September 1, 2002
By Ann Therese Palmer
Registered Rep.
Nancy Zanolini, 57, a semi-retired art gallery manager in suburban Sacramento, Calif., had been eagerly awaiting July 2002 for months. That’s when arbitrators were to have been appointed to resolve her claim of $200,000-plus in losses due to alleged misconduct by her Boston-based broker, Cantella & Co.
But Zanolini’s eagerness recently turned to frustration when she learned her arbitration panel – and an estimated 2,000 others in California – would be delayed indefinitely while the NASD and NYSE challenge the state’s toughened disclosure rules for arbitrators that took effect July 1.
The NASD and NYSE claim federal law prevents them from complying with the new standard. They’ve filed suit in California against the California Judicial Council, which implemented the new rules, creating a stalemate that throws investors, lawyers and nervous brokers into a holding pen.
“This is a serious issue,” says Constantine Katsoris, a law professor at Fordham University and one of three of the original public members of the Securities Industry Conference on Arbitration (SICA). SICA was conceived “with the SEC’s blessing…to create a uniform set of rules for all exchanges so that we could have a national securities market,” says Katsoris. “You can’t have different people getting different relief depending on which state they’re in.”
Until the case (the trial starts this month) is decided, the battle will continue to cause significant problems for California’s securities industry, and it’s even beginning to have repercussions nationwide. The revamped disclosure rules could lead to similar rules in other states.
Two California senators suggest that if the NASD and NYSE are concerned about maintaining uniformity in all 50 states, they should “adopt the California rules for the entire system.” John Burton, president pro tempore of the California Senate, and Martha Escutia, chairman of the state senate’s judiciary committee, made the suggestion in a “formal complaint” sent to SEC Chairman Harvey Pitt in mid-August. They asked Pitt to “force” the regulators to respect California law.
Meanwhile, on its Web site, the NYSE advises parties to relocate their arbitrations to neighboring venues, such as Nevada or Arizona, or appoint a local mediator to handle preliminary issues. There’s no data on how many parties are choosing this option. It’s not even clear if that’s legal, says Scot Bernstein, Zanolini’s Sacramento-based attorney.
The conflict started two years ago when California’s House and Senate passed bills by wide margins instructing its judicial council to force arbitrators to disclose more information about their family members and possible conflicts of interest. “Motivation for the legislation was to enact ethics standards for all neutral arbitrators in private arbitrations,” says Eugene Wong, chief counsel to the California Senate Judiciary Committee, which directed the judicial council to make the changes.
“They were responding to newspaper reports on alleged arbitrator bias in mandatory arbitration cases involving consumer complaints,” he says. These include arbitrations with HMOs and credit card companies, as well as broker/dealers.
Cliff Palefsky, a San Francisco attorney, claims he has “fielded written complaints, phone calls and briefs asking for help in this area for at least five years.” However, he declined to make them or the complainants available to Registered Rep. California’s department of corporations, the state’s securities regulator, doesn’t break out arbitration complaints from other securities complaints.
Disclosure: More or Less In a lawsuit filed July 22 in U.S. District Court in San Francisco against the California Judicial Council, the NASD and NYSE allege the changes are unconstitutional since only the SEC can regulate securities arbitrations. SEC market regulation division head Annette Nazareth agreed in a letter, dated July 1, to California’s legislative leadership.
But California officials want more disclosure, and say they have the legal authority to do it. “The standards require arbitrators to follow similar ethics standards that judges must follow,” says Wong. “The disclosure portion of the standards requires additional disclosures about professional, extended family and social relationships that might affect impartiality.”
However, some attorneys believe firms will exploit stricter disclosure rules and use them to their own advantage anyway, compounding the problem. The new requirements mandate disclosure about activities since Jan. 1, 2002. This includes disclosures where the arbitrator or a member of his immediate family worked as an employee, consultant or expert witness within two years of the arbitration for one of the parties, says Wong. He must also disclose whether his extended family has a current, close relationship with one of the parties or is an officer, director or trustee of a party.
“The person with the most money, usually the brokerage, may have an advantage,” says Bernstein. “He’ll have the money to attack every detail of the arbitrator’s life and argue that it’s material. That may get more awards vacated. An elderly investor may die before seeing any money that’s been justly won due to post-hearing motions.”
Officials at the NYSE and American Arbitration Association, or AAA, which also handles arbitration cases, dispute claims of bias.
“Of 100 arbitrations we annually have in California, we have yet to have one of our decisions vacated,” says Robert Clemente, NYSE arbitration director. Adds India Johnson, AAA senior vice president, “This is a solution in search of a problem.” AAA doesn’t see “many awards nationwide overturned for bias,” she says. NASD declined comment, citing the pending litigation.
“People are upset over their losses, but arbitrator bias isn’t necessarily to blame,” says Lawrence Klayman, a Boca Raton, Fla., securities lawyer with an extensive California practice. “Their claims may not be legitimate.” In one week last month, Klayman rejected three claims for this reason.
Making Arbitration Go Away NYSE’s Johnson and Clemente characterize the dispute as the latest in a long-running battle, launched several years ago, by plaintiffs’ attorneys.
“There’s a small group of trial lawyers stirring up this issue nationwide wherever they can to make arbitration so expensive and encumbered with so much complexity that it goes away,” says Johnson. “They tried to get rid of mandatory predispute arbitration clauses in consumer and employment cases in the U.S. Supreme Court and failed. Now, providers and neutrals are in their crosshairs.”
Johnson and Clemente fear other states could follow California.
“If I was a suspicious person, I’d say these changes were designed to impede arbitration,” says Clemente. “Currently, at least six bills are pending in California’s legislature to bar predispute arbitration and three more are pending in Congress. One federal bill happened to be introduced on the same day the Consumers Union announced its arbitration survey.”
Not everyone agrees with the NYSE and NASD.
“The new disclosure standards will make the process better,” says Santa Monica-based David Markun, partner at Liner, Yankelevitz, Sunshine and Regenstreif. “I’ve had dozens of cases where arbitrators haven’t disclosed important prior relationships. Oftentimes, it takes my own investigations to ferret out that information.”
“Along with federalism, there’s the concept of state’s rights,” says Wong, replying to NYSE and NASD’s allegations that federal law prevents them from compliance. “States can enact legislation to protect their residents. California enacted this law to protect consumers who use arbitrations.”
These standards require such enormous disclosure, warns Johnson, that if any standard isn’t complied with, an entire arbitration award could be overturned. “They’re creating new ways to get awards overturned,” she says.
Creating More Logjams Some attorneys, such as Markun, who has 20 pending arbitrations, are concerned customers of their broker/dealer clients will sue them in court claiming arbitration provisions are unenforceable because they’re impossible to perform.
“I don’t know what’s motivating the NYSE and NASD,” says Markun. “Its members clearly want arbitration instead of court litigation. Their actions may undermine the process.”
Meanwhile, a significant increase in arbitrations “has slowed down the whole process,” says Markun. “I don’t know if NASD needs more arbitrators, staff or money, but delays are common. I used to have arbitrations heard within nine months of the filing date. Now, it frequently takes over a year and, in some instances, close to two years, which is outrageous.”
Zanolini, the Sacramento art gallery manager, would be content if only her arbitration is heard promptly.
“I don’t have a good feeling about investing, trusting brokers or other investment people because of this,” she says. “I feel as if I’m out there alone.”
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