the stock exchanges possibly comply? They have enough trouble getting good arbitrators to sit on these cases. They can't have states putting all kinds of impediments in their way.”
Katsoris believes the case could ultimately end up in the U.S. Supreme Court as a result. For now, California legislative officials are satisfied with Pitt's response and claim other industries affected by the ethics standard changes haven't responded in the same way as the SROs.
“The additional disclosures are not as burdensome as the NASD/NYSE is claiming,” says Eugene Wong, chief counsel to the California Senate Judiciary Committee. “The rules have been in effect in California since July 1, and I have not seen one other story from any source saying that other neutral arbitrators are having difficulty complying.”
The SROs, however, argue that the additional disclosures will cause further delay in the already-burdened arbitration system. They also predict that experienced arbitrators could leave the system, rather than subject themselves to the California standards and be replaced by neophytes. That, in turn, could cause further problems in a system brokers are already unhappy with.
Even some experienced arbitrators, brokers say, lack sophisticated knowledge of markets and investing. “Some of these people have no idea whatsoever about our industry. Some don't even know how bonds, stocks and options work,” says a Merrill Lynch rep. “They need to have knowledge of the intricacies of the business, a complete knowledge of what happens on the Street. It's obvious they don't right now.”
Months of legal wrangling are expected, and further delays will occur. “I frankly think [Pitt's letter] is a holding action until the district court case works its way through the courts,” Katsoris says. “It may be six months before we see anything definitive in that case.”
Wong pins the onus on the SROs: “It really comes to this:If they want to comply, they can and will. If they don't want to comply, they won't and will find reasons to justify their refusal.”
