NASD Fines Firms Over Illegal Arbitration Agreements

Last fall, the NASD sanctioned Merrill Lynch, Bear Stearns and Biltmore Securities for using illegal New York choice of law clauses in customer arbitration agreements.The clauses are sometimes buried in the fine print of customer agreements. They state that New York laws will govern in any arbitration proceeding. Innocuous on the surface, the clauses give the firm an opening to argue, per New York

Last fall, the NASD sanctioned Merrill Lynch, Bear Stearns and Biltmore Securities for using illegal New York choice of law clauses in customer arbitration agreements.

The clauses are sometimes buried in the fine print of customer agreements. They state that New York laws will govern in any arbitration proceeding. Innocuous on the surface, the clauses give the firm an opening to argue, per New York law, that punitive damages and attorneys fees cannot be awarded in arbitrations, or that the statute of limitations is more restrictive than under SRO rules.

The sanctioned firms committed the violations between 1994 and 1997, were censured and fined, and ordered to withdraw any New York law arguments from pending cases.

This is something that weve been saying to the NASD for years, says Mark Maddox, president of the Public Investors Arbitration Bar Association (PIABA), a plaintiffs attorneys group. For years, PIABAs complaints fell on deaf ears, he says.

NASDR enforcement chief Barry Goldsmith declines to say where the enforcement leads came from.

The case is unusual in that the NASD investigated specific arbitration cases for enforcement action. Regulators dont routinely look at individual cases unless they receive a referral from the arbitration panel, and even then plaintiffs attorneys complain they see little or no follow-up.

They dont [investigate cases] as much as I would like to see them do it, Maddox says.

But Goldsmith counters, Its not unusual for us to look at various arbitrations, and points to a case last year in which a firm was fined for discovery abuse.

In the New York choice of law cases, the NASD had warned member firms in early 1995 that the clauses were in violation of NASD rules, which prohibit firms from limiting arbitrators ability to make awards.

I think [the firms] got sanctioned for arguing in arbitration cases that the arbitrators could not award punitive damages, Maddox says. This is generally regarded as why the NASD took this action.

The three firms were sanctioned for actually arguing that New York law applied, as well as having the clause in customer agreements. But Goldsmith doesnt rule out taking enforcement action against a firm for simply having the clause in an agreement.

In early 1995, the NASD issued a notice to members warning them to stop using New York choice of law clauses in arbitration agreements. Yet the three firms cited in the NASDs enforcement action continued to use this legal trick.

Merrill Lynch

Violation: From May through November 1995, Merrill Lynch used a New York choice of law defense in 17 arbitration proceedings.

Sanction: Censure and $25,000 fine.

Bear Stearns

Violation: From March 1995 through September 1997, the firm asserted New York law in at least five arbitration proceedings.

Sanction: Censure and $15,000 fine.

Biltmore Securities

Violation: Since 1995, Biltmore used a New York choice of law defense in a number of ... arbitration proceedings, the NASD says in its action.

Sanction: Censure and $20,000 fine.

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