The SEC has sent back to the NASD a controversial proposal that would cap punitive damages investors could win in NASDR arbitrations.
An SEC spokesperson says sending proposals back to SROs with comment letters the agency has received is part of the normal rule-making process, but several industry attorneys who are closely involved with the issue say the SEC has major problems with the proposal and might kill it altogether.
"The SEC has big problems with public statements [the NASDR] has made about investors having in arbitration all the rights they would have in court," says one plaintiffs' attorney who has been involved in the debate. If damages were capped, that statement would no longer be true, he says.
The SEC spokesperson won't comment on the punitive damage cap idea, saying only that the NASDR is free to resubmit the proposal.
The controversial proposal introduced by the NASDR last year would supersede existing laws in all 50 states, most of which allow for more liberal punitive damage awards in court proceedings.
The proposal would have restricted punitive damages in NASDR arbitrations to the lesser of two times compensatory damages or $750,000, a cap more austere than the majority of states.
The rule did not apply to disputes involving member firms and employees, but the NASD has said it will soon seek a similar restrictive cap for intra-industry arbitrations (see "Punitive Damage Cap for Broker Claims Floated").
Plaintiffs' attorneys and some members of the arbitration rule-making body, the Securities Industry Conference on Arbitration (SICA), vehemently oppose the investor cap because it would supersede current state laws. Because all firms require arbitration of investor claims, they say, substantive rights such as punitive damages should not be taken away.
The industry, however, has raised due process concerns regarding punitive damages because arbitration awards are not appealable. Firms also claim that even if capped, an adverse punitive damage award can put a small brokerage out of business.
The Securities Industry Association (SIA), lobbying on behalf of member firms, had originally recommended a cap of $250,000 or one times compensatory damages, whichever was less. It argued that $750,000 is more than the total net capital of half of the member firms of the SIA.
In its filing, the NASD rejected the lesser amount, but nevertheless echoed the SIA's concerns: "[T]he $750,000 amount is larger than the net capital requirement of many NASD member firms. The $750,000 amount is also larger than the annual revenue of most member firms."
The NASD has no specific rule with regard to punitive damages, nor does any other SRO. However, the NASDR arbitrators' manual says arbitrators can consider punitive damages as a remedy.
Several high-profile court cases, including the 1995 Supreme Court case Mastrobuono v. Shearson Lehman Hutton, have determined that punitive damages are allowable in arbitration, in the absence of a specific agreement or rule banning or restricting them. Several state legislatures have adopted their own punitive damage caps for court proceedings. Less than a handful of states disallow punitive damages altogether.
As part of its rule filing, the NASD stipulated that investors who are citizens of states that do not allow punitive damages may not ask for them in arbitration.
Despite the controversy, some wonder whether the issue is overblown. The NASD stated in its filing that about half of all arbitration claims include a claim for punitive damages, but that punitive damages are actually awarded in only about 1% of cases.
